I really don't know if the next five years at GenMark Diagnostics (GNMK) are going to be more like Luminex (LMNX) or more like Cepheid (CPHD). If it's the former, the stock will chop around a lot as the company struggles to establish its system as a preferred option in multiplex molecular diagnostics testing. If it's the latter, GenMark will see strong adoption of a fast, accurate, easy-to-use system that becomes a new must-have in hospitals and reference labs.
I like GenMark's technology and I think there is room in the market for a strong automated multiplex MDx system. By no means does that guarantee success, though, and investors are going to have to put up with many years where valuation is based either on long-distant cash flows or very arbitrary multiples to forward revenue. For today, GenMark's value seems sandwiched in between a DCF approach that suggests the shares are overvalued (as it would have for Cepheid and Illumina before, and during, their huge runs) and a discounted EV/revenue approach that suggests the significant revenue growth potential isn't adequately reflected in the shares.
A New Approach For Old Problems
The success of clinical diagnostic systems revolves around their throughput, ease of use, cost, and utility. These features derive from what's under the hood - the proprietary technology and engineering that diagnostic companies bring to their systems. This is where I believe GenMark can make a mark.
GenMark's approach rests on its proprietary eSensor detection technology, a technology that uses competitive DNA hybridization and electrochemical detection to detect up to 72 biomarkers in a single sample with a high degree of accuracy and rapid sample-to-result time.
GenMark currently sells the XT-8 system, a cartridge-based platform that can run up to 24 different test cartridges independently. There are eight tests available now (four of which are FDA-cleared), covering areas like cystic fibrosis, thrombophilia, warfarin, and respiratory viruses.
NexGen Takes It Several Steps Further
The company hasn't really changed the MDx world with the XT-8 platform, but the new NexGen system could be a different story. Management believes that the features of the NexGen should lead to an addressable market of 5,000 potential lab customers or upwards of $2.4 billion in revenue. A commercial launch outside the U.S. is expected later this year, with a U.S. launch around the middle of 2015.
The NexGen sounds appealing at this point. With fully integrated and automated nucleic acid extraction and amplification, all a NexGen user will have to do is pipette the sample into the cartridge and put the cartridge into the machine - a significant reduction in hands-on time compared to other systems. Once the cartridge goes in, the time to result of 60 to 90 minutes is no less impressive; roughly half of the current Nanosphere (NSPH) RVP test and much less than the competing Luminex test. All told, GenMark is shooting for a "Cepheid-like" level of simplicity, accuracy, and modularity. With the added benefits of multiplexing (testing a single sample for multiple markers), this should also be a very cost-competitive system.
As is always the case with new systems, GenMark must first actually deliver a system that does all of the things management has said it will do. The company must also support the system with a growing menu of tests. Following in the steps of Nanosphere and Luminex, I expect respiratory virus, cystic fibrosis, hepatitis C genotyping, gram positive/negative blood, and a GI panel to be among the first offerings.
Plenty Of Moving Parts Between Here And There
The XT-8 system is basically the opening act for GenMark, but it has at least produced some gross profit dollars to help offset the significant R&D costs that the company is incurring. It hasn't been a smooth performance, though. Back at the start of the year, GenMark was generating more than 60% of its sales from one customer, Natural Molecular Testing Corp or NMTC, and the market freaked out when Luminex announced an agreement with NMTC in June for NMTC to use its 42-target personalized medicine panel. The next twist came in October, when NMTC declared bankruptcy. With that, GenMark is not really likely to see meaningful revenue growth again until 2015 when OUS customers start ordering panels and then later when the system launches in the U.S.
There's also a long-term question about some core technology in the NexGen. GenMark had a collaboration and licensing agreement with Advanced Liquid Logic for its digital microfluidics technology (an "electrowetting" technology that eliminates the need for channels, valves, and pumps). Illumina has purchased Advanced Liquid Logic in the interim and while it sounds like Illumina intends to honor that agreement, Illumina's ambitions in the clinical diagnostics space would seem to create at least some risk to GenMark's access to this technology for the long term.
Growth Potential, But No Guarantees
Assuming that GenMark delivers NexGen on time and with the expected features/capabilities, there is still a significant sales effort in front of the company. Major entrenched players like Becton Dickinson (BDX) and Hologic (HOLX) are more focused on provided automated solutions to large reference labs, but GenMark will see plenty of competition from Luminex, Nanosphere, Qiagen (QGEN), Bio-Fire, and probably Cepheid in some instances. If what I've heard and read about NexGen's throughput, ease of use, and flexibility proves true, GenMark could do very well but there will be no lack of rival systems competing for a limited pool of lab dollars.
I'm using a Cepheid-like revenue build for GenMark at this point, which is definitely aggressive and bullish given that Cepheid is a standout in the space. I am looking for GenMark to pass $100 million in revenue during FY 2017, end FY 2018 at over $140 million, and end FY 2023 at more than $350 million in revenue. That ultimately generates a fair value of over $10 assuming double-digit FCF margins down the line, but my discount rate of 11% may be too conservative for some investors. Projecting EV/revenue based on 2018 revenue and discounting it back, I come up with a target of almost $18 using a multiple of 8x - the high end of the normal range for growth med-tech stocks.
The Bottom Line
I'm favorably inclined toward GenMark today, but the differing paths of companies like Gen-Probe, Luminex, Cepheid, Nanosphere, and Wafergen do help highlight the risks and uncertainties that go with predicting winners and losers at this company's stage of development. Aggressive investors should definitely do a deeper dive and conduct their own due diligence, while I expect more conservative readers to find too many unknowns here to invest today.