Investors can be a fickle bunch. While they will happily reward strong growth stories with eye-popping valuation multiples, they can be demanding when it comes to the timing of that growth and the marketing/investment spending that the company has to do to generate it. That's my basic thesis on OraSure (NASDAQ:OSUR), as the shares of this rapid point-of-care (or PoC) testing specialist seem undervalued relative to other diagnostics growth stories.
A Leading Share In HIV
OraSure has already done what many med-techs never do - it has established that it can not only get a test through the FDA and onto the market, but then drive significant market share. OraSure's OraQuick Advance test has over one-quarter of the overall U.S. professional HIV testing market (that is, testing performed in a medical setting) and over 60% share of rapid testing. While OraSure isn't as strong in the more price-sensitive international market (where companies like Trinity (NASDAQ:TRIB), Alere (NYSE:ALR), and Chembio (NASDAQ:CEMI) also compete), the company's flexible test (it can test saliva, whole blood, or plasma) has proven to be a winner.
Now OraSure is looking to extend that leadership to the over-the-counter/home testing market. HIV testing still carries an enormous stigma for some people and it is thought that the home testing market could be worth over $300 million, or 50% more than the professional market ($200 million), if not higher.
The OraQuick Home HIV test is FDA approved and on the market; consumers can buy it online (Amazon sells it for around $40) or at almost any major pharmacy. Now the trick is to drive acceptance. If potential test-takers are not willing to deal with a nurse at a clinic, I doubt they will deal with a retail clerk and so there needs to be a balance between product accessibility and theft deterrence (OraSure's market research suggests keeping the test behind the counter or in a locked cabinet greatly reduces purchases). In the meantime OraSure is moving forward with a large (at least relative to the company's size) direct-to-consumer marketing campaign, including targeted TV spots designed to reach particular markets.
In addition to market access, there are issues of competition to consider. Trinity recently got FDA approval to add a claim for HIV-2 testing to its UniGold HIV test and that should help drive share gains in the U.S. professional market. Alere and Chembio are likewise looking to increase their share with newer tests, and Chembio is getting into OraSure's wheelhouse with an oral fluid test. Like OraSure, Chembio appears to have designs on the potentially large OTC U.S. HIV testing market.
Is HCV The Next Big Thing?
Readers who follow the broader healthcare sector are likely aware of the abundant investor interest in next-gen hepatitis C (or HCV) treatments from companies like Gilead (NASDAQ:GILD) and AbbVie (NYSE:ABBV). Perhaps not as well appreciated is the potential testing opportunity these new therapies will unlock. With relatively few effective options to treat HCV, there didn't used to be all that much urgency to get tested for HCV. Now that there are treatments that can effectively cure the disease (so long as they are taken continuously), testing becomes a more relevant consideration.
HCV testing is likely a billion-dollar market opportunity for established diagnostics players like Abbott (NYSE:ABT) and Roche (OTCQX:RHHBY), as well as entrants like Becton Dickinson (NYSE:BDX), Cepheid (NASDAQ:CPHD), and Hologic (NASDAQ:HOLX). What's important to remember, though, is the difference between initial screening/testing and viral load testing. Abbott and Roche are going to be hard to unseat in viral load testing (though count on Cepheid to try very hard), but that isn't the relevant market to OraSure.
OraSure has developed the only rapid PoC CLIA-waived test for HCV. It requires a finger-stick (the company is working on an all-oral test), but delivers results in about 15 minutes instead of the two to four days with conventional tests. Multiple U.S. government bodies, including the USPSTF have recommended increased HCV testing, with USPSTF upgrading HCV testing for Baby Boomers (those born between 1945 and 1965) to a "B" test meaning that there is a "moderate net benefit". Just today the CMS added to the momentum, proposing that HCV testing should be covered for people in that age group who are at risk for having HCV infection.
Precisely how many people should (or will) get HCV testing is absolutely up for debate. There about 70 million people still alive in that Boomer generation, and if every one of them gets tested once that's a $1.4 billion market, to say nothing of the U.S. population under the age of 50.
Other Business Chipping In
Home HIV and rapid PoC HCV testing are the biggest growth drivers for OraSure today, but they're not the totality of the business. OraSure generates about $8 million a year from substance abuse test panels and a recent decision to drop Roche as a partner (in favor of Thermo Fisher (NYSE:TMO)) could result in a more compelling offering. This is also an employment-sensitive business, so job growth would likely result in revenue growth.
OraSure has a small cryosurgery business that offers the Histofreezer, a low-cost alternative to liquid nitrogen for removing skin lesions. OraSure also has an insurance risk assessment business that is built around oral fluid collection devices and ELISA kits.
Last and not least is DNA Genotek. This business offers products for DNA and RNA prep from oral fluid samples, and 23andMe was a major customer before the FDA's warning letter forced them to suspend U.S. operations. It is debatable as to when (or if) 23andMe will get back on the market in the U.S., but DNA Genotek has some interesting core technology that could attract other partners in the future and/or be utilized in developing new proprietary tests down the line.
Can OraSure Turn Opportunity Into Reality
OraSure has some pretty gaudy addressable markets, but it clearly remains to be seen how much of that they can actually penetrate. I believe that OraSure can grow its home HIV testing business to something approximately or exceeding the professional business in five years (around $45 million to $50 million), and I believe the company could get 2 million HCV tests a year at the end of that same period (around $40 million in revenue). Add that to underlying business growth and I think OraSure's revenue could grow at a compound rate of 15% or higher over the next five years and nearly that rate over a longer period.
I also believe that OraSure, like Trinity, should be able to translate that revenue growth into profits and cash flow. With low teens FCF margins in five years and mid teens margins over the long term, I would value OraSure's cash flows at around $8.25 per share today.
The Bottom Line
Why be bullish when OraSure's stock price already approximates that target? For starters there is definitely a chance that adoption/acceptance of home HIV testing will exceed my conservative expectations, and likewise OraSure's HCV test may prove even more popular (and/or the company may introduce other successful products that aren't on the radar right now).
It's also true that med-tech, particularly emerging med-tech, is not really beholden to DCF-based models for valuation. EV/revenue is a preferred approach and if I give a 5x multiple to OraSure's 2014 revenue estimate (on the low end for growth med-tech, particularly compared to Trinity or Cepheid), I get a fair value estimate of almost $11 per share.
OraSure has had some definite ups and downs over the past couple of years driven, I believe, by overheated enthusiasm for the prospects for home HIV testing. The shares have doubled the mid-2013 lows already but the opportunity in HCV testing is such that I would still give this name some consideration for a growth-oriented portfolio.
Disclosure: I am long RHHBY. 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.