Chit Chat Stocks - 23andMe (ME) | Not So Deep Dive

Episode Date: October 12, 2021

23andMe is a personal genomics and biotechnology company. The company is well known for its personalized genetic reports to individual consumers. With consent, 23andMe also leverages its array of DNA to help produce new promising drugs. Listen closely as Ian, Brett, and Ryan go through the history, financials, and future prospects of 23andMe. Enjoy the show! Our Tuesday Not So Deep Dives are sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "CCM" and get $10 off: https://7investing.com/subscribe/aff/4/ Interested in more of Ian's work? Follow him on Twitter: https://twitter.com/IanGrayLive  Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Contact us: [e-mail] Timestamps Company Background | (3:53) Industry | (8:00) Management & Ownership | (9:44) Valuation | (12:32) Earnings | (13:41) Balance Sheet | (16:30) Our Analysis | (18:30) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not-So-Deep-Dive episode. We have Ian Gray on this week and we're talking 23andMe. Ryan, this was your choice. So, did you know anything about this company beforehand?

No. And this was a recommendation, a listener recommendation. All right. So, it should be a fun one. Ian, did you know anything about this company? I did know a little bit about it. I've had a little bit of experience with it, but not too much about the company itself, just its product. Right. I think this is the first time all three of us have looked at the S1. So pretty much a first look for all of us. And we're going to let Ryan get into what the company does in the history. But first, let's talk about Potential Multibaggers, our sponsor for the Tuesday Not-So-Deep-Dive episodes. The aim of the Potential Multibaggers service is to find

stocks that can go up 10X over the next 10 years or compound at 26% per year. And we've said this before, and I know people might think, wow, that's a high hurdle. How are they ever going to do that? So far, the picks have actually done better than that when looking out over, I think it's a four or five-year time horizon. So pretty dang good. They picked Shopify at 77, CF 54, Cloudflare at 39. And there's a bunch of others they've had. I think at the time he sent this over to us, 23 picks. I'm sure there's a few more since then, since this was a few months ago, but it's not constant picks over and over again. It is just a few, you know, he's going to find something and you're going to swing big on it. And then you're going to, well, you go through

the portfolio management with him, but you know, he looks up all the stuff that you buy and verify, like he says, which means that he's updating, you know, on news alerts, say a stock drops 20% for no reason. You can discuss it within the community, all that great stuff. It's a great service for anyone looking for high growth stocks. And if you want to check it out and become a multi, you can go to Seeking Alpha and look for From Growth to Value. Google it or go to at From Value on Twitter. All right, Ryan, do you want to introduce 23andMe and then talk about 7investing maybe a bit too? The picks are just out. Do that first. Sound the alarm. We've got our October picks out. Did you look through them all? I did. Great as always. We were talking to

a bit about his pick he teased it on twitter which i thought was very funny uh and then but yeah you know you have a favorite uh i mean our style goes kind of with matt cochran's style but either way i mean we're talking about this episode about biotech uh 23 and me is kind of in the biotech realm realm now genetics i am very uncertain about you know the path forward in some of these companies but if you someone that isn't is max chats go we just had on the show talking about verve therapeutics that was not one of the picks just to be clear they don't talk about their picks uh beforehand but if you're looking for something within that realm learning about that i mean it's worth it just for those just for the the lessons and the reports that max gives out about the

biotech industry i mean i'm going through a little bit of a biotech rabbit hole myself and max is a great place to start for that uh well then now we're going to be an expert on the show i've taken ap bio you know uh ian ian's lurked up the service before ryan's watched some youtube videos now we're basically biotech analysts now. All right. And I guess use our code CCM if you want to check out 7investionsrex, especially for this month. But I'm going to get to 23andMe. So they are a direct-to-consumer genetic testing company. That's what they call themselves. And I believe they were the first. They said that they were the pioneer in their S1. Basically, you can go, if you're any person, you can just go to 23andMe's website. You can order one of

three kits. So there's the Ancestry Service for $99, the Health Service for $99, or both for $199. Customers then get shipped or receive a vial, and that's what's in the kit. And you're supposed to fill it with saliva for the 30 minutes prior to it. You're not allowed to have any mouthwash, food, anything like that. It's supposed to be a clean saliva sample. You fill up this tube or vial, and you ship it back with the packaging that they give you to a 23andMe laboratory. From there, the sample is tested and customers receive a plethora of information depending on the package that they ordered. And that's the basis or the basics of the service that everyone kind of likes. They like to see it.

Apparently, they get a lot of shipments during Mother's Day. That's 23andMe is kind of the kit is kind of a common gift for Mother's Day. If customers consent to it during registration, this is important. 23andMe can add the patient's information to their database. So that's really sort of the goal is that they can kind of collect this giant database of user information, user health information, but they obviously have to consent to it. And then from there, 23andMe can give licenses to their database to other research firms or pharmaceutical manufacturers. And 23andMe is trying to develop successful drugs themselves. So they have sort of this therapeutics portion of revenue, even though it's literally 0%.

Yeah, they're not in the market right now. Yeah, but I think they've identified 40 drug candidates or targets. So that's sort of the goal, get this user-generated database of health information and then use it to leverage either licenses to other firms or develop successful drugs yourself. uh most of their revenue still comes from what it calls personal genome services that's basically just the testing and giving back the results um i think that pretty much covers it i don't think i'm really missing anything there that's sort of the basics of their entire business subscriptions do you want to talk about that they're trying to do that for yeah they introduced a membership but from what i understand all you can get from it is just slightly more extensive

reports. Yes. And they only have 125,000 currently, but it started less than a year ago. So, okay. But I'll talk about the history. So, and Wojcicki, I might be, I'm sorry if I'm butchering that name. I think it's Wojcicki, right? Ian? Yeah, Wojcicki. Okay, Wojcicki. Started 23 in 2006 with Linda Avey and Paul Cusenza. And it was basically the same model that they have today. By the next year, they received $3.6 million in funding from Google and some other VCs, it's worth noting that Ann Wojcicki was married to Sergey Brin at the time. So, and I believe, I'll let Ian talk about it more, but I think Ann Wojcicki's sister, according to Brett, is the CEO of YouTube. He's nodding at me. Okay. Anyway, in 2013,

the FDA ordered 23andMe to stop marketing its tests because it wasn't clear to provide its customers with health risk information. That seems logical. It seems like the same possible risk that Theranos could go through, where you might provide misinformation if you haven't had clearance from the FDA. And so this basically halted 23andMe for four years. But in 2017, their application was approved. Now 23andMe is back up and running. And Wojcicki is still there, if I'm not mistaken. And they finalized their SPAC merger. That's how they went public with Virgin Group Acquisition Corp in June of this year. That is one of Richard Branson's SPAC vehicles. And now I think they've had one quarter as a public company.

Yeah. A little light on the documents. The S1 has some stuff, although the SPAC S1s are a bit tedious. They're all like 300 pages just because, well, it's just kind of the SPAC realm. But I'll hit industry and competition pretty quickly. Genetic testing is expected to reach $10 billion a year in the US by 2027. I would take that with a grain of salt because like with all these research reports, they basically expect every industry or predict, quote unquote, every industry to grow at above GDP levels, which I really would bet the other side that we're going to grow GDP at 10%. However, 23andMe also operates as a pharmaceutical company, like Ryan said, and that is a much larger market at about $500 billion a year. That is why I think they pivoted

from these TDC tests. We'll get into the unit economics and stuff, but the pharmaceutical business seems a lot more lucrative. Competitors in genetic testing include Ancestry.com, Futura Genetics, Veritas Genetics, Helix, Regeneron. There are a ton. There's some that are D to C focused like 23andMe, where it's more of like pick this up for a gift. And there's some that are probably more professional focused like Fulgent Genetics, which we talked about, I believe, a few weeks or months ago. I can't really remember at this point. But the reason that there are so many startups, and this is kind of a side note, is that genetic testing has gotten a lot cheaper over the past few decades. But there's a big but here. It does rely on an arguable monopoly

supplier called Illumina. So they supply 100% of the testing equipment to 23andMe and other companies like this. I think we talked about this with Fulgen Genetics too, where they're supplying 100% of the stuff. So you think that the power might be with Illumina. And I forget the ruling, but there's some sort of regulatory thing that enables Illumina to not have anyone copy their stuff, might be a patent, something like that. And then in pharma, they compete with all the companies trying to develop drugs. I don't think I need to list them all here. There are hundreds out there. All right, Ian, do you want to hit management and ownership? Yep. Ann Wojcicki is the co-founder and CEO, still the CEO as Ryan was talking about. She

owns about 24% of the shares outstanding and is the largest shareholder by far. As Ryan was mentioning, she was married to Sergey Brin. And it's a little bit of an interesting backstory so her older sister is the ceo of youtube um but she first started she was one of an she was an early google employee and she was actually the person who rented her garage to larry and sergey when they were first getting um google start and so she rents her garage to them and then eventually i think sees oh wow this is growing pretty fast and decided hey i want to come work for you and so became one of their early employees um worked her way up as the ceo of youtube um and that's kind of how Ann met Sergey and then they were married for a number of years um ended up

getting a divorce and then after that she actually dated Alex Rodriguez um the Yankees baseball or former Yankees baseball player who's been getting more into the tech world former Mariner too former Mariner that's correct former Mariner former Texas Ranger prime yeah yeah exactly so anyways she kind of has been running um she's kind of she's at the the elite tech circles of the United States, I think it's fair to say. A couple of little points. So she was on Masters of Scale, a podcast with Reid Hoffman, which I think is a really, I think that's a really well done podcast. And if you want to learn more about her, I think that does a good job of her explaining some of what drives her and some of her story. So I definitely

recommend listening to that. And then I would also say about her that it's pretty impressive to have steered the company through the difficult times all the way to the SPAC merger. They've had some kind of ups and downs as a company. Ryan mentioned the, um, the FDA issue that they had in 2013. And they've also, um, they had to fire some employees and slim down a little bit in 2020 when the pandemic hit and, um, around that time. So there's just been, it's, it hasn't been a straight path upwards. There's been a little bit of a bumpy road, but got it all the way to the SPAC merger, which is pretty impressive. And she seems very determined all the stories about her point to that. And then the last thing I'll mention is that on Glassdoor, 94% of employees

approve of her. And that's actually higher than those that would recommend the company, but they, um, all the employees seem to really like her. And so I think that's, that's a positive, um, when you've got someone who kind of purports to be very employee friendly and very determined and, and works pretty hard and sometimes has to make hard decisions, but still, um, the vast, vast majority of employees approve of her so yeah looks like the i mean the track record speaks for itself they've had to navigate some things uh pretty narrow you know make or break situations i guess i'll hit valuation quick market cap is about 3.3 billion ticker me price to sales is about 13.2 based on their full year guidance and then price to gross profit is 25.5 if you

extrapolate last quarter's financials i just took the gross margin from there and put it out i honestly, it was just a bit lazy. I don't think this business is seasonal, but if it is, it could be a little higher, a little lower. I don't think it is. I don't think there's any relevant ratios, lower on the income statement or cashflow at this point. They talk about adjusted EBITDA. I typically like to ignore that. They're right around breakeven, I think on cashflow, but they are going to probably be cashflow negative, but we'll hit the balance sheet later and they have plenty of cash right now. I would note though, that they have about 65.9 million stock options outstanding versus 407 million shares, 16.9 million in public warrants

and 161 million total future shares of common stock eligible to be issued. So I would expect dilution. They have, this is one of the, you know, that's one of the highest numbers, at least proportionally, you know, to the shares outstanding that we've seen. I would expect dilution to be going forward. This is something you got to factor in. All right, Ryan, you want to talk earnings? Yeah. And so overall, the earnings are not very exciting, but I'll caveat it at the end with something that I found a little interesting. So full year 2021 revenue was $244 million. That's down 20% year over year and down 45% from 2019. I think part of that might have been attributable to COVID. It looked – I mean, they had, obviously, the COVID disclosures in their S1, not to mention that revenue ticked down pretty substantially. A 2021 gross margin was 48%, actually up from 45% in 2020. I'll talk about why that was.

They have negative 75% operating margins. All in all, profitability just doesn't look very good. And it's a little hard to know or see how they're going to get there. And they spent 36% of revenue on stock-based compensation in 2021. which was a little absurd. And then Q1 looked a little bit better. Consolidated revenue grew 23% year over year. However, it's still down over two and three year comps. They expanded their total genotyped customer base, but they didn't say by how much. So I think they're at 11.6. And that was 11.3 at the end of the year. So growth has slowed in that regard,

but I think they pulled back on marketing spend. So I don't know what to do with that, but. Okay. And I know they for sure pulled back on marketing spend in 2021 or the last fiscal year, but it looks like Q1 was an improvement at least on annual comps. But here's where I found it kind of interesting. So from 2019 to 2021, first of all, they break out revenue into two components. There's consumer and research services revenue, and then there's therapeutics revenue. Therapeutics revenue is theoretical. It doesn't actually exist right now, or it has existed in 2019 and 2020, but it's gone down to, I think, it rounds to 0% of overall revenue. So from 2019 to 2021, consumer and research services revenue declined by 44%. However,

revenue from kit sales, which is that PGS, declined by 54% during that time. So in that period, revenue from what I assume is database licenses increased by 274%. There could be another contributor in there that I'm not thinking of, but it sounds like they're starting to leverage that database and sell it to other research firms. Yeah. I'm having a little hard time following that, but I think that makes sense if you run the math. That's something that if you're an investor, definitely try to calculate where any of that growth is coming from. Those two, I'll try to explain it, I guess, a little more. Those two, the kit sales and the database licenses get grouped together and kit sales is declining faster than the revenue between

the two that overall okay that makes sense okay the other one is actually improving it looks like um but i'll let ian kind of hit balance sheet liquidity yep so pretty simple balance sheet here um they've got cash of 770 million dollars which is enough to sustain about eight years of the current burn rate so a good amount of cash um no debt about 90 million dollars in operating lease liabilities um and i will just point out that they are keen to highlight strong strong cash position. And it's probably whenever I hear a management team really highlighting something like continually directing my opinion towards something, I try and think, okay, why are they doing that? I assume that they're doing that knowing that there's a lot of burnout and then

also trying to quell investor fears about significant dilution as Brett was kind of highlighting earlier that they want to give the impression, hey, we've got plenty of cash. We don't have to raise money. We've got plenty of cash. We're in a good position. But as Brett was mentioning, there's a lot of outstanding options and warrants out there that, um, even if they don't go to raise any more money, um, will weigh on the, on the overall shares outstanding. And then I just wanted to make a quick point too. We talked about seasonality earlier and it's not a crazy seasonal business, but there is some seasonality, um, particularly in their, their Q4, which I believe is from, uh, January to March. Um, is there a Q4 on their fiscal year?

so that's me so it's like i don't know if it's like um post sorry christmas i'm not sure why that is oh yeah because they don't recognize the revenue until after so christmas okay they recognize in january interesting okay so yeah that's what it is so there's a little bit of a bump typically over the last couple of years in q4 okay all right yeah and the i think another note, I forget what the number exactly was, but they're spending, it's like 65 or 75% of revenue on R&B. So that is going to be high for a long time. And that is because they've ramped up the research on drug development, which is expensive over the next, or sorry, over the last few years. All right, let's take a break. This episode is brought to you by KPMG. As a business leader,

How can you innovate, build trust, and move forward in a digital era? KPMG can help by bringing together the right talent and technologies, generating insights that spark opportunities. To explore their thinking, visit reed.kpmg.us slash opportunities. This episode is brought to you by La Quinta by Wyndham. Here you are miles from home and ready to start your vacation. Good thing you're staying at La Quinta by Wyndham. They have free high-speed Wi-Fi to stream all your favorite movies. And in the morning, get fresh waffles with their free Bright Side breakfast.

Or squeeze in a workout at their fitness center. Either way, you're ready to conquer the day. Tonight, La Quinta. Tomorrow, you triumph. Book your stay at LQ.com. Okay, welcome back. Next up, we got anecdotal evidence. Ian, looks like you got something for us. Yep, so I got a test about four or five years ago, actually. just an ancestry test and I typically wouldn't have gotten one but I had a family member who

was doing a little bit of genealogy work and asked me to get it and so I was like okay you know and she even bought the test for me so I was like yeah I can do it um I will say that like it's kind of cool to like get the app on the phone and see oh you know this is where you know I always was curious exactly kind of whether I was more Scottish or Irish or English or whatever or German um so being able to kind of see that it's been kind of fun and interesting um but like the type of thing i've pulled out like three times and looked at i will say that it's interesting because the data has changed and gotten like more specific and better it's probably not the right word to say changed but the ancestry data has actually gotten more specific over the years and so

when i pull it out whereas there used to be like larger swaths of my ancestry that would just say like broadly northwestern european now it will actually it's honed in a little bit more and it'll even say like within england um it'll say like oh you know primarily from like the london area or things like that and so um they seem to be getting because they've gotten more data they seem to be getting more honed in on some of the ancestry data but kind of cool to look at but um definitely don't feel any like great allegiance to the brand though or anything like that it's it's been a fairly minimal piece of my life right no you're not thinking i'm going to subscribe to this whatever monthly or yearly thing no not really and i didn't get any of the health testing

when i the test i got was just the ancestry test and i think i could go in and add you know pay for the health test now or something but um that hasn't been something bob done right i suppose those members are probably or the subscription is probably for the like the family members that you just referenced the ones that are trying to do a whole bunch of genealogy work or uh ancestral stuff yeah but i think it's for health mostly so i think it's more made for people that are worried about their health that are it's probably they're probably older than us but yeah ryan do you have anything or no yeah nothing i don't know uh i would just say that when when there's a product like this where like the the pitch is that everyone's going to get something or like

everyone's going to get one of these tests that's kind of what management says uh you have you should really ask yourself like all right how much do i want this thing and for me i really don't have any, I've never thought like, all right, I'm going to get one. Like, I don't know. It's just never passed my mind. And maybe my hurdle is like different than most, but I don't think so. I think a lot of people have that same thought where they're like, eh, there's not really much value there. So I think that's a concern I have at least anecdotally. And I think that kind of plays out within their marketing spend, because it seems like the only way they can grow revenue, at least from the kit side is when they spend a lot of money. I think this is something that probably

you garner as a customer you garner more interest in doing something like this with age yeah probably um i don't think it's really targeted for 20 year olds but i could definitely see how the it's pretty clear how the business model benefits from scale um and how it would be able to scale the more data the more complete their ancestral diagrams the the better their database the more uh exciting it is to license it to other research firms yeah that seems slightly theoretical for the time being but yeah i just well i guess we can talk about that later and what we like and don't like or any questions but future growth opportunities ian what do you have yep so i've got subscription service for my future growth opportunities um as we've discussed already it's

29 a year and provides access to exclusive health reports and then also some enhanced ancestry features and so there is a little bit of an ancestry component to it um i think that it's probably a low enough price that users who love it who love 23andme and everything it does make it into it. But for users like me, for just the average person who just got the test, I don't really see the value proposition. And to use the test that you were just using, Brett, I have no interest in purchasing it. I think you mentioned they've got about 125,000 subscribers currently. That number is probably a little bit lower than it could be because it's been more of a soft launch. They haven't really spent the marketing dollars behind it to push it

and really try and get people to subscribe. But I think that's probably because they know it's not going to be a big piece of their business. So this is something that they're doing, but I don't think it's the major growth opportunity with this business. Yeah, it seems like the value isn't there yet, but you can envision a world

if they really execute well on this database stuff and getting all the research and the insights on that. There is a world where you think, wow, you can provide a lot of value there. So many like ancestry things and so many health related things. It could almost be in conjunction with those bans you have or whatever, the health monitoring stuff. That's a little bit overhead technically-wise, but you can see a world where that could happen.

But from our view, at least, it seems far away. All right, Ryan, what do you have? Yeah, I initially had the subscription service jotted down as well. I kind of took it away because I had sort of the same worries, I guess, as Ian, which is I don't necessarily see the customer value prop there. Um, so I changed mine to targeting more pharmaceutical manufacturers or pharma labs. Uh, right now, I believe the majority of the revenue from that segment comes from what they said is their GSK agreement. So yes, that is a, it's exclusive till 2024 or 2023.

I can't remember the exact date. So it has to be. Yeah. Are they only allowed to license it to them? Currently until 2024. Cause GSK, which is, uh, I don't know, they're like a $30 billion company, but they made an equity investment in 23andMe. So, I think that was part of the deal.

Okay. Well, I guess once that expires or hopefully ends, either they get a new one or get a new extension that's worth a lot more or they're able to reduce concentration risk and add a lot more pharma labs. I think that's really the goal here is the value is all in the database. So leveraging that the best way you can, which because I don't have any expertise on their actual therapeutics and I have no way of telling whether something's going to be successful or not, it seems the most valuable way to do that is to license it. Yeah, we should hammer on the point that the kits seem like a bad business, not sustainable on its own. So it's really all about leveraging it into other products and services. I'll mention the other one, which is a cancer drug candidate they have called P006. uh i don't it doesn't have a marketable name yet since it's not you know past all the fda or

whatever yeah i think it's probably has something to do with the dna strands or whatever but it's supposed to treat tumors uh before they turn cancerous or deadly uh so like if you didn't know like tumors can be benign i think a lot of people know that but if this helps with that it could possibly be very useful for you know treating certain cancers uh in someone's body before or they become deadly. They have no information besides that. It's still pretty early stage. They do have actually, I think this is a good note. They had a lot of transparent information about the actual science behind how they find it and then how they're developing it and why this certain drug works. However, I think you guys are in the same boat here. I couldn't get

anything from it because it's way over my head. But if you understand that stuff, I think they're pretty clear about it. And those are good signs that they're not trying to be sketchy or misleading about their drug development. They're being very open about it. And I think they have a hundred scientists on staff. So they're really investing in all these, they have 40 candidates and I guess P006 is either their first or second one coming down the line. They're all preclinical. Yeah. They're still, none of them are even close to phase three, the last phase trial, um which means they're gonna have to spend a lot of money but like ian said they highlight they have over 700 million dollars let me invert that if you're a shareholder would you prefer

that they keep that secretive uh or what they're developing yeah um oh i don't think it's the secret sauce like they wouldn't do that but they're like explaining something without saying you know they're kind of because i think it's a new way of going about it but they did give more detailed stuff than say some other drug manufacturer that you're looking at i think the real question is though is it smarter to license out the stuff to other companies or if it's truly an advantage a competitive advantage why not keep it in-house yeah it's possible uh highlights low lights yeah yeah the main highlight for me is i think that they're right about the problem and and kind of the trend towards preventative medicine that people are going to want to rather

than just treating things after we know about them actually treat things like before they occur or right as they occur um i also think it's pretty impressive that the company is still around and has built such a big and broad database but for me a few of the low lights or the focus i think may be too broad i'm not sure what their core competency is and as we've talked about they're trying to get more into this pharmaceutical um this pharmaceutical development but that doesn't seem it doesn't seem like anything they've done in their history has really prepared them for that necessarily um they just happen to have the database and now they're trying to like i'd like it much better if they could just if the licensing was just really valuable that they could just

license it to other people and that was just a super valuable piece of business but i'm i'm not convinced that that's the case. Um, a couple of other low lights, just poor recent numbers. And then I, I am a little bit worried about just the ethical and legal implications of collecting all this data and, um, on people, right? Like I, I, even when I got my test, there was a little thing in the back of my head that was just thinking, you know, I hope no one, you know, I hope this data doesn't end up in the hands of the wrong person someday, you know, um, or gets, gets used against me in some way by an insurance company or something like that someday so um you know i think there's just there's a few few little yellow flags yeah that's why i don't that's kind of i

think a lot of people that's why i didn't want to get it ever again and the uh the way they market the consent button on their website is a little strange to me which maybe that's one of my low lights is they they're like 80 of people consent and then they've got like this glowing green button that says consent and then like a tiny link that says do not consent and i don't think people know exactly what they're consenting to and where that data might get shared that doesn't stop the internet companies in the past they're just running some ab tests whatever works all right uh highlights for me a user a user generated database sounds like an attractive model um and the room uh the remaining revenue that's not included from the kit sales which is the

research services revenue seems to be growing at a pretty impressive clip. The more I think about that, that might be integrating the subscription revenue. I don't know how valuable that is, but there is something to be excited about in there. Lowlights for me, overall revenue is declining. The kit business in and of itself, everything else feels a little bit riskier, hypothetical within the business um like building out this really really powerful database uh betting that maybe they produce a cancer drug that's uh effective whereas the kit business is really sort of their bread and butter i don't like that part of the business the lifetime value unless they're a subscriber is pretty low yeah oh it uh it's a i think it's zero i think it's zero

Yeah. I mean, if you have to spend all that on marketing. Yeah. I mean, the drug development part adds risk for sure. Highlights for me, I mean, with all those, you know, things we're saying, the negative aspects, it is a fast growing industry. Maybe we're a bit early. Maybe this is going to be ubiquitous. They have the biggest data set among competitors. And the upside from drug development is extremely high. Again, I don't know, for reference, I don't know the industry that well, but I think their chief scientist or whoever is in charge of that part of the business said on the conference call that it was kind of unprecedented. I don't know if he used that exact term, but to have 40 drugs in development at this young of a company, and that is because they have this database that they can go off of. I don't know whether it's just because they're kind of doing a spray and pray operation, and I don't know whether they can do that

without the database, but they're saying it because it's correlated. So that could be great. That makes me think that Ian's worries are valid, like that they're just spread too thin. 40, yeah, 40 candidates seems like a lot for a company that is just starting this. They do say they have 100 scientists on staff.

My first thought of that is like, okay, that's impressive. You convinced all the scientists to come over, but two, that sounds like a lot of salaries and you're going to need to get some development in there. But they have so much cash now. They do have a lot of cash. We have, guys, we raised a lot of cash that we can burn. Don't worry. It's a good business. All right. Low lights though, for me, the kit business, like we said, is bad. It's clearly bad on its own. And they are relying on two pivots to succeed. So that's adding risk, like we just discussed. And then lastly, I mean,

a lot of dilution here, potential share count, or excuse me, share count could double, I think, in a decade. That's kind of what could happen. They may slow down their granting pace and they may do a little bit less, but I could see it totally doubling. And that kind of means like, if you're looking at it, all right, I'm going to hold this thing for a decade. Am I buying it at a $3.3 billion market cap or am I buying it at a $6.6 billion market cap? That is a huge difference. Well, it's actually good because it'll improve their earnings per share. Well, okay. True. They're negative. That is true. The beat is working in the favor of the shareholders. Adjusted EBITDA could get higher than gross margin, than GAAP gross margin. I've

seen that. Tesla's pretty close, but on earnings per share, yeah, that is a bit of a loophole where they can beat on negative earnings per share. I think the stock soars. That's always a good little quirk that happens, but let's move right into bull case. Ian, what do you think would go right here? I think for this to go right, that it becomes a replica of Facebook. And what I mean by that is that there's a lot of questions right now about how monetizing this data is going to be feasible. It seems pointless. It seems like there's not really a great business here. But five to 10 years from now, it may become clear just how valuable this database is in a way that it's not currently clear. I think that's, you know, it's a little bit with Facebook, there is a little bit

more for people who were looking into it at the time. There's more ideas that, okay, it looks like they are on the right track. They have an idea about how to monetize this. I think this is a little bit in an earlier stage than Facebook when it became a public company, but it just, I think there could be a case where this data actually is much more valuable than we're giving it credit for right now. And it's not exactly clear. And I don't think they know exactly who pays for that value though right ryan yeah a lot of what ian just said the bull case for me is sort of this health health data lollapalooza where you have a lot of things working in tandem and working for you where you've got this user-generated content essentially or user-generated data people are the

more the database expands the more people want it the more that you can fuel your therapeutics business. If you have a few successful drugs, um, it begins to work even more so in your favor. Yeah. The upside is there's a lot, there's clearly a big upside, but obviously a lot of risk to caveat that. If you, if you know how profitable a drug can be, I mean, this could be a trillion dollar business if they're, if they're right. I'm not joking. If they, if they have like 10 drugs that are all super profitable, I mean, that's, you know and then leverage that i mean it surely is high but it's a huge if it's a huge if i and i think you know i don't know how much risk there is i think i mean i think there clearly is a lot

but my bull case is you know the database like you guys said it gives them an advantage uh you'd have to rely on management to be smart enough to use that advantage correctly and the best way to make money over the long term is it to just do all these drugs internally or is it best to license it out to these manufacturers, or I don't even think it's manufacturers. It's just drug developers. I don't know, but they'll have to make that decision. And then I think you got to ask, you know, they're putting money into the subscription product. Yeah. I think it's got to get to at least a million, probably a few million users for that to succeed as well. All right. Bear case. We've identified this a little bit already, but Ian, what do you think you go wrong

here? For me, the biggest bear case is that genetics never becomes a major component of preventative medicine and that it captures a relatively small piece of the value chain that most of the value in preventative medicine comes from not knowing my genetics being able to develop drugs for that but rather it comes from wearables and continuous monitoring and things like that that's just keeping track of me rather than something that's um rather than anything that's actually um from me right it's not about my genetics it's just that i've we've were tracking me and i see an alteration of my my uh blood pressure or something like that so i think that's the fear here is that this this database actually just isn't that valuable

right and what about this could i'm trying to think of this now this either is an advantage or a disadvantage the gene editing stuff i think that also could be a threat because if you can edit your genes to cure disease doesn't that make the database like obviously You need to know what the mutation, the mutation like hurts it. But I don't think that's, you know, that's not proprietary to 23andMe. So I think gene editing kind of throws in a possible wrench here. But again, if there's an expert on this listening, you may be saying, no, no, it's the opposite. It's going to help them.

But either way, that's another variable thrown in as well. All right. Bear case for you, Ryan. I think the spread here between the bear case and the bull case might be as large as any company we've looked at because the floor is bankruptcy. The floor is that they've burned through all the cash that they have. And there's, I mean, you could lose your entire investment. They don't really, I don't see all the points that we've pointed to, all the good possible things are still kind of in the future. And right now it's a cash burning business. If that persists

and the database isn't as valuable as we've been discussing, yeah, bankruptcy is definitely possible. Yeah, I'm in the same boat. Ian, do you have something? Yeah, I was just going to say, I think it's an interesting thing and what Ryan just brought up that what we've really got here is we've got an asset that no one knows the value of, but it's currently not an asset that's really cash flowing

or not cash flowing very much. And so that's the big question here is how valuable is the data and will it ever cash flow to a number that makes sense, right? is it and i think that's just what everyone's trying to figure out right now and it's it's interesting to see it in the public markets yeah and this is definitely not advice but this this makes me feel like i should buy put and call options long-term puts and calls what's funny is they didn't really emphasize that in their s1 they didn't spend that much time talking about it they talk about what uh the value of potentially licensing the database so it's because i think

the exclusive thing and i think they're pivoting to in-house that's what they're trying to do make it exclusive over the long term if they're successful keeping it exclusive is better but licensing it could be a lot more profitable if they do that and they don't develop a single drug uh then they're screwed yeah yeah all right my bear case similar as yours but i'd say subscription product that's a dud i think i'm leaning towards probably a dud uh that will hurt them doesn't kill them and then if the database doesn't give them advantage like you guys said that's my better case as well um but i get worried when a company says no no no don't worry you know we're burning cash now but we got big data it's like no no no no like come on

like i'm not going to invest in something just because they say no no we got a date advantage i just whenever someone says that or if that's supposed to be the bull case that gives just a huge i don't know that's just a big concern for me because it's one something that is unpredictable to me two you have no idea whether it's going to succeed or not why has it not become an advantage at 11.6 million like isn't that enough i would think that's enough statistically you know you also haven't seen we don't know the value of uh competing databases or competing services i guess so it's kind of hard to uh yeah yeah the big data is just it's uncertain like all this ai stuff it's all feels very dot commie to me because it's like no no

don't worry we got big data it'll be fine eventually it's like all right it's kind of Kind of like the users and eyeballs stuff that, you know, it worked for companies in 2010, but in 1999, it was all kind of BS. All right. More or less interested. We may have foreshadowed this a bit, but Ian, what do you got for us? Yeah, I'm less interested. And the big reason is this is the type of business that I sometimes do like to take a little bit of a swing on when it's got some sort of future that is very uncertain, but has a lot of upside. But a lot of times when I take a swing on a business like that, I like to do that when it's like a piece of the business that has a lot of upside, but is uncertain. And they've got some sort of core business that's still generating a little bit of cash flow, kind of provides a little bit of a floor and provide some funding for that growth opportunity. With this, I don't see any proof of a great business anywhere here. And like I said, I think we're yet to see the value of this data, this data network or this database.

We will see it like we'll start to get some data on that as ironically, but we'll start to get some data on that as the as these drug starts start to be developed and see if that actually leads to anything. If they still don't, they could start pumping out, like you said, Brett, some like great drugs that this data gives them an advantage in creating and developing that none of us are foreseeing right now. But right now, there's just not a great business here that I can really latch on to at all. And it's just a little bit a little bit too speculative for me. So I'm less interested. Yeah, look at the market cap of these drug developers once they get profitable. Some of them have one. There's someone I knew from earlier in my days, when I was younger, when I was a kid, that has a company that has one drug, basically, and the company is like a $15 billion market cap or something like that, maybe a little lower. But the companies that have multiple, I mean, you're saving people's lives. It's a bit morbid, but it can be extremely profitable because of the value they're providing.

Ryan, what are you more or less interested in? I would like one of us to be more interested, but I think it's going to be consensus here. I am less interested. I might read their earnings reports in the future and kind of just keep up with it. But the exciting part of the exciting part of the business, I would consider outside my circle of competence. Yeah, for sure. I think we're all in the same boat here. We would love to have an advantage in biotech, but we don't. We don't. We can't pretend. And we take years to get there. And if you want to do that, you can study for that. But, yeah, I'm in the same boat. Less interested. You can easily see this being a huge business someday if they're correct.

if they're pumping out drugs at an accelerated rate. I think they said that the typical drug takes seven years and they're on pace for like two to three years. So if that holds up, that could be great. We could definitely be eating our words here, but I'm less interested because of the downside risk outside of the circle of competence. I will highlight though, and this is yes, highlighting our sponsor, 7investing. If you want to learn about this stuff, I would seriously outsource it to 7investing. They have, I think, well, Max, he's the core guy that works on this. They also have Dana, who is in healthcare, who knows about this as well. And Simon, who is a jack of all trades, knows a lot about this as well. I am sure

they have stuff on this industry on their service, well worth the money if you're interested in this stuff, because we could be missing something here. You could be missing something here as listener and if you're really interested in biotech i honestly wouldn't buy like an etf uh i would subscribe to sound investing and just follow their picks i was thinking about asking max or shooting him a dm about 23 and me just to see if he looked at it but i forgot to so yeah all right well that's gonna do it stock for next time ian what do you have for us stock for next week i think we're going for uh twilio i've been doing a little bit of research on uh jeff lawson and i'm kind of curious about taking a deeper look at the company so nice sas we're not even sass cloud

apis what's it called uh yeah ipa as a service we're just doing so much communication as a service there we go yeah no great i mean great company gosh that's one that i don't know it's just been a huge winner it's just been a monster i think we looked at them three years ago so when and they have to go reference. Yeah, I did see that back. I did a quick Google search to see if you guys had ever talked about it. And it was, I think, back in 2019.

So that's when we were really bad. If any listeners want to go check it out, you can do a quick Google search and hear what they were saying in 2019 about Twilio. Yeah, I am sure it's a lot. It's way worse than the shows are now. I can guarantee that. But if you want to listen, get a good laugh, do that.

But that's going to do it for this episode. Thank you all for listening. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next time.