I can understand if long-term GenMark (GNMK) shareholders feel a little cursed. Although there have been plenty of self-inflicted issues that have dented management credibility and pushed back development and revenue timelines, even when management execution has been good, new challenges have emerged to threaten the company’s longer-term revenue ramp. To that end, adverse coverage decisions, prospects for a more mild flu season, and threats of/from new competitive entrants have cut these shares almost in half from their late summer peak.
GenMark shares do seem undervalued, and I believe the company’s core ePlex platform does address real and legitimate needs in the hospital testing space. I also believe, though, that competitive and reimbursement pressures are unlikely to abate and the company is likely to face some hard choices with respect to funding/liquidity before achieving cash flow breakeven. Accordingly, I have to consider this a pretty high-risk opportunity.
Trouble Never Sleeps
I’ve written many times in the past that management execution and dependability has been one of the ongoing negative talking points around GenMark. Over the last few quarters, though, I’ve seen what I consider to be a positive change – management has laid out achievable targets and largely achieved them.
Unfortunately there have been some challenging developments that are beyond management’s control. You don’t always know why a stock sells off, and in the case of GenMark you could certainly argue there’s been at least some collateral damage from a generalized “risk-off” shift in market sentiment, but I believe emergent reimbursement and competitive challenges are also part of it.
Palmetto, a Medicare administrative contractor, recently made local coverage decisions on multiplex respiratory and GI panels that will have a negative impact on GenMark and bioMerieux (OTC:BMXXY). Instead of reimbursing for broad-based panels like those provided by these companies, coverage is being restricted to only limited panels (three to five targets) for specific clinical situations. That’s a mild boost for manufacturers of more limited panels including Luminex (LMNX) and Hologix (HOLX)
The direct impact to GenMark is likely to be relatively small. First, Palmetto is a regional player and its decision doesn’t apply nationwide (though other Medicare and private payers may choose to follow in their footsteps). Second, the decision only tests conducted on an outpatient basis (inpatient testing is covered by DRG codes). This decision, then, directly impacts less than 5% of GenMark’s revenue base, but a worst-case scenario where all outpatient testing is treated this way would risk closer to 15% of GenMark’s revenue (and arguably closer to 20% for bioMerieux).
Still, potentially 15% of your revenue base is not a good thing. What’s more, this is a sharp reminder that the reimbursement situation for GenMark’s panels is not static. For as long as I have been following the space (which is over 20 years now), there’s always been some pushback on the idea of broad testing as a front-line approach. A large percentage of infections are caused by a relatively small number of pathogens, and there have always been those who argue that it is wasteful to use diverse panels until/unless the initial panels can’t identify the pathogen. The counterargument is that seriously ill individuals can’t always afford to wait, but in the battle between optimal patient care and economical patient care, I don’t think I need to offer a spoiler alert that economics often wins.
More Competition Coming?
GenMark has been seeing ongoing system placements, helped in part by offering the smaller, cheaper ePlex NP configuration and by offering more flexible placement options. Year-over-year launch comparisons aren’t so helpful given the early stage of commercialization, but the last four quarters have seen 45 (Q3’18), 39, 32, and 49 placements, with a consistent mix of capital purchases at around 30%.
GenMark has stayed on target vis a vis sell-side expectations, but it still looks like bioMerieux’s BioFire FilmArray has seen barely any dent or slowdown in their winning percentage (likely in the 85%-plus range). Now it looks as though Luminex and Qiagen (QGEN) will also have new systems hitting the market within the next year or so, with Luminex in particular appearing to have made some strides in automation. With GenMark already fighting an uphill battle to gain share against bioMerieux, and only spending around $20 million a year in sales and marketing, more competition is not going make things any easier.
Menu And Marketing – Can GenMark Afford It All?
There are two key drivers in diagnostics success – a broad menu of tests and a sales force that can get in front of the decision-makers. Yes, system performance matters, but a great system that can only do one or two things will only get you so far.
Menu expansion remains a challenge. GenMark did get its final two (of three) blood culture panels into the FDA in early October, but management said that they are “contemplating” the strategy for the GI panel in the wake of the Palmetto reimbursement decision. Contemplation is fine for philosophers, but not so much for early-stage med-tech, and I think the company needs to be more clear on what they’re going to do with the already-designed GI panel and how they’re going to fill out their testing menu.
To somewhat underline that point, I’d note that bioMerieux launched another panel for the FilmArray last month – a new pneumonia panel that offers semi-quantitation. That means bioMerieux has two respiratory panels (excluding the EZ), a blood culture panel, a GI panel, and a meningitis/encephalitis panel. It’s hard to argue that a hospital really needs to go with the GenMark ePlex (even given its advantages) when bioMerieux’s system can do a lot more. Granted, respiratory testing makes up the bulk of the market today, and many hospitals buy systems entirely for respiratory testing, but it’s still an issue that GenMark has to address.
Likewise with the sales and marketing effort. Management is looking to expand its sales force, and it doesn’t take a cast of thousands to market to hospitals (there are about 5,000 to 6,00 points of call in the U.S. and a similar number outside the U.S.), but GenMark’s cash, cash flow, and liquidity situation may well limit its marketing spending options.
GenMark’s 2018 results have seen a bigger contribution from the older XT-8 platform than I’d expected, and I’m slightly reducing my growth expectations on the basis of the reimbursement challenges, the prospect of rising competition, and the slightly slower ePlex ramp. It only knocks about 1% off my long-term growth rate (like I said, “slight”), but I do see a slightly higher cash burn, and that could be more troublesome.
My fair value range for GenMark shares is now $6 to $8.50, with the lower end driven by my cash flow model (which still assumes 20%-plus free cash flow margins down the line) and the higher end driven by my EV/revenue model. I use a lower forward revenue multiple than I normally would for med-tech, as diagnostic companies generally trade at lower multiples to device companies.
The Bottom Line
Buying on these sharp pullbacks has worked before with GenMark, and I do believe the FDA clearance and commercial launch of the blood culture panels in 2019 should bring several hundred million dollars of revenue into GenMark’s immediately addressable market. Still, the company has serious challenges to deal with in terms of expanding its portfolio of tests and winning more bake-offs against bioMerieux. Although the rewards for success from here could be significant, investors need to be aware of the above-average level of risk that attends that opportunity.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.