Recursion Pharmaceuticals

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Recursion is a clinical-stage techbio company that aims to industrialize drug discovery by decoding biology, relying on AI, automation, and proprietary datasets to accelerate the process and navigate the complexities of disease biology.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Recursion Pharmaceuticals is at the intersection of biology and technology, seeking to transform drug discovery. Its strategy involves building a large, multimodal dataset using automated experiments and applying machine learning (ML) to identify potential drug candidates. The company’s operations primarily revolve around its Recursion OS platform, which combines biology, chemistry, automation, and data science to generate drug candidates and facilitate preclinical testing.

Industry Analysis and Competitive Landscape

The biotechnology industry is characterized by high R&D costs, lengthy development timelines, and the risk of clinical trial failures. New players, in particular, are using AI and machine learning to disrupt the traditional model.

  • Competition in the pharmaceutical space is fierce, with companies varying their business model.
  • Several biotech companies have emerged with high aspirations to change and improve the current discovery model. The problem, however, is the number of failures in the industry, as the probability of success for drugs that pass Phase I clinical trials are very low.
  • The industry is increasingly utilizing AI and ML to help in discovering new and more effective drug candidates.

Recursion’s differentiation stems from its integrated approach, combining a proprietary dataset (the Recursion Data Universe) with advanced AI-driven analysis, and a vertically integrated platform, with the goal to reduce the time and cost of drug discovery.

Revenue Distribution

RXRX’s primary revenue comes through strategic partnerships and collaborative drug discovery agreements with pharmaceutical and biotech companies. This allows them to receive upfront payments, milestone payments (that could be a % of sales) and royalties for their platform and potential drug candidates.

  • The current business model is more of a service-oriented one as Recursion is generating revenue while acting as an AI platform.
  • They also have internal drug development programs to discover a new class of drug candidates.

Financials Overview

RXRX’s financial situation is complex as a clinical-stage biotech company, it has not yet generated revenue from commercial sales of its drugs, and is reliant on collaborations to generate income. This means that financial statements should be read in light of this situation.

Here’s a breakdown of Recursion’s financials, pulling from recent documents and earnings calls:

  • Liquidity: As of September 30, 2023, RXRX had $387.2 million in cash and cash equivalents and $490.6 million in total liquidity. They expect to fund operations with this until 2025. This implies that currently, they have enough funds for their operations and to continue their programs.
  • Revenue: For the nine months ended September 30, 2023, Recursion reported total revenues of $33.3 million, a significant increase from the $2.1 million reported in the same period last year, largely due to revenues recognized through strategic partnerships.
  • Operating Costs: For the nine months ended September 30, 2023, Research and Development expenses were $171.7 million, a notable increase from the $74 million, for the same period last year. This increase is driven by their internal drug development efforts and partnership programs. General and administrative expenses are $121 million, increasing from the $63 million reported in the first nine months of the past year.
  • Net Loss: The net loss was $210.6 million for the nine months ended September 30, 2023, increasing from the $164 million for the same period in the past year. The net loss shows that expenses are rising faster than revenue, since the company is heavily investing for the long-term.
  • Share Count: Recursion’s shares outstanding as of October 2023, are 273,338,000.
  • Equity: Total equity as of September 30, 2023, is $438.7 million, showing negative retained earnings. This indicates that total accumulated loss surpasses the total share capital.

Debt: The company has very little debt.

The company is in the phase of growth, therefore, expenses and losses are expected in this phase. Investors should watch for signs of operating leverage as they grow their business in the future. Their main income stream in from licensing out their proprietary drug discovery platform to other pharmaceutical companies for licensing deals or collaboration, but they do not have any approved drug candidates yet.

Moat Assessment: 2/5

RXRX’s moat is challenging to quantify using classical methods, however, we will try to analyze based on the different metrics that we have available:

  • Intangible Assets: While RXRX holds patents for its technology, particularly the Recursion OS, the long-term value of these patents is uncertain. Moreover, they also face legal battles with former employees, which could make their IP a bit muddy. Also, it is important to note that these patents might only affect some of the products and not all of them.
  • Switching Costs: As their current business model is based on licensing out the platform, there are high switching costs as companies will need to adapt and train their teams with a whole new system, along with transferring all their data to it, this takes time and money.
  • Network Effects: Recursion does not have any real network effects, where value of a product increases as more people use it.

  • Cost Advantages: By utilizing large amounts of data and automation, the company has tried to create lower costs and more efficient R&D. Also, by combining all these technologies to work in sync, Recursion has created a unique process. Their new AI-driven drug discovery model has not proven to be effective and there are other companies experimenting in the field.

  • Size Advantage: Although their operations are complex, they still don’t have the size to scale it.

Therefore, given that it is very uncertain how durable their advantages will be, I assign a weak moat rating. I have rated it 2 because currently there is some switching costs that would make companies difficult to leave, but it is not very certain whether they will be successful in the long term.

Risks to the Moat and Business Resilience

RXRX faces several risks that could erode its moat and threaten business resilience:

  • Clinical Trial Failures: The most significant risk to any biotech is the failure of its clinical trials. In such cases, the pipeline is affected, partnerships could come to an end, and investors lose their trust. While their internal discovery pipeline will also provide for a great loss if failed trials. This can negatively impact the company’s cash flows and stock.
  • Partnership Uncertainty: Current revenues are dependent on licensing out their platform. Any failed partnerships can hinder the revenue growth. Also, reliance on external parties makes the value of the platform to be dependent on others.
  • Competition: Many companies are pursuing AI-driven drug discovery. If their competitors find other technologies or make discoveries faster than Recursion, they can lose the market share. New players are entering into this domain and many established companies are also catching up.
  • Regulatory Changes: The company is subject to approvals from the FDA and other similar agencies. Changes in those regulations may make the commercializing process harder, longer, and expensive.
  • Intellectual Property Litigation: The legal battles concerning patents and IP could create negative sentiment around the company. The company may not be able to protect its technology if the legal cases drag on.
  • Commercialization Risk: Even when drugs are approved by regulators, companies still need to overcome commercialization risk, like manufacturing costs, pricing, market conditions, and patient acceptance.

Business Resilience: In face of the various potential risks that can harm the business, the management has focused on building partnerships, raising capital, cutting down on expenses, and progressing with their clinical trials to make the company more sustainable and make the pipeline more versatile.

Understandability: 4/5

RXRX is a relatively complex company, combining biotechnology and machine learning, but the basic idea of a drug discovery company is easy to understand. Therefore, the business may be a bit hard for those not familiar with this field, but overall, it is not difficult for most investors to understand the business.

  • The data universe the company is building is rather very specific and it may seem complex.
  • Their methods are also complex which might make investors shy away from understanding their business.
  • The company’s financial statements look complex, and are hard to analyze for a non-finance personnel.

Based on all of these factors I would give it a 4/5, where 1 is very easy to understand, and 5 being very complicated.

Balance Sheet Health: 3 / 5

RXRX’s balance sheet is not strong, primarily due to the high cash burn and lack of revenue. The company has enough funds to carry on its operations till 2025. However, their cash burn is too high, and given their dependence on collaborations, there is a chance of future dilution. If their internal programs perform, then their financials and overall stock will perform well.

  • High operating losses and negative net income makes the company inherently risky.
  • The company’s equity is very small for a company of this size.
  • Debt is virtually 0. Based on these factors, I will give it 3/5 stars, where 1 is very unhealthy and 5 being very healthy.

Recent Issues, Controversies, and Management’s Response

  • Layoffs: Recursion has faced a couple rounds of layoffs recently, citing financial restructuring and focusing on their pipeline programs. The news of layoffs negatively impacts sentiment about the company and its future prospects.
  • Partnership Termination In 2023, a partnership between Recursion and Bayer was terminated. Such events have a negative effect on the company’s reputation and ability to grow.
  • Lawsuits: The Company has faced lawsuits from its former employees, which impacts its credibility and future valuation.
  • Management’s Response: Management has stated that they are taking steps to improve their financial sustainability, improve transparency, focus on programs, and that they are very confident about the future of their discovery methods. They have also emphasized the importance of their platform and automation in making drug discovery process faster and more effective. They are also trying to reduce costs by focusing on high-priority programs and reducing the workforce. They have also stated the new partnership deals are structured in a way that they take more share of the upside.