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The performance of Pacific Biosciences (NASDAQ:PACB) (“PacBio”) is all too familiar to readers who’ve followed this stock for a long time, as once again the stock is trading below $2 on fears that the company simply won’t be able to stay in the game long enough to benefit from future growth in long-read sequencing (as well as skepticism that long-read sequencing will grow enough to support a $1B+ revenue base).
Down more than 80% since my last update, underperforming other sequencing rivals like Illumina (ILMN) and Oxford Nanopore (OTCPK:ONTTF)(ONT.L), as well as other small life sciences tool companies like 10x Genomics (TXG) and Seer (SEER), PacBio has been hammered by a weak life sciences funding and purchasing environment that has driven a sharp decline in system placements as well as mediocre trends in consumables usage. With that, management has not only talked down guidance more than once over the last year, longer-term growth projections are now off the table.
Valuation is almost irrelevant now, as I think the stock is likely going nowhere fast without the business returning to $25M-$30M in quarterly instrument revenue and $20M-$25M/quarter in consumables revenue or some external event like a buyout offer. I think the current valuation is too punishing relative to long-term prospects, but I have to concede that there are substantial questions about PacBio’s ability to deliver on those prospects.
Weak Funding Is Hammering Demand
I’ve written about the weak funding environment for life sciences tools in reference to companies like Agilent (A) and Bruker (BRKR), but it’s hitting PacBio even harder as the company’s long-read sequencing technology is less well-established in the market and less capable of maintaining a healthy base business even during downturns (versus a company like Illumina or Thermo Fisher (TMO)). Said differently, when the life sciences tools market catches a cold, PacBio is looking at a possibly life-threatening case of pneumonia.
Revenue declined 23% year over year and 8% quarter over quarter to $36M in the second quarter, missing expectations by 12% following a first quarter that saw the company miss by 23% and guide to substantially lower revenue for 2024. Instrument revenue declined 51% yoy (and 23% qoq) to just under $15M, with 24 placements of Revio systems, below not only management guidance (28 systems) but also the 28 systems placed in Q1’24 and the 32 systems placed in the year-ago period.
Consumables revenue rose 24% yoy and about 6% qoq to $17M, with Revio-related consumables revenue up 110% yoy and 15% qoq. Even so, pull-through declined about 1% sequentially to $251,000 (the amount of consumables, annualized, per system in the field). Funding for long-read sequencing projects is certainly having some impact on consumables, including the significant cut in funding for the All of Us project, and many new system placements are at less than 50% capacity as a result.
Gross margin did improve four points from the year-ago period to 36.7%, and the operating loss shrank about $13M to $58M as the company executes on a cost reduction program (SG&A declined 22% yoy and R&D declined 17%). The company ended the quarter with $510M in cash.
Looking at other life sciences tools companies, PacBio is not alone. Thermo Fisher reported a 4% decline in its Life Sciences Solutions segment, Illumina saw a decline of 6% in core revenue, and Seer reported a 23% revenue decline. A few companies have done better, with Oxford Nanopore disclosing basically flat revenue for the first half of the year and 10x reporting 4% growth in its second quarter.
Why would PacBio be doing worse? As I said, I think at least some of the issue is that long-read sequencing isn’t as well-established as a core technology at this point. I think geography also matters; China has been a more enthusiastic adopter of long-read sequencing, and tool spending has been notably worse from Chinese customers. To that end, PacBio saw its revenue from the Americas decline 13% in Q2’24, while APAC revenue declined 36% and EMEA revenue declined 35%.
To Finish First, First You Must Finish
With this sharp downward turn in the business, existential questions about PacBio are once again relevant. The company’s technology works, and works well, but the market is more concerned about the prospect of $100M to $200M annual cash burns against a cash balance of $510M than it is encouraged by the throughput, efficiency, and accuracy of the new Revio systems and the fact that Revio is opening doors to new customers (almost half of shipments in the first half of 2024 were to new customers).
There are still ample use cases for long-read sequencing. In human genomics (about 40% of PacBio system usage according to management’s update with Q4’23 earnings) long-read sequencing is invaluable in sequencing complex regions (repetitive sequences, structural variants, large insertions/deletions), identifying and characterizing structural variants, and understanding expression and epigenetic modifications. Likewise, it provides important advantages in agricultural applications and infectious disease, where it can handle highly repetitive genomes, verify gene-editing, and provide insights into antimicrobial resistance and pathogen evolution.
The problem is that while PacBio’s technology platform has been repeatedly validated as superior in terms of throughput and accuracy, it’s not the only way to resolve these questions and there are plenty of “day to day” genomics tasks where long-read sequencing is simply not necessary.
I do expect long-read sequencing utilization to continue to increase, even if I think PacBio management’s estimation of eventual 50/50 parity is perhaps aggressive, and I think PacBio can be a key beneficiary of that growth.
The Outlook
The question is whether they will make it to that future. I’m a little below the Street with my current 2024 and 2025 revenue estimates (calling for a 17% revenue decline this year and a 27% rebound next year), but there’s still ample risk of further miss-and-lower quarters, as life science budgets aren’t expected to rebound until 2025, with most of the benefit showing up in the second half of the year.
Beyond 2025 I’m more bullish than the Street with my 44% and 32% growth expectations leading to revenue estimates that are about 8% and 10% above current Street averages. Long term, my estimates work out to around 21% annualized revenue growth, with $1B in revenue in 2031.
Between operational efficiency efforts and an improving consumables mix, I expect gross margin to improve from 26% in FY’23 to about 35.5% this year and 39.8% in FY’25. Long term, I believe margins can exceed 60%. SG&A and R&D modeling gets tricky. In the near term I don’t have that many concerns about PacBio’s ability to cut spending, but I have doubts as to whether the levels of R&D and SG&A I expect for FY’24-FY’26 (around $135M/year and $150M/year) are sustainable over the long term if the company is going to hit my revenue targets.
As is, I see the company getting to FCF breakeven with the cash it has, but I wouldn’t be surprised to see the company raise funds at some point before then if the stock recovers (it’s better to raise money opportunistically than when you need it).
Discounting those cash flows back, $4/share looks like a reasonable valuation for the stock now and that is assuming that this recent reset to the business permanently impairs the long-term potential of the business. If PacBio can navigate this downturn, long-read sequencing continues to grow, and customers (or potential customers) continue to have confidence in PacBio as a going concern, there could definitely be meaningful upside as the business could recover to the prior growth trajectory I expected (as a side-note, I was never as bullish as some of the most bullish sell-side analysts, some of whom had $40-$50+ price targets).
DCF valuation explicitly requires assumptions about long-term revenue and earnings, and if PacBio has shown anything it’s that long-term modeling for small-cap life sciences tools companies is at best an exercise in guesswork. To that end, I also like to use more near-term approaches, including an approach that looks at what the markets have historically paid for various levels of revenue growth from similar companies.
If PacBio can generate 15% annualized revenue growth from FY’23-FY’26, a 6.5x multiple would be fair. Giving a 2.5x headcut to account for cash burn risk and general market pessimism, 4x 12-month revenue gets me to around $5/share.
The Bottom Line
I’ve been a long-time believer in PacBio’s technology, and thus far the company’s product development and real-world performance hasn’t disappointed me. The same cannot be said of the company’s financial performance, as driving adoption of the systems has proven far more challenging and there are still valid questions as to whether the company will ever attain profitability.
With expectations and the stock beaten down this far, I think there’s some appeal here for investors looking to roll the dice on what could well be a binary outcome. I think it will likely take a few more quarters for the Street to even think about turning positive again, but for investors who can accept the risk of a wipeout, PacBio may be worth another look down here.
