Even for somebody like me who spent the better part of a decade as a sell-side med-tech analyst, the diagnostics industry is often a muddle. While large established players like Abbott Labs (NYSE:ABT), Danaher (NYSE:DHR), and Roche (OTCQX:RHHBY) look to change with the times and hang on to lucrative market share, up-and-comers like Cepheid (NASDAQ:CPHD) and Gen-Probe (NASDAQ:GPRO) look to shake up the market and drive significant growth through major advances in testing technology.
With a new testing platform on the way and an expanding menu of tests, Gen-Probe may be looking at capturing some real share over the next couple of years. At the same time, valuation leaves little room for mistakes.
Closing Out The Year With A Shrug
Gen-Probe's fiscal fourth quarter earnings were pretty much mediocre. Revenue growth of about 16% was a bit light, with generally better-than-expected performance in blood screening (up almost 31%) offsetting the clinical diagnostics business (up 13%).
With Gen-Probe it's not a case where all revenue is equal; the company's partnership with Novartis (NYSE:NVS) in blood screening means that Novartis gets a cut. Perhaps not surprisingly, then, the larger contribution of blood screening pushed margins lower than most analysts had expected. Gross margin fell more than 300 basis points, while operating income rose 14% and margin compressed a bit.
Were it not for a lower tax rate and share count, Gen-Probe would not have beaten EPS estimates.
Panther Needs To Show Some Claws
Gen-Probe is planning to launch its new Panther testing platform in 2012 and the success of this launch is critical to Gen-Probe working as a stock. The earlier Tigris platform has been quite a success for the company (especially in the reference labs) and the Panther should solidify Gen-Probe as an ongoing player in the growing molecular diagnostics market.
Panther is a big machine, but it offers a lot of valuable features to a large lab, including extensive automation, low hands-on time, and the ability to run multiple simultaneous assays. Of course, part and parcel of the success of this platform will be Gen-Probe's ability to develop and launch tests for the system. Gen-Probe already has tests in development should nearly double the addressable Panther market by 2016 (to close to $3 billion), but these tests will take money to develop and the Street will punish any delays in the development timeline.
Of course, Gen-Probe's rivals are not just going to roll over and let Panther maul their own businesses.
Becton Dickinson (NYSE:BDX), Roche, Abbott, Cepheid, Qiagen (NASDAQ:QGEN) and Meridian Bioscience (NASDAQ:VIVO) are all pushing their own platforms and there are ample trade-offs in terms of machine footprint, cost, throughput, and the menu of tests offered.
The simple marketing muscle of Abbott and Roche make their systems formidable, even though they don't compare as favorably when it comes to integration/automation, random access, or throughput. Cepheid, though, is another thing entirely - its modular approach and relatively robust menu offering risk moving more testing activity back towards hospitals and smaller labs, even though the per-test cost can be higher than competing offerings.
Trying To Hold Share, Grow Markets, And Take New Business
Gen-Probe is looking to expand its business from a position of strength in so-called CT/GC testing (chlamydia and gonorrhea), where it enjoys 60% share in the U.S. and 25% share in Europe. This is presently about 70% of Gen-Probe's revenue base, but Becton Dickinson and Roche both want to expand their share, and Hologic (NASDAQ:HOLX), Qiagen, and Cepheid are all looking to enter the market as well. Even if this particular type of testing is only about one-third penetrated, it's a market where competition is heating up.
HPV may be one of the better near-term growth drivers for Gen-Probe. With a relatively recent approval in hand, Gen-Probe is targeting a nearly $300 million U.S. market that has long been dominated by Qiagen. Here too, though, there is emergent competition from Hologic and Roche, and Cepheid may well see this as an attractive market as well. Although Gen-Probe presently lacks 16/18 genotyping capability, it's test has been shown to be more sensitive than competing offerings.
Gen-Probe is also intending to enter the cancer diagnostics market in 2012. The PCA-3 is a new screening approach for prostate cancer and it is hoped that more advanced prostate cancer screening can reduce the incidence of false positives. Elsewhere Gen-Probe is also seeing good initial traction with its trichomonas assay and hopes to be a more formidable competitor to Luminex (NASDAQ:LMNX) in flu/respiratory virus testing.
The Bottom Line
Gen-Probe management will face challenges in the coming years in deciding how much profit margin and cash flow to concede to larger R&D spending. After all, a testing platform is only as valuable as the tests that it can run and Gen-Probe competes with deep-pocketed rivals. It's also worth noting that Gen-Probe was known to have been openly shopping itself, but to no avail - suggesting that its own peers and rivals don't necessarily see compelling value there.
Gen-Probe is going to have to grow its free cash flow at close to 10% a year over the next decade just to validate its current market capitalization. That's a fairly high bar to achieve when companies like Cepheid, Becton Dickinson, Roche, Abbott, Qiagen, and Hologic are all targeting largely the same markets and customers. With many of its rivals offering a better risk-reward trade-off today, Gen-Probe is a good name for the watchlist but not an especially compelling buy candidate at present.
Disclosure: I am long OTCQX:RHHBY.