Chit Chat Stocks - Fulgent Genetics (FLGT) | Not So Deep Dive

Episode Date: August 31, 2021

Fulgent Genetics provides genetic testing services, including COVID-19 testing, to physicians. The company offers clinically actionable diagnostic information by making use of data comparison and suppression algorithms. Listen closely as Ian, Brett, and Ryan go through the history, financials, and future prospects of Fulgent Genetics. 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 7 Investing with the code "CCM": 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 | (2:40) Industry | (6:32) Management & Ownership | (8:32) Valuation | (10:17) Earnings | (11:27) Balance Sheet | (13:32) Our Analysis | (14:56) 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 on Chit Chat Money, a show where you can learn about the basics of a stock in 30 to 45 minutes.

We have Ian Gray on the show today, and you're back. Well, you know, I think you had one week off with your busyness with work over the summer, but you're back, not doing the full hours over there and ready to put all your hours back into chit-chat money, right? Yep, exactly. And I just got back from a quick trip to New York City as well, where got to walk down Wall Street, check out the Raging Bull, and ready to dive back into the stock market now. Right. And we're going to be talking about Fulgent Genetics today. This is something that I don't know if a lot of people have heard about. It's kind of had a wild ride this year, but I'll let Ryan introduce that. But first,

we have to talk about our sponsor for the Tuesday episode, Potential Multibaggers. 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. If you want an insight into the person that manages the funding, you should listen to our Fiverr show that we did about two weeks ago. Or when this comes out, it might be three weeks ago. It should be right in the feed there. Chris is the guy that runs the show there, or sorry, he runs the service there and he was on that episode. And if you think 26% per year is audacious, their track record has actually been double that so far. More than double, if I'm not mistaken.

Yeah. Either around double, either way, really impressive. They picked Shopify at 77, Sea Limited at 54, Cloudflare at 39, et cetera. Their picks aren't perfect, but they have a strong, strong track record. If you want to become a multi and join the service, You can go check them out at Seeking Alpha. Look for them for From Growth to Value on Google or Twitter, or go to at From Value on Twitter. They do a two-week free trial, so you can check it out, see if it fits into your wheelhouse or your research process or your investing style. If it does, you can stay on for full time, or you can just leave it. They're very lenient about that type of stuff. All right, Ryan, do you want to introduce Fulgent Genetics?

Yeah. And so as Brett mentioned, this is a little out of our typical wheelhouse. And so we're going to try to kind of define what the business does, but it's a very scientific product and we don't have total understanding of it. But I'll go ahead and be the biology teacher for the day. And so Folger Genetics is a genetic testing company, and they're focused on transforming patient care for oncology, which is the study or treatment of infectious diseases and reproductive health. um essentially it's they have testing technology that helps identify patterns or reference to other dna sequences to help find uh diseases essentially patterns study stuff making breakthroughs all that stuff yeah and so i'm gonna i'm gonna go back to high school biology for a second so if someone takes a nasal swab and on that nasal swab there's dna

molecules comprised of different chemical building blocks. I looked this all up this morning, so I'm an expert. There's, remember the little double helix, the ladder structure with the nucleotides? What is it? A-C, A-T-G-C. I think those are the different chemical building blocks. Well, those sequences, when they're referenced against their sort of library of different disease DNA sequences, you can kind of highlight and you can find out which of those might indicate a disease so yeah there's mutations like if it's different than some typical person you know right if you can't tell by now this is why we say it's somewhat out of our circle of competence uh but fulgine genetics has an enormous test menu essentially so they have

more than 18 000 single gene tests and more than 900 panels that collectively test for more than 5700 genetic conditions so the test results are referenced against their massive gene library using Fulgence, and I'm putting this in air quotes here, sophisticated proprietary data comparison and suppression algorithms. Basically, they have a giant library. They're cross-referencing any DNA sequence or tests that they get in to see if they have a disease. And the reason that this gained so much notoriety is because they offered tests to detect COVID and they grew rapidly, like 2000% revenue or top line growth over the last year. So that's kind of, we're seeing what can sort of sustain in the business model. If this will be a long, good investment

from here on out, I think they're down 50% from their highs, the stock is. So it's kind of just in a unique situation. And then they sell to different customers that they classify into three groups or three different payer types. So there's insurance, and then there's institutional, which is hospitals, medical institutions, laboratories, government bodies, large corporations. And then there's patients who pay directly, which I assume is just people without insurance. Those are the three groups that they sell to. As far as history goes, they were originally founded in 2011 by Ming She. The company launched its first commercial genetic test focused on rare pediatric diseases in 2013, and its test covered more than 1,000 genes in 100

panels. Today, the company contests for more than rare pediatric diseases. It's cancers, cardiovascular diseases, neurological disorders, and then we'll talk about another one on the second half. But Shea has served as a trustee at USC since 2007. And I know this is kind of preferential. Most people might not care about this, but I think he was well off financially prior to founding Folger, which I tend to like just because he probably is less self-serving. And then in 2016, the company did a reorganization where they acquired their own subsidiaries. This basically was just to become a holding company and have a better corporate structure. And then right after that, they went public. So they've been public now for five years, roughly.

All right. Yeah, that's a good overview. I'll hit industry and competition. There's two industries here that I'll go over them separately. There's COVID-19 testing and the next generation sequencing, which we may reference as NGS. So the NGS industry is projected to grow to $35 billion a year by 2030. It is a lot smaller now. So I would caveat that with all these research reports I look up, they say every industry is going to grow fast, but I think gut check, it's probably going to go pretty fast. NGS competitors, there's Myriad Genetics, Progeneti, which is they're trying to do pro genetics and then something. It was a really bad name. One of the worst names I've seen when looking up competitors. There's Guardian Health, which is cancer testing and diagnostics. There's

Castle Biosciences and then plenty of others. If you know about 23andMe, that is not necessarily a competitor because Fulgent is focused on physicians, not necessarily individuals. individuals, it's like a tiny part of their revenue. So 23andMe, if that's a company you know well, Fulgen is more of the commercialized part of that. 23andMe is for personal stuff. And it sounds like what Fulgen does is a lot more complicated than 23andMe. I'll have the COVID-19 testing industry. That is estimated to be about $60 to $85 billion in global spend in 2020. As everyone probably can figure out, there's a lot of uncertainty around the durability of this market. And then there are hundreds of COVID-19 testing companies

out there. I guess Abbott is a big one. Fulgent has won some sizable deals. It seems like they executed really well going into 2020 into getting all these deals with New York public schools, LA County, stuff like that. And then Fulgent, I will mention, is a customer of Illumina. So if you know about that company, Illumina sells their products, their NGS stuff to Fulgent, and they use that their reagents that's kind of their inventory and the machines they have to use so alumina is like one step back up in the supply chain um all right ian you want to hit management and ownership yep ming shea is the founder chairman and ceo um prior to fulgent he founded a biometric id company called cogent which he sold to 3m for almost a billion dollars it was

actually close enough that i thought why couldn't you just get to a billion dollars and call yourself a unicorn at that point, because I think it was like $980 million. But anyways, he sold that company. So like you're mentioning, Ryan, he was fairly well off for a while now. He's originally from China, and his family was actually persecuted during the Cultural Revolution there. He and his family fled to Taiwan when he was around 10 years old. And so his formal schooling ended at that time. But he started working with his father, who was an electrical engineer and assigned to bringing power to a remote village. When he got a little bit older, he went to USC and got a degree in electrical engineering, both a bachelor's and then also a master's degree. And after that,

he's really made some generous gifts to USC, including naming the engineering department, I believe. And so he's pretty charitable, actually, from what I can tell. He's made quite a number of gifts, both to USC and to some other organizations. today he owns about 27 percent of shares outstanding and insider ownership in total equals about 30 percent um blackrock is the biggest institutional owner with about 10 percent of the company so he's definitely got a high stake in this company and cares about its success but as we were talking about earlier he's he's had some previous success um in his life too and has a pretty remarkable story to get out of china and um and to build these great companies after that

Yeah. And we'll talk about China later. They have a big joint venture that they're trying to do, or it's been around, but there's some news that happened recently with that. We'll hit that on the second half. But valuation, I guess I'll hit this quickly. It's going to be a bit interesting because the number is going to look really, really strong on a trailing basis. But market cap is $2.68 billion. Ticker is FLGT. Enterprise value is actually a lot lower though. It's about $2 billion due to the heavy cash position. EV to sales of 2.2, EV to gross profit of 2.77. So they have really high gross margins. And then EV to trailing operating cash flow of 4.4. So dirt cheap, but we know that there's uncertainty with COVID. So if you exclude

COVID testing sales, forward EV to sales is 18. Not crazy bad for a company growing that quickly. And I don't get into the earnings, that part of the NGS part of the business is growing quickly, and it has high margins, but the valuation might not be as cheap as people look at first glance. Share count is going up a lot. They have raised a lot of cash and I would probably expect this to continue being a headwind if they're going to be acquisitive. And it seems like that's going to continue to grow. It's not necessarily a bad thing, but you have to factor that in. It's probably smart to look at revenue per share, free cash flow per share, earnings per share, stuff like that. Ryan, do you want to hit earnings?

Yeah. And it's probably best to give the second quarter numbers overall, but I'll give a quick trailing 12-month figures just so everyone has a general idea. And so they did $909 million in trailing 12-month revenue. That was up nearly 2,000% from the period a year prior. And on that, they generated about 80% gross margins and about 73% operating margins. So I think maybe this is the greatest single year I've ever seen for a business. Good execution. Maybe Upstart. Upstart was what at that? A hundred thousand. But yeah, I guess perhaps Upstart's better. But second quarter, we started to see, I mean, some of the numbers still look out of whack

in terms of comp. So total revenue was 153.6 million. That's up 790% year over year. But I believe their Q3 revenue guidance came back down to earth. It was something like 30% revenue growth. But even they, any guidance that they give is a little, on the COVID specific stuff, it's a little susceptible to changes because I don't think they even know really what's going to happen.

But their core revenue, which is the NGS that we talked about, that excludes COVID testing was $25.7 million. And they are guiding for $110 million in NGS revenue for 2021, which would be 201% growth versus 2020. So really strong growth in their core business. Some of that's inorganic though. So look, they have a chart in their presentation. It's not 200% organic, but still pretty impressive. Yeah. And then for the quarter, they had operating cashflow of 76.1 million. So just about 50% operating cashflow margins and then gross margin improved by 21 percentage points year over year. So an incredible year. And I think the most promising part of that is the

growth that they're seeing in their core business and sort of what they're trying to bolt onto it. And ultimately, this is a business where we're going to try to get to is whether or not they can capitalize on the great year and kind of make this more of an enduring company. Yeah, for sure. Ian, do you want to hit balance sheet? Yep. Fullgen has about $715 million in cash and marketable securities. When you take into account the cash hit from a recent acquisition they made, the CSI acquisition. The marketable securities are mostly bonds or different types of debt securities that they've bought. So not like they're out there making super risky investments or anything like that. They should have plenty of cash

available for more acquisitions going forward with this huge cash balance and already being a very profitable business. This isn't a business that's burning a lot of cash. They're not burning any cash at all actually, but they only have $5 million in notes payable and about $15 million of a margin loan at 1% interest, which neither of those are concerning at all. Basically for all intents and purposes, it's a debt-free or very close to debt-free company. It's a cash rich company and has taken advantage of the rising share price to become a major player in this NGS market. And I think there's a question, like one thing we'll probably talk about in the back half of the show is how much of the cash that they've been able to generate

through this COVID business is going to help them really have some staying power and grow into what they consider more of their core business going forward. So anyways, currently the balance sheet looks very strong and no concerns there for me. Yeah. All right. Let's hit the ad 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 lakinta by windham here you are miles from home and ready to start your vacation good thing you're staying at lakinta

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you triumph. Book your stay at LQ.com. Okay, welcome back in. Next up, we have anecdotal evidence. I got nothing. Ian, do you have anything for us? Not currently, but I am moving back to LA this week, so I might have uh because they've got a deal with la county i may have a may have to get tested at some point

and might have some experience with fulgent hopefully fingers crossed i won't but um i may have some experience in the in the near future but the thing is we don't know what like i think we've all had covet tests done but we don't know who that testing technology is right it's just in most cases it's yeah but they said i mean they signed with la county so it could be them okay so they're one of they're probably multiple providers but um yeah ryan do you have anything i mean i no i don't like covet tests they are irritating but they're not that bad it's all the way up in the nose but whatever i mean you didn't have to do that you didn't actually have to do that that wasn't you didn't have to do that the you just put it like well

it wasn't up to me no i mean oh someone did that to you well that's uh that's uh that nurse you you know, I don't know. You might've got a bad nurse, but all right, let's say future growth opportunities. Ian, what do you have for Fulton? Well, in that vein, I actually think a future growth opportunity is more virus testing. They were really able to capitalize on the need for COVID-19 testing in the past year and a half. And it seems to me like virus testing might continue to exist for this coronavirus, for future coronaviruses, and possibly for other viruses that people start to realize, wow, it's kind of helpful to have tests for. Um, this growth opportunity doesn't necessarily mean that Fulgent revenue will continue to

grow year over year on top of what it currently is, but it doesn't mean that the current revenue might not need to be discounted as much as it is, um, that that current revenue may actually be a little bit more durable, whether with coronavirus testing or with some other sorts of virus testing that they, they were very opportunistic this past year. And I think if we think that the management team is going to be good at that, there may be other opportunities to continue to, to drive some growth out of virus testing. Yeah. And if you're listening to this and thinking, all right, what are the, what are analysts expecting? I'm looking at Coif and it looks like the consensus for 2022 is a 50%

drop in 55% drop in growth. And then in 2023, the consensus is for 48% drop in sales. So if you think that if you're listening to this and you think, okay, maybe that is a way too pessimistic, There could be an opportunity here, but always do your own research. All right, Ryan, what do you have for your future growth opportunity? Yeah, on the fourth quarter conference call last year, Ming-Shea stated that they expect M&A to be a potential avenue for growth moving forward. And they demonstrated that in this most recent quarter with their acquisition of CSI Laboratories. So CSI, I couldn't tell you exactly what they do, but it sounds sort of along the lines

of what Folger Genetics does, except just provides it for cancer diagnostic testing. And so this is just an easy way for Fulgent to expand their test menu to essentially offer anything. And I expect them to do a lot more of these little bolt-on acquisitions where they're just enhancing their offering. And they've got, like Ian said, $770 million in cash marketable securities. They're going to generate more this quarter too. Yeah, I could see them gobbling up a lot of those sort of niche competitors. Yeah. And then two things to note on that. They said CSI is profitable. And I think, I hope I'm not getting this wrong, but on the conference call, they mentioned they're trying

to do a comprehensive virus test. So that could be interesting where it can do not just a COVID one, but you do it and it's like all sorts of type of flus and stuff like that. That's something that I think they said they were researching, but I would follow up and read about that yourself. Ian, you have something? Yeah. I was just going to make one more comment on this CSI acquisition. They talked on the conference call about how CSI is really focused on the Southeast and they're basically going to try and take all the technology they have in the Southeast of the United States and build a similar laboratory on the West coast so that they can reach, um,

a lot of those West coast, uh, doctors. And I think that there's a little bit of some regional, there is, there's a little bit of regionality to these types of businesses because people want their tests close so that it can be fast. I think that transporting sometimes some of these, um, uh, specimens i assume are going to like sometimes having close testing centers is good and so they basically want to take what csi has been able to do in the southeast and recreate it on the west coast and i think going forward like ryan was mentioning some of these bolt-on acquisitions

are going to be like that where one of their officers said hey we really like to do some of these build or sorry buy instead of build it ourselves because we can go buy these companies that have all the technology and then just get it out through our entire network rather than have to build all the technology ourselves. So I think that's something we'll continue to see going forward. Yeah. And it just, it also just builds up that NGS segment, which we talked about that, that added some inorganic revenue growth to the NGS segment, but ultimately that's the durable one. Yeah. If you can acquire your way to building you know, that core business, building that up, it sort of de-risks the overall company.

Hopefully, yeah. And using that cash that they generate from COVID, it's kind of like a little, like a short-term cash cow. And I mean, with the Delta variant, they probably would be upgrading their guidance here, but who knows? It's kind of based on, they have different contracts. So just because cases are going up doesn't necessarily mean that Fulgen itself is going to grow. But that's interesting. You also said, Ian, because it seems like their sales team has executed really well. I don't know what it is about their sales team, but if you attach like CSI and some other companies they buy on top of that, I don't know. It just worked that magic again. I mean, short-term growth opportunities are the Delta variant and anti-vaxxers.

Yeah. Well, it's just durable COVID. And that's part of one of my highlights or maybe bull case is that it's always been a smart bet to say that COVID is going to last longer than the consensus and if that continues then people are probably underrating just two weeks if we that's exactly the two people yeah exactly that's that's kind of what i'm saying there are i'll hit mine and it's kind of similar with the acquisition thing but they're taking controlling stake of ff gene biotech which is their chinese joint venture this will bring the same u.s tools they have to china i don't know if they're allowed to do csi or this helio tech one that they've made an investment in that we didn't get to mention because they've made a lot of investments, but

that market is projected to hit about $4.5 billion in spending by 2030. Again, I kind of put on my arms like, eh, it sounds like it's going to grow quickly and that's a big opportunity. The joint venture has done about $10 million in sales, so fairly small versus Fulgen as a whole, but they believe that it can get to $5 to $10 million in Chinese sales in the back half of the year. So they're really optimistic about this. It seems like they're investing heavily. We can talk about how much if that adds some uncertainty maybe in our highlights and lowlights and bull and bear case but let's move to highlights and lowlights i think that i think that 2030 spend number you referenced might have been 45 billion instead of 4.5 did i read that wrong could have been 45

billion they that would be very optimistic because though the numbers i looked up which was like 20 percent kager through 2030 had global spend of 35 billion so okay all right either way it's It's a large... I mean, I don't know. TAM talk is... It's always just numbers. All right. Let's hit highlights and lowlights. Ian, what do you have? For me, the highlights start with Ming-Shea. Reading his story and seeing that he was able to run and sell a successful business before that gives me a lot of confidence in him and his ability to continue to run this company, along with the 27% stake that he still owns in the company. So between those 2 aspects, this becomes really a question of how much do I like

Mingxue? And I do like him quite a bit. So that's definitely a highlight for me. I think that the way that they're able to capitalize on COVID testing and take this business to a new level because of that, and generate all this cash because of that, that they could use for their more durable business was really impressive. And I would hope that they'd be able to continue to do that type of stuff going forward. Some lowlights for me, they do have a lot of customer concentration, which is related to these COVID deals that they've done. So in, I believe this was in 20, yeah, for 2020, LA County accounted for 28% of Fulgent's revenue and San Bernardino County accounted for 10% of Fulgent's revenue. Those numbers have been

decreasing in the last few quarters to slightly smaller percentages, but still high percentages of revenue coming from those contracts. The other low light for me, which we've already commented on is just the uncertainty of COVID revenues. No one knows how long they're going to last. No one knows whether they're going to drop off a cliff or whether it's going to be more of kind of a slow petering out of them. So that's just, there's just a lot of uncertainty about when exactly the shoe drops on that part of the business and whether they're going to be prepared to and able to continue to grow the other business quickly. I mean, isn't, I mean, all the viruses in history have ended eventually. So it's going to happen. It might just be a little longer than

people think isn't the customer concentration like naturally have to fall unlike like the more positive cases you get in a certain area well they could just sign i mean they could sign a big deal with like new york state like they just did um and that could be i think they're doing back to school testing for new york public schools if i remember reading that correctly and that there's a lot of tests so ryan yeah go yeah my highlights uh they were in the right place at right time, not just naturally. I think they built that. And part of that is, well, all of that's attributable to Ming She. Well, they have the tech to build it really quickly and launch it. Right. And I do like the story of Ming She. That's really cool. I listened to a few interviews with

them. And as we've all kind of figured out here, he seems pretty bright. And then also the growth the core revenue is really promising and the balance sheet gives them enough not only cash but time to kind of play around and take more adventurous bets whether it's like the r d that we talked about with multiple virus testing um or just you know investing in different laboratories i think they uh just generally it gives them a little more optionality and then low lights i know that sounds like a cop-out but the industry to me is pretty unpredictable i don't know not Not only I don't know what the innovations the competitors could come up with, I'm not sure. I just don't understand the industry that well.

But then I also am not sure what potentially, if there's any regulatory hurdles about just doing an M&A thing within this testing niche. That's probably a small concern. Well, if they can just bump up costs of testing after consolidating, that's probably a reasonable concern. Yeah, but I don't think they need to because their unit economics are so good when they make 90. They're the cheapest provider, and what is it, $96? And their cost per test is $23, and that's dropping rapidly. So I don't think that's going to be a concern. You don't need to, but it could, especially when it's an anti-competitive environment.

Yeah. I mean, almost all murderous big tech stuff has gone through. so i don't know if that's a big concern all right well get to yours uh let's see i mean industry tailwind great operating leverage is really strong i love how they put out the unit economics of just like it we sell it for 96 bucks we're the cheapest out there it's cost us 23 bucks per test and that's dropping as we scale it's like all right that's pure profit it's amazing And then their track record was really strong coming out of, you know, the last year and a half, low lights, COVID revenue, like we all have. And I think there is uncertainty around the Chinese joint venture, because this is one of the things or industries that the CCP wants to win domestically. That's kind of when what they've been saying, unlike maybe like social media or something,

they're not too worried about that. But these hard tech things like semiconductors and genetics, it seems like that's something that they want to win at. And I think that adds some uncertainty over there, but who knows? It's kind of just a black box to me. And then in general, this is a highly dynamic genetic testing industry where there's hundreds and maybe thousands of some of the smartest people in the world trying to tackle these problems and they could come up with something better than fulgent i'm unsure of the defensibility

of their position because it seems like they're relying on a luminous tech and aluminum might have a moat or competitive advantage because everyone has to use a luminous stuff to kind of go to the end consumer everyone's using a luminous technology so that's a little bit of low light here i'm unsure about their moat and stuff like that but also i would also add i'm not sure there like a sustainable data advantage because don't they have to make their gene libraries public sort of since that's for the good of society i i don't know i don't know ian do you know anything about that i'm not sure about that maybe something to look into for sure yeah i know some of their stuff i think like the data comparison tech that they have was proprietary but i thought they had

to make their gene library public i'm not sure i i'm definitely not sure but one thing with testing though is the brand matters a lot if you build up that brand and you're known as the highly reliable testing person no like no big company is going to be like all right we're going to skip out from fulgent they've supplied us for five years they always get it right and then we're going to go to some startup that's a huge risk that's not worth taking so maybe there's a moat there but who knows um all right bull case in what has to go right for this uh investment to work out The bold case for me is that Fulgen is just scratching the surface of next generation sequencing, this NGS that they talk about. The market propels them forward and they emerge as

one of the major companies in a massive industry, massive, fast-growing industry. Some of those TAM numbers we discussed earlier are actually true. And that just propels them forward. And they're sitting right there at the top of that wave. One quote I found about next generation next generation sequencing is that next generation sequencing makes large scale whole genome sequencing accessible and practical for the average researcher. And so I mentioned that because I think that there's an opportunity that the use cases that their technology has been used for today and all their testing and their, and their menu of tests,

that that will continue to expand and there'll be, there could be more and more uses for the technology and the tests that they've developed. And so I wonder, just about how much future growth there is that we don't even know yet. And they might not even know yet, but based on what they can do, that there may be future use cases that arise. Yeah. It seems like this is a company, and from our point of view as non-biotech or genetics people, it's hard to know, but it seems like this is one of those companies that could surprise you to the upside like they have been doing. That's always a good sign for the quality of a company.

uh ryan what do you want to hit with your for your bull case here yeah the bookcase for me seems like they would if there's a non-zero end point for covet testing so maybe it slows compared to 2020 but it still kind of persists uh over the next decade that feels that would not only be good for them but that would also feel pretty realistic especially with all the variants um well i mean that's kind of i mean we don't know either way it could i feel it could happen let me just I think it feels realistic that COVID testing will be here for the next five to 10 years. I know, but it could happen. It's kind of just on its own. Yeah, that's why it's the bull case. But then there's also, obviously, you have to see the NGS

segment grow. I think it would have to hit somewhere around 500 million in revenue. And right now, I think another possible benefit that they're getting is maybe they might have generated leads from the COVID testing that they could cross-sell NGS to, because, and this might be happening, but they expected 70 million in revenue from NGS at the end of last year. As the second quarter, they're now expecting 110 million in revenue from NGS. Well, CSI was, I think, 30 of that, but it's still a bump up, I guess. either way, it's, I mean, that part is growing like a weed and it has good margins. So I think at 500 million, that's a very plausible bear or bull case. And that would, the valuation right

now, it would make for a good investment. Yeah. And if that segment doesn't have good margins, there's tons of operating leverage with just the cost of the tests that are started with the gross margins being so high. So as that scales, you should see margin expansion from that segment. I don't know. Do we have a margin number for that segment yet, or do they just give revenue? I don't remember seeing one. Do you guys remember seeing one or no? I was looking for it a little bit and didn't see a margin breakdown. Okay. Well, it'd be interesting if they brought that out. But I'll hit mine. I think at this stock price, you probably need to expect COVID revenues to linger at least a bit. I mean, you don't need much more if it's going to keep

generating that much cash. And that's been a great bet that it's going to, you know, that it stays around longer than everyone's expecting. And then I think you have to expect NGS revenues from these new acquisitions, partnerships to help propel it to, you probably have to see like a billion in sales at some point over the next decade in annual sales. If they have the same sort of margins of like 50% at that type of scale, that could be really strong relative to the current market gap. but that's really it it's kind of a tale of two different things here and makes a very interesting story but what about the bear case in what do you have for us bear case for me is the valuation is still pretty steep at 18 times forward sales excluding covid they would need

significant growth in the core business to to justify that and admittedly it's been strong in q2 it was 296 growth which was including um the inorganic growth as well but growth if if growth does not continue at this this high rate and the smart acquisition acquisitions are harder to come by this is going to be a tough one to really generate good returns with going forward and excluding covid revenue this is still a very very small company if covid revenue wasn't here this would likely be not a micro cap, but definitely, definitely on a smaller end, it could be it would probably be under a billion dollar company, if there's no COVID revenue at all. And so there's just a little bit of a fragility with that, where someone bigger with more resources

and more cash could come in. But that's been the great thing about COVID is, is they've been able to get some build up the cash cushion. And so they have a little bit more staying power. But that's that's where the bear case is it's just that growth slows and um in their core business and they're not able to get to that 500 million or a billion dollars that you guys were describing in the bear or in the bull case uh ryan yeah for me it would be if co covid revenue dwindles i am still of the camp that there will always be covid tests at least for the foreseeable future or the near future oh yeah i mean for the next year i mean it feels like a cinch yeah i just i mean i there's always going to be a part of the population that doesn't want to get vaccinated we're seeing

all these things where like the stadium stadiums are saying you either need proof of vaccination or a negative covet test i think that's going to be here for at least a little while so uh but bear cases theoretically that grows or slows faster than people are expecting and then uh if this ngs segment i i mean obviously they can continue to grow inorganically but if it's more fragmented than I think. And there's those possible regulatory problems, or it's just, there's a lot of unknowns for me in that testing area. You don't know how big of a market opportunity is it? What if it's not as big as people think? It's like, we have no idea. Yeah. I mean, at least this isn't, the bear case is somewhat limited to me because I think our NGS core business is somewhat

profitable, I'm guessing. And they have $700 million in cash and equivalents. There seems be a floor on this business yeah 700 700 million at least uh plus the core business plus yeah it's i don't know how profitable that would be right now but the covet testing is a great it shows that once they get to a certain amount of revenue it's almost pure profit at least the gross margin all falls down to the operating line um i have a similar one to you guys i mean covet stuff uh if that falls off a cliff i think we all had that one but i would worry about pricing uh from competition on ngs because i don't know i think a lot of people can do ngs and alumina is the one that kind of controls the pricing here and there's all this talk about lowering the cost of testing

lowering the cost of testing it used to be a thousand bucks now it's a hundred bucks if it continues to lower i wonder how the margins are going to be that could be a risk that maybe we're not thinking of. And then I would worry about the Chinese joint venture. I do not really like them investing heavily into that country when the CCP says that this is one of the industries they want to win with domestic companies. It technically is a domestic company, but now it's being controlled entirely by an American company. I do not like that. I think the company itself could be fine without the chinese joint venture but that's that's something that i think could turn into a goose egg forum maybe maybe it also could be really successful

who knows um all right more or less interested ian i'm more interested um with the caveat that i think i could upon doing some further research or really thinking about this more talking to more people i could i could get um pushed out of this this idea but i do i do like the way that they're building their business and that they've been opportunistic and i think that it i think it's a growing market um so it's one i'm more interested in definitely going to be doing some more digging on um but yeah yeah i think that's what well ryan what do you got uh yeah it felt like the more i studied about this business the less i knew and the too hard pile is a beautiful thing and so this is going to go in there for me um obviously the price at a cheap price first

glance yeah it looks cheap but i have no way i have no way to forecast next three years earnings yeah that's that's what that's what where there's the potential opportunity so if you're someone that is okay with the uncertainty. Maybe there's an opportunity for you, but it depends really on your style. If you're comfortable with unknowns and investing in an industry where you may not know the ins and outs of it, this could be something that's a very strong opportunity for you. But I'm in the same boat as Ryan. I'm less interested. At a cheap enough price, something like this makes sense. And I think you're kind of getting paid a bit right now for the uncertainty, but it's just not the style that I like to go with. So that's why I'm less

interested. But if they're correct on what they're saying, I mean, this could be a $50 billion business one day, market cap wise. That wouldn't be surprising, but who knows? That's kind of it. All right. We have stock for next week and it looks like it is my turn. I guess this will be two weeks from now. And we're going to play out the same theme from Chris from Growth to Value. So we're going to be doing Upwork. That was recommended in the DMs on Twitter. I think it was Francis. I forget your name. I didn't look beforehand. But thank you for recommending that. We're going to do that one, pair it up with Fiverr. Look at both of those for the freelance industry. All right, let's wrap things up. 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.