I recently sat down with John Nicols, the CEO of Codexis from 2012 to 2022. He attended his last meeting for the board of directors this month, but he's not finished. He recently became Chairman of the Board at Antheia, a promising startup using industrial biotech to address bottlenecks in drug supply chains. I've toured the lab and headquarters of Antheia in Menlo Park – they're insanely well equipped. Meanwhile, Novo Nordisk pledged $2 billion earlier this month to shore up ingredient shortages for its own manufacturing footprint. #hinthint

This article has little to do with my conversation with Mr. Nicols, although it was insightful and always good to hear my analysis is respected by the right individuals. He'll be one of the first guests on the F*nch You! podcast later this year.

Instead, this article is to revisit Codexis after the company's recent quarterly report and developments. Is the business perfect? Absolutely not. I've always contested the company's foray into drug development (something John and I discussed) and our model expected difficult times when the Pfizer supply contract for Paxlovid subsided, but the business is pretty obviously undervalued at a market cap of less than $200 million.

The finer details suggest that makes it a relatively high-value acquisition target before the end of 2023.

By the Numbers

Codexis engineers enzymes for industrial applications ranging from drug manufacturing to food ingredients. Enzymes are proteins that increase the efficiency of chemical reactions by lowering the temperature, pressure, energy, and/or inputs required to convert one chemical into another.

The company has also engineered enzymes as drug candidates intended to correct metabolic disorders or enable gene therapy candidates. For example, Selecta Biosciences' lead drug candidate, SEL-312, is an enzymatic therapy for chronic refractory gout.

The technology platform has significant potential. For all the struggles of industrial biotech and synthetic biology, companies and platforms that have enjoyed the most success tend to take advantage of the unique capabilities provided by biology – and enzymes are typically the centerpiece.

Unfortunately, it's been a rocky road for Codexis. What makes enzymes great also limits their use. Customers make infrequent purchases throughout a one- or two-year period, which leads to choppy revenue.

During the pandemic, the company supplied an enzyme dubbed CDX-616 to Pfizer for the manufacture of a key ingredient in the COVID-19 medication Paxlovid. It generated $75.4 million in full-year 2022 revenue from the arrangement. However, the business expects to generate full-year 2023 revenue of only $65.5 million from all non-Pfizer customers. That's led to significant pain.

Data Source: SEC filings.

Solt DB Invest debuted a relatively subdued model for Codexis in September 2022. The stock needed to fall roughly 20% to reach the fair valuation according to our modeling. The primary drivers were the historical difficulty in scaling product revenue and an unfavorable cost structure. Unfortunately, both headwinds remain firmly in place.

The business increased expenses during the pandemic, in part to service Pfizer and in part to support an emerging drug pipeline. However, the revenue from CDX-616 has dried up while the overhead remains, which has sabotaged otherwise relatively attractive (albeit still negative) operating margins.

Now consider the company's historical quarterly revenue, comprising product revenue and R&D license revenue, when excluding sales of CDX-616. Although the business appeared to be on the beginning of a favorable trend through the third quarter of 2022, the pattern hasn't held.

Codexis doesn't expect 2023 to become a breakout year either. In fact, it expects to generate significantly less core product revenue than it did in 2022. The business will likely generate revenue from CDX-616, but it wasn't included in guidance and won't come close to levels in previous years.

What Makes Codexis an Attractive Takeover Target?

A business that's down on its luck, a new management team, and supportive industry tailwinds for shoring up supply chains in drug manufacturing – something enzymes can address by removing the need for certain inputs altogether – could make now a great time for the company to listen to offers.

What makes enzymes great also makes them difficult to build a business around – at least in 2023. A tiny volume of enzymes can go a long way. A very long way.

Case in points:

• Pfizer generated full-year 2022 revenue of $18.9 billion from Paxlovid, but Codexis has generated less than $110 million in lifetime revenue from the enzymes critical to manufacturing the drug product.
• Merck has avoided building new manufacturing facilities by utilizing Codexis enzymes to simplify existing processes. Fewer steps, fewer inputs, and higher yields can squeeze more product out of the same footprint. That's saved Merck at least $100 million in capex alone in the last decade.
• Or, consider the cell-free industrial biotech company Solugen. Cell-free manufacturing is essentially a mash up of fermentation (large tanks filled with microbes, water, and sugars at ambient temperatures and pressures) and petrochemical synthesis (large tanks with carbon-based feedstocks, high heat, and high pressure). Solugen's flagship facility operates with less than one-quarter cup of enzymes per day. There are other limitations that need to be ironed out, but the business has encountered few hurdles to raising over $642 million from private investors over the years.

In other words, enzymes used for manufacturing purposes create the most economic value for the entity that owns the product being manufactured. That unfortunately is not Codexis. However, an acquisition near our modeled Midpoint of roughly $359 million could be an attractive investment for the right suitor.

Who Might Acquire Codexis?

There are multiple profiles for a potential suitor.

• Roche (Genentech) could snap up Codexis and utilize its entire technology platform. Enzymes for drug manufacturing could help the company address supply chain shortage for its own pipeline and product portfolio. Enzymes for diagnostics could increase the efficiency and competitiveness of its diagnostics and lab hardware business (Roche is already licensing Codexis enzymes for certain consumables). And some parts of the therapeutic pipeline might be kept, salvaged, or spun-off into a separate, better funded entity.
• A large CDMO could put the bulk of the company's technology platform to good use, while seeking to divest the therapeutic pipeline. Nestle Health Sciences might be interested in acquiring a full stake in the programs it's currently licensing.
• A large drug developer could acquire Codexis to address supply chain shortages for its drug manufacturing footprint. An acquisition at a healthy premium to the current valuation could still be justified even if the diagnostics and therapeutic pipeline is axed, or divested to claw back part of the purchase price.

Forecast & Modeling Insights

(Lowered slightly to reflect full-year 2023 guidance.)

Solt DB Invest's updated 2023 model now reflects full-year 2023 guidance (midpoint of $65.5 million) instead of our modeled expectations (midpoint of $71 million). Aside from that, the same forecast and modeling insights from our November 2022 research note serve as a useful guide. All bold text was in the original.

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Codexis is difficult to model given the diversity of products and customers, choppiness of orders, and early-stage nature of the always delayed drug development pipeline. Until the statistical fog clears, investors can only focus on the most important drivers:

• Product revenue excluding CDX-616
• Program pipeline for the Pharma Manufacturing vertical, specifically programs related to phase 2 assets, phase 3 assets, and marketed drug products. These have the highest probability of success (POS) and therefore the highest value and revenue potential.
• Program pipeline for the Life Sciences vertical, which might be in flux with the next management team.

Product revenue: Codexis has historically struggled to consistently grow product revenue, but there are signs that could be changing. The business generated almost as much product revenue in the first nine months of 2022 ($35.4 million) as it did in all of 2021 ($36.2 million). It appears on track to deliver full-year 2022 product revenue of approximately $44 million, representing growth of 23% from the prior year. That would mark the second consecutive year of 20% growth.

Maintaining or accelerating that pace in the next few years could help the business achieve profitable operations by 2025, assuming moderate success in the Biotherapeutics vertical. There aren't any obvious product launches on the horizon, so investors might want to brace for full-year 2023 revenue guidance to be a little underwhelming.

Program pipeline, Pharma Manufacturing: Codexis provides a pipeline snapshot every June detailing the state of programs across its three core verticals.

As of June 2022, Codexis counted nine (9) programs for drug products on the market. That means the company was supplying enzymes to manufacture these drug products and generating recurring revenue.

The pipeline snapshot also listed 20 programs for drug assets in phase 2 or phase 3 clinical development. That means the company was supplying enzymes to help manufacture these drug candidates, but the revenue won't be meaningful or recurring until and unless they receive FDA approval.

Based on historical POS outcomes for clinical-stage drug candidates, the drug candidates in these programs have between a 15% and 52% chance of reaching market and generating sustaining revenues for the business. That suggests Codexis could increase the number of commercial programs (currently at nine) to between 12 and 19 in the next three to five years.

It's impossible to model the revenue potential without knowing the stages of development, therapeutic areas, and chemical classes of the drug assets. But anything in the range of outcomes above would represent a meaningful level of revenue growth from this vertical in that span.

Program pipeline, Life Sciences: Codexis doesn't break out revenue from Life Sciences tools. As you can tell by now, the company is hellbent on thwarting my modeling at every turn.

But the company has clearly focused on this new vertical in recent years. As of June 2022, Codexis was generating revenue from five (5) life science products on the market. It counted another 16 in development, including nine (9) partnered with customers. The 21 total programs represented year-over-year growth of 61%.

The new management team is still developing the strategy for this vertical, but it quietly represents the best growth potential for the business. Codexis may focus on becoming a valuable partner for established lab hardware platforms from companies such as Illumina, PacBio, and 10x Genomics. Additionally, cozying up to Roche (already a commercial partner) could toss another log onto the fire.

This vertical also houses the company's experimental DNA synthesis tools being developed by Molecular Assemblies. The market opportunity is new and large, but competing with more established providers such as Twist Bioscience and Danaher Corporation (via its Integrated DNA Technologies subsidiary) will pose a challenge.

Margin of Safety & Allocation

(Lowered slightly to reflect full-year 2023 guidance.)

Codexis is considered a Growth (Speculative) position. The current modeled fair valuation for the company based on our 2023 model is below:

• Current Price (market close June 22):  $2.75 per share
• Modeled Fair Valuation:     $4.69 per share
• Allocation Range:              Up to 2.5%

Codexis reported 66.768 million shares outstanding as of May 1, 2023. The above assumes 76.783 million shares outstanding, which prices in 15% dilution.

Further Reading

• May 2023 press release announcing first-quarter 2023 operating results
• May 2023 regulatory filing (10-Q) detailing first-quarter 2023 operating results
• November 2022 research note analyzing the company's cost structure. Codexis later took measures to address its cost structure, including program prioritization and the dreaded headcount reduction
• September 2022 research note initiating coverage of Codexis, which also explains enzymes and the markets they're used in