Digene Selloff Creates Buy Opportunity

Shares of Digene (DIGE), which screens for infectious diseases and cancers afflicting women, tumbled 12% last week after the MD-based firm announced that its CFO/COO Charles Fleischman was leaving “to begin the next chapter in his life.”

We view the sell-off as evidence of a panic attack on behalf of shareholders. At 112 x current year earnings, the stock is bound to shake out a few more longs before all is said and done. That said, we think investors may want to take a second look at this DNA testing company: the long term story is compelling and the recent management change should not, we expect, weigh heavily on DIGE’s operational performance.

Below are a few reasons why we find DIGE attractive:

1) Digene’s platform (“Digene HPV Test”) is the only federally approved test for the detection of human papillomavirus (linked to cervical cancer). It also tests for sexually transmitted diseases [STDs] including chlamydia, gonorrhea, and hepatitis B. The United States has the highest rates of STDs in the industrialized world. In the United States alone, an estimated 15.3 million new cases of STDs are reported each year. Women suffer more frequent and more serious complications from STDs than men. Experts expect this trend to continue, and we believe this creates a tremendous market-expanding opportunity for Digene.

2) Digene's balance sheet is solid and should bolster the firm’s current growth path. At the time being, DIGE is sitting on $140MM in cash ($6 per share) and is debt free. This is a sound liquidity position and gives DIGE plenty of room to wiggle in terms of acquisitions should it decide to add complimentary technologies to its STD-testing niche. Investors should note that management has already specifically said that DIGE will have to expand internationally and produce new products, possibly by buying other companies. On the flip side, we note that DIGE’s $964MM market cap makes the firm a possible acquisition candidate; we like MA-based Cytyc (CYTC) as a possible suitor.

3) The valuation, even at 112 x current estimates, is treacherous, but attractive. We expect DIGE to grow its EPS by approximately 25% from 2006-07. While DIGE trades at a vast premium on a peer basis, we are impressed by DIGE’s robust growth over the last year. The company recently reported fiscal fourth-quarter profit of $3MM, compared with a loss of $3.8MM in the corresponding period last year. Revenue increased 33 percent to $43MM for the quarter ended June 30.

Increased awareness of HPV (in the wake of Merck’s Gardisil launch) should instigate a fresh round of buyers after all the momentum players exit the stock. At $35, we think DIGE would represent a compelling buy and a pure play on STD detection services.

DIGE 1-yr chart:

The author is an MBA/CFA candidate at the Kelley School of Business at Indiana University. At the time of publication, neither he nor his family owned shares of Digene.