Big things begin small.
For synthetic-biology specialist Ginkgo Bioworks (DNA) , staying small appears to be the new strategy for winning new business.
The company operates a handful of automated labs for conducting biologic R&D, which it offers to customers as a service.
Although the word "biotech" is often synonymous with drug development, investors must be careful not to think too narrowly. Biology-based tech spans biopharma, industrial manufacturing, agricultural markets, consumer goods, and more.
Ginkgo Bioworks has customers across many industries, but it recently shifted its focus to the tried-and-true pharma and biopharma markets.
At the end of second-quarter 2022, the business counted 26 active programs in drug development, more than twice the 10 of the year-earlier period. The next-largest increases in programs during that span were food and agriculture (adding nine) and industrial and environmental (adding four).
Focusing on pharma and biopharma is a smart business decision. It also avoids yet-to-be-solved manufacturing challenges for products in nonpharma industries. That's because pharma and biopharma products require the smallest manufacturing scale compared with products in food ingredients, consumer products, and industrial chemicals.
But it might also suggest that Ginkgo Bioworks is overvalued.
Biology Is All About Scale
Ginkgo Bioworks offers its automated robotic labs as a service to help customers engineer biology. Some examples might include:
- A pharma customer may want to manufacture an antibody drug using mammalian cell-culture techniques.
- An industrial customer may want to manufacture 1,4-butanediol -- a solvent used in producing plastic -- using a genetically engineered bacteria.
- A flavor-and-fragrance customer may want to stop harvesting difficult-to-grow crops and instead port the genetics to a yeast strain that can produce the same ingredient via fermentation.
A customer program generally concludes with Ginkgo Bioworks handing over the microbial strain (a bacterium, fungus, virus, or mammalian cell type) it engineered to produce a specific ingredient or product. The customer then is typically responsible for manufacturing. Essentially, the business is being built as a contract research organization for synthetic biology. It is not vertically integrated.
But investors must evaluate each program case by case. That's especially true when they consider how difficult commercializing a biology-based ingredient might be. Manufacturing is not a trivial part of biology-based tech. In fact, it remains the most difficult challenge for synthetic biology and industrial biotech.
Consider some of the pain points for biomanufacturing:
- Economics: Microbes aren't magical mini-factories (they're pretty close!). They need nutrients, a food source, and the proper conditions to be coaxed into a productive state. The primary food source is generally a type of sugar, which is relatively expensive and puts many markets out of reach for synthetic biology.
- Mutation Rates: The microbes put into a bioreactor at the beginning of a process aren't always the same microbes that were engineered in the lab. That's because they can mutate away from the engineered genomes when commercial-scale production is being prepared. This is one reason larger-scale production is generally more difficult to control.
- Lack of Expertise: Not enough workers and engineers have been trained to drive the bioeconomy. Many also have the wrong expertise. Biomanufacturing for drug products is much different from production of an industrial chemical. Only so much can be borrowed from existing infrastructure and know-how to succeed in new areas promised by synthetic biology.
- Lack of Infrastructure: There simply isn't enough steel in the ground to power the biomanufacturing needs of the bioeconomy. Most of the biomanufacturing assets in the U.S. outside pharma are used to produce ethanol, but significant modifications would be needed to make it amenable to applications powered by synthetic biology.
Not all industries require the same level of manufacturing scale as measured by bioreactor volume. And this explains why Ginkgo Bioworks has been focusing so heavily on pharma and biotech. Smaller reactors are easier to control and therefore less risky from an execution standpoint, but the complexity of biology can always pose new obstacles.
For example, flavor-and-fragrance customers tapped Ginkgo Bioworks for more than 21 programs since 2016, but only two have been commercialized. These programs required only 50,000-liter bioreactors at the low end, which is relatively small for industrial biotechnology.
The definition of commercial-scale changes with the industry. As a rough guide:
- Drug-development applications typically require bioreactors with just 2,000 liters of volume.
- Specialty food and chemical applications typically require bioreactors with at least 50,000 liters of volume.
- Bulk-ingredient applications typically require bioreactors with at least 500,000 liters of volume.
- Commodity-ingredient applications might require bioreactors with nearly 1 million liters of volume.
A Smart Move -- but Valuation Risks are Rising
After surging to a market valuation of more than $29 billion in 2021, Ginkgo Bioworks has been hovering near a $5 billion valuation through much of 2022. Yet the business expects to report only about $180 million of full-year 2022 revenue from its CRO services. This is generally referred to as core revenue.
That means the stock is valued at roughly 28 times core revenue. That represents a nearly 1,000% premium compared with other contract research and contract manufacturing organizations.
Charles River (CRL) is valued at nearly $10 billion and is expected to have full-year 2022 revenue of $3.9 billion. Catalent (CTLT) is valued at roughly $13 billion and is expected to have full-year 2022 revenue of $5.1 billion. Both represent a valuation of 2.6 times sales.
To be sure, these aren't apples-to-apples comparisons, but they help illustrate that CRO and more important CMO businesses don't typically grab premium valuations.
Ginkgo Bioworks is in the early stages of growth and doesn't depend entirely on pharma and biopharma, so it deserves to trade at a steeper premium than Charles River or Catalent. But a 1,000% difference is not my definition of steep.
In other words, if Ginkgo Bioworks is going to build itself into a CRO for pharma and biotech because biology is difficult to scale in other industries, then it doesn't deserve to trade at such a sharp premium. Wall Street may not have fully grasped that yet.
