Oxford Nanopore is a great illustration of my broken record quote, "You own businesses, not technologies."

It's one of the most important companies in the future of living tech. I think the technology platform is the most futureproof in the DNA sequencing landscape. Heck, if the company delivers on its long-term goals, then it could be the future of RNA sequencing, single-cell analysis, and distributed diagnostics, too – all enabled from a single platform.

But it's important to recognize that shares are expensive right now. The last market close of £239.00 per share (December 9, 2022) is equivalent to the midpoint for our full-year 2025 core revenue model and absorbing another 10% dilution. You're more than welcome to be a rigid long-term investor and argue valuation doesn't matter because… innovation… something something… buy-and-hold… But I think sitting on the sidelines and waiting for a better entry point is the smart move for investors with a long-term mindset.

How Does Nanopore Sequencing Work?

Oxford Nanopore is developing a third-generation DNA sequencing platform based on nanopores. The technology works by threading strands of DNA or RNA ("nucleic acid") through a barrel-shaped protein called alpha-hemolysin ("nanopore") embedded within a membrane. It's the molecular equivalent to threading a needle.

As the nucleic acid passes through the nanopore, the electrical current of the membrane changes. These current fluctuations correspond to specific bases within the DNA or RNA, thus allowing researchers to read the nucleic acid sequence with software.

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Nanopore sequencing differs from the technologies deployed by Illumina and PacBio in a handful of important ways. First, nanopore sequencing is simpler at the molecular level, which allows it to be used for nucleic acids of any length. It's neither short read (150 base pairs of DNA, like Illumina) or long read (tens of thousands of base pairs, like PacBio). It's whatever read length is necessary for your sample – from 20 base pairs to millions of base pairs.

In the future, this simplicity could also eliminate sample preparation steps, which would save costs and make DNA sequencing distributed for the masses. Rather than require costly and specialized preparation from scientists or technicians, nanopore sequencing could one day allow samples to be processed in the doctor's office, Walmart, or on your phone.

Second, nanopore sequencing provides real-time data, which means software cleansing and data processing can occur before sequencing runs are finished. PacBio's long-read technology platform offers a similar capability.

Third, the form factor of nanopore sequencing is uniquely positioned for lower costs and distributable settings. There's a reason the third-generation technology has been on the International Space Station.

Whereas the NovaSeqX Plus (Illumina) and upcoming Revio (PacBio) instruments are the size of a refrigerator and weigh as much as 1,171 pounds, the workhorse PromethION 48 (Oxford Nanopore) fits on the countertop in any lab. A smaller version, the PromethION 2, can be purchased for only $10,455 and deliver full human genomes for less than $1,000 apiece. If paired with a larger PromethION 48, then the smaller system can sequence a human genome for as little as $300.

Oh, and it weighs only three pounds.

A Strong First-Half Performance

Solt DB Invest first covered Oxford Nanopore in July 2022, but I didn't provide margin of safety price ranges or forecasting. This was partly due to my unfamiliarity with reporting standards and nomenclature in the United Kingdom. I'm now (reasonably) up to speed.

Businesses in the United Kingdom play by slightly different rules.

• In the United States, companies report financial results every three months. In the United Kingdom, companies report first-half financial results and then full-year financial results.
• In the United States, companies must file financial reports in standard data formats in the EDGAR system operated by the U.S. Securities and Exchange Commission (SEC), which is both human and machine readable. In the United Kingdom, companies tend to upload poorly scanned PDF files of annual letters that include financial results in non-standard data formats to the U.K. Companies House (equivalent to the SEC).

That means investors only get glimpses of financial results twice per year, and you have to wade through documents that are difficult to search.

This impacts Solt DB Invest coverage in the following ways:

• I've decided to provide all forecast, modeling, and margin of safety price ranges in British pounds (£). This reduces errors from currency exchange rates, which are currently exchanging at rapid rates. I will likely do this for other international businesses in our coverage ecosystem.
• Oxford Nanopore is based in the United Kingdom and trades on the London Stock Exchange. It also trades on the pink sheets in the United States, but I don't recommend owning those shares. If you're going to own Oxford Nanopore, then do it through the native exchange in London.
• If Oxford Nanopore decides to list American Depository Receipts (ADR) or American Depository Shares (ADS), then this stance may change.

You can use whatever currency you'd like, but it doesn't change the fact Oxford Nanopore is crushing it right now. Investors should focus on Life Science Research Tools (LSRT), or core, revenue.

‍Data Source: U.K. Companies House filings.

As a general rule of thumb, lab hardware businesses must generate roughly two-thirds (67%) of total revenue from consumables -- the kits, reagents, and plastics needed to run experiments -- before they're even worth considering adding to your portfolio. Oxford Nanopore reports revenue mix (starter packs, consumables, other) slightly differently than U.S. businesses (instruments, consumables, services), but still excels.

In the first half of 2022, Oxford Nanopore generated exactly 67% of revenue from consumables, 25% from starter packs, and 8% from other. A starter pack typically includes the cost of the instrument itself and enough consumables to start running experiments, which means true consumables revenue was above the two-thirds threshold.

The business also breaks down revenue by customer type.

• S1 customers are "light touch" and typically generate less than $25,000 in sales. These include smaller scale operations and one-time purchases from customers such as DIYbio labs; individuals who might purchase a MinION USB DNA sequencer to play around with. Then again, customers as large as Gingko Bioworks have also purchased MinIONs, suggesting these may be initial purchases for larger and longer-term commitments to nanopore sequencing.
• S2 customers are "significant" and typically generate less than $250,000 in sales. These include any size customer who may purchase any size instrument, including MinION, GridION, or the powerhouse PromethION for multi-month projects. These could be a foothold into longer-term commitments from more serious customers.
• S3 customers are "strategic" and typically generate more than $250,000 in sales. These include customers who are purchasing the flagship PromethION instruments for multi-year projects. They represent choppy revenue upfront, but could emerge as important sources of recurring revenue over the long haul.

In the first half of 2022, Oxford Nanopore generated 20% of revenue from S1 customers, 35% each from S2 and S3 customers, and the balance from indirect sales. The business is still leaning on the Emirati Genome Program (EGP) for revenue growth among S3 customers, but it's not a concerning level of dependence. New product improvements and product introductions, such as the PromethION 2, will help to drive adoption and growth through all customer groups.

Here's a fun fact that's easy to overlook: Oxford Nanopore generates more core revenue than PacBio. That revenue is also of higher quality – at gross margins of 55% compared to 44% in the first half of 2022. The business expects gross margin to eclipse 65% in the next few years.

So, why does PacBio seem to get all the glory? ¯\_(ツ)_/¯

Kidding, kidding. PacBio has developed a great technology platform for long-read sequencing (our models are almost complete for this one...). The upcoming Onso short-read platform appears to overpower certain Illumina instruments in the same category. Most important, the company has ruthlessly focused on read accuracy, a metric where nanopore sequencing lags.

But once the third-generation approach catches up there will be no mercy.

Forecast & Modeling

Oxford Nanopore is on solid footing and at the beginning of a long growth runway. Nanopore sequencing has a much higher technical ceiling than other approaches, which means this tortoise has a much better chance of catching the hare (Illumina) than Wall Street currently expects. It'll take more than a decade though, so patience is required, but it's fun to identify these platforms early.

Numerous technical advantages – small form factor, low costs, any read length, and the potential for future improvements such as "no sample prep" workflows – and business advantages – low to no capital costs, consumables-heavy revenue mix, and healthy margins – instill confidence in the long-term trajectory.

Bountiful advantages also provide a high degree of confidence in management's mid-term guidance.

• Full-year 2023 core revenue of £205 million and gross margin above 60%.
• For the next three to five years, a compound annual growth rate (CAGR) of over 30% for core revenue, a gross margin of over 65%, and achieving adjusted EBITDA breakeven by 2026.
• Full-year 2024 core revenue of roughly £258 million ($315 million at current exchange rates).
• Full-year 2025 core revenue of roughly £335 million ($409 million at current exchange rates).

The real question for investors is: How should this growth, revenue, and quality of revenue be valued?

A historical perspective helps. Consider the last 20 years for Illumina as it was ascending into a cash flow powerhouse and the world's dominant DNA sequencing company. The price-to-sales ratio is not bulletproof, but it's a good ballpark metric every investor can grasp.

• When the business was in high-growth mode (goblin mode?) but still unprofitable (2006 to 2008), shares generally maxed out near 15x sales. That was expensive at the time, but it was considered the leading sequencing company in a much less competitive landscape than today.
• The business began generating reliable operating income once it eclipsed $500 million in annual revenue in 2008. Shares traded near 8x sales in the immediate aftermath of the Great Recession (2008 to 2013), which was the beginning of what would become a historically unusual period of ultra-low interest rates.
• Once the business established its dominance on the global DNA sequencing market (2013 to 2021), shares generally maxed out near 15x sales. Most of this period included ultra-low interest rates, a brief attempt at returning to more normal interest rates (2017 to 2019), and fears of an overheated stock market (2019). It's easy to forget now, but there were widespread concerns that the stock market was overvalued at the end of 2019. If only we knew.

Again, the PS ratio isn't bulletproof, but Oxford Nanopore is currently valued at 13.9x full-year 2022 core revenue and over 10x full-year 2023 core revenue. The business is also operating in a much different environment today.

• Interest rates in the United Kingdom (peak estimated near 4.25%) and the United States (peak estimated near 5%) are rising well above the near-zero rates enjoyed for the last decade. This naturally subdues the valuation premiums for stocks. However, a strong U.S. dollar could give the business an edge compared to Illumina and PacBio by making its products more attractive internationally.
• The competitive landscape in DNA sequencing is much more crowded for emerging companies than it was for a young Illumina. It'll be difficult to capture market share effortlessly when everyone is throwing elbows. However, the market is also more established, with more customers, and growing at a healthy clip.
• Mid-term growth opportunities in clinical diagnostics may be more difficult for Oxford Nanopore to access until it improves accuracy. Other advantages suggest it will be able to rapidly make up lost ground – your doctor's office or pharmacy will have an easier time purchasing and operating a nanopore sequencer compared to any other – but the lag time could still impact revenue growth and partnership opportunities.

Solt DB Invest forecasts and modeling suggest there's no rush for investors hoping to own Oxford Nanopore. The business might be fairly valued at £2.77 billion when based on full-year 2025 core revenue. That's roughly £283 per share with expected dilution, or only 18% above current prices.

There are scenarios where revenue grows more quickly than expected, or market share is gobbled up easier than expected, but there's plenty of time to allow the business to earn a spot in your portfolio. Or simply to wait for a more attractive entry point.

Margin of Safety & Allocation

(New!)

Oxford Nanopore is considered a Growth (Speculative) position. The current margin of safety range for the company is based on our 2023 models for core revenue only:

• Current Price (market close December 9): £239.00 per share
• Likely Undervalued:        <£125.76 per share
• Midpoint:                           £146.72 per share
• Likely Overvalued:        >£167.68 per share
• Allocation Range:            Up to 2.5%

Oxford Nanopore reported 8.89 million shares outstanding as of June 30, 2022. The margin of safety range above assumes 9.78 million shares outstanding, which prices in the next 10% of dilution.

Further Reading

• October 2022 press release announcing PromethION 2
• July 2022 company update introducing Oxford Nanopore

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