Recursion Pharmaceuticals: More Of A TechBio Industrializing Drug Discovery (NASDAQ:RXRX)

Bill Oxford Recursion Pharmaceuticals (NASDAQ:RXRX) is a clinical-stage biotechnology company that gained fame in July 2023 when it benefited from a $50 million investment by NVIDIA (NASDAQ:NVDA). As a result, the market cap doubled to around $3.2 billion as shown below, but, after some ups and downs, the stock has since retrenched and is trading at less than $9. Data by YCharts This thesis aims to show that it is a buy at the current price because Recursion operates more as a TechBio than biotech. The difference goes beyond using advanced computing, as it is also about decoding biology through artificial intelligence while leveraging big quantities of data in a way that industrializes the very process of drug discovery. To start with, I elaborate on the reasons why Nvidia may have invested in the stock. Differentiating Recursion’s Approach as TechBio Instead of Biotech First, even before the semiconductor giant stepped in, Recursion was already at an advanced stage of drug discovery with over ten years of experience in applying technology to data through its Recursion OS (or operating system). This approach seems somewhat similar to the platforms owned by software companies for processing large datasets. In the case of Recursion, it is about processing vast quantities of chemical and biological data using accelerated computing to construct large AI models to be used in oncology and other diseases. These efforts are monetized through partnerships with pharmaceutical companies as pictured below with the one with Bayer updated in November of last year. Company presentations (Seeking Alpha) Second, during the earnings call, the CEO referred to Recursion as uniquely positioned as a TechBio or a TechBiology company. To understand the difference, while biotech also uses computing resources, it primarily utilizes the molecules of living organisms to create drugs or therapies. Also, here, the tendency is more about using data specific to a certain therapeutic domain to develop a specific cure. This implies that a typical biotech has a limited pipeline consisting of up to two drug candidates for the same disease indication. On the other hand, TechBio differentiates itself by analyzing vast biological data sets to identify a wider range of target candidates, in a way “industrializing” the process of drug discovery, especially at the late discovery and preclinical stages. This explains the wide range of disease indications in the two therapeutic areas as pictured below, including a first-in-disease opportunity (REC-994 or SYCAMORE trial). Seeking Alpha Noteworthily, in addition to quantity, industrialization which also relies heavily on automation in contrast to conventional data processing techniques, also helps in quality as according to research by BCG (Boston Consulting Group), the success rate for AI-discovered molecules is as much as 80%–90% for Phase 1 clinical studies where a drug/treatment is first tested in a small group of people to identify safety issues or side effects. Valuing Partnership Opportunities and the Platform Including Data This may be the reason why big Pharma has shown interest in AI-led drug discovery, and the number of related candidates to undergo clinical trials has surged by 60% CAGR during the last ten years, according to Seeking Alpha News. Thus, in 2023, 67 of the 75 molecules to reach clinics made it to the clinical stage. This translates into an 89% success rate, the same achieved by Recursion during AI-enabled experiments for Covid research in April 2020 when it correctly predicted 8 out of 9 to advance to the clinical trials. However, rapidly identifying more drug candidates does not necessarily mean faster commercialization as again according to BCG, the clinical success rate dipped to approximately 40% during Phase 2, something also confirmed by Recursion’s CEO who puts the figure even lower, or 25% to 35% meaning a mid-point of 30%. This is mostly explained by candidates validated against the same standards as for biotech during Phase 2. Furthermore, as mentioned earlier, it has two partnerships with Bayer and Genentech (a subsidiary of Roche Group) for Fibrosis and Neuroscience respectively leading to some money having already been cashed upfront with billions of dollars in potential milestone payments. Now, considering the Genentech partnership with a total of 40 programs expected each to be worth $300 million in revenues and assuming only half, or 20 advance through Phase 2 this means $6 billion of potential sales in case the drug candidates are commercialized. However, after applying the 30% success rate mentioned earlier, this comes to $1.8 billion as tabled below. Now, according to the company, its Recursion OS or platform could be valued at nearly $1 billion. This may appear high, but consider that Paige.AI, a startup using machine learning to map cancer pathology with 10 petabytes of data consisting of cancer images, is valued at $239 million. Thus, Recursion with its 50 petabytes of data (after its partnership with Tempus which contributed 20 petabytes), or five times more than Paige, could be worth more than one billion. On top, it owns Nvidia DGX Super Pods which can be likened to supercomputers, and has upgraded its older A100 Tensor Core Chips with five hundred H100 to boost capacity by four times. These could be worth $120 million, since one super pod with 256 x H100 can cost a maximum of $60 million. Adding $200 million for developing an AI model from scratch, amounts to $1.32 billion as shown below. Seeking Alpha Adding together, I obtain a market cap of $3.12 billion, which divided by the total number of outstanding shares of 237.66 million yields a share price of $13.16. Now, this represents a 48.5% upside above the current share price of $8.86, but, noteworthily, it does not factor in the rest of its internal pipeline focusing on oncology and other rare diseases as well as the partnership potential with Bayer. There Are Catalysts for an Upside but Also Downside Risks This upside could come from catalysts in forthcoming quarters as Recursion’s drug discovery efforts start to evolve toward the later stages of clinical trials. First, there is the Phase II readout for REC-994 (cerebral cavernous malformation) in Q3. Second, there is REC-2282 (Neurofibromatosis type 2), another Phase II safety and preliminary efficacy expected in Q4. This will be followed by the Phase II safety and preliminary efficacy for REC-4881 (Familial Adenomatous Polyposis) expected in the first half of 2025. Any sign of success would likely see the share price appreciate, as the company’s pipeline attracts more value, but, in case of the contrary, things are likely to get volatile. Thus, after the upside to the $10 level in May, the stock could drop to the $8.71 level or the 50-day SMA as charted below. Seeking Alpha There is also a possibility of the stock dropping to the $5 support level, reached in November last year, when it missed both top line and bottom line consensus estimates. Another reason for its current downside is its rate sensitivity due to having to raise capital through the sale of equities at a time of uncertainty as to when the Federal Reserve will shift to a more dovish stance on monetary policy. Furthermore, even if the pipeline looks promising with drug candidates identified and advanced to clinical trials rapidly, AI has not reached the degree of sophistication to ensure 100% success in clinical trials as there can be big differences between what is hypothesized in a computer (in vitro) and achieved in the field (in vivo). Tellingly, according to Recursion’s CEO, it could be “a multi-decade journey” to refine the platform through improved AI models. Therefore, for those holding the stock or others prepared to stomach volatility, this is more of a longer-term opportunity. A Buy Based on Industrializing Drug Discovery and the Nvidia Collaboration Still, to its credit, Recursion has demonstrated the ability to take advantage of a reduction in storage costs to collect massive amounts of data and use the power of AI to analyze them rapidly to come up with drug candidates. This drug discovery industrialization process could get a boost from its platform (Recursion OS) being upgraded from “automated discovery” to “autonomous discovery” or employing AI agents to look at areas of unmet needs. Disrupting the industry further, it is making use of the parallel processing qualities of Nvidia’s GPUs to advance image-based drug discovery. In this respect, compared to older Gen CPUs which focus mostly on textual data, GPUs can process images faster by up to 100 times. To provide investors with an idea of Recursion’s computing power, after the upgrade of its BioHive-1 supercomputer with Nvidia’s H100s in the first half of this year, it may form part of one of the 50 most powerful supercomputers in the world across any industry. Additionally, the Nvidia collaboration has enabled the creation of the Phenom-Beta model hosted on Nvidia’s BioNeMo platform and accessible to the public through the cloud but keeping the data secret. This expands Recursion’s partnership and monetization opportunities while its collaboration with Nvidia has enabled it to differentiate itself while significantly enhancing its TechBio focus compared to peers Exscientia plc (EXAI) and Schrodinger (SDGR) which also other tech-enabled drug discovery companies with advanced computational resources. Looking at finances, with $296 million in cash versus $51 million of debt at the end of Q1, and a cash burn run rate averaging $126 million annually for the past five years, there could be a 24-month runway. However, with the cadence of clinical readouts in the second half of 2024, expenses are likely to increase. Still, with its mature internal pipeline, Recursion should be able to raise capital through equity offerings to extend its runway, but, the risk here is this will only result in further dilution of shares. Finally, as far as Recursion’s data-driven approach continues to widen its pipeline and potentially provides it with more readouts than a typical biotech, this increases the chances of a breakthrough.

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