Investment Thesis for Pacific Biosciences
PacBio's (NASDAQ:PACB) expansion with Revio and Onso sequencing technologies positions the company for market and technology gains. It promises a move away from previous dilution with a revenue growth forecast of 25% by 2029. Despite the risks from technological changes and further dilution, analysts see an upside potential of 178%. However, a gradual, Speculative Buy with an expected return of 29% is more reasonable.
Company Insights
PacBio is involved in developing and producing advanced sequencing solutions. Sequencing refers to determining the exact sequence of nucleotides (the building blocks of DNA and RNA) within a DNA molecule. These solutions are pivotal for scientists and clinical researchers aiming to enhance their understanding of genomes and life processes on Earth.
PacBio's offerings are rooted in two distinct core technologies: the HiFi long-read sequencing solution (Revio) and the newly developed sequencing by binding short-read sequencing solution (Onso). These technologies cater to a broad spectrum of research applications, from human genomics and infectious diseases to oncology, ensuring higher accuracy, quality, and completeness in genetic sequencing.
The overall market is worth over 7 billion dollars and growing fast. However, it is still primarily dominated by sales of an older short-read technology, which is less accurate but faster and easier to transport for field trips. PacBio's long-read technology is significantly more accurate and can solve huge puzzles. The company is now working on a portable "benchtop" long-read model for field trips. This development and the newly developed improved short-read solution will catapult them into the multi-billion dollar market. That's the idea.
In addition to hardware, PacBio has partnered with Google to enhance computing power through DeepConsensus. The company also supplies consumables such as reagents, kits, and sequencing chips, and develops the necessary software, incorporating open-source solutions. Please take a look at the revenue breakdown by product and region below.
Financial Performance of PacBio
PacBio’s annual revenue increased 10% from 2015 to 2023. Due to the rapid adoption of PacBio's new systems, 2023 was a year of significant growth. This trend is projected to continue, with a consensus annual growth rate of 25% through 2029.
The large operating loss in 2023, shown in the chart below, is forecasted to decrease gradually and become an operating income by 2029.
We have included below a quarterly comparison of revenues to R&D and SG&A expenses. The most important takeaway is a steep increase in revenues in 2023 due to introducing new and superior products.
The next chart illustrates cash flow trends over the years. The financing spike and investing outflow in 2021 are mainly due to raising debt and equity to acquire Omniome. The key takeaway is that operating cash flows are estimated to turn positive in 2027.
Solvency/Bankruptcy: PacBio's cash position, including short-term investments as of December 31, 2023, is $180 + $455 = $634 million. The company's estimated annual cash burn, until it becomes cash flow positive, is projected to be $250 million for 2024, $200 million for 2025, and $100 million for 2026. These projections are our own and lean towards a base case totaling $550 million. Technically, the company could survive without additional shareholder dilution or debt financing.
Financing Growth: Equity, Debt, and Impact
We like to compare per-share metrics, such as share price or revenue per share, with absolute measures like market capitalization. This comparison is an excellent way to illustrate what you are "missing out on" as a typical public shareholder.
The chart below demonstrates that. Your total pre-inflation capital gain on a hypothetical PacBio investment over the last ten years would have resulted in a -14% capital loss. Considering all the trust and risk you have placed in that project, this is pretty sobering. And while the company’s value is tripling, you are left with a “high risk/no return” situation, fighting dilution for a decade.
So, the real question for ordinary equity investors must be: Will the company increase its revenue faster than dilution occurs? In other words, can the company sustainably increase its revenue per share over the next three to five years, thereby creating real shareholder value without relying on another arbitrary stock market biotech frenzy?
This could be realistic in the mid to long term. The company began to explore debt financing in February 2021, when PacBio issued 1.50% Convertible Senior Notes due in February 2028. These were issued at the peak of their share price, resulting in a conversion price of $43.5 and totaling $900 million. Fast forward to June 2023, the company refined its strategy by exchanging $441 million of the original 2028 Notes for newly issued 1.375% Convertible Senior Notes. These still have a high enough conversion price of $21.5, extending their maturity by two more years and significantly reducing interest costs until February 2030.
This relatively inexpensive and well-timed debt financing mitigates immediate dilution pressure. Assuming the continuation of sales momentum, we could witness a positive impact on shareholder value sooner rather than later.
Below is how equity and debt financing has impacted the balance sheet over the years.
Insider Transactions: Since this is at odds with most automated stock screeners, it's worth mentioning that, although management recently sold shares, most selling is automated due to tax-triggered equity compensation plans. Additionally, as seen in the same SEC Forms 4, management is typically an active buyer at current levels through the company's 2010 Employee Stock Purchase Plan. Furthermore, two members of PacBio’s Board of Directors, Marshall Mohr and David Meline, have recently increased their stock holdings.
Comparative Analysis: PacBio & Peer Group
We have conducted comparative and valuation analyses with PacBio's publicly listed peer group. We present this peer group in the chart below, sorted by market capitalization. The dashed green line shows the market cap relative to total assets, with PacBio ranking low at 0.6x.
The chart below indicates that PacBio's R&D expenditure to revenue ratio stands high at 93%, a figure we welcome at this stage of the company's development. However, the asset turnover rate—reflecting the ratio of revenue to total assets—was notably low over the last twelve months, positioning it at the bottom of the group at 11%.
We regularly review the brokers' share price targets and are happy to share them if they are strikingly high or low compared to the peer group. PACB ranks close to the top with a potential upside of +178%.
Valuation of Pacific Biosciences
Shifting our focus to valuation, the chart below illustrates the market value multiples, price-to-book (P/B), and price-to-sales (P/S) of PacBio and its industry peers. The grey dots denote each company's current trading positions, while the orange and green dots represent the 90th (HIGH) and 10th (LOW) percentiles of the last ten years (L10Y).
Most companies are currently trading near their 10-year lows. PACB trades at a discount, below its P/B low, at 1.4x, and close to its P/S low at 4.2x. Compared to its peers, AES trades similarly undervalued.
Based solely on the 2024 expected book value and sales forecasts, PacBio is again trading at a discount compared to its peers, with a price-to-book multiple of 2.0x and a price-to-sales multiple of 4.2x.
Verdict
Based on our analysis, which includes standalone performance, peer comparisons, and multiple expansions and contractions, we have applied the ranges shown in the chart below to today's share price to arrive at a fair price target for 2024. We added the 2025E multiples to provide more data points and significance. The price target is $7.20, resulting in a Speculative Buy recommendation with an upside of 90%.
Risk Assessment on PacBio
Management mentions a wide range of risks in the latest 10-K report. We filter out the five most important ones we agree with and rank them by severity.
Top Five Risks - Ranked by Severity
Competition and Technological Advancements (High Risk): The genomics industry is rapidly evolving, with new technologies constantly emerging.
Customer Capital Expenditure Delays (Medium to High Risk): Due to economic uncertainties, customers are taking longer to buy PacBio's equipment, affecting when PacBio can recognize sales.
Transition from Sequel II/IIe to Revio Systems (Medium Risk): PacBio is in the process of transitioning customers from older systems (Sequel II and IIe) to its newer Revio system. Demand for older systems’ consumables might be lower during this transition.
Global Macro Trends and Geopolitical Risks (Medium Risk): Global economic conditions, such as inflation and interest rates, along with geopolitical tensions, can influence customers' ability to purchase and pay for PacBio's products.
Supply Chain and Manufacturing Scale-up (Low to Medium Risk): Scaling manufacturing for new products like Revio and Onso can pose challenges.
PacBio’s Worst-Case Share Price Projection
Our worst-case analysis indicates a potential 30% decrease in PACB’s share price to $2.6, based on conservative multiples from historical lows during challenging periods. This projection, detailed in the chart below, considers the above-mentioned risks.
Trade Execution - Top Idea for Pacific Biosciences
PacBio is a risky and volatile stock, trading below 5 dollars. We believe options trades are even riskier in this context and cannot identify a solid strategy we feel comfortable demonstrating. Additionally, option chains over one month of maturity are illiquid and exhibit large bid-ask spreads.
If you wish to get involved, we don’t dislike a gradual, long equity strategy over an extended period. This approach distributes the risk you are willing to take and mitigates potential sharp downside moves.
If you were to get in all at once, our back-of-the-envelope expected value calculation would give an expected return of 29% over the next twelve months. Please take a look at the result below.
Conclusion
Despite a competitive market, PacBio made significant strides in 2023, notably with the launch of the Revio system and the acquisition of Apton Biosystems, which enhanced its sequencing capabilities. Financially, the company has seen a 10% annual revenue growth since 2015, with a notable increase in 2023 and projections indicating robust future growth.
However, challenges remain, including the potential for continued shareholder dilution and the risks of being in an industry known for fast-paced technological change. PacBio's partnership with Google and innovations in portable sequencing models position it well for future market expansion, aiming to capture a fair share of the $7 billion sequencing market.
Juri von Randow
Turning risk into reward in stocks, commodities, and crypto/currencies. Leveraging derivatives for steady wins, regardless of market conditions.As an ex-investment banker, I've steered M&A and ECM from London to Wall Street. I've launched ventures in fashion, hospitality, and client services. Now, I trade friends and family accounts and share my insights on MacroDozer and Seeking Alpha. I also conduct specialised market analyses for external clients alongside leading Options Training courses at MacroDozer Academy. Follow me on Seeking Alpha and drop me a message anytime. I'm always here to connect with fellow investors and readers.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in PACB over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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