Working out what Genesis is worth

Friday 19th April 2002

One key principle used by professional investors such as Sir Ronald Brierley and Warren Buffett is "don't invest in what you don't understand."

That may explain why they don't have a lot of biotechnology companies in their portfolios. While many see biotech as offering more opportunities than the internet (another sector Sir Ronald and Mr Buffett famously avoided), few have the necessary PhD in biosciences to truly understand what's going on.

In its latest annual report, Genesis Research tries hard to communicate in plain language but there is a sense that one is only scratching the surface of its core business, which it describes as "functional genomics."

In his review, chairman David Irving starts off by talking about the need to think long term when operating, or investing in, a biotech company. He then devotes several paragraphs to defending the company's precipitous share price slide and expresses the expectation that investors will one day give the company a more "realistic valuation."

That value is open to interpretation, particularly of how much a company benefits by spending more than it earns.

As a research company, Genesis doesn't yet have a business. It is spending a large cash pile (which stands at $48 million) to try to develop new health and plant products it can sell or earn royalties from. One viewpoint is that the more it spends, the closer it gets to reaching that goal.

In the year to December the company reported revenues of $20 million, down nearly a third on 2000's $28.7 million. It had a net loss of $9.6 million, a massive turnaround on the previous year's profit of $0.7m.

Chief executive Jim Watson gives a lengthy and mostly understandable report that covers a wide range of topics. These include an overview of the biotech industry and where Genesis fits, the products it is developing and their level of development, the company's competitive advantage and its business strategy.

Its plan is to leverage its databases of genes into commercially viable products, with some help.

"While we lack the resources to undertake complete discovery-to-market programmes, partnering enables Genesis to share the risk, share costs and share access to related research. We also look to partners to provide market presence and access," he says.

He stops short of making any bullish noises about Genesis or any of its products, perhaps signaling that there is still a long way to go before the heady days of consistent net profits arrive.

The back half of the document starts with a profile of directors and management with their lengthy list of qualifications and directorships. Genesis has achieved a good mix on its board of businesspeople (former Brierley Investments finance head Herman Rockefeller, investment banker Jon Cimino and Mr Irving) to complement the bioscience specialists.

The Genesis accounts are simple because of the lack of operating assets. Income came from grants and license fees, costs were in the form of research and development (mostly staff costs) plus administration. The net loss of $9.4 million is virtually identical to the net operating cash flow deficit.

A note compares the company's performance with its 2000 prospectus and finds the numbers are in line with expectations. This indicates investors have been foolish, either in pushing the Genesis share price up so high 15 months ago or selling it down so far now. As Mr Irving points out, the company has around $1.84 per share in cash. "This means that with a share price currently fluctuating around the $3.20 mark, the market is valuing Genesis' substantial intellectual property portfolio and future cash flows at less than $36 million, or $1.36 per share. In time, as global markets correct, the directors expect to see a more realistic valuation achieved."

The company's share price this week is around $3. Perhaps investors are worrying about what might happen if the company burns through its cash and still doesn't have a commercial product.

Biotechnology is an uncertain business and shares in this sector are volatile. Sometimes their shares end up having no value. Mr Irving does no one a service by encouraging people to believe that the company is worth more than the market is prepared to pay.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. Web, www.mcewen.co.nz, email davidm@mcewen.co.nz

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