Recursion Pharmaceuticals (RXRX +1.77%) doesn't look like a stock that legendary investor Warren Buffett would usually be interested in. It's in the biotech industry, which tends to be volatile and often difficult to understand, without significant recurring revenue or any profits for many of the newer stocks in the sector. To complicate matters further, Recursion is engaged in the emerging field of artificial intelligence (AI)-enabled drug discovery and development, which means it lacks any of the long history of consistent performance that Buffett typically looks for in an investment.
But, if the company achieves its ambitions, it could become something a lot closer to what the Oracle of Omaha prefers. Here's why it's possible and how it can happen.
NASDAQ: RXRX
Key Data Points
Getting around this one sticking point is part of the plan
Traditionally, Buffett doesn't favor businesses that need to spend a big proportion of their revenue on research and development (R&D) expenses. High R&D costs imply that the company doesn't have a strong enough competitive advantage with which to protect its market share from competitors. After all, if it needs to constantly improve its products or invent new ones to maintain earnings growth, it could only be a matter of time before the engine of innovation sputters out and leaves investors wanting growth.
That's part of the reason why he rarely invests in biopharmaceutical companies like Recursion. Even the best pharma players tend to spend a large proportion of their revenue on R&D, and they're far from immune to experiencing costly setbacks that disrupt the growth that shareholders had penciled in. In fact, Buffett currently doesn't hold any pharma stocks whatsoever.
However, Recursion's vision is to at least partially solve this issue at the root via both its technical innovations in drug development and its business model.
The biotech's claim to fame is its drug discovery and development platform, which heavily relies on AI, machine learning, and reams of specialized data. The point of using AI is that it can help management select and optimize the most promising candidate molecules to advance through each phase of the preclinical research process, supposedly cutting down on late-stage failures while saving money and time along the way. Ideally, its platform also translates into better clinical trial data and faster progression toward commercialization.
The jury is still out regarding whether Recursion can actually deliver those improvements over the traditional drug development approach. Still, if it does, it'll realize three distinct avenues for growth. The first is to simply develop new drugs and commercialize them on its own, whereas the second is to partner with big pharmas that want to use its platform for their own purposes, and the third is to license out access to its platform or its data trove.
And that's where Buffett's ears could start to perk up.
Licensing out access to a platform is a very low-cost way of generating revenue, and if customers are consistently deriving value from gaining access, it would point to the presence of a competitive advantage via slashing biopharma R&D costs. Furthermore, if collaborators are willing to fork over a lot of milestone payments to get more hands-on help from Recursion, there's a high chance that they'll also be willing to sign on the dotted line for the biotech to earn significant royalties from any medicines produced by the collaborations -- another low-cost revenue stream.
Finally, if -- and this is a big if -- Recursion can genuinely reduce the failure rate of its own pipeline projects compared to competitors by using its platform, it might even be able to commercialize medicines regularly enough to satisfy Buffett's desire for stable earnings growth over the long term.
This biotech isn't in its final form yet
Time for a quick reality check. Per its Q2 earnings published on Aug. 8, Recursion's R&D expenses were $73.9 million, and its revenue was just $14.4 million. That puts its R&D expenses at more than 513% of its quarterly revenue, which is a ratio that Buffett would almost certainly find disqualifying.
Still, a lot could change over the next few years. Recursion is merging with Exscientia, another leading AI-enabled biotech pursuing new approaches to drug development, and between the two of them, it expects to report around 10 clinical trial readouts over the next 18 months. Each of those readouts is a (small) piece of evidence that could swing in favor or against Recursion's thesis about the effectiveness of its platform.
Within the next four years, it could get as many as four of its pipeline programs approved for sale. That means it should be possible within five years to make a more definitive judgment about the merits of its AI-based approach and its potential to deliver more revenue on a regular basis in the future.
Until then, it can't be a Buffett stock. But in the long run, if it delivers what it claims it has today, it's still quite possible that it'd meet Warren's stringent specifications.
