Download now: How To Invest in the Coming Bitcoin Boom

Let's Not Theranos This Up

Written by Alex Koyfman
Posted September 6, 2018 at 3:35PM

Dear Reader,

Yesterday, Theranos, the medical testing miracle company and one-time Silicon Valley darling, was officially dissolved, its assets now slated to be distributed among former creditors. 

Many people recognize the name of the company, as well as the face of its youthful founder, Elizabeth Holmes, but few understand the story that took the company from idea to venture capital superstar to scandal to ultimate destruction in just a decade and a half. 

It's a story of hope and world-changing potential, but also greed, deceit, and eventually disgrace... and it all began with a moment of inspiration in the mind of a 19-year-old Stanford student. 

Elizabeth Holmes was the kind of kid every parent dreams of raising.

No Frat Parties for Elizabeth

Both brilliant and precocious, her idea to create a “laboratory on a chip” — a wearable patch that could detect and report changes in patients' blood chemistry, as well as moderate drug dosages to respond to those changes — eventually gave rise to the company that would revolutionize the $70 billion blood testing industry. 

At just 19, Elizabeth took the money her parents had set aside for her college education and founded a company called Real-Time Cures. 

Eventually, the decision was made to change this name to Theranos, a portmanteau of the words “Therapy” and “Diagnosis.” 

Its product, in theory at least, was a system of blood testing that would reduce the volume of blood necessary to make an effective clinical evaluation by a factor of between 100 and 1,000, with the added bonus of a substantial reduction in cost as well. 

Silicon Valley venture capitalists lined up to back the company the same way they typically did for social media and net-based startups. 

In 2010, Theranos took its first major financing, raising $45 million by selling equity and options. 

By 2014, the company had raised more than $400 million and had risen to a valuation of $9 billion, half of which was still in the hands of its 30-year-old founder, making her one of the wealthiest women in the country. 

But in February of the next year, this apparent fairy tale of modern medical technology started to show signs of coming down to Earth. 

Doubts

The company came under fire in the Journal of the American Medical Association by a professor at Stanford's own school of medicine for operating “in stealth mode for more than a decade,” as it failed to publish any substantial material in peer-reviewed medical periodicals. 

The editorial questioned the validity of the Theranos process, even though by that time, it had been deployed to testing centers in dozens of Walgreens branches across the state of Arizona. 

That same July, the company received FDA approval for its herpes simplex 1 test, but the celebration was short-lived, as the company suspended its trademark “finger-prick” testing service just three months later. 

The following January, the Centers for Medicare and Medicaid Services issued a letter stating that the company had violated a number of clinical standards. 

Two months after that, the Journal of Clinical Investigation found that the company's blood test results were flagged “outside their normal range 1.6x more often than other testing services,” that 68% of lab measurements evaluated “showed significant interservice (sic) variability,” and that “lipid panel test results between Theranos and other clinical services” were “nonequivalent.” 

That same June, Walgreens formally terminated its relationship with Theranos, shutting down all 40 of its Arizona-based testing centers and effectively cutting Theranos off from bringing in new customers.

The Regulators Arrive

The following month, federal regulators imposed severe sanctions, including banning the founder from owning or operating a medical laboratory for at least two years.

Regulators also revoked the certification of its Newark, California, laboratory, prohibiting Theranos from taking Medicare and Medicaid payments for its services.

In October 2016, the company began to lay off employees as a major investor, Partner Fund, sued the company, citing securities fraud.

The following month, Theranos was hit with an additional lawsuit for $140 million by its former partner, Walgreens. 

The train wreck finally came to a climax in March of this year when the SEC charged the company, Holmes, and former President Ramesh Balwani with raising more than $700 million from investors through an “elaborate, years-long fraud in which they exaggerated or made false statements about the company's technology, business, and financial performance.”

Criminal charges including wire fraud were filed against both Holmes and Balwani in June.

Finally, earlier this week, Theranos was formally dissolved, going down in flames as one of the most conspicuous Silicon Valley failures in history. 

Lesson Learned?

The story of teenage prodigy Elizabeth Holmes and her industry-disrupting testing technology now stands as a cautionary tale, both for venture capitalists and for ambitious young engineers tempted by the promise of fame and wealth. But how should onlookers like us view these events, now that the truth (most of it, anyway) has finally been exposed?

The big lesson here isn't that the tech industry is fraught with danger and potential disaster, but rather that clear and indisputable evidence needs to be heeded when it surfaces. 

It probably seems crazy in hindsight, but Theranos took its last capital raise as late as December 2017, when the Fortress Investment Group loaned the company $100 million to avoid bankruptcy. 

This was mere weeks before the SEC reduced the entire operation to little more than a stack of falsified data, and just eight months before the company formally ceased to exist. 

What those final investors were thinking, when they tried to save a ship from sinking that was more rats than hull, remains unclear — unless we chalk it all up to the simple and basic human need to keep the faith, despite overwhelming evidence.

But that shouldn't dissuade investors and entrepreneurs from taking chances, even ones with apparently long odds, when those chances are backed by solid facts. 

The process of vetting investment opportunities is absolutely critical but, when executed with discipline, will strip the frauds and empty promises away on a consistent enough basis to justify whatever risk remains. 

As a lifelong stock-picker, this vetting process is my lifeblood. 

And I've come up with a simple yet reliable set of filters to cut the risk from even the earliest-stage ventures. 

Check out this brief instructional video on how it’s done.

Fortune favors the bold,

alex koyfman Signature

Alex Koyfman

follow basic@AlexKoyfman on Twitter

Coming to us from an already impressive career as an independent trader and private investor, Alex's specialty is in the often misunderstood but highly profitable development-stage microcap sector. Focusing on young, aggressive, innovative biotech and technology firms from the U.S. and Canada, Alex has built a track record most Wall Street hedge funders would envy. Alex contributes his thoughts and insights regularly to Wealth Daily. To learn more about Alex, click here.

Comments

Buffett's Envy: 50% Annual Returns, Guaranteed