XtalPi's Post-IPO Dip Raises Questions: Is AI Pharma Losing Its Luster?

On June 13, AI pharmaceutical company XtalPi (Stock Code: 2228.HK) was listed on the Hong Kong Stock Exchange.

The concept of AI has been the hottest investment theme in the past two years. The secondary market trading of technology stocks has even been "dominated" by the AI sector, with the short-term surge of relevant indices going without saying. AI pharmaceuticals is an important branch of the AI concept, and XtalPi, as the leader among startups in AI pharmaceuticals, its listing not only achieved "China's First AI Pharmaceutical Stock" achievements, also add a new investment target to the AI sector.

Moreover,XtalPi is the first specialized technology company to go public under Rule 18CThe establishment of Chapter 18C aims to facilitate financing for enterprises engaged in the R&D of specialized technology. The scope of the rules mainly targets technology enterprises in five major fields: next-generation information technology, advanced software and hardware, advanced materials, new energy, and new food and agricultural technology. From the perspective of XtalPi's business scope, it represents both next-generation information technology and advanced software and hardware, with a very clear attribute of specialized technology.

Compared with the high expectations before its listing, the company's stock price performance after the listing is far from impressive. As of July 4, during the 15 trading days since its listing, except for a surge on the first day of listing (with an intra-day increase once reaching 25%), the stock price quickly retreated afterward and has been experiencing narrow-range fluctuations. Moreover, it occasionally falls below the issue price.

Figure: XtalPi Stock Price Trend; Source: Wind, 36Kr

So, what categories does XtalPi's AI drug development cover? Why was it favored by the market before its IPO? What are the key points of investing in XtalPi?

01

What tasks can XtalPi's AI drug discovery currently perform?

Leaving aside technology, and looking only at the nature of the business,XtalPi is a CRO company that differentiates itself from traditional CROs by providing AI-driven pharmaceutical R&D outsourcing services to clients., using AI to replace some manual work, so there are naturally differences in business logic compared to traditional CROs.

According to the company's current revenue structure, its core business is divided intoDrug Discovery SolutionsAndIntelligent Automation SolutionsTwo major segments, these two businesses each contributed approximately 50% of the company's revenue in 2023.

Figure: XtalPi's Revenue and Structure; Source: Wind, 36Kr

Drug discovery is the earliest stage of new drug development, including specific tasks such as target identification and validation, hit compound identification, lead compound generation and optimization, and preclinical candidate compound nomination.XtalPi's drug discovery solutions apply AI technology to the early stages of pharmaceutical research and development, such as using AI for molecular design, drug-likeness evaluation, and predicting molecular interactions. This can simplify workflows and improve efficiency, theoretically offering higher success rates than traditional methods.

Intelligent automation solutions mainly empower the preclinical stage and clinical phase 1 and 2 research work after the early business through AI. The nature of the work is still outsourcing services, and the specific work content can be further divided into two sub-items: solid-state research and automated chemical synthesis.。

The purpose of solid-state research and development is to help customers select reliable and reasonable solid-state forms in preclinical and clinical trials. The specific work includes: before wet lab researchComputing Services, mainly through AI for crystal structure prediction, morphology prediction, etc.; with AI involvementWet Lab Services, including the screening and selection of polycrystals, salt form screening, crystallization process development, etc.;Integrated Solution Combining Computational Services and Wet Lab ServicesMainly aimed at extending the service cycle, thereby providing customers with one-stop services, which is also a standard approach for CRO companies.

Figure: Advantages of AI-involved solid-state R&D compared to traditional methods;

Source: Company prospectus, 36Kr

Automated Chemical SynthesisIt is through the company's independently developed XtalDynamics automated laboratory system that the process of chemical synthesis is carried out via remote automation. Compared to manual chemical synthesis, automated synthesis achieves more precise material input and can accelerate the chemical synthesis process. With reduced human intervention, automated operations ensure higher consistency, ultimately leading to better data quality.

Currently, the CRO services provided by XtalPi mainly focus on the early to mid-stages of drug development. From the details of its operations, it can be seen that,The main role of AI in participating in drug research and development is to improve quality and efficiency.. At the current level of technology, it can be said that AI has a certain disruptive impact on the pharmaceutical industry, mainly due to the primary replacement of human labor by AI and automated equipment. Therefore, the number of scientists is no longer a core dimension for evaluating AI-CRO companies. However, AI-driven drug discovery is not yet capable of completely revolutionizing the pharmaceutical industry, as the overall process of drug development has not undergone fundamental changes due to the involvement of AI.

02

Why Does the Market Give AI Drug Development a High Premium?

Looking at XtalPi's financial performance from 2020 to 2023, the total revenue was approximately 400 million yuan. Excluding the impact of convertible redeemable preferred shares, the adjusted net loss for the same period was about 1.5 billion yuan, with the main profit-eroding items being research and development expenses and general and administrative expenses.

Such a financial pattern is also easy to understand. As an emerging technology, AI drug discovery currently has a relatively small number of customers, so it has not yet formed a scale effect in business, resulting in a relatively low and volatile revenue base. At the same time, the company needs to maintain considerable R&D intensity, ensuring continuous updates and iterations of its AI platform and automated experimental platform to maintain technological *, which corresponds to the increase in R&D investment and management expenses (mainly salaries).

On the balance sheet, of the company's RMB 4 billion in total assets in 2023, a high proportion consists of highly liquid assets, primarily time deposits included in current assets (RMB 1.251 billion), cash and cash equivalents (RMB 711 million), and financial assets included in current assets (RMB 863 million). The proportion of fixed assets is relatively low, which is also one of the typical financial characteristics of a technology-driven enterprise.

Figure: Asset Composition of XtalPi; Source: Company Prospectus, 36Kr

Since the company is still in the early stage of development, AI pharmaceuticals, as an emerging technology, still have a lot of potential to be explored. As the business progresses, the company's financial structure may undergo significant changes. Therefore, traditional valuation methods based on finance are not applicable to the company.XtalPi's current total market value of up to 18 billion yuan (as of July 4) mainly reflects the market's positive outlook on the investment logic of AI technology and AI pharmaceuticals concepts, and due to its position as an industry leader, a certain premium has been added.

The market is optimistic about AI pharmaceuticals, first and foremost, because of the support from favorable policies.In order to encourage innovation in pharmaceuticals, China has gradually improved the review and approval system for innovative drugs and medical devices in recent years, helping innovative drugs reach the market quickly. In terms of AI, various national-level "plans" and "action programs" have emphasized the need to focus on the development of artificial intelligence, with AI-driven drug discovery being one of the key areas supported by policy.

Secondly, smooth financing channels are not only one of the core business logics of AI pharmaceuticals but also the reason why the market is optimistic about it.. As we all know, AI pharmaceuticals itself is extremely costly, and the industry is currently still in its early stages of development, with most profit models yet to be fully validated.Therefore, AI pharmaceutical companies have a strong dependence on financing.. Coinciding with the recent surge in pharmaceutical capital, bolstered by the pandemic, and compounded by policy advantages,AI Drug Discovery, as an important branch of pharmaceutical high-tech, has gained the favor of capital.. Public data shows that, between 2019-2022, the total annual financing in global AI pharmaceuticals increased year by year, but experienced a certain decline by 2023.

Third, the rapid development of the AI industry has made AI drug discovery possible in terms of technology and also given it certain advantages.With the significant progress in electronics and software science, especially the deep accumulation in computing power, algorithms, and data, coupled with the high maturity of the pharmaceutical industry itself, AI pharmaceuticals have thus become a real productive force, with corresponding application scenarios in drug discovery, drug development, and clinical stages.

Fourth, AI pharmaceuticals are a key focus for pharmaceutical companies and CXO enterprises, and some demand has already begun to be released.Currently, the main players in the AI pharmaceuticals market are of four types: large multinational pharmaceutical companies, large CXOs, leading internet companies, and start-up AI pharmaceutical enterprises. The financial reports of these companies show that the AI pharmaceuticals business of some companies has started to contribute to their performance, and AI pharmaceuticals have also participated in the R&D pipelines of some companies.

From the mesoscopic to the microscopic,Why the Market Likes XtalPi，Firstly, the recognition of AI pharmaceuticals as a technology route that represents the future., XtalPi, as the industry leader, naturally received significant attention from investors; secondly,The company has been among the top in terms of financing in the past few years.Among them are well-known investment institutions; third,By focusing on key collaborative projects and prestigious awards within the industry, a certain level of * is demonstrated at the technical level., such as the company's collaboration with Pfizer on the COVID-19 drug Paxlovid during the pandemic, and winning two * awards at the 2023 World Artificial Intelligence Conference, which brought the company significant fame.

03

What Should You Focus on When Investing in XtalPi?

Regarding how to value XtalPi, the analysis in the preceding text shows that the current financial situation cannot well reflect the company's business model and future potential. Then,From the industry perspective, the company's current nature is CRO.The source of income is service fees earned by providing outsourcing services. The business model of CROs ensures relatively stable income, as they earn service fees without bearing R&D risks; milestone payments are one of the main drivers of performance elasticity for modern CXO companies, but they come with a certain degree of uncertainty.

If XtalPi is valued entirely based on CRO, it would also be unfair at present.Reviewing the performance of the CXO sector in recent years, the surge from 2019 to 2021 was mainly driven by the capital boom at that time and the earnings boost during the pandemic. The market back then was more inclined to value CXOs as technology stocks. However, times have changed, and currently, the valuation of leading CXOs in China has dropped to 10-20 times PE. This valuation level only reflects the manufacturing aspect of CXOs, while their technological attributes have arguably been overlooked by the market. The main reasons behind this are:

1. The pharmaceutical sector is currently experiencing a capital winter, and safety margin is the primary consideration for investing in pharmaceuticals at present;

2. The main revenue model of CXOs also reflects more of the manufacturing attributes, with relatively less emphasis on the high-risk, high-volatility aspects associated with technology attributes. This is reflected in the business level as the proportion of risk-based income, such as milestone revenue and risk-sharing collaboration revenue among various CXOs, remains relatively low.

XtalPi's two core businesses, drug discovery solutions and intelligent automation solutions, mainly derive their revenue from service fees.In terms of revenue attributes, XtalPi differs little from traditional CROs.Moreover, a large portion of the company's operations are concentrated in the early to mid-stages of drug development. After eliminating the impact of base effects, estimates are primarily based on the current project’s R&D phase/quantity funnel and the average unit price per project, indicating that short-term performance elasticity is expected to be relatively limited.

From the perspective of industry logic, AI pharmaceuticals are still in the early stages of development. During this period, AI pharmaceutical companies have two main tasks. The first is to continuously improve their own technical platforms, which is the foundation for technology to be transformed into productivity and create profits. The second is to build a good reputation to win new customers. If these two tasks are accomplished well, a positive feedback loop will be formed, and the growth of business revenue will also serve as an important financial guarantee for the upgrading and iteration of the technical platform.

However, the current situation is that the continuous development of AI pharmaceutical technology platforms is very costly, and with the company's current revenue growth level, it is not yet possible to fully fund the R&D.Therefore, before achieving scale effects in the business sector, the company's development still heavily relies on financing.During 2021-2023, the company's highly liquid working capital (mainly cash and time deposits) showed a gradual decreasing trend, which is also one of the main reasons driving the company to go public in Hong Kong this year to obtain IPO financing.

It must be said that going public in Hong Kong this year is not a good choice.The Hang Seng Index and the Hang Seng Tech Index have both experienced significant volatility this year. The Hong Kong dollar has faced considerable exchange rate pressure, and the pharmaceutical sector is currently in a capital winter. These factors will all be unfavorable for pharmaceutical stocks seeking an ideal valuation upon listing in Hong Kong.

Regarding the special technology sector, XtalPi has gone public in Hong Kong under the 18C* share category. Compared to the requirement for non-commercialized companies under the 18C rules (with revenue of less than HKD 250 million in the most recent financial year) to have a minimum market capitalization of HKD 10 billion, the company's current market cap of HKD 18 billion can be considered relatively good. This performance is partly due to the AI concept being one of the hottest trends in the past two years, with significant market enthusiasm for AI, and also thanks to the support from cornerstone investors.

Looking back at XtalPi's valuation issue, the bullish points include recognition of the technical path, smooth financing channels, and * in technology, all of which have been detailed earlier. The aspects that are currently relatively unclear or uncertain mainly include the following two points:

1.Extremely High Cognitive Threshold。For concepts such as quantum physics and AI drug discovery that serve as company labels, ordinary investors—or even those with relevant knowledge backgrounds—find it difficult to comprehend their technical details. This easily leads to misjudgments of the company's value at the technical level;

2.There is a certain degree of uncertainty in short-term performance.In the past three years (2021-2023), the company's revenue growth has fluctuated significantly. The presence of revenue growth indicates that there is indeed demand being released, while the extremely high cognitive threshold and relatively immature business model have also, to a certain extent, affected pharmaceutical companies' outsourcing demand for AI-driven drug discovery.

This shows that, in order to make a fair valuation of XtalPi, it is necessary to base it on the manufacturing attributes of a CRO, while also including the valuation of its technological attributes, and taking into account its scarcity in the capital market.However, the difficulty in valuing this company lies precisely in the technology itself.AI drug development is already widely recognized as one of the core directions in pharmaceutical innovation. However, the current technical capabilities of AI-driven pharmaceutical companies still need to be tested by time and the market.

It must be said that,Many investors' investment in technology stocks is full of speculative nature.The investment logic is based on the belief that the technology of the bet represents advanced productivity. Although the success rate of this kind of betting investment is not high, once the technological advancement is proven, it usually brings substantial excess returns. The above investment philosophy is a typical example of high risk and high return.And such investment logic, in order to achieve positive returns in trading, generally requires two prerequisites: the economy is in a favorable cycle, and market liquidity is relatively loose.

In a pro-cyclical scenario, investors have a relatively high risk appetite and a stronger tolerance for high risk and high volatility; while abundant market liquidity, on the one hand, benefits high-risk equity assets and can resonate with pro-cyclicality. At the same time, ample liquidity and pro-cyclicality are also beneficial to financing-dependent technology companies, and the strengthening of fundamentals is a key bullish factor.

Examining XtalPi with the Logic of Investing in Technology Stocks, China's economy is in a weak recovery,Investors in the equity market currently place more emphasis on safety margins and certainty.; For the Hong Kong capital market,Pressure on the Hong Kong dollar exchange rate leads to tight market liquidity, Hibor prices of all tenors are still at historically high levels; moreover, Hong Kong stock trading is usually dominated by large-cap stocks,The issue of poor liquidity in small tickets also needs to be considered.Therefore, from the perspective of trading dimensions, the risk of currently investing in XtalPi, a typical technology stock, is not low.

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