It's never a good sign when the quote from management in a press release begins with the phrase, "Our result fell short of our expectations." That's exactly what happened with 10x Genomics (TXG) in mid July.
The preliminary results were shocking. The lab-hardware specialist had been one of the fastest-growing companies in the competitive landscape and was nearing profitability. In fact, it was outperforming Illumina (ILMN) on one important metric used to gauge the strength of a business. Management even reiterated expectations for year-over-year sales growth of at least 22% just two months prior. Now, 10x Genomics expects first-half 2022 revenue to have grown by just 3% compared to the year-ago period.
How did the situation deteriorate so rapidly? A strong U.S. dollar has become a significant headwind in recent months, but that's not the only factor. Investors hoping 10x Genomics stock rebounds quickly shouldn't hold their breath, although the long-term growth trajectory should remain largely intact.
What Made 10x Genomics a Top Growth Stock?
Lab hardware is a tough business model. Innovators need to develop an instrument that provides clear value to scientists, grow the installed base of machines before the technology becomes obsolete, and then generate recurring revenue by selling the kits and chemicals needed to operate the machines. The last part is key.
The kits and chemicals required to run lab instruments are called consumables. They're the secret to success in the industry. In fact, investors shouldn't even think about owning a lab-hardware stock until the underlying business generates at least two-thirds of total revenue from high-margin consumables.
Not many companies achieve this milestone. Illumina, Oxford Nanopore Technologies, and 10x Genomics were among the only to do so in 2021. By comparison, investor favorites NanoString Technologies (NSTG), PacBio (PACB), and Bionano Genomics (BNGO) all failed to generate more than 50% of revenue from consumables last year. Stock performance in recent years has a strong correlation to this metric.
10x Genomics has aced this part of the business model. Consumables revenue has represented at least 80% of the sales mix for 13 consecutive quarters, including the first quarter of 2022. That's really impressive, especially considering industry titan Illumina leaned on consumables for "only" 71% of revenue last year.
It's probably not enough for the stock to rebound.
Why Isn't Consumables Mix Enough Anymore?
Strong consumables sales enabled a continuous improvement in gross margin over the last three years for 10x Genomics. Importantly, the strength drove an operating cash outflow of only $21 million in 2021, which barely dented the end-of-year cash balance of $587 million.
That suggested the business was well positioned to achieve profitable operations in the next few years. Even if tightening financial conditions led to macroeconomic headwinds, 10x Genomics appeared capable of dialing back growth investments ever so slightly to weather the storm.
Of course, that scenario was dependent on achieving at least moderate revenue growth to make up the difference. If management reduces growth investments in the second half of 2022, then the business is likely to see revenue decline from last year's levels. A lousy 3% revenue growth in the first half of the year, even at sky-high margins, changes the calculus entirely.
It's not all bad news. 10x Genomics remains well positioned. It ended March 2022 with $539 million in cash and leaned on consumables for 86% of total revenue in the first quarter. There's no denying the business has enviable advantages compared to every other unprofitable peer in the lab hardware landscape.
The challenge for investors is that weak revenue growth will weigh on the valuation multiple for the foreseeable future. For example, slowing momentum suggests full-year 2022 revenue could settle near $500 million. That's a far cry from the $615 million guidance given in May.
It would also mean the current $4.4 billion market cap values the business at roughly 9 times sales, which seems pretty fair (or even a little overvalued) in the context of stalling growth and tightening financial conditions.
So yes, 10x Genomics is a premium lab-hardware business with a solid revenue mix. But the business needs to jumpstart its growth engine for the stock to earn a durably higher valuation. Investors will learn more when the company reports Q2 2022 operating results on August 8.
