Myriad Genetics (NASDAQ:MYGN) has long been on my watchlist as a growing and profitable business. I have long found shares too expensive, but the current troubles have created a significant sell off to the point at which shares being to look more attractive.
The story is simple, yet complicated. Myriad has long relied on a very successful core group of hereditary diagnostics tests but competition has hurt sales growth and fat margins. At the same time, Myriad has seen this coming and has diverted quite some resources (roughly $800 million) into M&A in recent years. This was supposed to create an unrelated revenue stream which could offset the pressure on the core of the business, but so far the results are not too impressive yet.
Despite the troubles, I think that shares might be overreacting given the promising new tests being developed and a full pipeline, while the core continues to throw of cash. For that reason, I might initiate a stake if shares hit the high-teens.
A Look At Myriad
Myriad has grown very rapidly over the past decade, expanding from a revenue base of $100 million in 2006 to $700-800 million in recent years. During this period of rapid growth, operating margins peaked in their high-thirties as competition and slowing sales have put significant pressure on margins ever since.
The company aims to personalize medicine by molecular diagnostics allowing the company to understand the generic basis of diseases. This allows the company to develop tests which can diagnose diseases at a very early stage, avoiding very expensive misdiagnoses, lowering overall healthcare costs and improving the welfare of patients.
The company lives of its diagnostics products which it has developed to treat hereditary cancer, among others. The company has numerous tests for this disease including myRisk, BRACanalysis, BART, Colaris, but it aims to develop a single test in the end. The total group of hereditary products generated revenues of $632 million in the fiscal year of 2016. While full year sales were down by 1%, it was worrying to see a 7% fall in sales in the final quarter of the year.
To reduce reliance on these falling revenue streams, Myriad has been diversifying. One of these products is Vectra DA which assess diseases activity for rheumatoid arthritis in a global $3 billion market. Another product is Prolaris which assess the aggressiveness of prostate cancer in a $1.5 billion global market. Other products include EndoPredict for breast cancer, myPath Melanoma and myPlan lung cancer.
Vectra DA revenues came in at nearly $48 million in 2016, up 8% on the year before. Spectacular was the growth of Prolaris as sales increased by a factor of 4 times to $11 million. Total revenues from these two and other products came in at $73 million in 2016, up nearly 30% on the year.
At last is the smaller pharmaceutical and clinical service revenue segments with revenues of $48 million in 2016. The company has indicated that sales are expected to fall in the coming year following this abnormally strong result.
The Problem Remains, Reliance On Hereditary
Hereditary products, at which sales fell by 7% in the fourth quarter of 2016 still account for 84% of annual revenues despite the growing revenue base of other products. With the core falling by 7% and perhaps even at a faster rate at the moment, the other activities will need to grow at a very rapid pace to compensate for that given the limited size of their combined operations.
To accelerate the growth of the "other" revenue base, Myriad announced two acquisitions in recent times. The company already closed the EUR 35 million deal to acquire Sividon, which owns a breast cancer test. Given the purchase sum and the potential market, the actual contribution of this test is anticipated to be very limited.
The bigger deal was announced just days ago as the company acquired Assurex Health for $225 million, with milestone payments potentially pushing up the deal tag to $410 million. This company has developed a test for psychotropic medicine selection and generated $60 million in sales in the fiscal year of 2016. Depending on the eventual purchase price, the deal is valued at 3.7 to 6.8 times sales. What is disappointing is that the revenue contribution for 2017 is seen at just $50 million. Given that Assurex will contribute 9 months to the fiscal year, the run rate of sales is seen at $67 million, indicating relative modest growth compared to 2016.
These deals will boost the "other" revenue category to roughly $130-$140 million a year, while growing by the double digits. Of course this does not include the near $50 million revenue contribution from the pharma and clinical division, although that number is expected to fall after an exceptionally strong year. With sales of the non-hereditary products approaching $175 million a year, the reliance on the core is reduced to roughly 75% of total revenues, a very substantial percentage.
Pro-Forma Business, 2017 Outlook
Myriad ended the fiscal year of 2016 with $240 million in cash and equivalents, but this net cash position will evaporate following the purchase of Assurex which has not yet been completed. That suggests that the business operates with a flat net cash position. The 72 million outstanding shares fell to $23 following the disappointing results, for both an equity and enterprise valuation of $1.65 billion.
The disappointment in the share price, which at $23 is down 50% from the highs of the year, results from the 2017 outlook. Revenues are seen flat at $740-$760 million, compared to $754 million in 2016. Note however that Assurex will contribute $50 million to this number, suggesting that revenue declines otherwise would have been pretty severe.
Adjusted earnings are seen at just $1.00-$1.10 per share, as GAAP earnings are expected to come in at just $0.47-$0.57 per share. The difference is the result of deal-related costs as well as non-cash amortization charges. Note however that adjusted earnings still came in at $1.63 per share in 2016.
Given that the business has bought back a quarter of its outstanding shares in recent years, while it pursued a couple of medium-sized deals as well, the sizable net cash position has evaporated. As a result, Myriad no longer enjoys the same kind of financial firepower as it has done in the past.
At $23 per share, shares are not necessarily very cheap at 20 times earnings, given a flat net cash position and a declining core product. The outlook is concerning as well, at least in terms of revenues. Assuming a 10% decline in hereditary revenue, sales could fall from $632 million to $569 million. The company indicated on the call that it expects hereditary sales declines for 2017 to approximate the 7% fall recorded in the fourth quarter.
That suggests that the remainder of the business should contribute $171 to $191 million in sales in the coming year. That includes Vectra, Prolaris, other testing products, pharmaceutical & clinical as well as a $50 million contribution from Assurex. Note that these businesses already generated $171 million in sales in 2016 ($50 million assumed for Assurex) indicating that growth of these products might not be as spectacular. This is worrying as these products should replace the core business and improve the diversification of Myriad.
Worries, But Room For Upside As Well
For an outsider it is hard to judge the competitive situation regarding the hereditary product business. To maintain leadership, Myriad has signed long term contracts for these products, as these contracts should secure 65% of sales in the upcoming year. While these contracts ensure visibility in the near term, the true long term outlook is up for debate.
Potential upside should result from conservativeness with regards to the outlook for sales of Vectra and Prolaris given the recent reimbursement coverage wins. At the same time, Myriad assumes no further coverage wins with regards to the outlook. Note that products such as myPath Melanoma and myPlan Lung Cancer are still in the pipeline along many others, representing a potential market of many billions, while the current revenue contribution is non-existing.
It should be said that management is conservative with some practices as it does not assume any coverage wins, no share buyback activity and a relatively high tax rate of 38%. Furthermore no US market entry for EndoPredict is seen, while the company continues to gain scientific knowledge and evidence across its test base. To illustrate the potential for upside surprises: Myriad mentioned that if Prolaris, Vectra and other products would gain full coverage in the US by 2016, revenues would be up by $300 million, while earnings would jump by $2 per share.
Valuing Myriad is more an art than a science at this moment and relies heavily on management projections and the degree to which the market believes them.
The issue is the core hereditary segment which still accounts for the vast majority of sales. As the company both owns a declining core and a portfolio of emerging products as well as pipeline, a sum of the part analysis seems most appropriate.
Hereditary sales are seen at $570 million going forwards, but they are under a great deal of pressure. Despite declining sales and margins, these products represent pretty much all of this year's earnings. This business segment probably generated operating earnings of $150 million in 2016, and that results in after-tax profits of $100 million. If we assume a modest 2 times sales and 10 times earnings multiple, we arrive at a billion valuation. Note that any acceleration in sales declines, or actual improvements in terms of sales could have a huge impact on the potential valuation. For that reason, I value this business anywhere between $500 million and $1.5 billion.
Interesting are the other segments of the business. Let's assume that the $225 million purchase price for Assurex is appropriate. We might attach a $100 million valuation to the pharma & clinical service revenue business. With sales of $73 million, emerging products like Vectra and Prolaris might fetch a $350 million valuation. A 5 times sales multiple does seem justifiable given the margin profile and overall 30% growth rate of these products.
At last is the pipeline which is arguably the hardest part to value A $100-$500 million range for those non-revenue generating products comes to mind.
That leaves a billion for the hereditary business, while the rest of the business including pipeline might be valued at $775 million to $1.17 billion. As a result I see a fair value for the entire business anywhere between $1.27 billion to $2.77 billion, equivalent to $17-$38 per share.
While shares are currently trading towards the lower end of the range at around $23, I would only start buying in the high teens to reflect for the uncertain developments and wide range of valuation outcomes.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MYGN over the next 72 hours.
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.