Small-cap biotech companies can deliver outsized returns over the long run if they develop breakthrough medicines that go on to generate massive sales. However, some of these smaller drugmakers aren't just drugmakers. That's the case with Recursion Pharmaceuticals (RXRX 6.67%), a biotech whose technologically focused approach to discovering and developing medicines could be even more important than the revenue it could eventually earn from its own pipeline candidates.
With a market capitalization of just $1.9 billion, Recursion still provides a potentially good entry point for investors, but that's only if there are good reasons to think that its strategy will pan out. Let's find out whether that's the case.
The next 18 months will be important
What exactly does Recursion Pharmaceuticals do? It describes itself as a TechBio company, meaning it seeks to use technology to improve healthcare. Specifically, Recursion uses an artificial intelligence (AI)-based algorithm in a virtual lab that tests clinical compounds on a library of human genes. The goal is to identify the most promising compounds to move to studies and increase the success of medicines that first enter clinical trials, the overwhelming majority of which never reach the market.
Recursion's approach could help speed up the drug discovery and development process, which is notoriously slow and expensive -- and has only gotten worse over the years despite technological improvements. So far, Recursion's approach has not produced particularly impressive results. The company was founded in 2013 but still has no products on the market. It currently has none in phase 3 trials either.
NASDAQ: RXRX
Key Data Points
That could change soon, though. Recursion Pharmaceuticals recently reported positive phase 2 results for REC-994, a potential treatment for symptomatic cerebral cavernous malformation, a disease caused by the abnormal formation of blood vessels in the central nervous system that leads to various symptoms, including headaches and seizures. REC-994 hit its primary endpoint in the trial: safety and tolerability.
Recursion expects nine more clinical trial readouts in the next 18 months, including three from candidates it got its hands on in a recent acquisition. The biotech has partnerships in place with several pharmaceutical giants, including Merck, Bayer, Roche, and Sanofi. That could be a clue that its programs are promising. Recursion Pharmaceuticals' upcoming clinical trial results will tell us quite a bit. While estimates vary, one study found that about 30% of medicines that enter phase 2 studies fail to advance to late-stage clinical trials.
That's an industrywide statistic, but if Recursion can best it and send 60% of its phase 2 products to phase 3 studies, that would be a win. If it does significantly worse, that won't be a good sign. It won't be definitive proof that its platform works -- or doesn't work -- but it could move the needle for Recursion. REC-994's positive results are a good start. But there is more work to be done.
Investors should hedge their bets
Recursion Pharmaceuticals could have two sources of revenue in the future. In addition to selling medicines, it could license its AI drug discovery platform to other biotech companies. But that all hinges on the success of its approach, and, so far, there isn't enough evidence that it does work as intended. There might be a way out even if Recursion's current crop of pipeline candidates isn't successful. The accuracy of the company's platform might increase with use.
Clinical trial successes, or even failures, would help it fine-tune its algorithm to allow for better results over time, a classic example of the network effect. Still, until Recursion Pharmaceuticals shows with tangible results that it can spend less money on R&D than its peers without sacrificing the quality and quantity of the medicines it launches, it remains a risky stock.
Investors comfortable with heightened volatility may consider opening a small position in Recursion Pharmaceuticals since the company could deliver outsized returns if things go according to plan.
