Would you want to know if you were at high risk of developing a rare disease? What about knowing whether you're hereditarily predisposed to enjoying chocolate? With the power of DNA sequencing technology, all it takes is spitting in a tube to answer these (not at all) equally important questions. You can't just spit into any old tube, of course -- you'll need to use a sample collection vial from a genetic testing company like 23andMe. 

As part of its plan to expand its growth potential and become a leader in genomic data-driven drug discovery, 23andMe announced this week that it will go public by merging with VG Acquisition Corporation (NYSE:VGAC.U) sometime in the second quarter. As the name implies, VG Acquisition is a special purpose acquisition corporation (SPAC), meaning that it is a publicly traded shell company formed explicitly for the purpose of merging with a promising private business. Merging with a SPAC is an alternative to an initial public offering (IPO), which typically requires more regulatory paperwork. This merger will be a huge move for 23andMe. Is it also a signal that it's destined for greatness in the quickly changing healthcare sector? 

A pair of researchers examine DNA sequences on a computer.

Image source: Getty Images.

Evolving from consumer genetics to biotech

23andMe's business model starts with a purchase of its at-home sample collection kit, which is ingeniously simple. Just spit into the tube, and your saliva is ready to be mailed in for genetic sequencing. After getting their genome sequenced, customers can get reports on their ancestry as well as a handful of health risk factors -- say, whether they have an increased chance of getting breast cancer. Then, they can select whether to allow the company to use their genetic code for research purposes -- and around 80% of customers give the OK. That paves the way for future therapy development, or hyper-personalized healthcare products.

There are two problems with this picture. The first problem is that revenue from therapy development is, at a minimum, years away. It takes a long time and a lot of resources to advance a drug from the laboratory to the end of the clinical trial process, and the company is only at the start of the journey. The second problem is that its consumer and research services business doesn't generate any earnings, and it isn't expected to until 2023. In fact, management predicts that revenue will shrink from $305 million in 2020 to $218 million by the end of 2021, which follows a similarly sharp drop from 2019 to 2020. That could be a problem for its share price over time, especially if revenue growth is slow to return.

Nonetheless, the company's real value is in its trove of genetic data, which isn't going anywhere. In total, its database has the genomes of nearly 10 million people, making it the largest of its kind by far. In 2018, GlaxoSmithKline signed a four-year research and development (R&D) collaboration deal worth an investment of $300 million to get access to the data, seeking new targets for drug discovery. As part of the deal, the two embarked on 30 joint-development programs where profits and expenses would be equally shared. With the capital from the merger, 23andMe could advance several of these programs closer to bearing revenue. But, investors should expect it to form more R&D deals with pharma giants moving forward, too.

What comes next?

Once VGAC's shareholders vote to consent to the deal, the shell company will be delisted and 23andMe will trade on the New York Stock Exchange (NYSE) under the ticker ME. Per the terms of the merger, it could get as much as $984 million in cash. That would leave it with an implied enterprise value of $3.5 billion.

23andMe is definitely a stock that will be worth adding to your watchlist. While I can't get behind buying it until it reports a few quarters of favorable earnings, its data is both invaluable and unique in the healthcare sector. Given its extensive collaboration with GlaxoSmithKline and the capital raised from the merger, it's easy to see that the company is ready to take the next steps down the (long) road to success.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.