What Investors Need to Know About 10x Genomics

In this episode of Industry Focus: Wildcard, Motley Fool Analyst Maria Gallagher joins host Emily Flippen to discuss the prospects for 10x Genomics (TXG -0.79%), a healthcare tech company looking to reform the way researchers discover single-cell gene expression. 

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This video was recorded on April 21, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Wednesday, April 21st, and I am your host, Emily Flippen. Today, I am joined by Motley Fool Analyst Maria Gallagher, as we wade back into the healthcare waters and talk about an interesting play on healthcare tech and consumables, 10x Genomics. Maria, thanks for joining.

Maria Gallagher: Thanks so much for having me.

Flippen: I say thank you and I do mean thank you, but I also hate myself a little bit for this episode because I saw that you, at our backend system, Fool IQ, as we call it, had put down some really interesting notes about this company, 10x Genomics. I read through the notes and I was like, "Oh, this sounds super cool. I'll ask Maria to come on and join me for this episode," and I genuinely did not realize what I was getting myself into by asking you to come on today. Because as many listeners may already be aware, healthcare is really not my strongest industry. There's a reason why I host the Consumer Goods show. Without Shannon here to help in the healthcare space, we've definitely been lacking. I have been spending a lot of time trying to understand healthcare more intimately and 10x Genomics is like this big boss fight I have at the bottom of all of this research. It's the healthcare company to end all healthcare companies. It was so complex, I wasted hours watching YouTube videos, reading through their 350 page 10-K report. Truly ridiculous. But before we get into discussing the business and all those details, I have to ask Maria, how in the world did you find this company?

Gallagher: I have been trying to think in the past week, since I knew you were going to ask me this, how I found it and I can't really remember. But we do have a system where we can do screenings and I think I might have done a screening and this company popped up as it checked all of the boxes I was looking for. I too don't follow healthcare very often. I spent a lot of time while I was looking at this company, Googling what it is, and then inserting some science-based words and watching a lot of YouTube videos to try and understand this type of company. But once I started looking at it, I think also a lot of times with healthcare, you see very specific companies that are solving one problem, a lot of them are pretty binary in their outcome so either this drug therapy works or this drug therapy doesn't work. I think I was really drawn to 10x Genomics because as we'll talk about, it's really technology and so it's really helping all of these other types of pharmaceuticals and academic institutions conduct their research on this, and so that's what I found really compelling about the company once I started looking into it and found that it had a lot of optionality within its offering, so I was excited about it.

Flippen: I got maybe three pages into their 10-K when I initially started to do this research and I think I spent hours just on the first page or two alone. In fact, I think the way that 10x Genomics describes themselves is a life science technology company building products to interrogate, understand, and master biology, which I don't know about you, Maria, but that meant absolutely nothing to me. That could be any healthcare company, right?

Gallagher: I know, but it sounds great. If you're saying you're going to master biology, I just feel like you're starting out strong. 

Flippen: Well, I feel like I've mastered biology, at least just a little bit as I researched this business. My understanding is that they provide this base of technology that can then work to understand what's happening on a cellular and molecular level that then can solve and help treat many different types of diseases. They essentially offer three main products that work to solve these problems. Their Chromium platform, a Visium platform and then software they sell on top of these. It's a little complicated and I'm going to let you explain it because I'm not sure I can.

Gallagher: Sure. Basically, the Chromium platform, also I'm going to get ahead of this and apologize if you hear a siren in the background. I hear one coming up my street and it always happens when I'm recording podcasts. I'm so sorry. But so what they do is the Chromium product enables high throughput analysis of individual biological components so up to millions of single-cells. So what it can do is it can divide a sample into individual partitions. A really interesting example of how they've used this is to do research on the COVID vaccine. It's been utilized by lots of academic institutions and biopharmaceutical companies and so it will take hundreds of samples from studies of COVID patients and then they can link key changes across large numbers of different cell types so it's really able to break down those to their smallest level. The controller is really the bread and butter of this. So it's the instrument that runs the Chromium platform. They sell it for about $75,000. 

Then what's exciting too about this is there's this microfluidic chip which is their recurring source of revenue. So if I'm an academic institution, I buy the controller, and then I pay for these chips to use consistently and so that becomes this recurring source of revenue. If I'm an academic institution, what's great about this is that the biology department can use it, the oncology department can use it, all of these different types of researchers are still able to use this one instrument which makes it really a useful investment. Then lastly is the Visium platform. Chromium is really what they've achieved. Still growing, but mostly at scale, it's their bigger platform or their bigger product right now. The Visium platform is still in its earlier stages of development. That's looking at the spatial positions of different biological components within a piece of tissue and so that can be used in a lot of different applications, cancer, Parkinson's, Lou Gehrig's disease. They acquired the base of this platform back in 2018 with an acquisition from Spatial Transcriptomics. Those are the two basic platforms. Then how they get their revenue is from selling the instruments and then as well as that recurring revenue from the chips that are used. That was a long explanation. I don't know if that made sense.

Flippen: It does. You said it in such a way that even people like myself can understand it, which I greatly appreciate. I think what investors really like about 10x is a couple of things. The first one is, you mentioned they sell these machines that are $75,000 or more a pop, which is pretty impressive. We see a lot of healthcare companies having to give their machines away for free often, just to prove out the technology. The technology here is proven and you can see that in the size of 10x, it's not a small company by any means. But 10x has already proven its technology. Has a pretty high selling price for their basic controller platform. But then more importantly, they have a recurring source of revenue coming from these microfluidic chips, which they claim is proprietary. What makes the Chromium platform, from my understanding, cool and better than their competitors, is that they have the ability using these fluidic chips and using what they call GemCode technology to essentially allow researchers to barcode and partition different cells. Then using this proprietary technology, it makes it easier for these researchers to understand what's happening on a cellular partition level as opposed to the cells as a whole. 

They claim, at least, that their technology is more efficient in terms of throughput so they can measure more cells at once and they have a high cell capture rate and a low doublet rate. It's all fancy words, I think a lot of our listeners probably know them better than myself, but it's all to say that they can do a better job of collecting and analyzing cells and they have more scientific veracity when they do collect and analyze on the Chromium platform. All of those things may get a really interesting business. The last thing I'll add before we move on to how this is being used and how it creates a market opportunity is something that's pretty new, called the Connect instrument, 10x Genomics just recently started shipping these. I think it was in the first quarter of 2020, they shipped the first Connect instrument. This Connect instrument is essentially the same thing as the Chromium Controller, except for it's a more turnkey solution. It's better suited for certain customers who don't want to spend a lot of hands-on time in the research process. It essentially does it all for you. They haven't released the exact selling price. But management has said, "It has a substantially higher selling price than the Controller instrument." That alone shows a little bit of optionality and how they have these platforms and these instruments built out. They have one success from the controller that's making up a majority of their revenue and they're taking that success, finding ways to innovate on it, to sell new instruments to existing customers.

Gallagher: Yeah, and that's the model that you want to see and that's a model that's really effective. Like you talked about Emily, they're proven in how useful this is. Two out of the 10 life science innovations of 2020 by Scientist magazine, their research was assisted using these platforms, over 2,200 peer-reviewed papers were using them and like I said, they were utilized doing COVID research, so it's really clear that when there's a problem, there is a solution that can be found a lot of times utilizing these platforms across so many different areas. I think that that's such an interesting and unique proposition that they have.

Flippen: Why we are not being really specific when we talk about the areas that it can treat is because it genuinely can treat so many different ones that calling out any area in particular feels a little silly. They have over 2,000 third-party peer-reviewed articles. They split those up into a collection of more than 21 different research areas where their technology is being used. Lots of different areas. The majority is around 20% centralized around immunology, which is why the conversation around COVID is particularly interesting. But they also have another 20% in developmental biology, cancer research, neuroscience, and computational methodology. All of those are notable as well. This is being used in so many different prospects that it's really hard to think about market opportunity because theoretically, the addressable market here is pretty infinite. Diseases, unfortunately, aren't going away.

Gallagher: Yes. I think it's fairly interesting. They claim their current market opportunity is about $15 billion. Then I think we'll talk a little bit too about their acquisition strategy moving forward. But as they're acquiring more companies, they think their next big product innovation is using in situ which if people are familiar with CRISPR Therapeutics, this also make CRISPR Therapeutics talks a lot about is instead of analyzing it outside of the body, it's basically analyzing it inside of your body, which can really open up another 10 billion market opportunity for them. Their 2020 sales were $300 million. For context, they theoretically claim that they have a $25 billion market opportunity. Like Emily said, there are just so many areas. I think this is just the life sciences market really. They can be utilized in so many of these aspects of the life sciences market that it makes a lot of sense to me.

Flippen: To be really clear, they don't really depend on the researchers and the people who are using the platform to have good results. It's great if they do, and it shows a demand for their product. It's wonderful because it typically means they're making improvements on treating diseases, or treating symptoms at least. But really what they're betting on is the need for people to do research, in particular, into areas like single-celled gene expression, which does make up a majority of their research right now. That includes things like mRNA. A lot of healthcare investors or healthcare podcast listeners will be familiar with mRNA molecule research. We've seen that be vitally important, especially for these mRNA-based vaccines like Moderna and Pfizer as they've come out. 

So mRNA technology is single-celled gene expression technology. Anybody who is doing research in this area, regardless of what the outcome of that research is, can use a Chromium platform and their GEM Technology to help speed up that research. There's lots of competition in the market. 10x Genomics isn't the only player. We'll certainly talk about some of the controversies they've had around competition in this space. But it is to say that there's so many different opportunities in single-cell. Another one out there, CRISPR Technology. That's another example of single-cell research. All of these are not competitive ideas. If you're an investor in this space, it's not that you are betting on mRNA over CRISPR. You're betting on a certain company learning or developing a drug to treat diseases. This is betting on the industry as a whole. If you believe that advancements are going to be made and either single-cell gene expression or single-cell immunization profiling. 10x Genomics is a picks and shovels play on this industry. Again, there are risks, but it is certainly an interesting way to play this industry.

Gallagher: Yeah, absolutely. It's interesting too, because I feel like I keep saying that they have so much optionality within this. But like you said, there's CRISPR and looking at mRNA research, but that's such a broad market within itself that it can be utilized, and so you can see it being utilized just for specific research purposes for understanding why diseases happened. Then you see it for curing diseases or understanding why diseases affect different people in different ways. There are so many areas that it can go too. I think that's what's really important about it. I think that's why investors like it a lot as well.

Flippen: Let's talk a little bit about their financial performance. 10x Genomics, as big as the company is today, still hasn't made a lot in terms of revenue headwind. Over the last year, revenue came in just under $300 million, which is up 22% of the year, which is primarily driven by, obviously, the adoption of their Connect instruments and their consumables, the chip and gel beads. When you think about this company's financial performance, what are you evaluating moving forward? Is it bottom-line growth? Are you worried just about them growing revenue? What are you looking for?

Gallagher: I look for a couple of things with this company. It's obviously the number of instruments installed, the amount that's called their pull-through per instrument. How much people are spending per year on that instrument? It's about $150,000 per year. It took a hit during COVID, which I think is understandable. But in the near to medium-term management has had 150K a year. Making sure that that number stays steady or we have seen it grow, COVID notwithstanding, the years leading up to COVID. Those are the two biggest numbers. Then looking through what their adoption strategy is, they've made a couple of acquisitions in the past couple of years to go into new markets. Like I said, there's in situ for new products, for looking at tissues actually when they are inside their body. Understanding what their new product pipeline looks like, understanding how they're selling it, how places are adopting it, and looking at all of those different metrics combined to understand the potential for this company.

Flippen: I think it's a good point and I admittedly don't have a great sense about maybe the optionality this business has in terms of future iterations of instruments. I love the fact that they came out with the Connect instrument, building off of the success in the controller instruments. I like that, I think it shows some optionality. I don't think my understanding of single-celled gene expression is strong enough right now to really have a predictable idea about what innovation could look like in the future. When I look at the financial performance for 10X, the first thing I go to is just the expansion of their installed instrument base. That grew by nearly 45% year-over-year to over 2,400 instruments. Those are critical because as we've mentioned so many times, these are people who would have to use their GemCode technology, these consumable products, chips, and gel beads, to even use the instruments for their intended purposes. It creates some sense of recurring revenue. Which does bring to what I perceive at least to be the most critical metric, which is what they call Chromium consumable pull-through per instrument. Say that 10 times fast. 

But essentially what it's saying is, if you've looked at the installed instrument base, how much revenue is coming from the consumable part of that business per installed instrument. Ideally, you'd like to see that growing. You want people using the instruments, consuming the consumables on a recurring basis. They look at that on a dollar level, concerningly, I'll give some caveats as to why it may not be quite concerning yet, but a little bit concerningly, the consumable revenues, this Chromium consumable pull-through per instrument, it fell from $158 per instrument to $124 per instrument over the past year. That's dollars. Now management said, there were a couple of things causing this. The first one, obviously COVID has an impact on funding cycles. That number is generally quite lumpy. It comes up much higher during the fourth quarter when a lot of these research institutions are spending the last of their grant money. There's some lumpiness. But over the long term, I'll be tracking this number, because I'd be afraid of people not using the consumables as much as they should be spending $75,000 on an instrument. It can be a first leading indicator that the use cases for 10x Genomics' products are going down.

Gallagher: Yeah. That's a great point and I think that's a really great metric to look at as well.

Flippen: I do just have to say, one of the things that can impact this, and I was going to mention this under risks, but it feels appropriate to mention it now, are what they call Halo users. I know that you've talked a little bit about these, so I'll let you explain what Halo users are and how that can impact that critical metric there.

Gallagher: Halo customers are customers who use the consumables but don't actually own a Chromium instrument, so they may share one with other labs. That shows promise in the sense that they have recurring revenue. It shows like, "If I don't work in this lab, but I come into the lab and I'm friends with the person, I can use the instrument." That number is growing, which can be taken as a good because it's showing that they're being utilized, but it's also showing that people aren't necessarily buying the instruments. I think it can be taken two ways, but those users have been growing.

Flippen: You're so positive, you make it seem so nice and maybe I'm being overly harsh. I tend to be such a skeptic, whenever I research new businesses. The first thing that my mind went to when I heard about these Halo users, was how it could muddy that consumable pull-through number. Because if you're having a lot of consumable sales that are not made on the platform, that consumable pull-through number, $158, $124, as it was in the last quarter, that could continue to go up and be like, "Oh, it's $130 per instrument now. Oh, it's $140 per instrument." But the only reason that's going up is because people aren't buying the instruments and people are only using those lower margin consumables. Although to your point, I think I'm being overly harsh here because even consumption of just the consumables not on the platform still is a testament to the strength of 10x Genomics technology, and just those consumable products, even if they're not using it on their platforms. Maybe I should not get my pants in a twist over this quite yet.

Gallagher: I think I've thought about it too in the way of $75,000 as we talked about, that's a pretty big investment for a lot of these, especially if it's an academic institution where a lot of budgets have been constrained, especially in the past year, but there have been budgetary problems for very many years in these types of institutions. I also think, I wonder how it works in terms of are you trying out and seeing, "Okay, we're utilizing this enough, it's now going to be an investment that we make." I think that that's also something that might be happening in these academic institutions which are the majority of who are purchasing these instruments as well. We'll see what that looks like. I agree with your sentiment that it could be a problem in looking at those numbers, but I think it could go either way for me.

Flippen: If Motley Fool podcast extraordinaire, Mac Greer, was here, he would be yelling at me right now. Maybe I'll get a Slack message from him because I've done the one thing that he said you should never do. It's to bury the lead. I think I have sufficiently buried the lead with 10x Genomics in a way that, maybe the most critical factor we haven't talked about yet, and it's a risk factor. Can you tell us what it is? I think you know what I'm talking about.

Gallagher: Yes. There are some litigation problems. 

Flippen: You're so kind. There is some litigation.

Gallagher: There is some litigation stress.

Flippen: To be clear, the litigation section of this company's 10-K is five pages long. We're not even going to get the chance to talk about all of the litigation. If you want to have yourself a chuckle, pour yourself a big cup of coffee, pull up this 350-page 10-K from 10x Genomics, and just read through the pending litigation. I promise it'll be a great start to your morning.

Gallagher: The biggest problem is with this company called Bio-Rad. I personally think that there might be some personal issues as well because the current CEO also used to work at Bio-Rad, so I don't know how they left, or what that looks like. Basically, there was a patent infringement within the chips and the gel that we were talking about, that's this driver of their consumable revenue, where Bio-Rad said that 10x Genomics infringed on their patent, 10x Genomics said no, you infringed on our patent. As happens frequently, everyone is legally fighting. They ended up having to pay these accrued royalties to Bio-Rad, and so they are now using these Next GEM, which they say aren't infringing on the patents. But I think it's a pretty massive risk in terms of if there's going to be another patent infringement suit, if they are actually changing the Gems enough. If that's actually going to change the efficiency of them, what that's going to look like moving forward. So it's definitely a pretty big red flag.

Flippen: The only people winning in this situation are the lawyers that for years now have been making bank from Bio-Rad and 10x Genomics as they go back and forth in this litigation.

Gallagher: That was a real highlight reel.

Flippen: There was a lot of back and forth for them. I mean, so much back and forth that it was hard for me to even make a timeline in my mind about when did this start? How is it going? What updates do we have today? It's truly a convoluted mess as most things legal are. But in this case, I actually think that this is a risk that's big enough to me that it would prevent me from even getting invested in this company. I genuinely do. Again, maybe this is just me being such a skeptic. But the reason why is because the courts have sided with Bio-Rad in the past over the GEM chip technology. 

Essentially what's been happening is 10x Genomics has been paying fees for all the legacy chips that they sold. The good thing is that that has largely stopped. They're only selling these Next GEM chips. But I wouldn't be surprised to see Bio-Rad file against this company for the Next GEM chips, claiming that they're not substantially different from the Bio-Rad chips. Even if they are, this is still probably going to be litigation that goes on for years and years. It's expensive, it impacts their margins in a really unpredictable way. Courts have not been lenient with the fees against 10x. Again, maybe this goes to me not understanding the GEM technology as deeply as I could, and maybe there are investors out there that feel pretty comfortable with that exposure because they have a much better understanding. Maybe they use the technology and they know that it's substantially different. From where I'm sitting, the research that I've done, I can't quite figure out what's different about their technology in comparison to Bio-Rad chips. So for that reason, it makes me a little bit nervous to even consider investing in this business. It's weird to me that a lawsuit could essentially flick a switch and turn off all of this company's revenue, which is what would happen if the court sided against 10x Genomics.

Gallagher: Yeah, I think that's very fair. I wouldn't disagree with anyone who comes to that conclusion. I think for me, it depends on what they're able to do in terms of that new growth, so that's for their specific chips for their Chromium instruments. So understanding what the Visium sales are going to look like moving forward, how soon they can launch new products. If weighing those risks is really what I think I am doing as a potential investor and saying, "Okay, what are the odds that this new chip also infringes a patent?" They go into another multi year long legal battle where 10x then says Bio-Rad infringed on their patent and understanding all of those aspects versus what is the potential upside in terms of optionality that we've talked about, increased adoption, the potential that these Next GEM chips are different enough that the courts would side with 10x in this case. I definitely think it's a really massive risk and I would agree with any investor who decides to forego it because of that reason. But I do think that I would think it through a little bit more and understand where I fall on that.

Flippen: You're so thoughtful and you moderate your thoughts so well, I'm not. I'm going to dig in even deeper here. Hear me out.

Gallagher: I love that.

Flippen: Even if nothing comes forward on the legal front, so even if there's no development in terms of new lawsuits against the business, if I'm a researcher, I have a limited budget. A lot of times these are government-funded labs so they're pretty frugal when it comes to where they want to spend their money. I'm not spending $75,000+ on a machine and upwards of $150,000 a year on consumables to invest and buy products from a business that I'm not sure is going to be around. So when I see the courts historically having ruled against the 10x Genomics platform and their GemCode technology, and I'm looking at my alternatives and my options for where I want to spend a pretty significant portion of my budget as a researcher, I'm being really cautious before I go with 10x. Again, maybe I'm understating just how great their technology is, but I have a hard time getting past the GEM, which is one single risk.

Gallagher: That's very fair.

Flippen: Yeah, and I apologize for tripling down there. There are lots of good things with this business. The one thing I will say is that from a financial standpoint, and I didn't really mention this, I could have, it just shows you how I'm framing the conversation. From a financial standpoint, 10x Genomics is in a pretty good spot. Pretty strong revenue growth. They have no long term debt. Margins might come down a little bit, but management has been pretty prudent about how they handle themselves financially. They've increased their sales force by over 30% last year in order to encourage adoption of the chromium platform and the Connect products, so that alone, alongside with the immense opportunity that exists in single-celled gene expression. There's a very clear bull case here. In fact, it's really hard for me to make a bear case for this business that doesn't have to do with these legal proceedings.

Gallagher: Yes. I think that in terms of risks, that's the biggest one and then you just have to decide for yourself. Is it so big that it's a deal-breaker for me or is it a big risk that I'm really aware of? Then understanding what that means for your investment thesis moving forward.

Flippen: I think that's a great place to leave off the show. I hope everybody enjoyed listening and learning about this business. It's weird to have spent so many hours, Maria, so many hours.

Gallagher: You've read those hours much more recently than I have, so I was a little rusty in my single-cell knowledge.

Flippen: I will say, this company was, and single-cell gene expression, and immunotherapy technology, all of this stuff is a little bit of a black hole for people who aren't intimately familiar with this space. It's weird to condense that knowledge into what is now a 30-minute podcast, and if I'm frank, I don't think it's quite possible. I hope everybody at least learns a little bit more about this business. If you decide that you have hours to waste, I would encourage you to read through the 10-K. As hard as it is to get through, I hope this podcast has at least provided a base level of knowledge that if you do read through, you'll be like, "Oh, I recognize that word. I kind of understand the business model." Maria so kindly supplied me with her previous write-ups, which provided me some context when I was reading through. But either way, it was a fun business to learn about. I hope I've done Shannon, our former healthcare host, I've done her honor here in talking a little bit of healthcare on this Wildcard Wednesday. But Maria, thanks for joining.

Gallagher: Thank you so much for having me. On behalf of Shannon, I think you did a great job talking about healthcare.

Flippen: I appreciate that. It's mostly me turning into little risk rants, but what's new? Fools, that does it for this episode of Industry Focus. If you have any questions or you just want to reach out, don't be afraid to shoot us an email at [email protected] or reach out to us @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today, for Maria Gallagher. I'm Emily Flippen. Thanks for listening, and Fool on!