SPAC (special purpose acquisition company) VG Acquisition Corp. (NYSE:VGAC) is merging with genetic testing company 23andMe. From here, the deal makes VGAC stock a buy.
So far, however, the market hasn’t seen it quite the same way. VGAC stock soared 31% when the deal was officially announced on Feb. 4. Since then, the stock has dropped 25%; it actually trades modestly below where it did before the merger was made official.
There are some reasons for that. VG Acquisition’s connection to the Virgin group of companies created some speculation that another Virgin company might be a target. That in turn led VGAC stock, which has a redemption price of $10, to above $13 even before the 23andMe announcement.
So the falling share price doesn’t suggest that investors necessarily hate the deal. But that lower price does create an opportunity. Before the merger was made official, I wrote that VGAC stock had several paths to upside. This deal was, and is, one of those paths.
The Consumer Business Isn’t Enough …
Most investors and consumers know 23andMe as a genetics testing company. 23andMe analyzes samples, then provides ancestry and health information based on the customer’s genome.
It’s a solid business. By March 31 of this year, the end of FY2021, 23andMe expects that it will have genotyped over 11 million customers, according to the data from its merger presentation. Revenue this year should come in around $218 million, with 23andMe seeing a path toward nearly doubling that figure over the next three years.
But the consumer side of 23andMe admittedly isn’t a spectacular business. Revenue actually has gone in the wrong direction, falling by roughly half from fiscal 2019’s $441 million. This year’s figures are taking a hit from lower marketing. The company pulled back sharply on that spend amid the novel coronavirus pandemic, according to the merger presentation’s conference call.
But even before that, the company hit a bit of a rough patch, which led to layoffs in early 2020. Looking to the bottom line, the consumer business should remain narrowly unprofitable in FY2021. That’s even with that lower advertising spend, and even on an Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) basis.
So there are some concerns on the consumer side. Those concerns might lead some investors to lose interest VGAC stock after reviewing the numbers in the merger presentation. But remember an enormously important fact: going forward, this won’t be just a consumer business.
… And That’s OK
If 23andMe were just a direct-to-consumer provider of genetic testing, I doubt the market would be too excited about this deal. That business is not terribly differentiated. As a result, margins are low, with gross margins at 45% this year (23andMe does expect improvement going forward).
But what the consumer business has done has created a massive base of user data. More importantly for VGAC stock, it has created a massively valuable base of user data.
Again, the company has genotyped over 10 million customers. And 23andMe plans to put that information to use going forward.
One way to do so is to add value to the company’s ancestry products. 23andMe will be able to automatically build a family tree (based on other submissions that approve such measures). And those trees of course will serve as low-cost customer acquisition methods going forward.
Ancestry data also is key for consumer health — and that’s the market that makes 23andMe truly exciting. The genetic testing can find potential markers like BRCA mutations which can lead to elevated risks of breast cancer. The ancestry testing can actually drive insurance coverage of that testing, since many similar mutations are associated with certain ethnicities.
That’s at the individual level. The overall base has real value as well. 23andMe believes it’s hit “critical mass” with its 10 million-plus genotypes. That data can be leveraged to create new pharmaceuticals; indeed, the company has a $300 million partnership to do exactly that.
Why VGAC Stock Can Rally
Looking at 23andMe purely as a direct-to-consumer play, VGAC stock looks badly overvalued. The current price above $13 creates a pro forma market capitalization of $5.9 billion. Backing out nearly $1 billion in cash, the market is valuing the 23andMe business at roughly $5 billion.
That’s about 22x FY2021 revenue. That multiple is probably too high for this kind of business. It’s a multiple that might have led investors to exit after the one-day pop following the merger’s official announcement.
But that multiple isn’t too high for a company that literally aims to revolutionize healthcare. As 23andMe put it in the merger presentation, its database can drive “personalized healthcare at scale.” Understanding your genome is of significantly greater value than simply knowing where your ancestors came from, or even what risk factors you might have for a few diseases with genetic components.
That’s the value 23andMe plans to capture. And that’s the value that makes this a truly fascinating, and exciting, business to own. With VGAC stock now cheaper, 23andMe looks even more attractive.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
