23andMe: a Risky Healthcare Technology Company With Substantial Upside

Equity Analyst

Dylan Finley

23andMe primarily sells direct-to-consumer personal genome service, or PGS, kits, analyzing specific genetic components (single nucleotide polymorphisms, or SNPs), to approximate genetic ancestry, predisposition to physical traits, and presence of genetic disease variants. The company leverages third party manufacturers for kit components, including the genotype array chip used to analyze the genetic material, and processes the samples on site at LabCorp locations. 12andMe has sequenced the genome of over 12 million individuals, over 80% of whom have opted in to sharing their de-identified genetic data and research survey responses with the company. 23andMe and privately held Ancestry.com hold a dominant share of the direct-to-consumer PGS market due to an early mover advantage, brand awareness, and database size. 

A recent slowdown in kit sales has drawn concerns over the long-term size of the addressable market. As it currently stands, many of the available reports serve more of a novelty purpose, and while the company might identify specific genetic variants corresponding with disease, the SNPs looked at are not comprehensive enough on their own to be a complete substitute for whole genome sequencing (in instances where that is desired by a medical provider). Despite this, the company possesses a massive database of genetic data and an active base of respondents to research questions, which are used to better understand the relationship between the human genome and health characteristics in academic research and commercial drug development. 

The company hopes to use its data to more quickly and efficiently develop therapeutics, particularly in the biotech space, and has attracted interest from manufacturers. In 2018, GlaxoSmithKline made a $300 million equity investment in the company, entering a five-year exclusive collaborative agreement with 23andMe to develop drug candidates. All current candidates are in Phase 1 or preclinical stages of development.

Business Strategy & Outlook

Despite being the pioneer of a model for direct-to-consumer genetic data services, the lack of meaningful barriers to entry in the space and presence of competitor ancestry and health-related gene testing kits preclude the company from establishing an economic moat. 

23andMe primarily generates revenue today through the sale of personal genome service, or PGS, kits. Consumers who purchase a kit provide the company with a saliva sample, from which DNA is isolated. The company uses a technology called genotype imputation, only analyzing a tiny fraction of an individual’s genome, which exhibits known variances in human populations and results in phenotypic (physical characteristic) differences, predisposition to disease, and correlation with other health-related characteristics. In the lab, the genetic material is tested on genotype array chips, which read several hundred thousand single nucleotide polymorphisms, or SNPs, in the sample. Most other competitor DTC companies that offer PGS services use this same process, opting for genotype imputation over whole genome sequencing, due to the very low cost incurred per sample. While whole-genome sequencing has made enormous strides in cost and efficiency since the human genome project was effectively completed in 2003 (13 years of research; costing nearly $3 billion), the cost to sequence a whole genome remains prohibitively high today for most individuals, at around $1000 per sample. By contrast, genotype sampling costs a fraction of that amount. While the technology could follow Moore’s law in the future and become more cost-effective over time, the added benefits of using full genome sequencing in a DTC offering are dubious. Our current state of knowledge of the human genome is extremely limited, and consumers and DTC companies wouldn’t be able to glean any deeper insights as a result of sequencing the whole genome anytime soon. 

To date, over 30 million consumers have used DTC testing kits worldwide, with the vast majority using 23andMe and AncestryDNA (Ancestry.com) over the dozens of smaller competitors. We attribute the high market share concertation between these two companies to superior brand awareness, database size, and availability. Despite, these competitive advantages, two factors preclude us from attributing a moat to the company: (1) a secular decline of kit sales in recent years, confirming fears that the addressable market for PGS is somewhat niche; and (2) the spike in sales around times when genetic testing companies offer steep discounts (for example, Amazon’s Prime Day, winter holiday period) suggests to us that consumers are generally price-sensitive and the company’s pricing power is limited. Furthermore, the company’s primary revenue stream is non-recurring, leaving no room to build up brand loyalty or switching costs within its existing customer base. By contrast, privately owned Ancestry.com has over 3 million subscription-based customers, primarily as a result of their focus on genealogical resources (billions of historical records; hundreds of millions of user generated family trees and user-uploaded photos and documents). While 23andMe has a subscription offering (23andMe+), the added benefits are more marginal than anything--access to several dozen additional disease carrier, wellness, and pharmacogenetic reports. Due to the static nature of these reports (our genome is fixed and reports shouldn’t change), future engagement is limited to instances where the company releases new genetic reports. Consequently, these incremental reports must be compelling enough on their own to move consumers over to this recurring subscription model. 

From a cost advantage or intangible assets standpoint, 23andMe does not have any material competitive advantages in sequencing customers’ genetic data. Similar to other DTC competitors, 23andMe relies on various third parties and labs. The genotyped samples are analyzed at Labcorp facilities in the U.S., using Illumina’s global screening array chip as a base (with some added SNPs of interest). While additional scale allows for the company to achieve a degree of leverage on operating expenses, and contracts with suppliers allow for advantageous pricing based on volume, these benefits are conferred to any kit seller generating meaningful volume. Furthermore, while the company is on the cutting edge of generating actionable insights based off genetic data (that is pharmacogenetic reports), its unclear at this time how valuable these reports are to consumers and whether this will translate into recurring business. For consumers who are primarily interested in the novelty aspect of sequencing their DNA (tracing their predicted roots; viewing trait reports), more detailed health related reports may not be of sufficient interest for consumers to upgrade to the latest version of a chip or pay a premium versus competitors’ offerings. As such, despite any advantage stemming from superior research, the company may continue to act more as a price taker, similar to most other kits on the market

23andMe entered the telehealth space in 2021, with its $400 million acquisition of Lemonaid. The standalone company generates around $60 million in revenue, on an annualized basis from the quarter the deal closed. From a strategic standpoint, the company sees the acquisition as a route to get from consumer genetics services to individualized health care. The status quo for primary care today does not take into account a patient’s genetic data (except in select rare disease cases), and 23andMe sees itself bridging this gap. Our primary concern is the disconnect between the company’s goals and Lemonaid’s offerings as of today. Lemonaid connects consumers with medical professionals via telehealth and delivers select prescription drugs to consumers via mail. The company’s focus is on treatment areas which patients may not actively be seeking out due to stigma (mental health, men and women’s reproductive health). Lemonaid offers primary care services via a monthly fee, which is not reimbursed by medical insurance. In the near-term, the acquisition does not provide for any meaningful synergies or enhance the competitive positioning of the company’s PGS business. From a primary care perspective, the company’s primary challenge will be educating telehealth providers on offering a new type of health care which combines traditional care tailored to specific genetic insights. 

Lastly, the company’s therapeutics segment is too far in its infancy for us to consider and economic moat. The company has dozens of drug candidates in very early development stages and is still several years away from having a commercially viable therapy. The value proposition of using genetic inferences to most efficiently find targets (particularly in the realm of biologics), is of high interest to biopharma firms. The company’s five-year agreement with GlaxoSmithKline currently has the company locked in an exclusive arrangement through 2023, after which we could see the company taking on several partners on a nonexclusive basis. We are a bit hesitant of the company’s ability to develop and take to market a drug on their own at this stage due to the capital intensity. While 23andMe has a large amount of cash on its balance sheet, the cash flow dilutive nature of its core business, and the company could get more value in the near term by continuing with 50/50 partnerships or by electing to take royalties from collaborative projects.

None

Economic Moat

23andMe

23andMe is a DNA testing technology company that enables its users to access their ancestry, genealogy, and inherited traits.

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23andMe Holding Co. is a consumer genetics and research company, which engages in assisting people to access, understand, and benefit from the human genome. It operates through the Consumer and Research Services, and Therapeutics segments. The Consumer and Research Services segment consists of Personal Genome Service, Telehealth Business, and Research Services. The Therapeutics segment focuses on the genetic insights of genetic and phenotypic information. The company was founded by Anne E. Wojcickiin 2006 and is headquartered in South San Francisco, CA.

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