Category Archives: Finance

Amazon and PE

Conventional business indicators such as the price-earnings ratio, the price-to-book ratio, and discounted cash flows belong in the Bronze Age – so say the new economists. But if the old metrics don’t capture the potential of today’s fast-growth companies, some new formulas can.

PERManent Upside, WIRED Staff, February 2000

I think about the above quote a lot these day. At about the absolute peak of the dotcom bubble, there were writers and (supposedly) economists claiming that the foundation of the stock market had changed, and that what appeared to be overvalued tech stocks driven by computer-illiterate investors FOMO-ing into anything with a website were in fact some of the greatest stocks to own since sliced bread. PE, PB, DCF were useless in evaluating these stocks, they stood on their own through a new metric created just for them, PERM. No one knows, cares, or remembers what PERM stood for (you can read the linked article if you really want to), but it was supposed to prove that earnings weren’t important and that high PE stocks were still good deals. I think about this a lot because this is the same argument many have used on me regarding Amazon.

Amazon had a bad 2022, over the year it’s stock price cratered around 50% and it lost 1 trillion dollars in market cap. The old adage that “Amazon’s PE doesn’t matter” has seemed less and less true as it’s PE has gotten closer and closer to “normal.” Sure it’s still well above value stocks, even well above most tech stocks, but it’s not to far off from Walmart these days which would have been unthinkable just a few years ago. It may be that economic gravity is catching up to Amazon, and if so I’d like to share my theory as to why. Full disclosure, I did buy 10 shares of Amazon right after their latest stock split and have held them ever since. I’m down rather a lot on the investment and if what I’m about to say is accurate I’m soon to be down even more, so you can consider that data point as a hedge against my thesis and read on.

The conventional theory for why Amazon’s PE never mattered was that it invested almost every dollar of profit back into the business. By re-investing their profits rather than claiming them as earnings, Amazon avoided a lot of corporate taxes. And if Amazon’s reinvestments were wise, then the stockholders gained value tax-free rather than through taxable dividends. There’s also an argument that Amazon’s reinvestments were more efficient even outside of tax implications. Every dollar Amazon reinvested could create so much growth that it was better for an investor to let Amazon keep their money and grow than for an investor to demand Amazon hand money back to shareholders. When you look at what Amazon was investing in: cloud computing, content delivery, and an every increasing share of online shopping; this certainly seems to have been the case for the last decade or so, an investor gained more value by parking their money with Amazon than they would have parking their money with a company that handed earnings back to investors.

But perhaps something has changed, and changed drastically enough that Amazon’s PE lows won’t be temporary. Amazon’s revenue and earnings continue to grow year after year, but if its stock price continues to sink it’s PE may eventually reach downright normal levels. If that is the case then I think the reason why would be clear: investors no longer believe that a dollar re-invested by Amazon is worth quite so much more as it used to be. Amazon may be approaching the limits of its momentous growth, and may now start evolving into a “mature” company like Microsoft and Apple before it. In those cases a moderately high PE is still justified, I mean these are trillion-dollar tech companies, but they can’t be expected to continue their meteoric growth and so PEs in the 100s are no longer sensible. Amazon is famous for how much it re-invests, but the dollar amount of investment is less important that the future dollars that investment generates. In the past, Amazon’s future returns of ever re-invested dollar were great enough to justify a sky-high PE but that won’t last forever. Many companies that aren’t valued like Amazon re-invest a lot of their profits, the Red Queen Hypothesis makes as much sense in biology as it does in Economics “you have to run as fast as you can just to stand still.” Companies which re-invest a lot to maintain their dominance don’t necessarily get a premium over those that hand money back to shareholders but maintain dominance. And if Amazon reinvests a greater percent of its earnings vs Apple or Microsoft but doesn’t grow significantly faster than them, then it’s stock price shouldn’t command a premium either.

I think it’s possible that Amazon is indeed maturing into a company that will be valued by it’s PE just like all the other tech companies. That doesn’t mean it’s time to dump the stock, the revenue and earnings continue to grow and will probably catch up to the PE, or at least that’s just as likely as the PE falling to meet the revenue. Regardless of the mechanics, economic gravity will eventually catch up to Amazon just like it caught up to Tech stocks of the 2000s. Nothing is ever truly new.

“Market Capitulation” is a circular argument

Will the market recover in the new year? Or do we still have a ways to go? Bears online have been going on and on about “capitulation” as in “nothing will change until we finally have capitulation.” Capitulation in normal terms means surrender, so in financial terms it means the point where investors finally give up holding and sell their shares at a loss. According to Investopedia capitulation is also the point where the investment hits its bottom. Prima facia this is a circular argument, “we won’t hit the bottom until we’ve reached the bottom” is another way to phrase it. But even dumber, this is a backwards looking argument that cannot be used for predictions. Over the year of 2022, $SPY (a popular ETF that tracks the performance of the S&P 500) hit it’s 52 week low in November at 348$ per share (it currently trades at 382$). Who’s to say that that wasn’t the capitulation, and it won’t go below that? When the S&P500 hit 666 in 2009, that was the bottom of the bear market, yet many people still didn’t believe it, expecting that there was still more pain to endure. It wasn’t until a while later that we realized no, that really was the bottom, there’s no more “capitulation” after that. So I don’t put any stock in people talking about “market capitulation.”

Short post today: green hydrogen isn’t always

“Green” hydrogen power has become something of a minor meme industry. Hydrogen power (or “fuel cells”) is used to burn elemental hydrogen with elemental oxygen producing only water as a waste product. This industry has long been the fantasy of those who want to reduce our reliance on fossil fuels and prevent the accumulation of carbon in our atmosphere, the problem is that the most economical way of producing elemental hydrogen does neither. Hydrogen is usually produced from natural gas, but “green hydrogen,” could theoretically be created by splitting water into hydrogen and oxygen. Recently I read a story of a company seeking out tax breaks to produce green hydrogen from water, but the company isn’t interested in installing solar or wind power and using that for their purposes, they want to simply buy power from the grid and use it directly. The problem is that most of America’s grid isn’t actually powered by green power but by fossil fuels. This so called “green hydrogen” would simply use the electricity from fossil fuels to produce hydrogen, with no analysis done as to whether this would produce more or less greenhouse gases than producing hydrogen from natural gas instead. In this case then, green hydrogen may not be so green.

The stock market doesn’t care about your cost basis

When someone is down 50% or more in a stock, they’ll often take to social media to complain and casually ask “what should I do next”? No one wants to sell for a loss, people almost act like it’s admitting failure. And people’s perceptions are often colored by the price at which they bought the stock. “Oh I bought 10 shares at 100$ and now they’re each worth 50$, when can I expect to break even again?” I can’t predict the market but I can say one thing: the price you paid for the stock DOES NOT MATTER. It doesn’t matter if you’re up or down, you should look at any stock you own and as yourself “do I think this stock will perform as well or better than the market in the near future?” A lot of people get stuck in a mental narrative, they start to think trends will either continue indefinitely or definitely reverse soon, depending on what would make them feel better. But a stock that is way down could still be overvalued just like a stock that is way up. A few months ago Carvana ($CVNA) stock was down 50% year to date. What did it do after that? It dropped another 50%, and another 50% from there, and just for good measure another 50% from there. Dropping 50% 4 times in a row meant it had lost about 94% of its starting value from January 1st. And Carvana still had a ways to go as it’s currently down 98%. If you had bought $CVNA on January 1st, then by April 1st you would have seen it lose 50% of it’s value. Your friend may have been tempted to think “it can’t go much lower, can it?” and bought the dip while you held your shares. You would then see your shares go on to lose 98% of their value while your friend’s shares lost 97% of their value. Your friend lost relatively less than you did, but still lost nearly everything.

Your cost basis on a stock is only relevant for tax purposes, it should have no bearing on your investment decisions. The only thing you should care about is the current price and the expected future price.

Synthetic biology: why it still might be a miracle industry

I’ve spent most of the last 2 weeks ragging on a few of the hottest SynBio startups. I’ve pointed out that these synbio startups have a very difficult path to profitability, and some might not even have a working business model. But from the scientific side, there’s still a revolution out there for synthetic biology, and I want to explain it.

To start with, the insulin and drug products revolution is a definite win for synthetic biology. The ability to take any gene, clone it into a bacteria or yeast cell, and then express it and collect the product is what has made many drugs so much cheaper than they were decades ago when we had to extract the drugs from animal carcasses or massive amounts of plant matter. It has also allowed revolutions in the types of drugs we can study and offer to patients, just about any protein you can think of could be turned into a drug that is usable for patients. Antibodies are a special type of protein which can also be produced through synthetic biology, and many antibody products have hit the drug market to treat all kinds of diseases. Aducanumab is one such antibody, a much hyped drug for treating (or rather slowing the progress of) Alzheimer’s disease. Quick note: you can tell if a drug contains an antibody by it’s name: aducanumab’s name ends in “mab” which stands for “monoclonal antibody.” Gemtuzumab (AML drug), Tezepelumab (severe asthma), pretty much any drug who’s name ends in “mab” is an antibody drug, and almost always they are produced through synthetic biology.

Biology can also catalyze certain reactions that chemistry can’t easily do. The classic example of this is creating molecules with specific stereochemistry. This will be a bit technical, but consider your left and right hand: they both have 4 fingers and a thumb but they are mirror images of each other, you can’t put your left hand in a right-handed glove and vice versa. In chemistry we would call left and right hands “stereoisomers” of each other, and just as with hands and gloves you can’t put left-handed molecules into places that require right-handed molecules. But chemically stereoisomers are identical, they have almost the exact same chemical properties and so a reaction which produces one stereoisomer will usually produce all possible stereoisomers in equal amounts. Image you wanted to produce only right hands, your starting material is the assembled 4-finger-plus-palm, now you just have to add the thumb in the correct place. Ignoring that the 4 fingers are of unequal length, if you put the thumb on one side of the fingers you get a right hand, while if you put the thumb on the other side of the fingers you get a left hand. A chemical reaction will make an equal number of right hands and left hands because it will add the thumb randomly to both sides. A reaction catalyzed by an enzyme however will only put the thumb on one side, the side you picked, and thus using an enzyme you can ensure you only make right hands and not left hands. This is another place where synthetic biology can be critical, there are many stereoisomers where one isomer is a useful drug and the other isomer may be a harmful chemical, we need to have some process to create only one of them and for that engineering enzymes with synthetic biology can yield good results.

Finally biology can greatly catalyze reactions in a way that greatly reduces the amount of energy we have to put into the system. Make no mistake, catalysis doesn’t yield free energy, but it does lower the energy barrier for a reaction. To turn carbon dioxide into some non-harmful form of carbon, we would chemically have to pump in a lot of energy to break the carbon-oxygen bonds which hold it together. That energy would require a high temperature and high pressure, which would then require containment, meaning scrubbing carbon from the atmosphere chemically is a very difficult process. However plants remove carbon dioxide every day, and do so at the modest temperatures and pressure that we find anywhere on Earth. They can do this because they use enzymes to catalyze the reaction, which lowers to energy barrier for the reaction to proceed forward. IF carbon capture technology ever becomes economically viable, mark my words it will have to be done using enzymes.

So synthetic biology allows us to tap into biological processes to perform jobs that are difficult to do chemically. The tools we have to do so, the genetic code of living organisms, also provide us with a vast array of starting tools to choose from to make things easier since we aren’t starting from scratch. And finally the fact that living organisms will grow and develop from things as simple as sugar instead of requiring oil or rare earth metals means that synthetic biology can be done just about anywhere and isn’t as limited by commodity costs like most other industries. In short, I DO believe synthetic biology may be the future, but I’m just not sure the current crop of biotech upstarts have what it takes

Amyris: might they be profitable?

Amyris ($AMRS) is another small-cap biotech that alongside Ginkgo ($DNA) and Twist ($TWST) has lost over 50% of its value year-to-date. With a stock price of ~2$ and a market cap of less than a billion, I think they technically qualify as a “penny stock” so all the usual caveats about volatility and such apply here. With that said, Amyris might be the better positioned company out of the 3. While Ginkgo wants to be the Apple App Store and take a cut out of everyone else’s money, Amyris is content to make money themselves by making and selling biosynthetic products. In the first 3 quarters of 2022, they made 194 million dollars a year in revenue, and spent 610 million dollars (GAAP) in order to do so. They had 483 million dollars of cash in December of 2021, but only 18 million in cash was left at the end of 2022 Q3. It all seems rather unsustainable and what’s worst is that only 81 million dollars of their expenses come from R&D ie most of the expenses are just running the business. Cost of products was 170 million, Sales+Admin was 358 million, and revenue remember was 194 million.. But if you fired all the salesmen, administrators, and R&D people they might theoretically be making a profit, whereas Ginkgo expects to make a profit from licenses that may never materialize and Twist is being accused of selling products for less than their cost.

That does not mean Amyris is a good investment, even in this theoretical world where they made 26 million dollars in earnings they would have a P/E north of 200, and not even Amazon trades that highly these days. Still revenue has been growing close to 100% year on year, and there is perhaps a profitable company somewhere inside Amyris that could be worth your money.

Amyris is interesting to me because they appear to be the most “pure play” of the synthetic biology micro-caps that I see talked about. Ginkgo and Twist both operate on the “shovel salesman” business model, the old chestnut that in a gold rush you’d rather be a shovel salesman than a miner. Ginkgo wants to license the GMOs that would produce synthetic biology products, Twist wants to sell the DNA that goes into those GMOs, but Amyris is actually doing the work of making biosynthetic products and selling them on. And what are they producing? Well beauty products, mostly.

Most of Amyris’ products are a good window into the synthetic biology world. There was some chemical discovered ages ago that was useful to humans, but it only came from a rare plant or animal, so we humans would harvest these plants and animals by the billions to extract the chemical and put it in whatever product we needed. Then synthetic biology comes along and finds a way to produce the chemical in a microorganism instead. The benefits in cost for this should be massive, but they don’t seem to be showing up in Amyris’ balance sheet. Instead the biggest benefits appear to be in Amyris’ branding and product ethics. There’s been a years long push to make products be “less cruel” depending on one’s definition. For some consumers this means products should not be made using animals, for others they should not be extracted from conflict zones, still others demand the products be made with only unionized or at least well-paid labor. Everyone has their own definition of ethical consumption, and their own boundaries that they will not cross. Importantly our boundaries usually depend on how necessary we find that product for our daily lives, some folks will only drink Fair Trade coffee but some will take any cup of joe served by an underpaid Starbucks employee because they need their caffeine and need it now. Beauty products sit right at the top of Mazlow’s hierarchy of needs and so the consumers of these products can demand as much ethics as they want because the consumer doesn’t really “need’ them and the producer knows it. There’s also the fact that beauty products are already sold to us as an avenue of self-expression, and for some folks moral/ethical self-expression is the most important type of all. To this end, beauty products have recently tried to show themselves as world leaders in ethical consumption, advertising that they have no animal cruelty, don’t contain products from combat zones, aren’t produced by underpaid laborers, and all sorts of ethical guarantees. This is a place where Amyris and other synthetic biology companies should have the greatest benefit because there are very few ethical concerns to making a product in a Silicon Valley lab using micro-organisms. To that end, it’s not surprising to me that beauty products are so far Amyris’ strong suit.

But beauty isn’t the end all be all, there are stories floating around on social media that Amyris only pivoted to beauty in a desperate attempt to get cashflow and save the company. It still might not work because they’re burning cash and have little of it left on hand. But if it works, the higher ups (it is claimed) still want to make all the other synthetic biology products you can think of, plastic substitutes, green hydrogen, novel drugs those kinds of things. It’s a lofty goal and if Amyris can do it and make a profit then I’d invest. But right now they’re still burning cash and their fate is likely tied to how far and fast the Fed tightens the money supply. Only time will tell.

Twist Bioscience, do they have it?

When reading up on Ginkgo Bioscience ($DNA), another biotech mini-cap was brought to my attention. Twist Bioscience ($TWST) claims to be another company of the future, disrupting the DNA industry by being able to synthesize massive amounts of DNA on a large scale for low cost. Synthesis of DNA is the first step in creating GMOs to produce biosynthetic products, as I described when talking about Ginkgo Bioscience. Because GMOs are supposed to fuel the incoming biotech revolution, the company that gets to synthesize the DNA going into those GMOs should make a lot of money, and sure enough Ginkgo and Twist recently partnered so Twist could sell Ginkgo DNA.

Browsing the price options, Twist does seem to offer DNA for a bit cheaper than it’s nearest competitor, GeneScript. These modest savings are supposedly thanks to Twist’s silicon-based DNA synthesis platform, a technology that is namedropped in every Twist press release but which I am unsure of it’s full scope nor how much it’s used in their actual manufacturing. The technology appears to be old-fashioned DNA synthesis coupled to a microarray that allows the process to be controlled by a computer. I’m sure name-dropping silicon is supposed to make people think of Silicon Valley, semiconductors, and the computer/tech revolution, but the novelty seems surprisingly modest and I’m not sold on how it is supposed to lead to the huge magnitude of savings claimed by Twist. Because while their prices are a bit cheaper than their competitors, it is worrying that Twist has been accused of selling their products below cost which is not a sustainable way to run a business. Twist’s publicly available earnings reports do show that they’re spending 2$ for every 1$ they make in revenue, so the shorts may be right on this one. Burning investors’ money to gain market share may work when interest rates are low and money is cheap, but in the currently constricted environment it doesn’t seem sustainable which is probably why Twist’s stock is down 70% year to date.

Twist has also tried to generate hype by claiming that DNA is the next information-storage medium, and that they have the patents to make this happen. I honestly think this sounds a lot like Elon Musk’s claims that Tesla will produce Robotaxis or build a robot, it’s hype for hype’s sake with no path to a profitable product. DNA does store information, but information is only as good as our ability to write and retrieve it. Silicon is a great store of information because photons can be used to change the electron states of the atoms and thus to read and write information at the speed of light. On the other hand DNA does not easily read/write. Writing information to DNA means changing a DNA base, which is a very difficult process requiring very precise biochemistry (like CRISPR or other enzymes), and it fails as often as it success. Reading DNA information means extracting it into some usable form, and while photons from silicon are easily converted into electric impulses which can drive some process (the movement of a robot arm or the display of a pixel on a screen), DNA codes for RNA which codes for proteins and none of those are easily converted into an electric impulse or anything else that could drive a process. At best, you could do some kind of X-ray crystallography and hit the DNA with photons to read out its sequence, but doing so damages the DNA to the point that you’re better off just using silicon, and you still haven’t solved the problem of writing new information to the DNA.

So does Twist have it? They are currently selling DNA for cheaper than anyone else I could find, but they’re also burning investors’ money to do so meaning I’d rather be a customer than a shareholder. They had a net loss of 218.9 million dollars and 505 million dollars in cash, so they can keep this up for at least 2 years without taking loans or selling more stock. In that time, it’s possible that they could gain market share and economies of scale to the point that they become profitable, but I kind of doubt their silicon-based hype will be the key driver of of those profits. I also am highly skeptical of their DNA-as-information-storage hype, and don’t think it will contribute much more than Elon Musk’s robotaxis. If they can profitably sell DNA for less than their competitors they’ll be a buy, but until I see evidence of it I won’t touch their stock myself.

From a shareholder’s perspective, losses from stock compensation are still loses

Yesterday I talked about the economics of Ginkgo Bioworks’ ($DNA) synthetic biology business. In that post, I mentioned that Ginkgo had a loss of 650,000,000 dollars in the third quarter of 2022, against an expected annual revenue of just 500,000,000 dollars for the full year of 2022. What I didn’t mention was that a lot of that revenue was stock-based compensation, and I’m sure the $DNA boosters would be furious at me for not saying so.

When some companies release their earnings reports, they’ll focus on the “non-GAAP” number instead of the GAAP. GAAP stands for “generally accepted accounting practices” and so a non-GAAP number is obtained by using non-generally accepted accounting aka “funny math.” For our purposes today, note that GAAP considers stock based compensation as an expense, just like wages, and all expenses must be tallied up to obtain the profit or loss for the company as a whole. But for some folks this isn’t ideal, after all stock isn’t “cash,” you can’t go bankrupt by running out of it, so why should the company have to count it as an expense? For that reason, a common non-GAAP trick is to simply remove the stock based compensation to make the numbers look better. This isn’t breaking any laws, you have to make the GAAP numbers available for anyone who wants them but nothing precludes you from focusing on the non-GAAP numbers in your press release and earnings call. Lying is illegal, but optimism isn’t. This is important for $DNA as most of their expenses in Q3 were from stock based compensation: they lost 650,000,000 dollars in GAAP earnings, but only 100,000,000 dollars when stock based compensation is removed.

For a Ginkgo booster that 100,000,000 number is the only important one. Who cares about stock? They have 1.2 billion in cash and are losing 100 million a quarter, so they can keep doing this for 12 quarters (3 years) with no problems whatsoever, and by that point they’ll be profitable so cash-on-hand doesn’t matter, right? But for an investor the stock is still very important because without a dividend the value of your stock going up is the only way you’ll make money on a company. When 500,000,000 dollars worth of stock are given to the C-suite and senior execs, that dilutes how much of the company you own with your few shares of stock. Assuming the company’s total value stays the same, you now own a smaller slice of the same size pie so the total value of your slice has gone down. Even if the folks don’t sells their stock (and trust me, they always do), the threat of that sale will also have downward pressure on the stock price as skittish investors sell off so as not to become bagholders for the C-suite. That 500,000,000 dollars still represents a loss of value to the investors and should be treated as such.

There are a lot of ways a company can pay for things, and they all have their pros and cons. A company can sell stock, or hand over stock in exchange for something, a company can use the cash it has or it can take out loans and use those instead. Then a company can do a lot of different things with the revenue that comes in, it back buy back stock (or hand out a dividend, functionally the same) pay off its loans, or let the cash pile up for use later. There are many different reasons for a company to do any of these but they all involve the movement of value to different places. A company with a wildly overvalued stock price could benefit from selling share because the cash is worth more than the (transient) value of the stock. A company in a high interest rate environment could benefit from paying down its loans more than from sitting on cash, etc etc. But stock is a thing of value, it’s a source of money that the company controls, and handing that value over to the C-suite dilutes its value for every other investor. That’s why I only like to talk about the GAAP numbers for companies.

Ginkgo Bioworks: the economics of genetic engineering

Yesterday I discussed the science of genetic engineering, or at least its application to synthetic biology. Today I’d like to discuss how Ginkgo Bioworks is trying to monetize genetic engineering and gain all the value of its total addressable market.

To recap, genetic engineering is used for the production of biological molecules. If you have a drug for curing a disease you’ll need to produce mass quantities of it to both get through clinical trials and sell to patients down the road. In modern cases, that drug will usually be produced in specially made genetically modified organisms, and then purified out of those organisms using a specific purification pathway. The end result is a pure drug, which is something that the FDA demands and patients really want as it cuts down on variability and potential side effects. This is the business that Ginkgo Bioworks wants to get into, they want to be the ones producing those genetically modified organisms and validated those purification pathways. The organism and the pathway then become akin to intellectual property (IP) for the production pathway of that drug. So say you’re a company that own a drug but has no ability to produce it at scale, Ginkgo will develop a production pathway and charge you the lowest possible price for doing so (making zero profit themselves). They do this because their IP specifies a revenue sharing agreement whereby they get a cut should you manage to sell your drug in the future. This system is what gave Ginkgo such a ridiculous valuation based on TAM, if they can be the lowest-cost provider of drug production pathways, then every single company will want to contract with them, and so they’ll get revenue from every single drug on the market.

The problem is… that’s not how it seems to have worked. First, Ginkgo wants to drive down the cost of producing these production pathways, but they’re competing with companies that already work at economies of scale far greater than them. Let’s start with just the first step of the producing a production pathway: you had to get DNA for your drug and insert it into an organism. There are already many companies that will do this job for you if you’re willing to pay up. Those companies include heavy hitters like Genescript (market cap of more than 3x what Ginkgo was at its peak) and Thermo Fisher (the 600lb gorilla of this sector). These companies have driven down the cost of DNA, genetically modified organisms, and other tools to the point that Ginkgo doesn’t seem much like competition. Now Thermo Fisher And Genescript to my knowledge won’t make an entire pathway for you, but they will you a large part of the pathway for dirt cheap and then sell you the tools to finish it up yourself. But that still means that for many of the steps, Ginkgo is competing with companies that are far larger than it which are better able to deploy economies of scale than it. So Ginkgo might not even be offering you the best price possible when you compare with using some of the big boys instead. And remember they need to be offering the best price possible as they don’t even make money by selling you this process, instead they need to entice you to sign the deal where they get a portion of your future revenue.

Then there’s the fact that their business model relies on successes but self-selects for failures. It’s important to start by remembering that most drugs which go through clinical trials will fail to make any money whatsoever. Ginkgo’s business model is to produce a drug production pathway and sell it for zero profit and bank on the revenue sharing portion to make them money, but they of course understand that most of these revenue sharing agreements won’t make any revenue. But then what type of drug discovery company will even take such an agreement? A large drug company (Johnson and Johnson, Pfizer) already has the in-house tools produce a drug production pathway, they have little reason to enter a revenue sharing agreement especially when Ginkgo’s cost might compare unfavorably with just buying stuff from Thermo Fisher and doing the rest themselves. A small drug company is exactly the type Ginkgo needs to go after, but what type of small drug company? A small company that has lots of money and a product they are very certain is a hit also will be dissuaded by the revenue-sharing agreement, why fork over so much future revenue unnecessarily? On the other hand a small drug company will less money, or a drug company that has a product it isn’t sure of, those would be the kind of customers who would willingly bet on Ginkgo, but they are also the customers who will be least likely to succeed at bringing their drug through clinical trials. If they have no money they could easily go bust before they make it, and if they’re unsure of their drug then it probably means their scientists know it’s a long shot. So Ginkgo’s business model is forcing it to self-select and take on the customers who are least likely to make it a lot of money through the revenue sharing agreement.

And that’s important because the revenue sharing is supposed to be how the company will grow larger, and until it grows larger it can never compete with the big boys on economies of scale, therefor never address it’s total addressable market because there will always be big companies for whom it’s cheaper not to even work with Ginkgo. This is a chicken and egg problem, they need to grow large to reach economies of scale and drive down the cost of their services, and they need to drive down the cost of their services to make it more enticing to sign those revenue sharing agreements, but as long as their services are still higher they’re stuck in a holding pattern. It’s important to note that at this point that Ginkgo had a loss-from-operations of about 650,000,000 dollars in Q3 2022 alone. They are expected to have total 2022 Revenue of around 500,000,000 dollars. They lost more in a single quarter then their expected year-long revenue and that trend shows no sign of changing. Their cash on hand at the end of all this was 1.3 billion dollars, and with plenty of stock to sell and loans to take out, they can continue this business for a while yet. I’ll talk more in a future post about their burn rate and their losses, but it’s important to note that this is where the company is: growing but not necessarily at at rate that will let it achieve lift-off. It needs find some way to make its revenue-sharing business model work, either by driving down their costs so much that other companies have to use their services or by somehow enticing more winners instead of losers to use their services. The only part of the firm that is close to break-even is the “biosecurity” arm a COVID-monitering and diagnostic service that will likely fade as the salience of COVID continues to fade. Perhaps they can pivot to new avenues of biosecurity, flu monitoring? Either way this work is much lower margin than the synthetic biology revolution that was supposed to propel their TAM, and stock price, into the stratosphere.

Ginkgo Bioworks: what is the point of Total Addressable Market (TAM)?

Ginkgo Bioworks ($DNA) is a stock that I’ve heard a hell of a lot about. The idea of “DNA as a programming language” is something a lot of stocks and hype-mongers trade on, because it promises the insane growth of the Tech industry but with whole new markets where you can get in on the bottom floor. What if you could invest in Apple, Amazon, and Google in the 90s? Well now you can by investing in $DNA and other biotechs like it. Their tech is supposed to be the future, and is supposed to make us all a lot of money (if we invest in it).

Part of the appeal of investing in “DNA as a programming language” comes down to the concept of “total addressable market” or TAM. TAM is a way to calculate the greatest possible revenue you could ever achieve, by bringing your product to every person on earth who wants it and charging them a fair price. Valuation based on TAM aren’t necessarily ridiculous, Facebook is used by just about 1 out of every 2 people on earth these days, so if you had gone back to 2008 you could have realized just how monstrous Facebook would become by looking at their TAM (and deciding Facebook and not MySpace would win the war). So investing based on TAM might have made you money if you’d thrown it at Facebook. Sure, these days Facebook only gets a few bucks in ad revenue per person, that’s still several billion every year. So bringing your product to every single person in this wonderful world of ours, all 8 billion people, is almost guaranteed to make you some money.

Ginkgo and DNA-based companies like it have some eye-watering TAMs because DNA and biotech is so fundamental to everything the world economy does. Agriculture? Modern crops are all engineered (yes, even your GMO-free crops are engineered, they just use different techniques to get around people’s prejudices). Health? Modern medicines are all engineered and grown in cell culture vats. Commodities? Biochemists are already working on using engineered proteins to create all sorts of industrial chemicals, or to clean up industrial waste, so that’s yet another avenue for biotech revenue. There are endless possibilities for using proteins and cells in industry, so there are endless amounts of money you could conceivably make bringing your product to these industries. But what Ginkgo brings isn’t any particular protein, or any particular cell, they supposedly bring a platform to create all proteins, and all cells at a lower cost than anyone else. Ginkgo wants to be a shovel salesman in the Biotech gold rush, and they think they can sell shovels to every company on earth. Whether you’re a Big Pharma company producing drugs, an AgriTech selling seeds to farmers, or even a mega-factory trying to comply with the EU’s industrial pollution directives, biotechnology can help you and Ginkgo can help biotechnology.

Here’s what Ginkgo says it does: say you want to make a drug and get FDA approval to sell it to sick people. Your drug needs to meet the highest standards of quality control, every batch needs to be identical to the others in all the right ways so that what the sick people get is the same every time. Any sort of variation can be deadly in these cases, and the FDA looks very disapprovingly at variation for this reason. But producing a drug at scale is hard and expensive, even at the relatively modest scale needed for phase 1-3 clinical trials. This is supposed to be where Ginkgo comes in. They’ll create a modified cell for you which makes the drug all on its own. They’ll produce a purification pathway that is easy to use and gets consistent results. Then you can grow up that yeast cell into massive colonies (easy enough, yeast eat anything) and harvest them to purify the drug they are producing (again, this should work).

The problem is this pipeline doesn’t necessary lead them to the TAM-style valuation that once sent their stock price skyrocketing. Most drug products start by being produced in an academic lab at ultra-small scale, and for these purposes making the cells and purification pathways yourself is actually the cheaper option vs paying a big company to do it for you. Once you have a cell and a purification that sort-of works, you publish it and it gets picked up by some massive biotech that wants to monetize it. Now this company isn’t starting from a base of nothing, the work that the academic lab already published will probably be a very strong base from which the company can make its own cells and purification pathway (with only minor tweaks to what the academic lab did). And because it’s so easy to do this, again it rarely makes sense for a big company to partner with Ginkgo to do these things, especially when it’s not just the cost but also Ginkgo’s business model you have to deal with. See, when Ginkgo does something for a Biotech company, they don’t just as for money upfront. Ginkgo writes contracts that say that if you use the cells and purification pathways they create, then they will get a certain percentage of your revenue or profit (negotiable, of course). This was sold as an unbeatable deal that would catapult Ginkgo to the stratosphere and help them reach the valuation predicted by their TAM, understanding why this deal is failing is key to understanding why Ginkgo is failing.

I’ll talk more about the specifics of Ginkgo’s deal and why I think they will never manage to address their theoretical TAM in another blog post. For now, reflect on the fact that $DNA is in the exclusive club of stocks that lost over 85% of their value in the last year, $CVNA is another. I think both businesses were predicated on a business model that was more science fiction than fact.