When the DNA sequencing industry splashed onto the scene 20 years ago, it took a special kind of crazy to predict that multibillion-dollar companies would emerge. The cost of reading a single human genome was over $1 billion, and there was little value to be gained from knowing a person's genetic sequence at the time. But today Illumina (NASDAQ:ILMN) has earned a $40 billion market cap -- which admittedly still might be a little crazy -- by beating out dozens of competitors, acquiring others, and developing the best technology platform for reading DNA sequences.

As engineering principles begin to be applied to biology (a field unfortunately named "synthetic biology"), there's an emerging need for going in the other direction as well: writing DNA. Healthcare, agricultural, and industrial biotech companies need to manufacture precise genetic sequences to insert into organisms and create biology-based technologies with predictable functions. That need has fueled the creation of DNA synthesis companies such as the industry's leading player, Twist Bioscience (NASDAQ:TWST), which just raised about $70 million from its initial public offering (IPO).

It's the latest synthetic biology stock to hit the stock market. It's by far the best company in the tiny corner of the field occupied by writing DNA. It boasts major investors including Illumina (all companies that order synthetic DNA also need to sequence DNA, so there's a logical customer overlap) and Applied Materials, and customers such as $1.2 billion synthetic biology start-up Ginkgo Bioworks and Microsoft. Is Twist Bioscience stock a buy?

A white-gloved hand holding up a piece of DNA on a silver platter.

Image source: Getty Images.

What does Twist Bioscience do, and what are its strengths?

Twist Bioscience manufactures and sells custom DNA sequences. That in and of itself is a decades-old capability, but churning out very large volumes of DNA sequences with low error rates at low cost is potentially revolutionary. In the first nine months of 2018 the company generated 73% of revenue from R&D services and industrial biotech customers, 25% from academic customers, and 2% from agricultural biotech customers. 

The company's technology platform is based on a novel approach that uses a silicon chip with tiny wells carved in it. The chemical building blocks of DNA are combined in the wells, then assembled into precise DNA sequences. Compared to traditional methods routinely used in life sciences labs, Twist Bioscience's approach can reduce the amount of expensive reagents needed by a factor of 1 million, and increase the number of genes that can be synthesized by a factor of up to 9,600.

Simply put, no company is better at writing DNA today than Twist Bioscience. Case in point: The company actually sells synthetic DNA to four of its top competitors.

A scientist in the lab with a disappointed look on his face.

Image source: Getty Images.

What are the weaknesses of Twist Bioscience?

Biology-based technologies must make sense of complex knowledge areas of study such as genomics, proteomics, and metabolomics. But the most difficult "omics" of all for young companies might be economics.

Twist Bioscience is still attempting to prove its hypothesis that delivering high volumes of DNA will eventually lead to operating profits. However, the business strategy may be fundamentally flawed. The reality is that very few customers today need massive quantities of DNA for R&D activities, and there's no concrete argument for why that will change in the next few years. As the company gets better at delivering cheaper DNA, it may effectively lower its overall market opportunity, not expand it.

Case in point: Twist Bioscience has sold products to over 600 customers since inception, but in fiscal 2017 nearly 78% of the financial value of orders placed came from just two customers: Ginkgo Bioworks and Microsoft. In the first nine months of fiscal 2018 fully 91% of all revenue came from repeat customers. A highly concentrated customer base has still allowed room for revenue growth, but has not stemmed operating losses. 

Metric

First Nine Months Fiscal 2018

First Nine Months Fiscal 2017

Year-over-Year Change

Revenue

$17.0 million

$7.3 million

133%

Cost of revenue

$23.1 million

$17.2 million

34%

Operating income

($50.8 million)

($41.8 million)

N/A

Net income

($51.4 million)

($42.3 million)

N/A

Source: SEC filing.

And the risk of being too dependent on the top two customers is even greater than it initially seems: Ginkgo Bioworks is still attempting to prove its own business model and is struggling to follow through on partnerships, and Microsoft is still in the early stages of researching the use of synthetic DNA for digital data storage. If the tech giant walks away from the research project, Twist Bioscience would suffer a steep drop in revenue.

A genetic test and buccal swab.

Image source: Getty Images.

What are the key opportunities for Twist Bioscience?

The company is aware of the near-term business obstacles posed by focusing solely on DNA synthesis for genetic engineering applications, which has led to expansion into other products and services. Twist Bioscience also sells sample preparation kits that increase the accuracy of next-generation sequencing (NGS) analysis. These products generated an impressive 10% of total revenue in the first nine months of fiscal 2018.

Twist Bioscience is also actively developing tools that could aid biopharma companies with drug discovery, which could result in future collaboration or milestone payments for biologic drug development. Yet while the company is closely tied to traditional biotech sectors (healthcare, agriculture, and industrial), the biggest opportunity likely resides in manufacturing custom and inert DNA sequences for materials applications such as digital data storage and self-assembling nanomaterials that gain unique functions from their size and shape. Materials engineering could be the most valuable application because sequence accuracy is less important than in genetic engineering (thereby lowering production costs) and much higher volumes of DNA are required.

In addition to application-specific opportunities, Twist Bioscience is investing heavily to expand in China. The company expects to be operational in the country in 2019, although corporate espionage and lax intellectual property enforcement are well-documented risks for American biotech companies crossing the Pacific that shouldn't be ignored by investors.

A hand holding up a piece of DNA.

Image source: Getty Images.

What are the key obstacles for Twist Bioscience?

In addition to economics, the business must contend with the fast pace of innovation within the field of synthetic biology. Synthetic Genomics subsidiary SGI-DNA sells a piece of hardware called the BioXp 3200, a DNA printer that allows researchers to synthesize genetic sequences in their own labs. It has its own flaws and shortcomings, but it may be a glimpse of the future -- perhaps a future that Twist Bioscience can help create.

Similarly, companies such as DNA Script are pioneering new processes for synthesizing genetic sequences enzymatically, which is the next logical step in DNA synthesis technology, as it follows natural processes. The methods are still in the earliest stages of development, but theoretically could yield high volumes of DNA with unparalleled accuracy at low costs. To be fair, Twist Bioscience claims that its silicon chips might be combined with such methods, although investors have few details to work with.

More pressing, Twist Bioscience is currently involved in particularly serious litigation brought by analytical hardware leader Agilent (NYSE:A). The lawsuit alleges that trade secrets surrounding the silicon chip-based DNA synthesis methods now deployed by the young company were misappropriated by Twist Bioscience CEO Emily Leproust, who previously served as Agilent's Director of Applications and Chemistry R&D. The next decision in the courts is scheduled for early December 2018.

A businessman looking at a complex drawing on the wall.

Image source: Getty Images.

Is Twist Bioscience stock a buy?

Twist Bioscience is a leading synthetic biology company because it owns the most advanced technology platform for synthesizing DNA -- and it's not even close. But technical strength doesn't always lead to business strength.

Given that the business is on pace to lose nearly $70 million from operations in fiscal 2018 (and on a trajectory to lose even more in fiscal 2019) and has yet to prove that there's a profitable market opportunity in selling increasing volumes of synthetic DNA (it's much too dependent on its top two customers), individual investors should not buy this synthetic biology stock.

While the stock could still perform well initially if Mr. Market gets excited, it may only take a few quarters of growing losses -- or updates from the Agilent litigation -- to send shares significantly lower. The synthetic biology stock could become a buy if the company finds major success in biopharma collaborations or materials applications for DNA, but investors will have plenty of time to see those opportunities develop before taking action.

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Illumina. The Motley Fool has a disclosure policy.