A little momentum and a big short squeeze can go a long way. Genetic testing platform Invitae (NVTA) ripped 277% higher on August 10. It was truly epic.
Roughly 217 million shares traded hands. For comparison, the average daily trading volume was just 13.7 million shares over the previous three months. Furthermore, the business entered August with only about 235 million shares outstanding total.
It was also truly bizarre. Invitae announced a strategic pivot and provided financial guidance on July 18. That included unflattering growth projections, replacing the CEO, laying off one-third of its workforce, and promising to keep cash burn to "only" $825 million in 2022 and 2023. Nothing changed when it reported second-quarter 2022 operating results on August 9.
Investors might argue the genetic testing platform was undervalued at a market valuation of $500 million, which is where the valuation settled in the weeks after the pivot was announced. Then again, there's not much to look forward to until 2024.
Momentum Is Not a Durable Advantage
Many companies pursued a growth-at-all-costs business model, which promises potential profits many years in the future, over the last decade. That was easy to do when the Federal Reserve kept interest rates low to spur growth and keep the economy from slipping into a deflationary environment after the Great Recession. The easy-money era is coming to an abrupt end in the aftermath of the coronavirus pandemic, for which the economic recovery is characterized by some of the opposite challenges.
Pledges (and actions) to jack up interest rates virtually overnight have exposed the unsustainable nature of growth-at-all-costs business models. Now, many companies large and small are prioritizing traditional metrics of business success, such as cash flows and profitability. Some are better positioned than others.
Invitae was among the worst positioned. It spent money a little carelessly, prioritized revenue growth over every other metric, and wasn't delivering any financial benefits from achieving larger scale. From 2018 to 2021, the business grew revenue 212%, but only grew gross profit 63%. That's a problem when operating expenses grow 302%. The result was unsurprising: Operating cash outflows swelled 507% in that span.
That trend was never sustainable. It necessitated a pivot and a new focus on operating efficiency. The strategic reset was finally announced in July, but investors should acknowledge the improvements will still make Invitae a relatively lousy business.
Let's consider a little perspective:
- Invitae plans to report a cash burn of roughly $600 million in 2022. That will be more than Exact Sciences (EXAS), which generates more revenue every quarter than Invitae generates in a year.
- Invitae plans to reduce cash burn to roughly $225 million in 2023. That will be roughly equivalent to PacBio (PACB), which generates 70% less revenue than Invitae.
- Cash burn guidance suggests Invitae will enter 2024 with roughly $210 million in cash – likely only enough for another 12 months of operations. Companies typically make that the minimum level of cash on the balance sheet, suggesting another capital raise will be needed in late 2023 or early 2024.
- Invitae plans to wind down certain aspects of its business. It doesn't expect total revenue to grow in 2023 compared to 2022. When growth resumes in 2024, management expects an annual rate of 15% to 25% -- much lower than the historical promises of 40% annual growth.
Promising to be less bad 24 months from now is hardly cause for celebration.
Is This the Real Reason for the Pivot?
My read on the situation is that management's strategic pivot is an attempt to make Invitae more attractive for an acquisition. However, most would-be suitors are also furiously focusing on improving cash flow and achieving profitable growth. That alone makes it difficult to see an acquisition taking place any time soon, even if the described operating improvements are achieved.
Does Exact Sciences or Roche (RHHBY) or Guardant Health (GH) really want to spend $2 billion or more on an acquisition for the privilege of burning hundreds of millions of dollars per year in a commoditized industry? It's possible, but there are more attractive acquisition targets in the fragmented landscape of genetic testing. Besides, it may be more valuable to let a competitor crash and burn, opening more elbow room in the commercial landscape.
To be fair, there are opportunities for positive surprises. Invitae could divest parts of the platform.
One of the best moves would be to offload its recently-acquired liquid biopsy portfolio. The tools are delayed, well behind the competitive landscape, and the company doesn’t have the correct commercial infrastructure built to achieve success. Such a sale could provide hundreds of millions of dollars in cash, allow the business to focus on core hereditary testing, and make it more appealing for an acquisition itself -- both from a financial and anti-trust standpoint. Management intends to keep the liquid biopsy tools for now.
Whether bullish or bearish, investors should remain grounded. It's premature to take a victory lap on the mere announcement of plans to improve from very poor benchmarks. Even if successful, Invitae is likely to enter 2024 as a deeply unprofitable business, which will present challenges. The current momentum and volatility are certainly fun, but focus on meaningful metrics and durable outcomes. It will take years to play out.
