Liquid Biopsy's First Victim, Exact Sciences' Cologuard

| About: EXACT Sciences (EXAS)

Summary

Exact Sciences' Cologuard test has seen rapid growth over the first full year. This rapid growth will be short-lived thanks to competition.

EXAS's operational efficiency leaves a lot to be desired; the competition will take market share before the company reaches profitability.

With the recent announcement from some well-known parties, the competition in the cancer screening space is heating up.

Sell Exact Sciences as the long-term prospects do not look rosy.

Exact Sciences Corporation (NASDAQ:EXAS) is a biotechnology company based out of Madison, WI. The company currently holds a market value of just under $800 million. Exact's Cologuard assay, which is a non-invasive colorectal cancer (CRC) screening tool, will have a short lifespan, thanks to the rapid advances in the biotechnology space. Cologuard was approved by the FDA in August of 2014 along with receiving favorable coverage decisions from the Center for Medicare and Medicaid Services (CMS) in parallel. Following the announcement of the FDA approval and favorable coverage, Exact Sciences was off to the races.

Operational Data Review

On January 11, 2016, Exact Sciences released the preliminary data related to its operational performance for all of 2015, the first full year operating with Cologuard as a FDA approved test. EXAS completed about 104,000 tests in the first full year, generating just short of $40 million. The company also offered up a brief glimpse into its expectations for 2016. EXAS felt realistic estimations for 2016 were about 240,000 Cologuard tests accessioned, generating between $90 million and $100 million.

While the growth year over year is impressive in both test volume (+130%) and revenue (~+125%), I am a little concerned with the long-term prospects of Cologuard and Exact Sciences. As of the third quarter 2015, the company had a gross profit of $5.1 million on revenue of $12.6 million, showing a gross margin of 40%. With the cost of running the test around $100, I would anticipate that gross margin will continue rising quarter over quarter alongside volumes with it leveling out around 60%.

I arrive at the 60% using the $100 cost to run the test, 10% repeat rate, 10% royalty (which is a guess) and average reimbursement rate around $400. The other component that affects the gross margin is the compliance rate, which is around 70%. EXAS is paying postage to ship the kits to the customer, and 30% of the time, the kit is not coming back. I would estimate that the shipping accounts for about $40 of the $100 cost to run the test. For every 100 tests, the company ships 100 kits ($4,000 cost), performs 70 tests ($4,200 in testing costs, $4,620 including 10% repeats), royalties of 10% ($2,800), and is reimbursed for the 70 tests completed ($28,000). Using the numbers, I arrive at 60% gross margins. I feel the 60% gross margin is optimistic as this will only be achieved when the company is firing on all cylinders close to maximum capacity.

Operation Data Estimates

Now let's run the numbers on 240,000 samples to estimate next year using the optimistic 60% gross margin. On 240,000 samples, the gross profit would be around $57 million using revenue of $95 million and 60% gross margin. As of the third-quarter 2015, the company had operating expenses of $48.3 million each quarter. Using the $48.3 million over four quarters, I estimate the annual run rate based on the third quarter of $193.2 million. For the sake of this argument, let's assume the operating expenses remain flat year over year for 2016, so operating expenses of $193.2 million. Based on the gross profit of $57 million and operating expenses of $193.2 million, my estimates are for a loss in the neighborhood of $135 million for 2016. Keep in mind this estimate is assuming the operating costs do not rise, which is highly unlikely. The company currently holds north of $300 million in cash and short-term investments, so the short-term liquidity of the company is not a concern.

The company currently has facilities to process one million samples annually before additional facilities will be needed. Based on one million samples using the previous calculations, the company would generate $240 million in gross profit, which barely ekes out a small gain when using the operating expenses at a 104,000 sample run rate. This leads me to believe the company needs to look for areas to cut costs as it continues expanding if it wants to reach some form of profitability.

If the company is able to double volumes year over year for the foreseeable future, EXAS will reach the one million sample level some time in 2018. The reason this is significant is a result of the competition that is currently lurking in the biotech space. When I say competition, I am not thinking of the traditional competition such as colonoscopies or FIT tests, rather I am thinking of the companies working on clinically validating liquid biopsy testing. In researching recent announcements, several companies targeting the liquid biopsy market provide formidable competition.

Competition

While the notion of liquid biopsy is not new for those of you that follow the biotech space closely, the term is rapidly becoming more main stream as a result of a couple of recent announcements. For those of you interested in learning more about the liquid biopsy, please see this Seeking Alpha article. With the rapid advancement in Next Generation Sequencing (NGS) technology, several companies are looking at detecting tumor cells circulating in the blood stream. An announcement on January 10 from Illumina (NASDAQ:ILMN) CEO Jay Flatley has many people discussing the potential of a liquid biopsy test. Along with Flatley are Bill Gates, Jeff Bezos and Dr. Richard Klausner. The individuals involved with this company have a history of tackling complex subjects with great success. I cannot think of any reason to bet against any one of these people individually, let alone together.

The startup is termed Grail, as in "Holy Grail" of cancer testing, and is an off-shoot of Illumina and will begin with $100 million in funding, targeting "...a simple blood test that can detect any kind of cancer at an early stage, when it is easiest to treat, and possibly cure" as mentioned in a New York Times article. Grail's goal is to have a test ready for clinical testing in 2019, keep in mind the earlier discussion of EXAS's optimistic estimates. In addition to Grail, several companies with a strong hold in similar testing markets are targeting liquid biopsy tests with even shorter time lines.

Foundation Medicine (NASDAQ:FMI) is an oncology-based testing powerhouse in the diagnostic laboratory testing market. Foundation currently offers two of the most comprehensive oncology-based testing platforms, FoundationOne and FoundationOne Heme. FoundationOne is a 315-gene solid tumor assay and FoundationOne Heme covers over 400 genes targeting hematologic tumors. The company performed nearly 33,000 tests in 2015 and expects that number to climb to over 37,000 in 2016. Additionally, the company is working towards a commercial launch of a liquid biopsy test anticipated to be in Q1 2016. Foundation Medicine also has the backing of Roche (OTCQX:RHHBY), which is a deep pocketed behemoth in the laboratory testing space, thanks to a $1 billion investment in 2015.

Sequenom (NASDAQ:SQNM) is a small biotech company that is well known for its experience in Non-Invasive Pre-Natal Testing (NIPT) which uses technology similar to the liquid biopsy to detect fetal aneuploidy. Sequenom is currently validating a test targeting over 100 genes that could help identify cancer with routine screening.

Qiagen (NASDAQ:QGEN), TrovaGene (NASDAQ:TROV), RainDance Technologies (Pending:RAIN) and Genomic Health (NASDAQ:GHDX) are also exploring opportunities in the space and are at various stages in the development phase.

Based on the rapid expansion in interest in the liquid biopsy space, one has to wonder how long a test will last that targets a single type of cancer, CRC, will stay competitive. The competition is rapidly bringing a blood test to market that will detect CRC along with several other types of cancers in the body through a simple blood draw. The collection procedure for the liquid biopsy seems quite a bit more appealing when compared to the stool processing for the Cologuard test. Additionally, estimates from the companies put the price tag of the liquid biopsy test in the same price range as Cologuard's ~$500.

Take-Home Message

EXAS experienced rapidly growing volumes for its Cologuard assay through 2015. I would anticipate the volume growth continuing through at least 2016. Throughout 2016 and into 2017, several competitors have a realistic opportunity of offering a clinical cancer screen through a liquid biopsy that would offer a more comprehensive test for a similar price as Cologuard. I feel that in the tail end of 2016 and into 2017 is when EXAS will start to feel the pinch from the competition as consumers have shown they are open to new technologies based on the adoption rate of both NIPT and Cologuard. I also feel that EXAS may wind up being stuck in the middle by offering a test that is not as reliable as a colonoscopy and not as comprehensive as a liquid biopsy. As fast as consumers jumped on the Cologuard train, they will be jumping onto the liquid biopsy train.

Based on the cash burn for EXAS through 2015, which I would anticipate to get worse before it gets better, I worry that the company will not reach profitability before the competition catches up. Even though EXAS has seen its share price drop dramatically in 2015, I would not be a buyer at any level until it has plan to address the rapidly approaching competition.

Disclosure: I am/we are long SQNM.

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.

Additional disclosure: This analysis offers up opinions of the author and are not recommendations to either buy or sell any security. Please remember to do your own research prior to making any investment decisions.