This article was published by The McAlvany Intelligence Advisor on Monday, August 8, 2016:
Every investor has, or at least should have, rules. A few good ones are: If your barber starts giving you investment advice, find another barber. Tips are for waiters. Never get into something that you can’t get out of. Always set a stop loss. If you miss one opportunity, don’t worry: there’s another one right behind it. Wherever possible, hedge. And so on.
Above all these is Rule Number One, a rule so hackneyed it’s almost embarrassing to put it down on paper:If it looks too good to be true, it probably is. And yet, for reasons yet to be determined, Silicon Valley investors have just had their collective heads handed to them to the tune of nearly three-quarters of a billion dollars. It might have been greed. It looked like a ten-bagger, easy. It might have been relying on someone else’s due diligence. It could have been blind faith: If these guys are in, so am I! It could be wanting to rub elbows with the big boys: Surely they know what they’re doing, I’ll just draft behind them.
Picture the setup: a bright kid has an idea to take a bite, potentially a big bite, out of a $75 billion industry. Dance between the elephant’s toes. Undercut them in cost but have margins that are triple the industry average. It’s in a boring industry: blood testing. It’s dominated by two billion-dollar companies: Quest ($11 billion) and LabCorp ($13 billion). The kid already has hundreds of patents on her idea, a pin-prick tool called Edison. It solves lots of problems: 1) many people don’t like needles; 2) blood tests are costly; and 3) prognosis often takes a week or more.
On the board of her company sit big names, very big names. Names like former Secretary of State George Schultz, Riley Bechtel, chairman of the Bechtel Group, Richard Kovacevich, former Wells Fargo Bank chairman, former Senators Bill Frist and Sam Nunn, former Secretary of Defense William Perry, and last but definitely not least, former Secretary of State Henry Kissinger.
Her first three funding efforts raised millions, with millions more just waiting to see. She set up walk-in labs at Safeway and Walgreens. Walgreens invested $50 million in her company. She got the OK to bill Medicare and Medicaid for the tests.
She was on her way.
This is Theranos, founded by 19-year-old Elizabeth Holmes (pictured above) back in 2003. She doesn’t like needles. At the urging of her Stanford University professor, she dropped out of school to work on her idea full time. She started acquiring patents, hundreds of them.
She started acquiring money from venture capitalists and then some big money. And then some more big money. They took preferred equity positions but left her with enough common stock to control the company. By 2014 she had raised $724 million. Based on what they paid for their stock the company was worth $9 billion. Her personal net worth jumped to over $4 billion.
Last year she was named one of Time magazine’s “Most influential People in the World in 2015,” the “Under 30 Doers” award from Forbes magazine, and “Woman of the Year” byGlamour magazine. She even received the 2015 Horatio Alger Award, the youngest recipient in history to receive it. To top it off, Holmes’s picture was featured on the October 2015 cover in Inc. magazine.
But something happened on her way to permanent stardom. A few disgruntled employees told the Wall Street Journal what was happening inside her company: Edison didn’t work very well, and top officials hid the facts from states and the feds in order to keep the compliance certificate current. The closer the Journal looked, the worse it got. It turned out that of the 240 various tests Edison was supposed to be able to run, it could only run about 15 of them. The rest were run on traditional blood test machines that Theranos bought from others. When customers began to discover that their diagnoses were off the mark, they started to complain. They got no answer. When government agencies like CMS (Centers for Medicare and Medicaid Services) began poking around, the company stalled: studies that proved Edison worked just fine were promised but were never delivered.
The Journal ran another article and the unravelling began. The deals with Safeway and Walgreens were cancelled; the FBI and the Postal Service Investigative Service got involved. A class-action lawsuit was filed. A House committee started investigating.
Holmes was forced to leave Obama’s Presidential Ambassadors for Global Entrepreneurship (PAGE) board. Inc. magazine was forced to apologize for running her picture on its October 2015 cover. Forbes backed off on its estimate that Holmes’ net worth was $4.5 billion. It is now zero, said Forbes.
She learned last week that she cannot run a lab for the next two years, that she must pay a hefty but undisclosed fine to CMS, that her company’s laboratory certificate has been revoked, and she cannot bill Medicare or Medicaid any longer. CMS is stepping on her oxygen hose.
Holmes is slated to give an update to her investors later this month. But the lesson has already been learned. All the investors attending will learn is just how much relearning Lesson Number One will cost them.
There’s another rule investors learn when they fail to follow the other rules: You may have graduated from college but you never stop paying tuition.
Sources:
Jim Cramer’s Ten Commandments of Investing
Theranos’ Elizabeth Holmes Resigns As Advisor To President Obama
Background on Elizabeth Holmes
Inc.com: Following Ban, Theranos’ Elizabeth Holmes Becomes the Ultimate Cautionary Tale for Silicon Valley
Theranos Receives Notice of Sanctions from the Centers for Medicare & Medicaid Services
The Wall Street Journal: Hot Startup Theranos Has Struggled With Its Blood-Test Technology
The Wall Street Journal: Theranos Is Subject of Criminal Probe by U.S.
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