Biotech Unicorns are new biotechnology companies that IPO with a market valuation above $1,000,000,000. Although once unheard of, this phenomena is becoming more and more common. This new species of Biotech Start Up presents many opportunities and risks for the bold investor. Here is what you need to know to make sure that you earn more than fantasy profits from these legendary start ups…
My five year old niece is all in on unicorns. She loves movies and cartoons based on the mythical beasts. She adores bedtime stories featuring horses with magical abilities. And she loves to rock the unicorn fashions; when it comes to shoes, shirts, and dresses, the more sparkly unicorns, the better. I am starting to think that she could have a promising future as a biotech stock analyst.
The “Unicorn” phenomena really gained traction as Silicon Valley emerged stronger than ever from the 2008 financial crisis. The term was first coined around fast growing tech startups that produced everything great except profit. At various moments the financial media has applied the term to companies such as Facebook, Snapchat and Uber. Typically the unicorn frenzy has been especially applied around the time of IPO…any company debuting at a 10 figure market capitalization with little or no tangible profit could be labeled a “unicorn.”
Most veteran tech investors already have five to ten years of experience dealing with this scenario. A cursory examination of the biggest names reveals a wide range of long term results. Some have debuted huge, and grown to humongous, with profits to match ($FB). Others have grown quickly, but still failed to turn a profit, leaving investors befuddled, ($SNAP), and others….well, we’ll just have to see…(Uber…..).
Now the mystical financial beast has entered the realm of biotech. With it’s IPO this past November, Moderna Inc became the largest Biotech IPO so far. Without turning a profit, or even much revenue, the Silicon Valley darling now has a market capitalization of around $7 Billion dollars. In order understand a lot of the risks and rewards inherent in these kind of stock offerings, we need to first examine what goes on “behind the curtain” before the unicorn makes its debut on the world stage.
WHAT HAVE YOU BEEN FEEDING THAT THING???
The number one attribute that defines most unicorns, of the traditional type or biotech type, is growth. These private companies have grown to gigantic proportions without ever turning a profit , even before filing for an IPO. How does this happen?
It’s important to realize that the term “private company” means something totally different in Silicon Valley than what it means almost anywhere else. When most investors hear the term “private company” we imagine a chain of local pizza shops, with just one owner, or perhaps owned by a family, with several brothers or cousins owning a percentage of the business. While most of these types of businesses never top a few million in revenue, all of us know someone who started out with one pizza shop, and now has twenty pizza shops. There may be several wealthy shareholders in these cases, but they are typically descendents of the founder, close business partners, or original angel investors.
In Silicon Valley, nobody wants to open a humble pizza shop to make a decent living for his or her family. Instead, they would start with some grand concept, some way of revolutionizing the global pizza trade through application of advanced technology or genetically engineering the pizza; its got to be something big. From Day 1, they aren’t envisioning a business that grows organically; if they are going to take over the world, they are going to need investor cash. Lots and lots of investor cash.
So, they set up a corporate structure that allows for sophisticated professional investors to get involved, from Day 1. These investors might be very wealthy retired tech execs who act as “angel” investors. They might be venture capital firms. Or they might be other, larger, established corporations. Whatever the arrangements, these private companies start off with multiple owners right from the beginning.
So the pizza tech company, or whatever it is, starts off with ten stores right away, has some success, and rapidly grows to thirty stores. In this scenario, profit is considered irrelevant; as long as the “proof of concept” can show growth with the promise of much greater growth ahead, new, even richer, investors can always be found that will keep pumping money into the young company. With each new round of investors who slap ever increasing amounts of money down, the “private valuation” of the startup grows. These are called, “uprounds” because the theoretical value of the company keeps growing as long as private investors are continually willing to pay more and more for private shares, profit be damned.
In this scenario, it’s important to remember this key concept: A private company can still have many owners. The only real differential between a “private” company and a “public” company in today’s world is liquidity. If I get tired of owning my shares in Bluebird Bio ($BLUE), I can simply log onto E-trade and hit, “sell.” If I own 10% of a privately held billion dollar Unicorn stock, I must, on my own, find a willing buyer who will then go through their own due diligence process, which may not be as easy as just looking up the data on E-Trade. Also, I may need approval from other shareholders to sell. Know anyone who’s got $100,000,000 laying around and a lot of patience?
All of this explains how $MRNA had reached such an enormous market capitalization before ever going public. Prior to filing IPO paperwork with the SEC, Moderna had already raised more than $2.6 Billion from deep pocketed private investors since 2009. All of this despite not even having a pharmaceutical product in phase three development. Mythical creature indeed!!
The PROS Understand the PROS and CONS
What does this ultimately mean for you as a potential investor in the IPO of a Unicorn stock? Should you leave Unicorns with the Loch Ness Monster and Bigfoot, or should you buy into the fairy tale? The answer is… it depends. Sometimes this jumbo size and momentum can be a huge advantage, sometimes its pure hype that will end in tears. Here are a few pointers to keep in mind.
Remember that, with Unicorns, someone has already made a massive fortune, no positive cash flow needed.
One of the biggest rationales behind investing in publicly traded companies is that most executives who work for shareholders, hold the very same shares that the public owns. Therefore, your average public shareholder should have interests that are closely aligned with the C-Suite.
With Unicorns, this theory flies out the window. Remember the founding members of our imaginary Pizza Tech company? By the time their company finally goes public with a $2 Billion market capitalization, they have already sold shares worth tens, or hundreds of millions of dollars, despite the company never earning a dime. A real world example of this would be Travis Kalanick, the disgraced former CEO of Uber. Mr. Kalanick somehow managed to reap billions of dollars in personal profit from a company that has done nothing but incinerate cash for almost ten consecutive years. Other execs at the company have done exactly the same thing, although in a more clever, low profile way. When Uber’s IPO finally does come, will these “early in” execs really have the same interests as millions of “regular joe” shareholders?
On the other hand, Innovation Ain’t Cheap, and Deep Pockets really Matter.
One of the reasons why Moderna has been able to convince so many sophisticated investors to risk so much money on it’s immature scientific platform is because the company has demonstrated some scientific breakthroughs with salivating profit potential. Many believe that the company’s Messenger RNA platform could one day give birth to a whole new world of badly needed medical treatments. But pioneering new science costs money, and a more conservative financial approach may never have given the Moderna team the strong financial base it needs to continue pushing towards it’s lofty goals. At the end of 2018, just a month after the company’s IPO, the mega startup had $1.5 billion in cold, hard cash in the bank, with about another billion in untapped borrowing capacity. The company only burned about $300 million in 2018. So this would mean that even if Moderna faces roadblocks on it’s way to creating marketable products, it’s funding is solid enough that the endeavour can continue. This solid financial start to life as a public company would have been impossible had $MRNA not been a Unicorn company.
Fundamentals Still Rule.
At the end of the day, Unicorn status is just another way to fund a new enterprise. Despite all of the hype and drama that these entities attract, they aren’t immune to the fundamental facts of business. If an investor ignores the hype, and scrutinizes the fundamentals of each Unicorn on an individual basis, good investment outcomes become more likely.
The poster child for all that a Unicorn can be is Facebook. At the time of $FB’s blockbuster debut in 2013, the company was already a household name, but had little revenue, and even less profit to show for it. Now, as we all know, $FB is still a household name but has leveraged its absolute social media dominance to build an advertising business that prints money. The astute investor in 2013 would have concluded that the basics surrounding the business were right.
Blue Apron Inc, on the other hand, has been a disaster on the order of legends like the Titanic. After debuting on the public markets in 2017 with a nearly $2 Billion market capitalization, $APRN shares have fallen from $10 to just $1. This stunning fall from grace really wasn’t impossible to predict for the meal kit company. Is there anything essential to your life that only Blue Apron could provide? What would stop everyone and their mother from merely copying Blue Apron? The Facebook IPO had everything that poor Blue Apron lacked. It wasn’t really the pre-IPO market capitalization, or funding, that mattered. $APRN was just an inherently flawed business model that had been pumped up by media cheerleaders.
Let’s face it; there is always something magical about investing. Anything that can turn $1 into $5 will always be the stuff of legends and lore. But it takes more than rainbows and sparkles to make the magic happen. Before you decide to invest in a biotech Unicorn, do your research to make sure that the spell can last….
DISCLOSURE: THE SICK ECONOMIST OWNS SHARES IN $MRNA.