✒️#18 - The quantum market test

A Scorpion, Bear, and Scientist walk into a bar...

May 23, 2022

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Here's your weekly roundup of the most interesting things I've read, learned, or listened to. I write about the people and funds that can create a better world for us.

🖥Scorpion Capital stings quantum computing

As I’ve made abundantly clear and will continue to proclaim, I’m incredibly bullish on quantum technologies. Quantum sensing can enable hyper specificity for new healthcare diagnostics. Quantum key distribution can create unhackable communication networks. Quantum computing can can solve optimization problems like the traveling salesmen problem, which impacts everything from logistics to microchip manufacturing (as I wrote about in Spicy Chips) to DNA sequencing and drug discovery.

In 2019, I was speaking to Arthur Hermann who helped stand up Hudson Institute’s Quantum Alliance Initiative. I told him the quantum industry was the train leaving a station that I needed to be on. He laughed and said “that train is leaving very slowly. You’ve got more time than you think.” It turns out he was right. But then, amidst a very frothy public market, a handful of quantum companies (Quantum Computing Inc, Arqit, Rigetti, and IonQ) went public, providing a new level of transparency into these companies. Rigetti and IonQ are the biggest of these companies both in terms of name recognition and market cap (~$1.0b and ~$1.1b, respectively).

A few weeks ago, Scorpion Capital Management, an activist investor specializing in shorting (i.e., betting against) public companies, wrote a scathing 183-page report of IonQ. They likened IonQ to Nikola, the embattled electric trucking company that has lost 95% of its value since settling with the SEC over fraudulent claims related to its products and progress.

The quantum world lit up in response to Scorpion’s report. The market reacted as well. In the week following the report, IonQ lost 45% of its market cap and has since recovered slightly. It’s now down 30% from the day prior to Scorpion’s report. This might indicate there’s something to the report. Or it might indicate the people who are invested in IonQ don’t fully grasp what they were or are invested in. Cue the quantum bears:

Bear Guitar GIF - Bear Guitar Bear Playing Guitar GIFs

Some background on Rigetti and IonQ:

Last week, both Rigetti and IonQ issued their Q1 results. Rigetti brought in 2.1m in revenue, which is essentially flat from last year. IonQ brought in $2.0m. So that is a combined $4.1m in Q1 revenue or $16.4m annualized revenue for companies that are worth a combined $2.1b. On first blush, you can see why somebody would take a big short position. The markets are roasting Uber for not being profitable, but the mobility segment alone did $2.5 billion in revenue in Q1, compared to our quantum companies’ $2ish million. On one hand, Rigetti and IonQ are two companies with minimal revenue that went public in the midst of the SPAC whack (I’m trademarking that) and the height of a bull market. So maybe they’re ripe for the picking. On the other hand, folks who invested in both of these companies with some knowledge of the quantum landscape did not expect (or certainly should not have expected) near-term cash flow. As the Quantum Observer put it:

“These points are both relevant and irrelevant. The whole point of SPACing IonQ, if you are serious about making a quantum computer, is to raise over half a billion dollars to fund serious R&D for the next 4-6 years to make something that works well enough to either raise more money, or entice commercial partners to pay to use the hardware, thereby raising money.
In my mind, pursuing partnerships and loudly announcing them is missing the point. Having partners pay for compute time is missing the point. The whole point is that there’s $600M available for IonQ to staff up, get some serious technical partners and grind out some real, exciting advances to the QC state of the art before the cash is gone.”

A SPAC for IonQ and Rigetti is another type of fundraising for them, but it is a fundraise that puts these companies in a tough position. Public companies need to publish quarterly results. In a downmarket environment, it can be difficult for R&D companies to manage a quickly moving narrative. The only companies that really successfully bet on frontier R&D projects are those like Alphabet, IBM, and Honeywell (i.e., they have other businesses that shed cash they can reinvest into R&D). It’s also hard because there’s not a linear path to achieving quantum supremacy. Quantum computing companies takedifferent approaches to achieving quantum supremacy and it is 100% a space race. Working with trapped ion-based approaches as IonQ does is a bet that other quantum computing technologies don’t get over the line first.

From a company perspective:

Seeing this short report and not driving revenue doesn’t mean IonQ or any public quantum companies are bad companies. But they must be ready for the fact that there will not be as much support for them over the next year as there was over the past year. The folks that these short reports and minimal revenue scare off were never the long-term investors that these companies need. These companies must be able to batten down the hatches, take control of the narrative (as IonQ has begun to in their response), and continue to make progress.

From an opportunity perspective:

The worst thing that can happen for all of us would be if these companies falter and fold after making so much technological progress. That technological progress is not just important to hoody-wearing technofuturists. It’s important to suit-wearing politico. Quantum computing has significant geopolitical implications. Quantum computers will be able to crack our most sophisticated cybersecurity measures in the blink of an eye. So adversaries can steal information today, knowing they can’t read it yet. But once they achieve quantum supremacy, they can read any encrypted file like an open book.

The former CEO of quantum key distribution company Quantum Xchange pointed out to me that we are already across the “quantum threshold” for cybersecurity. Some information stolen today will be past its useful life by the time adversaries can use quantum computing methods to unlock and read them. But what this CEO was referring to was that other information, like health records, can be stolen today and will have a very long useful life, meaning this information today is at risk because of adversarial advances in quantum computing. Funding the progress of these companies and the opportunity they bring is a national imperative.

From an investment perspective:

Investing in innovative opportunities is critical to uncorrelated exposure in a portfolio. Because of the timing of when Rigetti and IonQ went public, many investors in these companies may not be sophisticated investors. Perhaps they view their exposure to these companies in the same way they YOLO’d into any other tech stock. Maybe that’s who Scorpion is scaring off.

This doesn’t mean companies heavy R&D companies shouldn’t be public. It’s one of the ways we can fund necessary innovation (as I wrote about in Cathy’s Ark and Science isn’t broken, but it could be better). The bet with Rigetti and IonQ is the business model will work, and it will be incredibly profitable. Once any company achieves quantum supremacy, it will essentially become a public utility. Everybody from start-ups to Fortune 500 companies to government entities will be eager clients. But getting there will require long-term investors. Anybody looking for immediate cash flow will and should flee these companies now. This is a 5-10 year investment. As Arthur Hermann put it, the train is still leaving the station. Or as Andre Konig nicely summed up:

“These aren’t old-time software startups where everyone can eat pizza and get things delivered by pulling an all-nighter. These are long term endeavours that have to combine skills from physicists, engineers and computer scientists just to make things work. In the real-world, marketing flair and commercial skills are set to be an equally important part of the mix. Combining such impenetrable disciplines amidst great uncertainty; mixing founding and new senior talent; retaining everyone around a realistic common company narrative (and realistic pay expectations) are going to be challenges many in the sector will face”