23andMe (ME -4.47%) investors have had a bumpy ride in the last 12 months. The company's shares are down by more than 67%, quarterly revenue growth has slumped into the single digits, and profitability remains far out of reach.
Nonetheless, enterprising investors may believe that the company's fortunes will soon be looking up -- a view that management shares. Is this stock priced attractively for a purchase?
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Genetic testing and drug development should make great teammates
In case you're not familiar, 23andMe sells consumer genetic testing kits for ancestry and health. Once people have mailed in their saliva sample and gotten their genome sequenced, the company provides them with reports about their ancestral homeland and their genetic risk factors, depending on which service they subscribe to. These services account for around 81% of its revenue, but they might be much less over time.
As a result of the success of its consumer testing business, 23andMe has a massive database of genetic information, with genomes from upwards of 12 million people. Of those subscribers, around 80% opt into its research program, which enables their data to be used in drug development. Using that data, the company has initiated and is currently working on more than 40 different drug discovery programs.
So if even a fraction of those 40 programs can advance through the clinical trials process and eventually get regulatory approval, it'll supercharge the stock. It will also prove the company's chops as a biotech company rather than as a diagnostics provider.
But 23andMe doesn't just do the research and development work to move projects into the clinic. It also harvests more leads for new drugs from its databases and then sells those leads to major collaborators like GlaxoSmithKline, which made a $300 million equity investment in the company and struck a deal to split profits and costs.
Furthermore, GSK recently opted to expand the collaboration through July 2023, which means it will be paying an additional $50 million. These research services make up around 19% of 23andMe's income, and that percentage could rise over time as it invests more in drug development capabilities.
Critically, if it can prove itself as a worthy collaborator, 23andMe won't need to keep expanding its membership base to keep racking in more revenue. Therefore, it's feasible that the business will look entirely different in five years when its pivot to biomedical lead generation will be complete.
Does the valuation fit the business model?
The trouble with judging 23andMe's value is that it doesn't fit cleanly into a single classification, which makes it hard to compare directly.
Its price-to-sales (P/S) multiple is currently 8.3. Compared to the biotechnology industry's average P/S of 6.7, the stock is on the high side but not by a prohibitive amount.
Although drug development isn't the primary way it makes money, at least for now. If you interpret 23andMe as a diagnostics company, it looks much more favorable, as the in vitro diagnostics industry has an average P/S of 16.2.
The issue is that its consumer genetic testing business isn't growing very quickly, which is part of the reason why the stock has performed so poorly as of late. As a whole, the company is still operating at a massive loss, and it'll likely continue to for quite some time.
In other words, 23andMe looks underpriced compared to other diagnostics businesses because the market expects it to keep underperforming. In contrast, the stock looks slightly overpriced by the standards of biotech because it will likely continue to have plodding revenue growth, which makes it stand out in an ocean of pre-product biotechs that don't have any income whatsoever.
So in my view, this stock is neither undervalued nor overvalued. Given that faster-paced revenue growth will be hard to come by, it doesn't make sense to invest in 23andMe right now as a diagnostics play, as there are more attractive opportunities elsewhere. Likewise, there are cheaper biotechs out there that also have the potential for significant future growth.
Nonetheless, I'm not a bear when it comes to 23andMe. Over the next few years, its research services business may start to finally take off, and if it can keep advancing drug candidates into early-stage clinical trials without the help of a larger collaborator, it'll be on the (long) road to success. Until then, it's probably best to steer clear.
