One of the most important lessons of the stock-market correction is that the power of positive thinking can take investors only so far.
For the shareholders of Invitae (NVTA), it could lead to more pain and suffering.
As shares of the genetic-testing business flounder, some investors expect a larger peer, like Exact Sciences (EXAS), to swoop in and acquire Invitae on the cheap.
The speculation might sound credible considering that rumors of a potential merger swirled in August 2021.
However, hopes for a such a deal seem highly improbable once investors recognize the difficult operating environment affecting all companies and the promising trajectory of the larger peer.
Profits Are the Next Big Thing
Invitae was the poster child for the growth-at-all-costs business model that became commonplace during the era of ultra-low interest rates.
The vulnerabilities of the company's approach were exposed almost as soon as Wall Street began pricing in the impact of higher interest rates. Shares of the genetic-testing company have fallen 83% in 2022. (Although a brief meme stock moment made things fun in August, it didn't last.)
Investors are well aware of the company's performance and pivot, which included dialing back growth expectations, handing pink slips to 33% of its employees, and replacing the chief executive.
The business expects revenue to remain flat in 2023. When sales begin to increase again in 2024, the annual growth clip may be less than half of prior promises.
A couple of important nuances get lost in the acquisition speculation. One detail is that the operating environment for the genetic-testing industry has changed. Sema4 (SMFR) , 23andMe (ME), and other peers have also pledged to abandon the growth-at-all-costs business model.
Exact Sciences never took that approach. It didn't have to. The company is anchored by the colon-cancer-screening tool Cologuard, which last year became the first and only diagnostic product to generate at least $1 billion in annual revenue. The flagship product is still growing at more than 20% a year despite -- or perhaps because of -- its scale.
Management has nonetheless pledged to reach profitable operations by 2024 on an adjusted Ebitda basis. The key difference between Exact Sciences and peers is that this pledge was announced before the stock market began to wobble. Even if that wasn't the case, Wall Street would likely demand more efficient operations given increasing macroeconomic uncertainty.
This is what makes Exact Sciences unlikely to acquire Invitae anytime soon. Breaking down the financial details shows it would jeopardize an increasingly solid position for the larger peer.
- Quality of revenue: Exact Sciences generates more revenue each quarter than Invitae generates in a year. Yet the larger peer reports a smaller operating loss: The operating margin is negative 30% for Exact Sciences and negative 170% for Invitae. An acquisition would cause an immediate deterioration in the quality of revenue.
- Cash is king: Exact Sciences is on pace to burn about $350 million from operations in 2022, although about half of that was incurred during the first quarter of the year. Invitae expects full-year 2022 cash burn of at least $600 million (it's on pace to be lower than that) and full-year 2023 cash burn of at least $225 million. An acquisition would double the cash burn of Exact Sciences. Additionally, an acquisition might cost nearly $1 billion – money the larger peer doesn't have. And it could put such cash to better use elsewhere.
- PreventionGenetics: Exact Sciences did make an acquisition to jump into hereditary cancer screening tools. But it acquired a small company. PreventionGenetics, that was already profitable. It may generate only full-year 2022 revenue of $41 million, but it can scale quickly within the commercial infrastructure of its new parent. An acquisition of Invitae wouldn't integrate well with the current strategy on profitable growth in this new business category.
Don't Invest on Rumors
It's easy to get caught up in speculation and emotion when investing in growth stocks. It's certainly fun to imagine what would happen if you correctly bet that a down-on-its-luck business can return to its former glory.
But Invitae's new management has clearly communicated that growth expectations will be limited through at least 2024. Investors have no reason to expect much more beyond the guidance provided.
Invitae still may be an acquisition target for a larger peer – eventually. But investors shouldn't expect the suitor to be Exact Sciences anytime soon.
Exact Sciences is oh-so-close to reaching profitability with its existing product portfolio and development pipeline. For example, an updated version of Cologuard may launch in 2024. If it lives up to expectations, then adjusted Ebitda might be the wrong metric by which to judge the business.
The new Cologuard could help the company achieve a positive operating margin and cash-flow-positive operations by 2025 or 2026.
Simply put, Exact Sciences acquiring Invitae would decimate its quality of revenue and put profitable operations out of reach for the foreseeable future. No amount of positive thinking can change that.
