Cepheid's (CPHD) shares closed down over ten percent as it reported that minor shipping disruptions will cause 3rd quarter revenue to be slightly lower than expected. This revenue won't disappear by any means. It will, in fact, just be recognized in the 4th quarter with delivery, since the consumers already ordered the cartridges. Full year guidance of both revenue and earnings were not changed.
This minor supply disruption of $5 million, or 6 percent of 3rd quarter revenue, caused a 10 percent change in price on 4x average volume. Does this not seem a little extreme for a simple delay of one quarter in revenue recognition?
Some seem to think so. And so do the analysts at Piper Jaffray, Oppenheimer, and Goldman Sachs, who said this "pullback presents a buying opportunity," "long term fundamentals have stayed the same," and "shares are oversold" respectively. The market continued to punish shares and they hit a intraday low right before the session ended. Analyst notes that came out in the morning were quickly ignored by investors who got out of the company.
The Hazy Market Rationale
The extreme reaction to yesterday's news, plus the buy-side ignoring the sell-side, shows this name has found little rationality.
Whether or not the market is reacting to just this event, seeing this event as a long term business plan execution problem, or just a wake-up call that the name is overvalued is not clear. Trying to understand the market rationale is difficult right now but one thing is pretty certain: it appears that the Cepheid bulls have zero credibility with the buy-side.
From a valuation point of view, revenue moving back a quarter does very little in terms of justified value, particularly with Cepheid which has a lot of valued tied to cash flow 5-10 years in the future. On a strict valuation scenario standpoint it does not deserve the 10 percent haircut the stock received yesterday.
Another take away from this hazy reaction is that I believe Cepheid has priced in a high probability of M&A and perfect execution. Given this execution failure, be it minor, I believe it is more likely to move to the downside.
Value of Cepheid
Last month I wrote about how Cepheid's shares on both a relative basis and on a discounted free cash flow basis are extremely overvalued. I still believe that even after yesterday's haircut. It still takes extreme assumptions to force a DCF model to the correct market price. On a relative basis, you need to almost double every industry multiple to get to the current price. This is very high price, as this industry already gives healthy multiples or around 40x earnings and 2.5x sales.
I maintain a one year target price of around $28 and but reiterate my caution on short selling. The molecular diagnostics sub-industry is very heavy M&A oriented. Although I believe this set back might show less investor confidence in Cepheid as a stand-alone company, I believe this also could make management listen more attentively to a few offers.
Although the stock took a major hit, the market is still being irrational and Cepheid is still selling above fair value.