Motley Fool Hidden Gems Investing - Chip Outlook Gets Cloudier

Episode Date: October 16, 2024

Early is not always better. (00:21) Jason Moser and Mary Long discuss the semiconductor supply chain, ASML earnings, and what’s ailing the pharmacy industry. Then, (16:40) Motley Fool contributor Brian Orelli joins for a look at how the genetic testing company 23andme went from a $6 billion valuation to a penny stock in a mere three years … and where the company (and its data) might go from here. Vote for Motley Fool Money in the 2024 Signal Awards for Best Money and Finance podcast: https://vote.signalaward.com/PublicVoting#/2024/shows/general/money-finance Learn more about the Range Rover Sport at www.landroverusa.com Companies discussed: ASML, WBA, CVS, ME, GSK Host: Mary Long Guests: Jason Moser, Brian Orelli Producer: Ricky Mulvey Engineers: Tim Sparks, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

When WestJet first took flight in 1996, the vibes were a bit different. People thought denim on denim was peak fashion, inline skates were everywhere, and two out of three women rocked the Rachel. While those things stayed in the 90s, one thing that hasn't is that fuzzy feeling you get when WestJet welcomes you on board. Here's to WestJetting since 96. Travel back in time with us and actually travel with us at westjet.com slash 30 years. Today, we got chips and we got scripts. You're listening to Motley Fool Money.

I'm Mary Long, joined today by Jason Moser. J-Mo, great to have you. Thanks for hanging out with me this morning. Mary, thanks for having me. Always a pleasure. Okay, before we talk numbers, before we started recording, you had to exit to go check on your dogs. They were barking. You know, they have, I was saying, they have just this sixth sense that Whenever I'm getting ready to start doing anything media related, man, they come out in full force. So, yeah, I had to reel them back inside here for a little bit to quiet things down. Were they barking about anything in particular or were they really just trying to bother you? You know, probably the latter, but we live in a pretty wooded area in our neighborhood.

So there's all sorts of wildlife running around and they are always they're always barking at something. Could have been a rogue deer. Who knows? Who knows? Could have been. Could have been. ASML earnings came out a day early and a dollar, perhaps a few dollars short, the semiconductor equipment maker suffered its biggest single day drop since 1998. Yesterday, results were released a day early due to a technical error. And the news within those results sent nearly all semiconductor stocks sinking.

Before we take a closer look at that news, maybe you can give us a refresher on where exactly ASML sits within this broader semiconductor landscape. Yeah, so ASML is a crucial link, I would say, and perhaps one of the most complex supply chains out there. But the company, so they make the machines that ultimately make the semiconductor chips that are powering everything that we do in our lives from smartphones, computers, data centers. You may have heard of this thing called AI

that is making some progress and they play a big role in that as well. So it's an interesting company because what separates them, ultimately they make these machines, they're called lithography machines. And they're two different kinds. There's this deep ultraviolet lithography machine

And that's something that a number of companies out there make. And I guess you could consider that kind of a lower tier chip producing machine. But when you start talking about these higher tier sort of bleeding edge technology chips, they're using what is called EUV or extreme ultraviolet lithography. And ASML is the only player in that space. They're the only game in town, really. And that technology, it's necessary to manufacture all of these chips. So they hold a very strong competitive position just by virtue of what they build. So news from this latest quarter came out yesterday, as we said.

Some key takeaways from that, just to start us off. Revenue and earnings per share both up compared to the last quarter. We saw a slight increase in the number of those lithography systems that were sold. Here's what's getting all the attention in the press. Net bookings for the quarter were down far below analyst estimates, came out to about 2.6 billion euros. That's up year over year, but again, far below analyst estimates, which were closer to 5.5 billion euros.

Gross profit margin right on track at just over 50%. What in all of this is most interesting to you? Well, we say it often, investing is all about the future, right? And so for me, it really is the bookings numbers. Number one, just kind of the significance, that disparity there. But it also, I think those booking numbers reflect a number of challenges in the market from the state of its customers, companies like Intel and Samsung, to the political landscape, U.S. restrictions on exports of its manufacturing tools to China. So I think all in all, it's just that look forward, right? That bookings number tell us kind of what the future looks like, at least in the near term. And that to me is what stands out the most. So help me understand why we're seeing this pullback in the bookings numbers, because demand for AI is booming.

AI needs semiconductors. ASML plays a, as you said, crucial part in the semiconductor supply chain. why aren't we seeing that AI demand come through in these net booking numbers that ASML is posting? Yeah. Well, so I think part of that is they called it out. They actually called this out in the earnings call. And they mentioned that their low order intake is a reflection of what they call the slow recovery in their traditional end markets. And as their customers, these big companies, they remain cautious in this current environment. So it's something that rhymes with a lot of what we've seen throughout the last several quarters with a lot of these big

enterprise companies and enterprise customers is that they're just spending a bit more frugally, I guess, but they're a little bit more cautious in the current environment. And, you know, you add that to the ongoing issues in regard to China. I mean, China is something where I believe last year, China was around 30% of revenue. And next year, it's forecast to be around 20%. And so, all of that put together. And then finally, I mean, these are big purchases, right? This is not something where companies just go buy these things like we go to the grocery store. I mean, the latest EUV machine runs upward of $380 million. So, I mean, these require a lot of thought and a lot of planning. And their customers right now are just spending

a little bit more cautiously than they have in the past. So let's zoom in on that China piece for a moment, because as you said, this is kind of the restrictions that the U.S. and the Netherlands have put on certain countries, China in particular, when it comes to shipping advanced AI chips there. That has played a huge role in ASML's kind of pullback here. um bloomberg bloomberg reported yesterday that the white house is mulling even more of these chip caps on other countries so not just china what is asml what's what's their path forward where else can they turn to to make up for losing theoretic losing and likely continuing to lose a

large piece of that market yeah that's a bit of a more difficult problem to solve right again looking at china and just looking at some of the numbers it's last year uh they sourced 29 of their sales from China. In the second quarter of this year, they noted that they sourced about 49% of their sales from China. So it's very significant. And now, again, going into next year, they're talking about that being closer to 20. And they can look to other markets where they don't hold, that they are not as reliant on today. A few that stand out, Japan, you're talking about areas of Middle East and Asia, and potentially the U.S. as we continue to invest in our own capabilities here. But make no mistake, this is not an insignificant deal. And I don't think it's

something that they're going to be able to figure out overnight. I think this certainly could turn into a bit of a longer-term drag on the business. But by the same token, I think it is something that ultimately, it'll kind of ebb and flow, I think, with the political landscape. We'll see how that, how that turns out in, in given their specialized nature. Um, they're still in a good position. Management talks about this, this broader industry slowdown, and you can kind of think of this as like an inventory issue, but it's different than an inventory issue. It looks different than an inventory issue. We might see with something like target that's easier to conceptualize for me, right? Target has a lot of like for any consumer facing company, if target

it has too much inventory on its hands, it can have a back to school sale to kind of offload some of that inventory onto its consumers. What ASML is dealing with here is a bit more complicated. Their clients hold too much of the inventory. So they're not buying as many new ASML products. You don't solve that problem with a back to school sale. So how do you solve it? No, it's like iPhones keep getting better and better. So we just don't we don't need to upgrade nearly as often as we do. And obviously, that's not a fair comparison, but you get the idea. They make really good equipment, and their customers can use that equipment for a long time. But as we know, particularly as it pertains to AI, I mean, tech moves very fast. And so,

I think on the one hand, we're not going to see them resorting to fire sales to try to push product out. I mean, they know their equipment is special and necessary, and they'll stick with that. So this may be something that in the near term, at least, is just more or less a bit out of their control. There are greater forces at play. So they may just need to be patient and let innovation kind of run its course. I like to look at this as a little bit more of a timing thing than anything else. So I think the business, the company is going to be just fine. I mean, this could be something that actually ends up opening up a window of opportunity for investors. I mean, we like to find great businesses that are dealing with some near-term challenges.

This may just fit that bill. Talk about a window of opportunity. How do you value a company like this? Because, okay, we've seen a massive drop-off in shares just today alone. But still, we know that this is a top dog in the space. Okay, so that bodes well for the long-term story. But still, as we've discussed, its output is kind of constrained. Yeah.

So what do you make of that from a valuation perspective? What do you do with that information? Well, I mean, you look at the stock today, it's definitely cheaper than it was a couple of days ago. I'd say today, you know, it's valued around 38 times earnings. And I think for folks who are looking for a bargain, you'd look at 38 times earnings and think, well, man, that's still not cheap. But also remember, I mean, this is, like you said, it's a top dog.

It's always garnered a premium valuation because of its position in the market. And then when you consider where the stock is today, I think somewhere in the $600 change range, I mean, a 52-week high was just over $1,100 per share. So, I mean, this is clearly a special company with a tremendous competitive advantage. But that said, I think given the challenges that we've outlined, for folks who are interested, and I think you're right to be interested in a company like this, this is one, I think, just where investors will need to stay patient. And that kind of goes back to those greater forces at play. that's something that's a little bit more out of the company's control. But again, I think when you look further out, I mean, this company is just in such a strong competitive position there. You really have to like the long-term prospects. Let's turn to a far less technical

part of the economy and talk drugstores. Walgreens announced during its earnings call the other day that it would be shuttering 1,200 stores. So that's about one in seven locations and that that would happen by 2027. 500 of those stores are going to be gone by the end of fiscal 2025. Despite its massive footprint, this is a company that lost $10 per share in the past fiscal year. They're not the only player in this industry to resort to cost-cutting or that's struggling. Rite Aid is in the process of closing 800 stores. They filed for Chapter 11 bankruptcy last October. CVS is slashing jobs left and right. They had an announcement about that earlier this month after having already cut 5,000 jobs last year.

What is ailing the pharmacy biz? Well, I think in a word, it's digital. I think that's probably the easiest way to put it. Now to expand on that a little bit. I mean, ultimately, it's just shifting consumer trends, right? We as consumers, we're opting more for online solutions and that applies for prescriptions. And, you know, you look at Walgreens and CVS,

companies like that, they rely very heavily on the pharmacy side of the business. And the other part of the business, when you go into those stores, I mean, they're kind of like a different version of a grocery store almost, right? And they carry a lot of stuff. And so kind of going back to your inventory point there, the inventory in those places has got to be a nightmare keeping up with all of that. And whether it's pharmacy or whether it's grocery or anything in between, you look at a company like Amazon, and clearly they've been making a lot of inroads in the online pharmacy business and focusing more on digital health. And I think that you put that all together, these are just businesses that were built out to this scale, this footprint in a different world where those solutions weren't necessarily as obvious at the time. And so what they're faced with now is just exactly as you described.

They're closing stores. They are having to whittle down the workforce and become leaner. And that clearly has played out on the stock price over the last several years. We make easy comparisons between CVS and Walgreens because as consumers, we really know them as very comparable companies. But they are different businesses. CVS, their approach in recent years has been to kind of vertically integrate, and they've merged with an insurance company, Aetna. They have a middleman pharmacy benefits manager, Caremark. That's been their tactic.

On the other hand, Walgreens, their new CEO, Tim Wentworth, his turnaround plan and shuttering stores as a part of this turnaround plan is to really focus on what the business does best, and that is its retail pharmacy stores. Those are two different approaches. If you're betting on a horse here, which do you think is the better path forward? Well, I mean, I'll be clear. I don't own shares in either. I don't know that I'm really interested in owning shares in either. But I would have to give the nod to CVS right now. And I think part of that stems from that Aetna acquisition.

And I also think another part of it, and I think CVS has done a better job at this than Walgreens has, is turning those stores into healthcare centers, really, more or less. And I mean, there are plenty of areas all throughout the country where access to healthcare is just not readily available. People have to drive kind of a long way to get there, but there's a CVS seemingly on every corner. And so, I mean, giving that dynamic to that business where they're basically healthcare centers along with the pharmacy, along with that Aetna dynamic, the insurance dynamic, to me, that makes more sense. It's not to say Walgreens can't get to that point, but they are far behind CVS in doing so.

And so consequently, right now, they're just playing a bit of defense. jmo as always pleasure to talk to you and to have you on to the show thanks so much for joining us this wednesday on motley fool money thanks for having me before we get to the next segment for today's show i come to you with a humble request if you listen to the show over the past couple of weeks you might have heard us mention that motley fool money is currently a finalist for signal's best money and finance podcast for 2024 for. We're up against some big dogs at Barron's, the Financial Times, and Bloomberg. We are humbled and excited and honored to be a part of this group, but the winner is determined by your vote,

and tomorrow is the last day to vote. So if you enjoy the show, all of us here at Motley Fool Money would really appreciate you taking a moment to cast your vote for us. There will be a link where you can do so in the show notes. You will have to share your email in order to prove that you're a human, not a robot. We really appreciate you taking the time not only to listen, but to cast a vote for us if you choose to do so. Okay, up next, a DNA test can tell you a whole lot about your ancestry, but then what? 23andMe has been trying to figure out the answer to that question for years. Now, its consistent unprofitability is catching up to the company. Up next, Motley Fool contributor Brian Morelli joins me to decode how the genetic testing company went from a $6 billion

valuation three years ago to a penny stock today. 23andMe, the at-home DNA test company is, it's fair to say, on the struggle bus. At its peak, this company was worth $6 billion. Now, it's worth less than $150 million. Brian, what was, like, take us back into the time machine, because this is a company that definitely had its moments of virality. What was the original value proposition from 23andMe? Yeah, I think when it IPO'd in 2021, the big three things were that they had tons of data, right? So like 84% of US customers consent to research. So that allows them to use their patient's data or the customer's data. And then they also, those customers are giving them not only their DNA data, but also their patient data.

So they're filling out surveys and whatever to say, you know, what other issues am I having? And then that allowed the company, in theory, to link DNA markers to diseases and then therefore find targets that could design drugs for. In 2021, they had a drug development deal with GSK, the European large pharmaceutical company, and then they had just launched the year before a subscription service. So 23andMe is at a pretty major breaking point right now. It's at risk of being delisted from the NASDAQ. Every independent board member has signed, leaving only the founder, CEO, Ann Wojcicki. Last year, the company had a massive data breach that exposed all this personal, this trove of information that it has from its nearly 7 million customers.

Where, that's a lot of bad. Where exactly did 23andMe go wrong? Can you pinpoint an exact moment or has it just been a snowball effect building up to this? I think it's the diversification that they went through. So we talked about the GSK, you know, so they started off with just DNA testing and then they added DNA testing for Ancestors. And that kind of makes sense because that's going to be something that you're going to want to continue to look at, right? Because you might have other ancestors that then get into the system and therefore you can find them that way. But then they went into drug development and they really had two options here, right?

They could have gone with just a licensing deal and said, hey, GSK and anybody else that wants to do it, maybe we do exclusivities for different diseases. but look at our data and we'll give it to you as a package deal. You develop the drugs, we'll take some milestone payments, we'll take some single-digit low royalties. They could have done that for the initial payment and they wouldn't have any of these expenses. But instead, what they did was they went and did a co-development deal with GSK. And so now the drugs that they're developing, they were paying for half of the cost. And so then that created a lot of costs for them that they had almost no control over because GSK is the drug developer and they're the ones that are making the decisions on

how much to spend on the drug development side. And so they eventually decided that they didn't really want to deal with GSK anymore. And so in 2023, they took over development that allows them to control cost and decide exactly what they want to develop. But it also means that they're paying for most of it at this point. That just feels like a crazy, complicated and expensive business to try to step into. Yeah. And that's the reason I never bought it, right?

It's just because like drug development's hard enough. You don't need to be doing drug development plus something else. Are there any therapeutics that 23andMe has at some point in that process made progress on? Is that segment still a potential, potential lifeline for the company? I mean, yeah, absolutely. They have two drugs in the clinic. They have one, an immunooncology antibody for cancer that's in phase two development. So, you know, it's already progressed all the way through phase one. That clinical trial started in 2022. And then they have another 123Me-1473, which is an effector-enhanced antibody that activates NK cells,

again, for cancer and trying to get the immune cells to attack the cancer. That's in phase one, and we're waiting for data from that. Yes, they have promise, but we're still many millions of dollars away and many years away from having a product on the market. So phase three trials is going to cost tens of millions, if not tens and tens of millions of dollars, maybe not a hundred million, but a lot of money. And then it's going to take a couple of years and they got to wait for the FDA, which is another year. So there are long ways before these would be creating revenue for them. So the founder CEO, Ann Wojcicki, for what it's worth, she is still fighting for this thing. The company announced a one for 20 reverse stock split that

goes into effect on October 16th. Sometimes this could be an effective path for a company. I'll flag that Booking Holdings did a one for six stock split after the internet tech bust bottomed in late 2000 and is now up more than 6,000%. So it's not, sometimes that can work out. That said, it's probably going to take more than a reverse stock split for 23andMe to ever see those kinds of returns. Brian, looking ahead, like what what is next for this company? Where do they go from here? Yeah. So, I mean, you know, the CEO, Wienczewski, she wants to take the company private. She had already announced that that was the reason why all the all the independent board members resigned. They did it literally all in the same, you know, same same, you know, letter to

to her, basically, because she wasn't they didn't think she was negotiating in good faith. They're supposed to be keeping the stockholders best interests at heart, right, because they're the independents. And so if she's trying to take it private, sure, you know, they have to see whether, you know, any whether any company wants to buy it or take it private or, you know, an individual wants to take it private. They they have to, you know, entertain those ideas. But She wasn't giving them any prices that that she that they thought was fair for the shareholders. And so that's why she resigned. She still owns 20 over 20 percent of the shares and she has 49 percent of the voting power.

So, I mean, it seems to me likely that she's going to put in board members that will support her go private initiative. You know, she could probably get another percent or two of of the rest of the of the voting stock to agree with her. And then, you know, what does she do next? If she's able to get the company private, I mean, I think the most sense would be to just sell off the drugs and take the profits and then put them back into the genetic testing thing and also then do more licensing deals with their data that they do have. She could also try to sell off a large chunk of the business, raise additional capital to fund the drug development. You know, I think they're trading at about their cash on hand, which at the end of June was $170 million. So, that's not going to last them very far since they burned in the quarter that ended

June 30th, $46 million. So, they don't have very much cash left. So, they need a huge amount of influx of cash. But at a market cap of $150 million, if you do a secondary offering at that, you know, let's say you want to raise $150 million, that means you're diluting all your shareholders by half, and that's going to cause the valuation to go down by half. And so then it would definitely be trading under their cash. And so I think it's probably easier as a private company for her to raise capital because there's different terms that would be involved in a

private equity raise versus a public equity raise. What happens to all that personal data that 23andMe has, especially considering how uncertain their future is? Yeah. I mean, I mean, obviously if it goes private, then she's in charge of it and they, you know, will hopefully continue to use it for, for good, not evil. Um, and you know, yeah. And hope, you know, uh, I think that the issue may be, you know, if, if the worst case scenario is that the company goes bankrupt, right. And then, but the, the, the data is still valuable. So somebody is going to buy that data and probably do the business model that I say that they should have started with all along, which is taking this large amount of data and,

letting pharma and biotechs, you know, have at it and give us a percentage of the profits. If you were ever able to develop anything, you take the risk, but we take a small percentage of the like, you know, if there's a success, we take a small percentage of that total. We've kind of touched on various parts of the 23andMe story. You know, it went public in 2021. Now we've seen a steady and steep decline in its in its stock price and its potential since then. Are there any lessons that you think investors can take away from this story, whether it's in regards to what you should be looking for when a company goes public or or even just what to keep an eye on when you're trying to dabble in the personalized medicine and therapeutic space? Yeah, I mean, so money is key for every biotech developing company, you know, drug company, you know, small drug company. And so the idea is that you you get it, you have enough money so that you can develop to your next inflection point that lowers the risk and increases the value of the company.

And now you can raise more additional capital at a higher valuation and so therefore dilute your shareholders less than you would have if you bought if you'd done it the same valuation at the earlier valuation. And so no company that I know of has ever gone from IPO to a drug on the market, right? They always have to do secondary offerings because you just can't raise enough in an IPO. It's too risky because it's too early stage. And so you raise a small amount in the IPO, $100, $200, $300 million. You spend half of that, hopefully, and then you get to phase two data, proof of concept data.

And so it's, you know, we're still years away from being approved, but, you know, then we raise more data or we, we, we raise more money. And then that allows us to run a phase three clinical trial. And we have enough money to, to get to that inflection point. And then, you know, hopefully we get a positive and then we, you know, raise more money to launch the drug. And that, and that cycle just keeps going until they eventually go to profitability. So they didn't, they didn't have enough money.

Right. So that's the main, that's the main point here is that if they'd had more money, this wouldn't be a problem. Or if their valuation hadn't dropped so much and they'd been able to get to the next inflection point that increased their valuation, then they would have, then they would be able to raise more money. And so that's, that's the, that's the lesson here is anytime you're investing in a biotech company, the first thing you should be going to is looking at how much cash they have on hand. That's, I, that's always what I do. Before I even look at the pipeline, somebody, you know, mentions a company, you know, you should look at this company. First

thing I go to is how much cash did they have at the end of the last quarter? Yeah, you know what they say. Everybody wants money. That's why they call it money. Brian O'Reilly, thanks so much for joining us on Motley Fool Money. Always a pleasure to have you. And thanks for sharing your insight into this company with us. No problem. Thanks for having me. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow, fools.