NIPT Poised For Average Risk Inflection Point

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Includes: AFFX, AFFY, DGX, ILMN, LH, NTRA, PKI, SQNM, TMO
by: Marty Chilberg

Summary

NIPT for high risk pregnancies experienced an adoption curve previously unprecedented in molecular diagnostics. The next stage is average risk which is a much larger opportunity.

US Lab networks are positioning themselves to participate in the next wave of tests via licensing arrangements. Illumina and Sequenom are leading the effort with their pool IP approach.

International lab networks are growing rapidly through M&A and expansion. These networks are actively working with NIPT providers as licensees to get tests developed and validated.

Background

Non-Invasive Prenatal Tests ((NIPT)) have been adopted rapidly since the launch in 2011 by Sequenom (NASDAQ:SQNM) in the U.S. and BGI in China. Verinata, Ariosa, Natera (NASDAQ:NTRA) and Berry Genomics launched competitive tests in 2012-2013. These companies represent the NIPT foundation of which over a dozen additional tests have been derived and licensed. Each company states in their marketing that their test is superior. Analyst surveys paint a different story reporting that the market believes these tests are largely undifferentiated.

The early adoption cycle was primarily high risk pregnancies. Medical necessity was quickly determined based upon very high test sensitivity, specificity and negative predictive value. All three of these are statistical measuring sticks. Sensitivity measures the proportion of positive test results that are correctly identified. Specificity measures the proportion of negative test results that are correctly identified. Negative Predictive Value "NPV" measures the proportion of actual negative outcomes correctly identified by the test. The National Society of Genetic Counselors provides a handy NPV and PPV calculator which shows Trisomy 21 tests have an overall sensitivity of 99.2%, specificity of 99.91% and for a 35 year old high risk women a NPV of >99%. The bottom line: The tests are very accurate and rarely miss a negative result (i.e. the child does not have any abnormality being tested for). As a result the mother can eliminate a risky invasive procedure > 97% of the time. Any positive result needs to be confirmed with invasive procedures.

Lab Developed Tests and the US lab market

A Lab Developed Test "LDT", as the name implies, represents a test that is developed to run in the laboratory that developed it. The FDA currently has made no effort to regulate the use of LDTs, other than to require they are processed by the lab that developed it. This simple reality has created a dilemma for NIPT providers. They all launched tests as LDTs requiring internal lab capacity to process them.

Quest Diagnostics (NYSE:DGX) provided data on the US lab market in their November 2014 presentation that can be found on their investor relations website. They segment the $75 billion market as follows:

  • Hospital Inpatient 21%
  • Hospital outpatient 17%
  • Outside the Hospital 63% ($46 billion)

The Independent lab segment represents $25 billion of the "outside the hospital" market. The Affordable Care Act and declining reimbursement rates for molecular diagnostics have increased the pressure on labs to reduce cost. National lab chains are in consolidation mode, building capacity and increasing throughput to reduce test costs. Quest and LabCorp (NYSE:LH) represent a combined 46% of the independent lab market and are actively pursuing the next growth stage by partnering with hospitals to process an additional share of the outside the hospital segment.

It is only natural that labs would want a piece of the NIPT market given the dramatic growth seen to date. This is in anticipation of the average risk market which most expect to become reimbursable soon. Average risk is roughly 3 to 5 times the size of high risk.

Consider the requirements associated with LDTs and the push by independent labs to absorb this volume. It's not surprising to see the evolution of licensing, which is expected to continue. Niche NIPT labs have to choose between two paths:

  1. Create a defensible moat and compete as a niche lab. This requires a substantial effort to secure a network of coverage providers, blood draw sites and lab locations. Lab processing tradeoffs balance the need for redundancy and competitive response time with the cost efficiencies of high volume labs. The limited focus of niche labs leads to higher test processing costs making it challenging to compete with national labs. Absent test differentiation, the decision to stay niche is likely to lead to reduced gross margins and lost market share.
  2. License the test to independent labs and help them get to market quickly. This approach bundles any IP licensing with assistance to develop and validate a new LDT by the licensee, allowing them to begin processing tests more quickly. The inherent risk is the resultant business model. Licensing empowers others to take market share leveraging core competencies. The royalty revenue stream may not be adequate to compensate for lost product revenues required to fund ongoing research and development.

International lab participants are extending reach

It appears international markets are similarly pursuing an expansive lab footprint model. The international lab market has lagged the US market, so the opportunity exists to both open new labs and to consolidate existing capacity. Cinven acquired both Labco and Synlab in separate transactions in the past year creating what they believe is the largest European lab network. Sonic Healthcare has been actively buying labs as well, creating a dominant share in Australia and an important one in Europe. Eurofins is showing a similar pattern recently acquiring Biomnis in France and a majority stake in Emory Genetics Lab in the US. Berry Genomics has opened four labs in China and one in Hong Kong. Both Quest and LabCorp are opening labs in various international markets. LabCorp included the impact of their acquisition of Covance in September 2015 results. The acquisition provides an increased presence in China, Switzerland and Singapore.

Analysts are publishing misleading unit volumes

There are some significant perspectives to keep in mind when reading published market share data. Most average risk tests are not yet being reimbursed. Natera has disclosed that a high percentage of their accessions represent average risk. Their strategy is to build volume market share and brand awareness in the OB/GYN channel where the majority of average risk NIPT will be ordered. They are generating significant losses as a result, but the strategy may yield dividends should average risk be endorsed as medically necessary soon.

Whenever a licensee completes the validation process and begins processing tests in house, their volume is largely being ignored by analysts. To get a truer picture of market share it's better to build an NIPT tree including all licensing branches of an NIPT test provider. That provides a clearer picture of the volumes being derived from each foundational provider.

Finally, note that distributors send samples to the labs of origin. Any effort to determine geographic market share by using disclosed accessions is likely inaccurate. It's unfortunate but for now the ability to calculate worldwide market share is a bit easier than individual geographies. The following NIPT tree consolidates estimated volumes by foundational NIPT provider:

Volume (000) Ariosa (1) BGI (2) Natera (3) IP Pool (4) Total
CY 2012 32 51 0 119 202
CY 2013 142 111 58 265 576
CY 2014 204 300 185 397 1086
YY 44% 170% 219% 50% 89%
Mar 2015 40 80 56 138 314
June 2015 43 85 58 142 328
Sep 2015 46 90 67 152 355
Dec 2015 50 92 71 155 368
CY 2015 179 347 252 587 1,365
YY -12% 16% 36% 48% 26%
Cumulative 557 809 495 1,368 3,229
2014 share 19% 28% 17% 37%
2015 share 13% 25% 18% 43%
Click to enlarge

Table Notes

  1. Ariosa was acquired by Roche in December 2014. Per their preliminary S-1, Ariosa disclosed the loss of LabCorp as a distributor contributing 62% of their Q1 2014 revenues. LabCorp subsequently signed with Illumina first as a distributor and then a licensee launching InformaSeq in late 2014. In November 2015 Roche disclosed Harmony had been used to direct clinical care in > 500k pregnancies in > 100 countries. An Cowen analyst report disclosed significant declines in the US offset by international growth.

  2. BGI is viewed by most as the market share leader in China. They have also aggressively signed distributors in other markets. A LifeCodexx web report estimated BGI had processed > 350k tests through mid-2014. A GenomeWeb article estimated the cumulative total as 462k at the end of 2014. The current BGI website states they have processed over 800k tests to date. GenomeWeb also noted 3 separate licensing agreements signed in Italy, Spain and Poland which were also referenced by the July 2015 Cowen report.

  3. Natera volume was reported in their S-1 and in 10-Qs for the June and September quarters. The December 2015 results have not yet been reported. An estimate is included for comparison purposes. Natera disclosed the Quest and Progenity distribution contribution to their revenue and volume in their filings. They also disclose that > 40% of their accessions from the Panorama launch in 2013 through September 2015 have not been reimbursed. Some of this is likely timing but the majority seems to be related to this strategic decision to accept tests for which they are unlikely to receive insurance reimbursement.

  4. Accession volume from Sequenom has been disclosed quarterly since 2011. Illumina has estimated tests over the past year on their earnings calls. Quest signed with Sequenom as a distributor after termination of their Natera agreement. In May 2015, they began in-house processing of their licensed NIPT QNatal. Sequenom disclosed the unit volume associated with the Quest conversion. Progenity signed with Illumina after termination of their Natera agreement. Progenity is believed to have begun processing tests in June 2015. Both SRL and GeneTech in Japan have converted to licensees of Sequenom and are processing in Japan labs. Laboratoire Cerba has been processing licensed tests from Sequenom in France labs since 2014. LifeCodexx has been processing licensed tests from Sequenom in Germany labs since 2012. Berry Genomics, a licensee of Illumina, has the 2nd largest market share in China. Berry Genomics estimated volume through 2013 is from GenomeWeb and a Dr. Bianchi articles. 2014 volume estimates are from LifeCodexx. BGI recently partnered with Dr. Lo to jointly operate a lab in Hong Kong. Dr. Lo and The Chinese University of Hong Kong are a distributor for Sequenom and own an exclusive license for Hong Kong. Licensed testing in Hong Kong is believed to be minimal through 2015. Several other licensees are not believed to have contributed significant volume through CY 2015.

Ariosa/Roche

Roche Diagnostics, which acquired Ariosa in December 2014, has also begun licensing their NIPT Harmony. Their first licensee lab to begin processing (per Cowen NIPT analyst report) was Cenata in Germany. Sonic Healthcare has long been a worldwide distributor of Ariosa. Sonic recently acquired Medisupport SA in Switzerland who was a licensee offering Prendia from an undisclosed California NIPT partner. Sonic appears to be readying a launch of a licensed product in the U.K. and Australia. Their license partner has not been disclosed but is believed to be Ariosa.

BGI

BGI had 3 licensing arrangements per Cowen in Italy, Spain and Poland. It is unclear if they have added licensees since this report was published in July 2015. BGI claims to have a network of > 2,000 clinical partners in 52 countries per their website.

Natera

Natera has announced 11 licensing agreements for their cloud-based system Constellation. These licensing arrangements do not specifically include the Panorama NIPT. As of September 30, 2015, Natera disclosed only one of their four active licensees were paying royalties. That licensee was DNA Diagnostics Center who hired Natera to develop a paternity test. In the financial filings, Natera has emphasized their direct field sales approach was employed to maximize their gross margins. They have also announced an agreement to pay half of the projected $13.5 million cost of developing and validating an NIPT for an unnamed major manufacturer in a country. This is expected to take between two and four years. No costs have been incurred through September 2015. On February 9th Natera announced the Panorama launch of Constellation by licensee Gentica in Switzerland.

Illumina (NASDAQ:ILMN) acquired Verinata in January 2013. They partnered with Sequenom in December 2014 to further their combined NIPT reach through licensing their combined intellectual property and expertise. They have both become licensees themselves paying royalties for Verifi and MaterniT21 into a pool that they then share quarterly. It's likely but not disclosed that Sequenom also pays royalties for their low price NIPT VisibiliT and their newly launched whole-genome NIPT MaterniT Genome.

The two companies have also signed 36 other labs worldwide as licensees. Of these only 10 were validated and processing tests as of September 30, 2015. The validated labs include the two largest lab networks in the US (Quest and LabCorp). Labco and Synlab have issued press releases launching their licensed NIPT neoBona in both Italy and Spain and have stated the test is now available in all lab locations in 35 countries. This has yet to be announced or confirmed by Illumina or Sequenom.

U.S. Market

Natera currently appears to have the largest U.S. market share. This was achieved after replacing their two large distribution channel partners with a direct field sales model. Their accession data could include a higher percent from international customers than competition given the licensing landscape. The test volume is heavily weighted toward average risk in the OB/GYN provider channel which is a challenging reimbursement environment today. This strategy may pay off if they can maintain this market share when reimbursement guidelines are approved. However national labs are positioning themselves to compete for this market share.

Illumina and Sequenom are combined because of their IP Pool licensing approach. Illumina benefits somewhat more than Sequenom because they achieve incremental revenue from selling equipment and reagent kits required to process tests. With the aforementioned strategy of Quest and LabCorp to win over incremental processing from outside-the-hospital it would appear that the long term lab consolidation trend will drive incremental volume to these independent labs via their own licensed LDTs branded QNatal and InformaSeq. Initially this volume shifted from Sequenom and Illumina as expected, but share gains in the future as expected to continue given their reach, coverage network and cost advantages. The Illumina MiniSeq platform along with their stated goal to achieve FDA approval for a VeriSeq NIPT In Vitro Device "IVD" bodes well for platform and NIPT market share gains in the future. This seems to match a likely interest by larger OB/GYN practices interested in processing tests in house to save cost and improve turnaround times. This could be a couple years off.

Roche appears to be primarily focused on international markets and is expected to continue to see their US share erode.

BGI does not offer their tests in the US.

China/Hong Kong Market

BGI owns the largest share of the China market which is expected to quickly become the largest in the world. They are unlikely to see their market leadership position threatened but Berry Genomics appears to be closing the gap with many other small players also earning share. The BGI NIPT brand in China is NIFTY.

Berry Genomics CEO Daixing Zhou recently was interviewed by GenomeWeb (subscription required). He said the company is now making progress selling NIPT to hospitals in China as an IVD. He stated that of the 108 hospitals in China approved to run NIPT, Berry is working with 62 of them with 33 now up and running. He went on to state that Berry now has 900 employees and four certified labs in China. They have also jointly established a lab in Hong Kong with Dr. Lo. Mr. Zhou stated that China is accelerating, predicting that 750k tests will be run in 2016 and by 2020 NIPT will be run by over half of the 10 million annual births in China. The Berry Genomics NIPTBamnbi is licensed from Illumina.

PerkinElmer (NYSE:PKI) has a very strong neonatal franchise, especially in China. On their last earnings conference call they stated that there are over >130 million babies born every year but most are not screened for treatable disorders. They announced the acquisition of Vanadis Diagnostics to assist in the development of a next generation NIPT. It's unclear which test they are currently using after their distribution agreement with Illumina expired.

Germany/Switzerland Market

The Germany and Switzerland market is seeing a lot of activity now that NIPT is reimbursed for both high and low risk pregnancies. The EU lab networks have focused on this market though it's too early to say who has the longer term advantage. LifeCodexx has been offering the test as a licensee since 2012 and has been able to garner share as a result. The combination of Labco and Synlab Group provides a significant presence and it's believed they will also be an IP Pool participant though unconfirmed at this point. Sonic Healthcare acquisition of Medisupport provided Sonic their first licensed in house NIPT branded Prendia. It's unclear which provider licensed this test. Sonic has a significant presence worldwide and is a distributor of Harmony worldwide. Natera has stated they have a Constellation licensee in the market. Centana is the only known Ariosa licensee. With Roche based in Switzerland it's likely they have a significant presence as well.

France Market

Market share data is hard to find for France though the TAM is approximately the same size as Germany/Switzerland. The IP Pool has been fairly successful to date in France with licenses with the American Hospital of Paris, Biomnis, Laboratoire Cerba and likely Labco and Synlab. No details have been found relating to other tests licensed in country.

U.K. Market

The U.K. market is poised for growth following the January 2016 U.K. National Screening Committee recommendation that NIPT be offered as an additional screening option for high risk women. The Doctors Lab has been an influencer in the market as an Ariosa distributor. There are numerous competing tests both licensed and distributed in the market with all NIPT providers partnering up. Additional details should be released by the NSC soon which may provide further details specific to individual tests. Recent reports indicate demand both high risk and average risk market segments are growing rapidly. All four major players seem to be poised to compete to grow market share. Premaitha Health is an independent NIPT provider of a test called Iona which has been adopted by some U.K. clinics and hospitals. A Premaitha customer has reported strong demand for their licensed NIPT SAFE in both the government covered high risk and self pay ($500) average risk segments. They are partnered with Genoma in Switzerland to attempt to gain traction in other markets. They have made some modest gains on the Ion Torrent sequencing platform but its' unlikely they can become much of a player without significant support Ion Torrent platform provider Thermo Fisher Scientific (NYSE:TMO).

NIPT Summary

NIPT has become a preferred screening option for high risk pregnancies. The consensus opinion is that it is just a matter of time before average risk is endorsed as medically necessary and reimbursable. Some believe we are only a few months from that decision, while others put it in the next 1-2 years. This should be a significant catalyst for all the companies involved once announced. The total eventual market for NIPT has been estimated at about $2 billion in the U.S. and as high as $10 billion worldwide. The total available market reflects the current annual births of approximately 130 million with NIPT adoption constrained by pricing and market health care per capita spending.

Investment perspectives

The following US companies were mentioned in this report. The investment opinions are my own. Track updates by following me on twitter or my blog. Readers should do their own due diligence and not rely on anything herein as investment advice.

LabCorp

Investment thesis: Preferred operating metrics with strong upside from Covance acquisition. Weaker balance sheet and no dividend in current investment climate could provide better entry point.

  • Yield: NA
  • Q4 2015: Not yet released.
  • 2015 revenue growth > 40% (primarily acquired).
  • Earnings miss ratio trailing 4 quarters: 0%
  • Debt (net of cash) to Equity ratio: 1.08
  • CY 2016 PE: 11x
  • Lack of dividend limits short term upside in current climate.
  • Operating efficiency and organic growth drives rating LT.

Illumina

Investment thesis: Valuation is rich but deserved with numerous investments in markets yet untapped including personal genomics and early cancer diagnostics. Investments include Genome England, Action Genome Consortium and new company investments in Helix and Grail.

  • Yield: NA
  • Q4 2015: Revenue: Beat. EPS: Miss (guidance beat)
  • 2015 revenue growth: 19% (organic)
  • Guidance: Reduced (Japan market, currency, hard comps)
  • Earnings miss ratio: 25% (Q4-15 guide beat, consensus miss)
  • Strong balance sheet. Cash balance > LT Debt.
  • CY 2016 PE: 38x
  • Some valuation premium warranted long term.
  • Current market rotation to yield will limit short term upside.
  • Long term sequencing franchise, recurring revenue and market tail winds drive investment thesis.

Natera

Investment thesis: High risk strategy to capture average risk NIPT unit share without reimbursement. Bucking trend in US toward licensing to independent labs with direct sales force. Strong analyst support behind company. Would consider shorting after any significant rally associated with average risk NIPT endorsement.

  • Yield: NA
  • Q4 2015: Not yet released.
  • 2015 revenue growth estimate: 38% (organic).
  • Earnings miss ratio: NA (Q2 IPO)
  • Balance sheet: Cash position strong. Cash burn an issue.
  • Valuation: 70% decline in trailing 6 months brought EV to trailing revenue multiple to attractive at 0.7x. No earnings multiple.
  • Analyst price target and rerating risk make stock a do not touch until 3 days posts earnings release. Should see rally on average risk news after any earnings call reaction is complete.
  • History of governance issues disconcerting (officer loans and housing allowance, over billing dispute).
  • Best positioned company to rally off average risk NIPT positive news.
  • Long term avoid due to direct selling strategy with licensed labs headwind.

Quest

Investment thesis: Management focus on improved operating efficiency, strong balance sheet and above average yield make this an attractive investment. Top line growth will need to be a priority in C17 to justify the multiple longer term.

  • Yield 2.5%
  • Q4 2015: Revenue: In line. EPS: In line.
  • 2015 revenue growth: 1%
  • Earnings miss ratio: 0% (beats have been modest).
  • Management focus on operating efficiency and EPS growth.
  • Debt (net of cash) to Equity: 0.54x
  • CY 2016 PE: 12x
  • Short term attractive for yield and strong balance sheet.
  • Long term attractive with expected multiple expansion.

Sequenom

Investment thesis: Best situated NIPT company with respect to licensing, especially with Illumina limiting their internal processing of accessions. Plans to cut overhead and reduce capacity should provide improvement of cash burn and bottom line which is not yet reflected in street estimates. An equity-friendly debt refinancing and resumption in revenue growth should significantly improve valuation.

  • Yield: NA
  • Q4 2015: Preliminary revenues and cash burn only.
  • 2015 revenue growth: -15% (pricing, licensing, competition)
  • Earnings miss ratio: 50%
  • Management focus on reducing lab capacity and OH to transition more fully to licensing model.
  • Balance sheet very weak. Convertible debt maturity in 2017 increasingly a dilution concern. Equity friendly debt refinance required for long term outperform perspective.
  • Analyst rating and price targets bearish. Rerating and guidance upside from average risk influence short term rating.
  • Long term credit watch alert. Management has indicated they have options to refinance but no indication if equity friendly.

Thermo Fisher

Investment thesis: Valuation relative to growth and minimal yield make investment opportunity modest. Acquisition of Affymetrix (OTCPK:AFFY) and progress in sequencing market internationally provide some upside opportunity to growth estimates.

  • Yield: 0.5%
  • Q4 2015: Revenue: Beat (modest). EPS: Beat (modest).
  • 2015 revenue growth: 0%
  • Earnings miss ratio: 0%
  • Debt (net of cash) to Equity ratio: 0.47
  • CY 2016 PE: 16x
  • Management focus on sequencing opportunity and improving market share.
  • Short term upside opportunity limited by low yield and earnings multiple relative to growth.
  • Long term tail wind in sequencing, precision medicine and companion diagnostics.

Disclosure: I am/we are long ILMN, SQNM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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