In a world where biotechnology is always becoming more sophisticated, manufacturing-oriented biotech businesses like Ginkgo Bioworks (DNA -3.08%) are upping the ante by becoming larger and more capable of handling complex asks from customers. But doing that requires a lot of capital expenditures, and from the standpoint of investors, big capex committed into an area at an industry's frontier means big risks in buying the stock.
So what's the right move? Let's go through the arguments for selling this stock first, then we'll discuss why it might actually be worth buying more or holding it, depending on your inclination.
Why you should sell it
There are a handful of reasons why Ginkgo isn't a great investment for everyone. The core issues are that it's a biotech stock, which makes it risky, and it's pursuing a highly capital-intensive business model that hasn't been proven to work, which makes it even riskier.
For Ginkgo's model to work, it needs to deliver bespoke biotechnology research and development (R&D) and manufacturing services to biopharmas, agriculture companies, and anyone else that has a need for customized microorganisms (or their byproducts) at industrial scale. Each servicing agreement is known as a "program" in its parlance, echoing the terminology in a traditional biotech development pipeline.
A program has to be able to serve the needs of a business like Moderna, which wants to hire it to produce organic vaccine components, as well as a business like Merck, with which Ginkgo is teaming up to make its biologics manufacturing process more efficient. That means its internal set of capabilities has to be expansive, or it'd miss out on revenue.
Therein lies a bit of a paradox. Being highly efficient at scale typically only happens when a company focuses on scaling in a couple of closely related domains, and flexibility is often sacrificed. After all, the more each customer relationship is defined by the customer's particular needs, the less applicable any one-size-fits-all solutions will be.
But Ginkgo's appeal to its customers is that it's both highly flexible, and also lower-cost than what those customers could accomplish on their own. Its financial performance so far supports the idea that making good on its value proposition is going to be incredibly difficult.
It isn't profitable on an operational basis, and its trailing-12-month operating losses are in excess of $786 million. Furthermore, the biotech only has $944 million in cash, equivalents, and short-term investments, so it'll need to find a way to become a lot more efficient within the next couple of years.
Management has long pointed to the presence of economies of scale in biomanufacturing as being the saving grace waiting over the horizon. And it's hard to deny that growing its customer base and scaling up its offerings are the only ways to test if that's true. But if high efficiency doesn't ever arrive, investors will be left holding the bill, and such a risk is too high for shareholders to tolerate -- or so the argument goes.
Why it's worth buying or holding
Gingko does indeed have a bit of a problem regarding its path to profitability. In the long term, that problem will need to be sorted out. But taking a quick look at the assets it's accumulating to work toward that goal will show that management's ambitions are unlikely to be rebuffed, so long as short-term financing can be found.
Doing biological work at large scale gets expensive quickly. Closet-sized gene sequencers, rows of bulky liquid-handling robots, and bioreactors that are as big as cars aren't cheap to buy, nor are they cheap to operate and maintain, especially not in a semi-sterile or sterile environment. At the same time, the skills needed to use that equipment fruitfully are valuable and rare, so labor costs are another key constraint.
The upside is that having all of those people and hardware under one roof can make a big difference in terms of what can be accomplished. Per Ginkgo, thanks to refinements of its core automation work cell, its manufacturing capacity is theoretically capable of increasing by as much as 500% before needing to hire additional staff. That means the marginal cost of onboarding new programs from clients can stay incredibly low.
It also means that the company's big capital expenditure push is likely going to cool down for a while until it has work to fill its excess capacity. In other words, expect efficiency improvements to start rolling in and showing up in its earnings reports, potentially within the next couple of quarters if management's thesis is correct.
Once its operating efficiency looks less like that of a biomanufacturing start-up and more like that of a semiconductor foundry, where the initial massive capital investments have a high rate of payoff for years, the market won't think twice about bidding up Ginkgo's shares. And it's that hope that is enough to suggest that risk tolerant investors buy it today -- and it's also enough to justify holding it if you currently own it.
