A small- to mid-cap biotech company with a 5-year CAGR of 22%, a P/E just over 15, no debt, and a 28% return on equity? Already, Myriad Genetics, Inc. (NASDAQ:MYGN) sounds too good to be true. Is it?
Glancing at the newspapers from 2013 to present, it is easy to relegate MYGN as the punching bag of bureaucrats, regulators, and academic organizations, to toss it in the wastebasket and move on, to just say "TL;DR" (too long; didn't read).
But despite being relentlessly beat down by groups whose accomplishments are pathetically mediocre in contrast (I'm talking about you, Association of Molecular Pathology), MYGN has demonstrated excellent execution of its business model. It addresses real problems physicians are facing in medicine, and offers cost-effective solutions. The utility of its breast cancer test platforms has been debated ad nauseum, but their profitability is unquestionable. The next project coming out of the MYGN pipeline, the PROLARIS test, will likely go on to achieve similar success.
Let me offer some observations.
When I was going through medical school in 2008, we were required to learn approximately 8 mutations related to cancer, because they had such a strong impact on treatment and prognosis. Two were the BRCA1 and BRCA2 mutations (pronounced burkah in some hospitals, brackah in others). These mutations were game-changers because they consistently predicted the future cancer risk of women who had either "pre-cancer" (typically ductal carcinoma in situ) or no cancer. Now, in the BRCA and HER2 age, we can quantify risk and present clear odds and clear choices to patients. We can screen aggressively in patients with a significant family history of breast cancer, and save the daughters and grand-daughters of breast cancer victims of the 20th century from meeting the same untimely demise. We can prevent breast cancer with greater treatment precision than ever before.
You can see for yourself what this has done to MYGN's top and bottom lines over the past 4 years.
While Q-over-Q revenue and income growth flattened in the wake of the events of 2013, Y-o-Y revenue growth from 2012-13 was 37%, and Y-o-Y profit increased by nearly 43%.
Regulatory issues and discrimination from academicians both currently overhang MYGN. The Supreme Court issued a ruling in the Association of Molecular Pathology vs. Myriad Genetics, Inc. case that tossed out some of the company's patents, but allowed the continued patenting of MYGN's proprietary cDNA libraries. The preservation of the cDNA and also the method of use patents preserves much of MYGN's competitive moat. Further information on the impact of the ruling can be found here and here. CEO Peter Meldrum has consistently expressed confidence that the court case would have limited material impact on the company's financial performance, and from both scientific and economic perspectives, I agree with the company's statements on gene patents.
To satisfy doubts among those who question the competitive moat of a functioning cDNA library, a brief overview of standards for laboratory results may be helpful. As Quest Diagnostics (NYSE:DGX) announced its intention to provide a BRCA1/2 test, let's consider what would happen if it did.
MYGN has had 15 years to gather data on various kinds of wild-type and cancer-specific mutations seen in the presence and absence of the BRCA1/2 mutations. Some of these are publicly known; many others are not. A map of some of the widely known BRCA1 mutations can be seen below.
Can you explain to a patient the impact of a deletion of nucleotide base 401, and the replacement of nucleotide base 814? Can you tell which of these mutations are wild-type (essentially normal) and which might indicate a positive BRCA mutation and susceptibility to breast cancer? No? Neither can I, and neither can Quest unless it spends considerable time and effort not only to incorporate publicly available BRCA gene information, but to normalize BRCA patient data using thousands to tens of thousands of patient controls. In other words, to run tests with sensitivity and specificity comparable to MYGN's, Quest and other competitors would have to conduct tests on thousands of patients. MYGN has been doing this for over a decade.
What would happen if Quest and others did not perform this normalization? Physicians ordering the test would encounter the difficult situation of explaining embarrassingly large margins of error. Currently, MYGN runs tests with 99.99% sensitivity and specificity, meaning they can get it wrong up to 1/10,000 times. For the medical community, those are acceptable odds. But what if the Quest test has only 95% sensitivity? Can you imagine your reaction if your doctor told you the $1,000 test you just waited 4-6 weeks for has a 19/20 chance of being right, but may leave you with the 1/20 odds of being at risk anyway? Or looking at 95% specificity, can you imagine being advised by your doctor to undergo a prophylactic double mastectomy with the 1/20 chance that you might not even need to? Any competitor with MYGN would need to spend significant time and capital to normalize its data on both BRCA1/2 positive and BRCA1/2 negative populations, or risk having a significantly inferior product that no person would knowingly buy, a test that no physician would knowingly order.
Although less widely covered than the MYGN Supreme Court case, the other to hit MYGN in 2013 came when the Centers for Medicare and Medicaid Services (CMS) issued a reimbursement decline (read, government price control) on the BRCA1 and BRCA2 tests, of $1,440 per test. These tests account for over 70% of MYGN revenue. However, the income bracket of most women seeking molecular testing is high, and the population is comprised of women predominantly in their 40s and 50s. As pointed out by David Trainer on Seeking Alpha:
"...Medicare patients make up only 10% of MYGN's revenue for its BRACAnalysis tests, so the impact of the reimbursement rate cut (which is still open for public comment and could be reversed) will not be a massive blow to MYGN's revenues."
That cut is in the context of revenue growth in excess of 20%. We'll find out the ultimate impact of this reimbursement cut on May 5th, when MYGN releases Q3FY14 results. Analysts project forward 1-year P/E ratios from 14.5 to 18.4, and 1-year price targets range from $17-48.
That's the bad news. The good news is that BRCA1/2 adoption continues to expand, and that MYGN has the BART1 mutation in its patented diagnostic arsenal, which with the COLARIS test, has contributed to most of the remaining revenue.
MYGN plans to repackage many of its mutation tests into the MyRisk platform. MyRisk is a battery of the top 25 mutations seen in 8 common cancers. It's the molecular pathology equivalent of offering a free thyroid screening, a free blood cell count, and a free glucose level along with your cholesterol levels. A molecular diagnostic panel is handy for patients to have, and it offers MYGN the opportunity to aggressively expand its market. As a physician, I would recommend this test to nearly every patient with a family history of cancer.
This marketing and repackaging strategy also strikes me as a way to renegotiate pricing with CMS and insurance carriers, similar to how telecom companies get you to buy cable and internet with your landline subscription.
Most excitingly, I want to leave you with my thoughts on the PROLARIS test for determining prostate cancer risk.
Prostate cancer is a huge problem for physicians, not because it kills people, but because it doesn't. Prostate cancer arises in older men, as does a benign process called benign prostatic hyperplasia (BPH). If you are over 60, there is a 35% chance you have BPH. Why is BPH a problem? BPH screws up our ability to diagnose prostate cancer. Traditionally, we measured prostate specific antigen (PSA) levels in serum, but PSA levels are elevated by both prostate cancer and BPH. Both PSA levels and the infamous digital rectal exam have been determined to be inadequate screening methods. Various modifications of PSA interpretation (including monitoring for serial PSA elevations) have shown some improvement, but remain inadequate.
Yet because we fear cancer development, especially in those with a family history of prostate cancer, we subject patients to biopsies. The 12-needle core targeted prostate biopsy, advocated by Bostwick Labs and others, has now become the standard of care for patients who have unexplained elevated PSA in addition to certain risk factors. This is a large group of old men.
We then process the biopsies, interpret them, and grade them according to the Gleason scoring system. Although the grading system is straightforward in concept, there is a lot of gray area, and there are various pre-cancerous growths in the prostate (prostatic intraepithelial neoplasia [PIN]) that confuse things. There are hundreds of thousands of people walking around right now with PIN or Gleason 3+3 prostate cancer who will die of an unrelated disorder like a heart attack.
It becomes easy to see that a reliable test like PROLARIS, which predicts the likelihood of a patient to develop cancer, can help us better direct our treatment efforts. And in those limited cases when we still need to take biopsies, we can use the PROLARIS test as an adjunct to the Gleason grade. For example, a PROLARIS positive Gleason 3+4 patient might be recommended to undergo a prostatectomy, where a PROLARIS negative Gleason 3+4 patient might only be followed closely.
Impressively, the PROLARIS test is more predictive of prostate cancer risk than traditional biopsies. A less technical overview of it can be seen here.
To determine utility in making treatment decisions, the PRECEDE 500 study examined the use of the PROLARIS test in 5,000 patients, and was found to have sufficient statistical significance to guide treatment modalities in patients with prostate cancer. The study demonstrated a 50% reduction in surgeries and a 30% reduction in unnecessary radiation treatments.
Physicians' response to PROLARIS will likely be very positive. The test provides family medicine and internal medicine physicians with an excellent way to screen their patients. Urologists will be conflicted, as it will help their decision-making and risk stratification dramatically, but will likely decrease the number of high-margin surgical procedures. Medical and radiation oncologists can use the test to better guide therapy. Further, the PROLARIS test will likely be a boon for radiation oncologists performing radiation treatment, as prostate irradiation (ex brachyradiation) is among their more complicated and time-consuming procedures. Overall, physician support will be strong, and with CMS and other government agencies on a preventative health kick, payors will likely get behind the PROLARIS test just as they did the BRCA1/2 test.
Just as breast cancer is the second most common cancer in women, prostate cancer is the second most common in men. Given the commonality of prostate cancer and the difficulties in predicting its outcome using traditional methods, the PROLARIS test is likely to become just as much a game-changer as the BRCA1/2 test. With Myriad Genetics' successful management, marketing, and business model, the PROLARIS test is likely to become just as great of a financial success, also.
In Part 2, we will explore the mixed approach likely to be taken by regulators, find out more about MYGN's pipeline, and address any complicated questions or comments from readers.
Disclosure: I am long MYGN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.