Buffett didn't get rich by buying biotechs, and his traditional value investing perspective is difficult to square with the industry's frequently unprofitable businesses.
But could a company with a highly repeatable and difficult-to-imitate business like Ginkgo Bioworks (DNA -10.43%) buck the trend and become a Buffett favorite? In my view, it's more likely than it may sound.
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Not a stock for the Oracle of Omaha (yet)
For the uninitiated, Ginkgo Bioworks is a deeply innovative biotech that specializes in automating the design and cultivation of synthetic bacteria and fungi.
The first barrier that Warren Buffett might have with this stock is that it's difficult to understand exactly what they do and how they make money. When it comes to investing, you don't need to be Buffett to know that it's foolhardy to invest in a company you don't understand in full.
Let's clear up that issue somewhat by considering Ginkgo's business model. Customers come to Ginkgo with problems they think a custom-made organism could solve, such as producing a specific chemical or protein at scale. Then, Ginkgo develops a strain of bacteria or fungi that does the job the customer is looking for and passes off the blueprint.
Next, customers pay out royalties on their downstream sales earned from using the microbe, or they render milestone payments as appropriate for progress with more complicated projects. That means there's the potential to realize years and years of royalties long after customers need any active help with development, which is definitely something Warren would appreciate.
Though it's nowhere near profitable, its services yielded Ginkgo with year-over-year quarterly revenue growth upwards of 483% as of the third quarter of 2021, not to mention trailing 12-month sales of $197.4 million. So at a minimum, its business model has some validation in the sense that it's generating growth. At the same time, Buffett isn't well-known for investing in unprofitable companies -- and over the trailing 12 months, Gingko saw a loss of $126.6 million.
Building an economic moat
As complicated as its process might seem even from a 10,000-foot view, developing task-specific organisms isn't exactly new in the world of biotech. That might make Buffett assume that Ginkgo lacks an economic moat to protect its business from incursion by competitors, but the opposite is true.
The ace up the company's sleeve is that it relies heavily on software and hardware automation, including sophisticated laboratory robotics and cutting-edge bioreactors. Thanks to this automation, the company claims that its tailor-made microbes are up to 10 times cheaper to develop compared to the industry's standard methods for generating custom organisms. What's more, management claims that its unit costs for programming cells are dropping by as much as 50% per year, so the moat is widening.
Building up so much automation is doubtlessly research-and-development (R&D) intensive -- another thing Buffett isn't crazy about -- but it does make it significantly less likely that competitors can mimic Ginkgo's service very efficiently. In concrete terms, the business reported trailing 12-month R&D expenses of $159.7 million, which in the most recent quarter works out to be around 68.3% of quarterly revenue. Buffett's hesitations are at least somewhat justified, as perpetually high R&D spending may be the only way for Ginkgo to maintain the size of its competitive advantage in automation.
The final issue that Buffett might find with Ginkgo is that it's far too new of a company to have the consistent history of earnings growth that he craves. It went public in September 2021, and its initial public offering (IPO) raised $1.6 billion in cash. Compared to the canonical Buffett favorites like Moody's, the biotech is still a tadpole. That means there isn't enough data to determine its long-term performance characteristics.
Potential ahead, but still early innings
Despite Warren's likely distaste for Ginkgo's complicated activities, high R&D costs, short history, and unprofitability, there are still a couple of other tidbits that he might find appealing.
Because its service is potentially useful for many different industries, it has a diverse base of customers. Therefore, downturns in any single industry aren't likely to majorly harm the top line. Other than that, the company has only $16.2 million in debt, which means that payments are unlikely to get in the way of investing in growth.
And if management's vision of being a low-cost microbe development partner can be realized, it'll set the biotech up for a massive amount of growth on an ongoing basis. But that might take quite a while to accomplish.
In summary, Ginkgo Bioworks probably isn't the right stock for Warren Buffett. But it could potentially be right for those who are willing to consider a more speculative biotech investment. Either way, it's still early innings for this stock, and it's entirely possible that the company could fit Buffett's bill after it finishes maturing.
