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Last week, I wrote an article detailing the different parts of the DNA analysis market. There, I used DNA giant Illumina (NASDAQ:ILMN) as a jumping off point to start my discussion, and looked at the parts of the DNA market where it made large contributions, and the new areas it wants to get more involved in. Most recently, ILMN began making a move to expand from providing research tools for pharmaceutical companies, and into molecular diagnostics -- the field that uses info from DNA to make diagnostic decisions. Towards the end, I mentioned Illumina's newest partnership in this area, with molecular diagnostic company TrovaGene (NASDAQ:TROV). TROV developed technology that can analyze cell free DNA without drawing blood or using other invasive procedures, instead, it acquires the cell free DNA sample through the patient's urine.

In this article, I will examine TROV in considerably more depth. Specifically, by giving an overview of the company, I will try to demonstrate that investors have not given credence to all of TROV's product lines. This analysis will center on the value of TROV's cancer diagnostic business, and will try to show that while it represents the most advanced and promising of TROV's business lines, investors have totally focused on this without giving credence to TROV's other opportunities.

TROV: An Overview

As mentioned in the opening paragraph, TROV manufactures technology that allows physicians to sample cell free DNA from urine. TROV has applied this technology to four specific diagnostic markets -- oncology, transplant monitoring, infectious disease, and prenatal disorders. I will now spend some time analyzing TROV's current cancer diagnostic products.

TROV has made significant progress in developing its assay for detecting the KRAS mutation. This mutation, found in 35-50% of colorectal cancers, and 40-90% of patients with pancreatic cancer can strongly determine the course of treatment for patients with these diseases. Each year in the USA, 140,000 patients get diagnosed with colorectal cancer, and 43,000 with pancreatic cancer -- 183,000 total. Reimbursement rates remain somewhat erratic, but the most recent reports say that reimbursement for KRAS mutation tests run about $225.

In addition to its work in developing a KRAS mutation assay, TROV has also made significant progress in developing assays for the BRAF and PIK3CA mutations. Almost 50% of melanomas harbour mutations in BRAF, and 45% of the most common type of thyroid cancer harbor the mutation as well. In the USA, 77,000 patients get diagnosed with melanoma each year, and 60,000 with thyroid cancer. The reimbursement rates for KRAS testing have taken a hit recently, dropping to around $57/test. Lastly, TROV continues to develop its biomarker for the PIK3CA mutation -- commonly found in breast, colon, and endometrial cancers. These cancers make up 430,000 of the total cancer diagnoses each year, and have high, but varying incidents of the PIK3CA gene mutation. In sum:

Gene Mutation

Types of Cancer

Total Diagnoses

% of diagnoses that have mutation

Cost Per Test

KRAS

Colorectal, Pancreatic

177,000

40% for CR, 40-90% for Pancreatic

$225

BRAF

Melanoma, Thyroid

137,000

50%

$57

PIK3CA

Breast, Colon, Endometrial

400,000

Significant, but varying

$50

Now, that we have an overview of TROV's products -- we need to ask what value do they add for patients? How does this information help patients in dealing with their treatment before after and during their cancer treatment? What financial implications does this have?

Gene Mutation Implications

Patients diagnosed with colorectal or pancreatic cancers have a few treatment options available. One of the more common treatments uses Eli Lilly's (NYSE:LLY) and Bristol-Myers' (NYSE:BMY) anti-EGFR drug Erbitux, or Amgen's (NASDAQ:AMGN) anti-EGFR drug Vectibix. However, these drugs have shown lower efficacy when treating colorectal and pancreatic cancer patients who have the KRAS mutation. Thus knowing if a patient has or doesn't have the KRAS mutation will strongly influence whether or not the patient should receive either of the anti-EGFR drugs mentioned above. The current method for analyzing whether or not a patient has the KRAS mutation calls for a biopsy of the diseased area of the colon -- a terribly difficult and invasive procedure. In this area, TROV's totally non-invasive urine sampling clearly gives patients a far superior option to the current standard of care.

This ability to offer more personalized care extends into detecting patients with both the BRAF and PIK3CA mutations. Genentech (RHHB.OBY) has developed a special melanoma drug -- Zelboraf -- to treat melanoma patients with the BRAF gene mutation. In the case of PIK3CA, breast cancer patients diagnosed with this mutation have shown a poorer response to Roche's herceptin. As such, by testing for this mutation doctors can order a different course of treatment away from herceptin.

The above only represent a sample of the diagnostic capabilities doctors have when they know a patient's genetic makeup. A lot of this research is still ongoing, with some information -- like that from the KRAS mutation -- very strong, and other information a bit more speculative. However, we see from here the tremendous wealth of knowledge doctors can gain by knowing a patient's genetic makeup, and the significant role TROV will play going forward.

And what about during and after treatment? What clinical value does molecular diagnostics have? To paraphrase slightly from the government's cancer website:

During treatments, protein expression patterns are used to make sure that treatment is effectively disrupting the targeted cellular pathway of the tumor. After treatment, more gene and protein expression patterns verify that the cancer is in remission.

We see from this that molecular diagnostic holds relevance before during and after cancer treatment. Considering the constant monitoring required during all phases of treatment, developing a technology that can acquire a sample in a non-invasive way provides a tremendously beneficial service for patients. With this knowledge in mind we can now move to try to make revenue predictions for TROV's different diagnostic products.

Revenue Projections

None of TROV's products have received approval for use yet (more on that later), but nonetheless I think even a rough revenue projection will prove useful in arriving at a valuation. See model below (explanation to follow)


(Click to enlarge)

The total patient population and cost per test figures come from the numbers referenced above. While I cannot accurately say how much of the population will actually become TROV users, I think considering the tangible benefits of a far less invasive procedure, we can approximate at least a 10% adoption rate (on average). Considering the necessity of multiple tests for before during and after treatment I think we can assume patients will receive at least five tests total during their course of treatment.

In terms of the revenue numbers, a recent study said that gross margins for molecular diagnostic companies ran somewhere in the 70% range on average. I took my SG&A and R&D figures (20% and 18% of revenues respectively) from Cepheid (NASDAQ:CPHD), the closest comp available. Most other companies in the molecular diagnostic space traffic in other areas as well, which cloud their overall R&D and SG&A figures. CPHD, however, focuses only on molecular diagnostics giving us an accurate comp for TROV.

We see from the above that valuing the cancer diagnostic alone yields a valuation of $9.76/share. Accounting for a discount because the lack of revenue, brings you to a valuation somewhere around the current market price of $7.50/share. This leaves out the transplant, infectious disease, and prenatal disorders -- essentially giving you a free call for all those businesses. Granted, none of these assays have received approval yet, but as we will see approval for these assays does not require the same rigorous testing as other areas of the healthcare business.

FDA Approval And Final Thoughts

TROV bought a CLIA laboratory in February 2012, which allowed them to sidestep the need for FDA approval for their assays in specific situations. Meaning, a company that owns a CLIA lab, and does not market its tests to outside labs -- called laboratory developed tests, or LDTs -- does not need to seek FDA approval for its tests. And while it still needs to pass certain standards, this relaxing of the rules allows for much easier revenue assumptions.

To end on a macro note, diagnostic medicine allows doctors to prescribe the right therapy for the right patient at the right time. This has allowed the market to achieve a low double digit growth rate over the past years, and with the continuing advances in diagnostic treatments that number should continue to go higher. And even though the market has seen pricing pressure for certain diagnostic tests, I think this represents a blip on the radar of a young and developing market. Going forward, the significant improvements over the current standard of care will continue to drive the molecular diagnostics market specifically, and the pharmaceutical market in general -- offering tremendous benefits to patients, and a lot of upside for investors. TROV's significant improvements in this space -- allowing truly non-invasive testing, as opposed to current standards -- position them at the heart and forefront of this exciting field.

Source: TrovaGene: A Stock Filled With Freebies