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Summary

  • GenMark's existing system and assays have outdone Street expectations for the last three quarters.
  • The launch targets for the new ePlex system have slipped about four months, but this is still shaping up as a very competitive multiplex MDx system.
  • Multiplex MDx testing can deliver meaningful improvements in lab efficiency and patient care and the potential for $400 million in revenue within 10 years of launch supports a $17.50 target.

Molecular diagnostics is still a relatively new opportunity in the clinical diagnostics space - about $4 billion/year if Roche's (OTCQX:RHHBY) estimates of its market share are accurate. It remains a good growth opportunity, though, as molecular diagnostic technologies can in many cases offer faster and more accurate results for healthcare providers. GenMark Diagnostics (NASDAQ:GNMK) is looking to emerge as a leader in hospital/lab-based multiplex molecular diagnostics with a new system (ePlex) designed to deliver fast and accurate results with good throughput.

GenMark's existing business isn't going to take the business very far, so a great deal is riding on that new system. The performance specs look very competitive, but rivals aren't going to back it in and give up. This remains an exceptionally speculative story, but one with worthwhile upside from here if the 2015 launch goes well. While the stock has been weak since my last article (along with many other riskier med-tech stories), I think the name is still worth consideration.

Near-Term Performance Not A Real Driver

GenMark has posted three straight quarterly top-line beats, though the company's current offering (the XT-8 system) is not really a significant part of the company's long-term value. GenMark has overcome the loss of a previously major customer to bankruptcy, with reported revenue growth of 27% in the second quarter and underlying base revenue growth of 71%. Consumables revenue per analyzer rose almost one-quarter in the second quarter - a good result given that it was an off-season quarter for respiratory testing (one of the two major uses for the XT-8 system).

GenMark is still a relatively small player next to bioMerieux (and its BioFire business) and Luminex (NASDAQ:LMNX); bioMerieux has an estimated two-thirds share of the respiratory virus testing market. Even so, I think that what the company has accomplished with the XT-8 system has laid some groundwork for future success with a better system.

Waiting For ePlex

The ePlex system, formerly known as "NexGen", is the key asset for GenMark's future. The ePlex is a cartridge-based multiplex molecular diagnostics system that can detect 72 biomarkers in a single sample, test 24 samples at once, and deliver results in under 90 minutes with minimal hands-on effort from the technician (essentially just pipetting in the sample and inserting the cartridge). This system should address a much larger market (around 5,000 sites instead of 1,000), with a potential installed base of over 10,000 systems.

GenMark will be launching ePlex with seven assays, including a respiratory panel, a GI panel, gram positive/negative panels, a CNS panel, a fungal infections panel, and an HCV genotyping panel. The RVP panel market is a sub-$100M/year market, but still underpenetrated. The FilmArray from bioMerieux/BioFire has established a pretty high bar for GenMark, but with similar workflow and speed and potentially stronger throughput and menu offerings GenMark's ePlex should be competitive. The ePlex also compares quite favorably to existing multiplex systems from Nanosphere (NASDAQ:NSPH) and Luminex , not only in terms of time to result, but also in hands-on time and overall throughput.

I also expect sepsis (gram positive/negative), GI, and fungal infections to be good opportunities. There are still an estimated 20 million blood cultures done each year for sepsis and another 20 million stool cultures for GI ailments, and these cultures require more hands-on effort and a longer wait to result - time where the patient is not getting the optimal care for their circumstances. Not unlike how Cepheid (NASDAQ:CPHD) has established itself in hospitals on the basis of rapid, convenient testing for hospital-acquired infections, GenMark can offer hospitals a system that will enhance the productivity of their labs and support better patient care/outcomes.

GenMark recently announced that the ePlex system design was complete and it was in the final design stages for consumables and assays. Based on management's comments regarding the CE Mark and launches in the EU and U.S., it sounds like the company's timeline has slipped by about four months. The company is looking for the CE Mark in Q4 of this year and may get systems placed before year-end, but the U.S. launch is looking like a late 2015 event. A four-month delay is not a big deal in terms of the valuation and its very important for the company to get it right from the beginning.

Can GenMark Make This A Sticky System?

I would expect GenMark to follow a marketing plan for ePlex similar to what Cepheid has used for its system - a plan that emphasizes working with clients to purchase systems, not placing systems on a rental or reagent-use basis. System ownership seems to incentivize utilization and the fact that GenMark will be launching with seven assays should make it easier to sell customers on the utility and flexibility of the system.

Looking at the ePlex on a pre-launch basis, I think this is a system that can gain (and hold) real share in the MDx space. Like the Cepheid system, it's simple to use and it delivers fast results (a meaningful advantage over Luminex and Nanosphere). The cartridge system also allows hospital/lab customers to make the most of system flexibility, an important consideration as any given customer may have limited demand for a particular test at a given point in time.

Estimating The Value

I don't think it is unreasonable to think that GenMark could follow a path similar to Cepheid after the launch of the ePlex; achieving revenue growth in the neighborhood of $350 million to $400 million ten years from now. I see the downside risk as being a more Luminex-like trajectory - from similar starting points, Cepheid has grown to about twice the size of Luminex as the latter's more limited menu, longer time to results, and greater hands-on requirements have limited the adoption curve relative to initial expectations.

Management thinks that they can achieve long-term gross margins above 70%, with net margins between 20% to 25%. That seems ambitious, but not impossible, and it would support a DCF-based fair value in the mid-to-high teens. A discounted EV/revenue approach supports a similar target; the experience of companies like Cepheid and Gen-Probe supports the idea that GenMark could get an 8x revenue multiple if GenMark approaches $100 million in revenue in 2017 and discounting that back (at 13%) supports a target above $17 today.

The Bottom Line

GenMark's rivals - including Luminex, Nanosphere, and bioMerieux - aren't going to stop developing their own technology and systems and the diagnostics field is littered with once-promising systems that end up relegated to a corner or closet where they're seldom (if ever) used. Along those lines, the performance of the ePlex may fall short of its advertised capabilities and hospitals may not see enough value in the company's approach or assays to adopt the system. So this is by no means a sure thing.

That said, I think GenMark has a good chance of generating close to $400 million in annual revenue within 10 years of launch and that growth potential supports a mid-to-high teens fair value today. Street enthusiasm on a successful launch could easily push multiples into the double-digits and the shares into the $20's. The Street will pay a great deal of attention to the company's launch, and the shares could be volatile over the next 18 to 24 months, but the reward potential looks interesting relative to the risk.

Source: GenMark Diagnostics Hoping To Make Its Mark In Clinical MDx
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