Twist Bioscience Gets Stung by Short Report

Somebody as soon as mentioned it’s simpler to idiot individuals than persuade them they’ve been fooled. For individuals who make investments with conviction, nothing damages one’s pleasure greater than accusations of being conned. Traders have to be cautious of letting such feelings get in the way in which of objectivity. Anybody who dismisses a complete brief report as biased one-sided tripe that’s solely meant for manipulation isn’t a very good investor. Brief experiences at all times comprise one thing fascinating value noting, however they must be taken with a grain of salt as nicely. Decoding a brief report is a fantastic balancing act that should finish with an announcement of conviction.

As soon as Bitten, Twice Shy

Scorpion Capital first got here into our lives a yr in the past once we printed our piece on Why We’re Promoting Berkeley Lights Inventory which largely stemmed from confirmations – and plenty of new data – offered of their brief report. Simply because BLI shares fell 89% since we bought our place doesn’t imply we did the best factor, however proof appears to counsel there have been certainly issues. Earlier this yr, the CEO was demoted with no succession plan, one thing that suggests he was compelled out. The corporate missed their income steerage as Scorpion predicted, and this yr they “anticipate full-year 2022 income to be roughly according to 2021 full-year income.” So, the expansion tailed off simply as Scorpion predicted, and now the corporate has a brand new working technique, they usually’re assured within the turnaround plan.

We’re nicely on our method to reworking Berkeley Lights from a expertise platform firm right into a rising, worthwhile, and sustainable life sciences instruments and companies firm.

Credit score: Berkeley Lights

For the reason that brief report, they’ve been surviving, not thriving. We’re not eager on giving firms a second probability after they muck issues up the primary time round, so let’s transfer on to Scorpion’s subsequent sufferer – Ginkgo Bioworks (DNA).

An Assault on Ginkgo Bioworks

Since Scorpion’s brief report, shares of Ginkgo Bioworks have tumbled 79% vs a Nasdaq lack of 21% over the identical time-frame. Our piece titled Ginkgo Bioworks Responds to Brief Vendor Report talked about Ginkgo’s delay in responding to the report, and the following DOJ inquiry that adopted:

Shortly after the Scorpion Capital report got here out, Ginkgo Bioworks obtained an off-the-cuff inquiry from the Department Of Justice (DOJ). In response, Ginkgo organized for an unbiased investigation that discovered any “suggestion of fraud, reporting violations, accounting errors, or different wrongdoing contained within the brief vendor’s report had been unfounded and importantly that no restatement of our financials was wanted.” When pressed as to the place the DOJ inquiry sits, Gingko’s CEO responded with “there’s not an excessive amount of extra I’d add at this level on it.”

Credit score: Nanalyze

One other criticism made by Scorpion Capital surrounded “associated get together” Foundry revenues, one thing we shared issues about in a bit titled Ginkgo Bioworks Inventory Simply Received a Complete Lot Riskier.

Our method to Ginkgo Bioworks has at all times been to concentrate on Foundry revenues that don’t come from associated events, one thing we detailed extensively in our piece on Ginkgo Bioworks Responds to Brief Vendor Report. Pure Foundry revenues for final quarter had been $14.7 million or about 59% of whole Foundry revenues. Evaluate that to final yr when non-related get together Foundry revenues got here in $21.6 million or 62% of whole Foundry revenues. So, based mostly on final quarter, issues aren’t getting any higher for Ginkgo Bioworks, at the very least in keeping with the metric we’re monitoring. As soon as the Zymergen acquisition has been rolled up into their financials, we’ll take one other look.

We’ve at all times thought Ginkgo Bioworks has probably the most thrilling tales on the market. Having the ability to manipulate DNA means we will now wield probably the most highly effective expertise identified to man – nature. Ginkgo’s Foundry is the place AI meets artificial biology, and all the chances come true. In order that’s the place we need to make investments our bucks, not in some COVID-related testing service that happened throughout Ginkgo’s pandemic pivot.

The jury remains to be out on Ginkgo, which brings us to the subject du jour – Scorpion Capital’s report on Twist Bioscience (TWST).

Third Time’s The Allure

Earlier this yr, we printed a bit titled Challenges Forward for Twist Bioscience Inventory which talked about how “Twist is competing towards some very established firms and spending a ton of cash to take action, significantly on the gross sales aspect.” We additionally had “issues round their enterprise mannequin taking a companies method versus a {hardware} product/consumables method,” and famous the razor-blade mannequin on provide from {hardware} producer DNA Script. On account of that piece, we determined to carry off on accumulating any extra shares of Twist Biosciences till additional discover. Following the Scorpion brief report, shares are buying and selling at a 33% low cost, so we learn via the 238-page report back to see what buyers must be involved about.

The report is damaged down into seven sections that are paraphrased under:

• Twist Bioscience is subsidizing clients by providing DNA synthesis companies at lower than price
• The flagship DNA chip on provide from Twist doesn’t work as marketed
• Twist is incorrectly stating COGS by allocating a few of it to R&D and CAPEX
• Twist is a bottom-tier vendor with a poor popularity that companies small, price-sensitive tutorial labs and biotech startups
• Twist operates in a commodity, crowded, hyper-competitive area
• Development has peaked in NGS, TAM is miniscule as a result of Twist can not compete towards massive gamers, and 20 new firms are getting into
• A few of their Chinese language buyers are shady

A Worth Dumping Technique

Half one of many report accuses Twist Bioscience of working “an unsustainable scheme that purchases progress with a value dumping technique, by subsidizing clients with costs 50-90% decrease than the competitors.” In different phrases, they’re saying the cost of goods sprevious (COGS) have to be false. Twenty analysis interviews level to unbelievably low costs with opponents questioning how the corporate will survive with new entrants pricing artificial DNA 70% under Twist’s already cut price basement costs. The response from the corporate will probably be settlement. After all, they compete on price! The rationale they’ll do that’s due to the silicon chip they developed which gives them with a aggressive benefit.

Vaporware?

Scorpion claims that Twist’s DNA chip – 10,000X throughput and decrease price – is simply plain fraudulent, and that “Twist’s workflow requires the identical steps as each different commodity DNA producer.” To make the most of the whole capability of a chip, Twist allegedly must batch orders which delays supply time. The choice is partial utilization which will increase COGS. Even then, the chip is claimed to solely make “negligible volumes of DNA” with the output having a really excessive fee of errors. Guide intervention is required all through the method, which suggests utilizing Twist’s chip truly requires extra effort than simply guide work. Once more, the important thing allegation right here is that COGS isn’t being mirrored correctly by the corporate.

Income Development and Profitability

That is the place the report strikes to some very particular accusations that are as follows:

• Twist is misclassifying COGS
  • as an R&D expense
  • as CAPEX through two autos:
    • a) its purported “Manufacturing unit of the Future,”
    • b) its “DNA Storage Initiative”

Simply because administration talked about “gross margin” 15X on their final earnings name doesn’t imply they’re fudging their numbers. The principle concern we have now – one which’s mimicked by Scorpion – is that prices are very excessive with no evident path in direction of profitability. Of their latest earnings name, Twist Bioscience doubles down on their dedication to spend closely on CAPEX and R&D with steerage supplied for the subsequent two years based mostly on present money.

The 2 sentences on the backside of the slide concerning profitability aren’t reassuring. The primary says they’re engaged on it, whereas the second is a great distance off with $40 million in Biopharma revenues anticipated for 2023. An August investor deck mentions – twice – that they’ll hit EBITDA breakeven when the core enterprise (Synbio and NGS) hits $300 million, so we’re holding them to that.

The latest earnings name wasn’t overly compelling with Twist making no touch upon the brief report, however fielding many questions regarding it. The decision was kicked off by the Chief ESG Officer who’s liable for the cash they wasted on a prolonged and largely meaningless ESG report, and who units aggressive targets like “improve the proportion of girls and racial range by 3% by December 31, 2022.” (Suggesting that hiring managers have in mind intercourse and race when making hiring choices ought to be a terminable offense.) After studying via her script, she passes it to some French fellow who speaks in such a powerful accent that even the AI algorithms transcribing the decision bumped into issues. In a nutshell, Twist Bioscience is spending closely on R&D, their Manufacturing unit of the Future in Portland, and DNA knowledge storage, even if straightforward capital has dried up.

DNA Information Storage

A number of years in the past, Twist Bioscience and Netflix collaborated on a canine and pony present that highlighted the potential for DNA storage. Intuitively, it’s laborious to imagine that is near being economically viable. Writing the information is one step, then you definately want DNA sequencing machines to learn the information, all whereas using error-correction strategies to make sure knowledge integrity. It’s no straightforward activity, and the primary software would in all probability be the worldwide marketplace for tape storage which is claimed to be between $2.75 to $5 billion. Twist labels this chance “archival storage,” and attributes a $35 billion whole addressable market to it. Possibly the larger query is simply how reasonable this aspiration is given present technological developments. (We’ll comply with up on this subject in a later piece.)

Within the newest earnings name, administration wouldn’t describe what contribution DNA knowledge storage may need to the $350 million they’re guiding in direction of for 2024. Assuming the $100 million plus funding can’t handle to commercialize their DNA knowledge storage expertise, we have to know this firm can survive based mostly on their core enterprise actions.

What to Watch For Going Ahead

The brief report has proved to be considerably of a blessing. Twist Bioscience wants to consider carefully about how their actions help the claims being made within the brief report which makes a number of accusations based mostly on rumour. Our issues haven’t modified. Twist Bioscience spends a large amount of cash on SG&A/R&D which – whereas serving to propel income progress – isn’t a prudent method to be taking when the provision of straightforward capital has dried up. Scorpion’s report factors to a number of conclusions:

• Twist won’t ever be capable to function a worthwhile enterprise -> losses won’t lower over time
• Income progress will stall -> Twist received’t hit their 2023 / 2024 steerage

That brings us to the under numbers, noting that it’s fairly odd for a corporation to present steerage for 2 years trying ahead within the face of robust macroeconomic headwinds.

Money is vital to concentrate to. On the finish of Fiscal 2023, Twist expects to have $300 million in money remaining. On the finish of Fiscal 2024, they anticipate to have $170 million in money, which suggests they’ll have burned $130 million in 2024. This means they’ll have sufficient money to make it via 2025 at which era we’d anticipate them to have achieved profitability.

Offering such detailed steerage to date into the long run appears to be in direct response to the brief report, however the line within the sand has been drawn. The investments being made within the Manufacturing unit of the Future are anticipated to indicate outcomes, and buyers want to carry the corporate accountable to those estimates. Any stutter on income progress can be punished as a result of it’ll affirm Scorpion’s accusation.

Whereas ARK Make investments largely dismissed the brief report, we imagine it raises some vital factors about how a lot cash Twist Bioscience is investing in future progress whereas shares excellent improve and straightforward capital dries up because of as we speak’s bear market.

Conclusion

It’s by no means enjoyable to get up to a brief report on a inventory you’re holding. Notable brief sellers at all times elicit a pointy response from buyers which solely creates value motion noise as shares enter a tug-of-war between bulls and bears. We’ll have a powwow right here at Nanalyze to digest what we’ve discovered as we speak and determine what to do with our half-a-position in TWST. Scorpion has mimicked a few of our issues, however a lot of the report is rumour and hypothesis. Twist Bioscience now must hit their income targets and improve visibility round after they’ll be worthwhile or Scorpion’s issues can be validated.

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