Description

TXG

This is a growth-to-profitability transition story. Given this is a life sciences company, I am oversimplifying a little (largely to leave out noise related to smaller products that are all excluded from the analysis and should be considered upside optionality).

10x Genomics pioneered the single-cell category within genomics, which has proliferated since 2017 as a key level of resolution in academic experiments. In 2021, TXG made 60% of its sales to academic labs and the balance to biopharma for drug discovery R&D. The company operates with a razor-and-blade model in which 85%+ of its sales are high-margin consumables (think plastic chips with chemicals in them). It trades at 7x NTM sales, has a high 70s/low 80s gross margin under normal conditions, and is close to cash flow breakeven. Before 2022, it was growing revenue at 2-year CAGRs of >40%. The low end of guidance puts 2022 growth at just 2% due to COVID and supply-chain related 1-timers as well as some tough comparables. 

Impacted by a transitioning customer base in the United States, a supply chain stumble in Europe, and the complete shutdown of genomics labs in China, TXG trades at its lowest valuation since IPO in 2019. I believe the market is ignoring a long and growing end market, a massive product cycle, and high profitability potential due to a confluence of one-time headwinds and an overemphasis on a new product category for the company that I view as more of a call option than a growth driver.  

Why 10x is in the Penalty Box (more than the rest of the genomics)

TXG has had 2 consecutive guidance cuts in the first half of the year that have destroyed the stock price, estimates, and its multiple. The key points are as follows:

1.     “Halo” customer transition in the US: heading into this year, consensus was modeling TXG under the assumption that the pull-through on each of its installed instruments would remain stable or rise in 2022. However, TXG has largely penetrated what academia calls “core labs”, which are centralized labs that do gene sequencing for smaller labs. As TXG reaches out to smaller labs, they buy 10x instruments for themselves and learn to use them instead of paying a premium to a core lab, effectively cannibalizing on a net-negative basis in the near-term.  It appears there were some stumbles here in ramping up smaller customers, given the untimely departure of TXG’s CCO.

2.     Europe: In 1Q TXG flagged an issue with its EMEA customers in which cold chain processes were violated and some customers got spoiled product from TXG. This extended into the second quarter as well. Beyond the logistics problem, TXG doesn’t typically report in constant currency, so the large move in the Euro in 2Q was likely a sales headwind as well. European academic demand was also generally weak per ILMN’s commentary. ILMN makes the sequencing instruments that single-cell experiments are run on. EMEA revenue slowed to 7% growth in 1Q and declined 11% in 2Q this year.

3.     China: China lockdowns lasted from the end of March through the end of June. China revenue declined 50% q/q as a result. Many were caught off guard as reports that China was returning to work led some to believe that academic customers were back in their seats when they likely weren’t.

Why Fears are Overblown

Together, the above events have called the size of TXG’s TAM into question and has many wondering if it has saturated its markets. The sell-side is certainly shaken up as well – analysts have used 2022 to justify large cuts to 2023 and 2024 revenue numbers:

However, napkin math on TXG’s and Illumina’s pricing suggests that of the ~2M samples run on Illumina’s instruments for academic experiments alone in 2021, just 300k were done at single-cell resolution, and assuming that biopharma makes up 40%, it implies ~9% of academic experiments were done at single cell resolution. This is surprising because over time, you could argue that every experiment should be done with a single-cell overlay if the data generated is to be useful over the long run. Large population studies could be considered an exception, but they too would likely be more insightful with single cell resolution. The analogy here is getting all the data points vs just an average (gene sequencing data is the average of cells without TXG).

Even going from here to 50% of samples, at 50% of the cost/sample would leave room for revenue to grow ~2.5x from here. As single cell becomes increasingly popular, it will be important to biopharma as well, creating more room to grow. However, at these levels, you don’t need a return to TXG’s old growth profile to make money.

Transition to Profitability

Management is aiming for breakeven in 2023. With $500M in cash and little burn today, I don’t care which quarter it falls in as long as the trend remains clear. TXG will get to profitability without needing a dime of new capital to make it happen. Given the prior focus on its growth, I believe that many have lost sight of what TXG could do on the profitability front.

TXG has a useful analog when it comes to estimating profitability – the complementary technology uses the same sales channels to commercialize as 10x. Illumina enjoyed operating margins of as high as 30% in 2019 (COVID was a major headwind in 2020). It sells almost the same products – razor-and-blade instruments and consumables.

TXG has the potential for even higher margins – it has shown gross margins in excess of 80%. Let’s assume 75%-80% is the right range for TXG.

ILMN would have shown the following at TXG’s gross margin:

Even the widest range you can make here looks great for TXG – especially considering that this OMx profile still has a teens % of sales in R&D. With no debt, a 35% op margin, and a 20% tax rate, 10x Genomics would be trading at 25x its NTM EPS if it was at that level of profitability today. Even with 2 rounds of cuts, the street is estimating mid-20s revenue growth for TXG for the next couple of years, which is backstopped by academic and biopharma R&D budgets both growing 4-6% a year, with the lion’s share going to next-gen tech like sequencing consumables and single cell analysis.

The levers to get to this level of profitability are easy to see – R&D and commercial infrastructure leverage. It is playing out relatively organically today. TXG has been working hard on launching a new product category which has created a lot of incremental spend that won’t repeat in 2023. I expect 2023 and 2024 to be huge in terms of showing this leverage more explicitly. 

Catalysts/Upside Drivers

I believe TXG can’t stay this cheap for much longer for 3 reasons:

1.   Growth will reaccelerate in single cell next year: Next year we will be lapping the 1Q shutdown in the US, the 2Q/3Q China shutdowns, and the 1Q/2Q/3Q Europe softness and FX. On these alone, TXG can easily put up growth in the 20s. Accelerating growth is often enough to put pressure on a single-digit forward sales multiple, even more so when it’s the same as large caps that grow 7% a year.

2.   Profitability would make TXG an M&A target if not valued appropriately: If TXG stayed at these levels while showing incremental profitability, and growth disappointed, there would still be several likely buyers who could swoop in and make an offer and accelerate these levers. These include Thermo Fisher, Bio-rad, Bio-Techne, Qiagen, and Roche. These companies all have synergistic product portfolios and a penchant for M&A.

3.   New products and clinical potential create a skew to upside for numbers: Starting in late June, TXG launched 2 new products for its single-cell customers and has been/will be launching spatial (adjacent category) analysis products throughout 2022, all of which take about 3-6 months of lead time to ramp up and contribute. These are likely not well-contemplated in 2023 estimates, which only assumes 25% growth (which, as mentioned before, is achievable just by lapping shutdown quarters). There is also a thesis that single-cell analysis could be a component of cancer diagnostics in the future. Any kind of clinical utility would be pure upside for 10x.

I have been following this business since IPO, and have always struggled with my admiration for its cult following among scientists (ask any genomics researcher if people like 10x. Go ahead.) in the context of its sky-high multiple against growth that I saw as capped in the 30-40% range at a certain point as many tools companies are. In hindsight, I could have justified owning TXG by pairing it with a short on a basket of other genomics companies to isolate away from the multiple. Thanks to the sh*tshow that this year has been, we no longer have to.    

Risks include other growing areas of research (proteomics) conflicting with transcriptomics (usually different disciplines), macro (academic budgets are moderately macro-sensitive), and execution risk (new CCO has to execute on getting smaller customers educated on the system). 

Catalyst

Base biz growth re-accel, M&A, new product upside