On February 4, 2021, 23andMe announced its plan to go public by merging with Virgin Group’s VG Acquisition Corp (VGAC). VGAC is a special purpose acquisition company (SPAC) created solely for the purchase of taking a company public via the SPAC process. Instead of pursuing a traditional IPO, companies of lower quality have been choosing to go public through merging with SPACs because it is faster and receives less scrutiny. Case in point—WeWork, which spectacularly flamed out in its attempt to IPO, recently announced it will instead go public via a SPAC merger with BowX Acquisition Corp. The fact that 23andMe has chosen to go public via a SPAC should raise some red flags by itself.
23andMe is the leading brand for consumer DNA test kits. For $199 and a tube of your spit, 23andMe can sequence your DNA and provide fascinating data on your ancestry and health risks to genetic diseases. I took the test myself and found out that I am 82% Chinese (no surprise there) and 14% Manchurian and Mongolian (interesting). My wife is apparently nearly 100% of Korean ancestry. Unfortunately, it is not always fun as some people have discovered uncomfortable truths about biological parents or that they have a mutation that significantly increases the risk of cancer.
While the test kits can be an interesting purchase, it does not appeal to everyone and lacks a good business model given the non-recurring nature of its $200 purchase. Having already been around for a number of years, 23andMe may be running out of people who are excited to buy its test kits. Newly genotyped customers declined 40% in fiscal year ending 3/31/20 and another 30% in fiscal year ending 3/31/21 as 23andMe pulled back on marketing.
Google search traffic for 23andMe also shows search interest is well off prior year peaks.
Of course, 23andMe is more than just a DNA test kit company. Approximately 80% of its customers have agreed to have their DNA data used for scientific research. Having genotyped around 11 million individuals, 23andMe has one of the largest databases of DNA for genetic research. 23andMe is trying to leverage this data and has partnered with pharmaceutical company GSK to develop new therapeutics. Investors who are excited about this portion of 23andMe’s business would be well served to remember that developing new drugs is a high risk, low success business. This is akin to investing in an early-stage biotechnology company, something best left to the venture capitalists.
Financials
To help investors better understand its future prospects, 23andMe provides forecasted financials through 2024. But first, a word of warning about projected financials (which is not allowed for traditional IPOs but permitted for SPACs). Asking a company trying to go public for its own projected financials is a bit like asking a car salesman to tell you whether a car is a good buy. You are bound to end up with a strong recommendation and a very rosy image. It is only when you drive the car off the lot that you discover all its warts. This is to say projected financials typically do not reflect the base case or even a slightly optimistic case. Rather, it frequently represents somewhere between a very optimistic to the best-case scenario.
True to form, after seeing its actual revenues cut in half from $441 million in 2019 to $218 million in 2021, 23andMe projects a steady recovery to $400 million by 2024. (I have yet to meet a financial projection that forecasted a decline in revenues). Perhaps most concerning, even in this optimistic scenario, 23andMe still projects a loss of $78 million in 2024. This loss of $78 million is not net income but rather adjusted EBITDA (earnings excluding interest, taxes, depreciation, and amortization). Adjusted EBITDA is one of the most generous definitions of earnings and is akin to a spendthrift consumer who says he is not spending that much if you exclude the interest on his credit cards, his taxes owed, and his car payments! The fact that 23andMe still projects a loss on this rather favorable definition of earnings in 2024 is a real concern.
23andMe does provide some of the key assumptions underlying their projections. First, the company assumes that annual test kits sold increases steadily from 1.5 million in 2021 to 2.5 million by 2024. Given the decline in Google search and consumer mindshare, this could be a stretch. 23andMe will almost certainly have to increase marketing spend again which could in turn hold back improvements in profitability. A second key assumption is that 2.9 million of its past users will sign up for a newly developed $29.99 per year 23andME+ subscription service, which promises some additional reports and data. The service is currently in soft launch and has 75,000 subscribers. Getting to 2.9 million by 2024 seems like a tall order. All I can say is that I see little value and have no intentions of subscribing to the service myself. Finally, 23andMe assumes that the number of targets for therapeutics increases from 18 in 2021 to 37 by 2024. It is near impossible to evaluate the therapeutic prospects from the outside. This is another reason why 23andMe belongs squarely in the bio-tech lottery bucket.
Valuation
The SPAC transaction values 23andMe at approximately $3.5 billion. This is nearly 16 times 2021 estimated revenues! This is still nearly 9x revenues on projected 2024 revenues. Both represent a very expensive valuation for a company that has questionable growth prospects and no clear path to profitability.
While new SPACs started out 2021 flaming hot, the market has soured on SPACs recently, partly due to increased scrutiny by the SEC. The chart below shows that SPACs such as Lordstown Motors and Canoo are already down 50% on the year! 23andMe is set to launch into an unfavorable backdrop.
In summary, 23andMe offers a neat DNA test kit and the hope of developing new therapeutics, but it represents a highly risky investment with limited growth prospects in its consumer offering, expensive valuation and projected losses for the foreseeable future. Investors who want to take a flyer with 23andMe stock should treat it as a lottery ticket and keep it to a small percentage of their total portfolio.
Disclosure:
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
The information in the article is provided for informational purposes only. It should not be construed as investment advice or advice on buying, selling, or other types of transactions relating to an investment in products or services, much less an invitation, an offer or a solicitation to invest.
The information in the article is provided solely by virtue of the fact that everyone will independently make their own investment decisions: the report does not take into account investment objectives, nor specific needs or financial situation. In addition, nothing in the article represents or is intended to express financial, legal, accounting or tax advice. You should consult your own investment or financial advisor before taking any actions.
