02 Feb 2022
Theranos’ dramatic fall from grace may read like a cautionary tale about the dangers of investing in disruptive technology. It isn’t. Jonathan Parsons explains why its downfall has little to tell us about growth investing.
FOR PROFESSIONAL AND/OR QUALIFIED INVESTORS ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. CAPITAL AT RISK. All financial investments involve taking risk which means investors may not get back the amount initially invested.
Theranos, the blood-testing company whose chief executive now awaits sentencing for having fraudulently deceived investors, never achieved the fabled ‘product-market fit’ that venture capitalists prize. The potential market – for radically more efficient blood tests – was certainly there; unfortunately, a viable product was not.
That the downfall of Theranos received so much attention may be because its CEO, Elizabeth Holmes, did achieve product-market fit – at least in the eyes of the media. The media lapped up her story and her black turtleneck: surely this is what Silicon Valley entrepreneurs ought to look like? In 2015, Inc., an American business magazine described her as “The Next Steve Jobs”; Forbes adorned its cover with her photograph. Her profile was instrumental in helping the company to raise so much capital so quickly and, perhaps, in avoiding serious scrutiny.
Theranos’ technology offered the tantalising promise of carrying out hundreds of blood tests using just a single drop of blood collected by finger prick and tested in a sleek machine whose design cues came from Apple: the Edison. A private market funding round in 2015 implied a valuation of $9 billion for the company. It didn’t last. A short while later, the whistle was blown to the Wall Street Journal by Tyler Shultz, a former employee… the Edison may have looked the part – but it didn’t work.
The stories required to keep the flywheel spinning became increasingly grand, moving from dizzily overoptimistic forecasts to outright fraud. Pfizer and Schering-Plough logos were photoshopped onto lab reports and used in presentations to deceive partners and investors.
Theranos told markets that the FDA had assessed the ‘nanotainer’, its device for collecting consumer blood samples, as having a “low risk of causing illness or injury,” making it a Class I medical device. In reality, regulators had actually put it in the Class II category, where devices require warning labels and evidence that they perform as expected before they can be used by consumers.
Fortunately, the financial damage from Theranos’ implosion was contained to private markets; the whistle was blown before it could go public.
In short, not much.
The warning signs were there: Theranos refused to disclose how its Edison testing machines worked; it didn’t release them for independent testing or peer review and no details how its technology work were given to the market. It was incredibly secretive. This alone would likely have been a barrier to it becoming a public company.
But if – whether by some misdeed or mischance – Theranos had managed to list we are confident in saying that we, at least, would never have appeared on its shareholder register.
We are growth investors – and evidence of revenue growth is a central plank of our process. With declining revenues ($1.4MM in 2010, $0.5MM in 2011 and zero revenues in both 2012 and 2013) Theranos simply wouldn’t have passed our screening process.
My teammate Craig Bonthron recently explained why a focus on growth is central to our approach. It doesn’t guarantee success, but evidence of growing revenues demonstrates a stage of maturity at which we can begin to assess a company’s dynamic power and its ability to achieve its vision. Without evidence of revenue growth we cannot, in all honesty, assess the probabilities of various potential outcomes.
Tangible evidence also matters because the game of predicting the ‘next big thing’ is one that even inventors struggle with. In 1901, Wilbur Wright said to his brother that “man would not fly for 50 years”; just two years later they were airborne. On the other hand, AT&T demonstrated a video phone at the 1964 World’s Fair. It would be decades before the technology came into practical use.
The rise and fall of Elizabeth Holmes – and the glee her former acolytes in the media have exhibited in tearing her down – is shocking. And although the financial fallout from this sad tale has been contained, it has provided those who were already sceptical with a convenient brush with which to tar the world of venture capital.
In reality, however, Theranos tells us little – not even about the venture capitalists of Silicon Valley (who were largely absent after the very early funding rounds). Rather it reminds us of something much more straightforward: sometimes people running companies – whether they be start-ups in Silicon Valley, energy trading companies in Texas or hedge funds in New York – do bad things.
That’s why, when we invest for a positive future, we demand transparency from the companies we invest in and hard evidence in the form of revenues – and not just a convincing-sounding executive with a nice line in black turtlenecks.
To find out more about Artemis visit www.artemisfunds.com.
FOR PROFESSIONAL AND/OR QUALIFIED INVESTORS ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. This is a marketing communication. Refer to the fund prospectus and KIID/KID before making any final investment decisions. CAPITAL AT RISK. All financial investments involve taking risk which means investors may not get back the amount initially invested.
Any research and analysis in this communication has been obtained by Artemis for its own use. Although this communication is based on sources of information that Artemis believes to be reliable, no guarantee is given as to its accuracy or completeness. Any forward-looking statements are based on Artemis’ current expectations and projections and are subject to change without notice. Issued by: in the UK, Artemis Investment Management LLP which is authorised and regulated by the Financial Conduct Authority; in Switzerland, Artemis Investment Services (Switzerland) GmbH.