By Aswath Damodaran
I saw the Steve Jobs movie, with the screenplay by Aaron Sorkin. As a long-time Apple user and investor, I must confess that I was bothered by the way in which the film played fast and loose with the facts, but I also understand that this is a movie. Sorkin clearly saw the benefit of using the launches of the Macintosh in 1984 and the iMac in 1997 as the bookends of the movie and the tortured relationship between Jobs and his daughter to create an emotional impact, and took dramatic license with the truth. As I watched the movie though, I kept thinking about Theranos, a company with a gripping narrative and a CEO who, like Steve Jobs, wears only black and who seemed headed for a biopic until a few weeks ago.
The Theranos Story: The Build Up
The Theranos story has its beginnings in March 2004, when Elizabeth Holmes, a 19-year old sophomore at Stanford, dropped out of college and started the company. The company was a Silicon Valley start-up with a non-Silicon Valley focus on an integral, but staid part, of the health care experience, the blood test. Ms. Holmes, based on work that she had been doing in an Stanford lab on testing blood for the SARS virus, concluded that she could adapt technology to allow for multiple tests to be run on much smaller quantities of blood than the conventional tests did and a quicker and more efficient turn around of results (to doctors and patients). In conjunction with her own stated distaste for the needles required for conventional blood tests, this became the basis for the Theranos Naotainer, a half-an-inch tube containing a few drops of blood that would replace the multiple blood containers used by the conventional labs.
The story proved irresistible to just about everyone who heard it, her professor at Stanford who encouraged her to start the business, the venture capitalists who lined up to provide her hundreds of millions of dollars in capital and health care providers who felt that this would change a key ingredient of the health care experience, making it less painful and cheaper. The Cleveland Clinic and Walgreens, two entities at different ends of the health care spectrum, both seemed to find the technology appealing enough to adopt it. The story was irresistible to journalists, and Ms. Holmes quickly became an iconic figure, with Forbes naming her the “the youngest, self-made, female billionaire in the world” and she was the youngest winner of “The Horatio Alger award” in 2015.
From the outside, the Theranos path to disrupting the business seemed smooth. The company continued to trumpet its claim that the drop of blood in the Nanotainer could run 30 lab tests and deliver them efficiently to doctors, going as far as listing prices on its website for each test that were dramatically lower (by as much as 90%) than the status quo. In venture capital rankings, Theranos consistently ranked among the most valuable private businesses with an estimated value in excess of $9 billion, making Ms. Holmes one of the richest women in the world. The world seemed truly at her feet and reading the news stories, the disruption seemed imminent.
The Theranos Story: The Letdown
In the following days, things got worse for Theranos. It was reported that the FDA, after an inspection at Theranos, had asked the company to stop using the Nanotainer on all but one blood test (for Herpes) because it had concerns about the data that the company had supplied and the product’s reliability. GlaxoSmithKline, which Ms. Holmes had claimed had used the product, asserted that it had not done business with the start up for the previous two years and the Cleveland Clinic also backed away from its adoption. Theranos initially went into bunker mode, trying to rebut the thrust of the critical articles rather than dealing with the substantial questions. It was not until October 27 that Ms. Holmes finally agreed that presenting the data that the Nanotainer worked as a reliable blood testing device would be the most “powerful thing” that the company could do.The Theranos story started to come apart on October 16, when a Wall Street Journal article reported that the company was exaggerating the potential of the Nanotainer and that it was not using it for the bulk of the blood tests that it was running in house. More troubling was the article’s contention that senior lab employees at the company found that the nanotainer’s blood test results were not reliable, casting doubt on the science behind the product.
It is entirely possible that the data that the company has promised to deliver will be so conclusive that all doubts will be set aside, but it does seem like the spell has been broken.
Looking back at the build up and the let down on the Theranos story, the recurring question that comes up is how the smart people that funded, promoted and wrote about this company never stopped and looked beyond the claim of “30 tests from one drop of blood” that seemed to be the mantra for the company. I don’t know the answer to the question but I can offer three possible reasons that should operate as red flags on future young company narratives:
- The Runaway Story: If Aaron Sorkin were writing a movie about a young start up, it would be almost impossible for him to come up with one as gripping as the Theranos story: a nineteen-year old woman (that already makes it different from the typical start up founder), drops out of Stanford (the new Harvard) and disrupts a business that makes us go through a health ritual that we all dislike. Who amongst us has not sat for hours at a lab for a blood test, subjected ourselves to multiple syringe shots as the technician draw large vials of blood, waited for days to get the test back and then blanched at the bill for $1,500 for the tests? To add to its allure, the story had a missionary component to it, of a product that would change health care around the world by bringing cheap and speedy blood testing to the vast multitudes that cannot afford the status quo. The mix of exuberance, passion and missionary zeal that animated the company comes through in this interview that Ms. Holmes gave Wired magazine before the dam broke a few weeks ago. As you read the interview, you can perhaps see why there was so little questioning and skepticism along the way. With a story this good and a heroine this likeable, would you want to be the Grinch raising mundane questions about whether the product actually works?
- The Black Turtleneck: I must confess that the one aspect of this story that has always bothered me (and I am probably being petty) is the black turtleneck that has become Ms. Holmes’s uniform. She has boasted of having dozens of black turtlenecks in her closet and while there is mention that her original model for the outfit was Sharon Stone, and that Ms. Holmes does this because it saves her time, she has never tamped down the predictable comparisons that people made to Steve Jobs. If a central ingredient of a credible narrative is authenticity, and I think it is, trying to dress like someone else (Steve Jobs, Warren Buffett or the Dalai Lama) undercuts that quality.
- Governance matters (even at private businesses): I have always been surprised by the absence of attention paid to corporate governance at young, start ups and private businesses, but I have attributed that to two factors. One is that these businesses are often run by their founders, who have their wealth (both financial and human capital) vested in these businesses, and are therefore as less likely to act like “managers” do in publicly traded companies where there is separation of ownership and management. The other is that the venture capitalists who invest in these firms often have a much more direct role to play in how they are run, and thus should be able to protect themselves. Theranos illustrates the limitations of these built in governance mechanisms, with a board of directors in August 2015 had twelve members:
|Henry Kissinger||Former Secretary of State||92|
|Bill Perry||Former Secretary of Defense||88|
|George Schultz||Former Secretary of State||94|
|Bill Frist||Former Senate Majority Leader||63|
|Sam Nunn||Former Senator||77|
|Gary Roughead||Former Navy Admiral||64|
|James Mattis||Former Marine Corps General||65|
|Dick Kovocovich||Former CEO of Wells Fargo||72|
|Riley Bechtel||Former CEO of Bechtel||63|
|Elizabeth Holmes||Founder & CEO, Theranos||31|
|Sunny Balwani||President & COO, Theranos||NA|
I apologize if I am hurting anyone’s feelings, but my first reaction as I was reading through the list was “Really? He is still alive?”, followed by the suspicion that Theranos was in the process of developing a biological weapon of some sort. This is a board that may have made sense (twenty years ago) for a defense contractor, but not for a company whose primary task is working through the FDA approval process and getting customers in the health care business. (Theranos does some work for the US Military, though like almost everything else about the company, the work is so secret that no one seems to know what it involves.) The only two outside members that may have had the remotest link to the health care business were Bill Frist, a doctor and lead stockholder in Hospital Corporation of America, and William Foege, worthy for honor because of his role in eradicating small pox. My cynical reaction is that if you were Ms. Holmes and wanted to create a board of directors that had little idea what you were doing as a business and had no interest in asking, you could not have done much better than this group of septuagenarians.
My sense of Ms. Holmes’s unquestioned authority was reinforced when I read a December 2013 letter that she sent to investors in the company, asking them to agree to a five for one stock split and the creation of two classes of shares with different voting rights (class A would have one vote per share and class B would get 100 votes per share), with Ms. Holmes retaining the voting shares and voting control of the company. Lest I be accused of being sexist in begrudging her this power, I have been just as harsh in my assessments of Mark Zuckerberg (with Facebook) and the Brin/Page duo (with Google) for their desire to raise money from investors but not give them a proportional say in how the business gets run, and Ms. Holmes has not quite earned the rights (that Zuckerberg and Brin/Page have claimed) to be a corporate dictator.
I would like to believe that I would have asked some fundamental questions about the science behind the product and how it was faring in the FDA approval process, if I had been a potential investor or journalist. However, it is entirely possible that listening to the story, I too would have been tempted to go along, wanting it so much to be true that I let hope override good sense. Some of my worst mistakes in investing (and life) have been when I have fallen in love with a story so much that I have willed a happy ending to it, facts notwithstanding.
The question of whether Theranos makes it back to being a valuable, going concern rests squarely on the science of its product(s). If the Nanotainer is a revolutionary breakthrough and what it needs is scientific fixes to become a reliable product, there is hope. But for that hope to become real, Theranos has to be restructured to make this the focus of the business and become much more transparent about the results of its tests, even if they are not favorable. Ms. Holmes has to scale back many of her high profile projects (virtuous and noble though they might be) and return to running the business. If the Nanotainer turns out to be an over hyped product that is unfixable, because it is scientifically flawed, Theranos has a bleak future and while it may survive, it will be as a smaller, low profile company. The investors who have put hundreds of millions in the company will lose much of that money but as I look at the list, I don’t see any of them entering the poor house as a consequence. There is a chance that the lessons about not letting runaway stories stomp the facts, never trusting CEOs who wear only black turtlenecks and caring about governance and oversight at even private businesses may be learned, but I will not hold my breath expecting them to have staying power.
Aswath Damodaran is the Kerschner Chaired Professor of Finance at the Stern School of Business at New York University, where he teaches corporate finance and valuation to MBAs, executives and practitioners.