Underappreciated Drivers, Bargain Valuation, And Cash Infusion Set Interpace Up For Substantial Upside

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Med Genie
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Summary

  • Imminent positive catalyst in 1Q20 with local coverage decision to nearly double Medicare reimbursement on largest franchise accounting for ~65% of legacy sales - not in estimates.
  • Trading at currently a mere 1x '20 EV/sales versus 5-10x for cancer diagnostics comps, there is a lot of room for multiple expansion. Annual growth rates of 30%+ justify higher multiples.
  • BarreGEN's $1-1.5 billion market opportunity represents a substantial upside into the $60+ range longer term. More data, reimbursement, commercialization, and partnership are potentially coming this year.
  • Building presence in artificial intelligence and data driven analytics creates open-ended blue-sky opportunity. AI is likely the future direction of healthcare among other sectors.
  • 66% now owned by two healthcare PE firms at a cost basis of $6.00 who are motivated to actively realize a return. Dilution incurred but, importantly, no more financing overhang.

The opportunity in Interpace (OTCQX:IDXG) represents highly compelling upside at a very favorable entry. At about $70 million market cap (fully diluted pro forma for the recent financing), just a move to lower end peer multiples can almost triple the value of the company to be conservative even accounting for the preferred shares and warrants in the capital structure. In my view, investors may be overly fearing the reverse split (effective today) and have grown weary of the continued capital raises, dilution and cash constraints. I believe these concerns can now fade away as I will discuss. Cancer molecular diagnostics for screening and treatment planning using genetics has generated considerable industry and investor interest as we have seen acquisitions of Foundation Medicines (FMI) and Genomic Health (GHDX) go for up to 10x revenue. Companies like Natera (NTRA), Exact Sciences (EXAS) and Invitae (NVTA) have all returned over 100% in the past year or two. The involvement of now two dedicated healthcare private equity (PE) firms brings in highly motivated shareholders that want a target return and exit, a much better situation now than the previous 80%-plus retail holder composition prior to Ampersand's involvement last year. They likely see an apparent path for value creation in Interpace. Post-reverse split, institutions restricted from <$5 penny stocks may quickly acquire the outstanding public float of 3.8 million shares when they see two thirds of shares owned by motivated activist (who own 7.9 million equivalent preferred shares convertible to common equity or 66% ownership). Add to this the catalysts of a big increase in reimbursement for lead product ThyGeNEXT and substantial opportunity in BarreGEN and predictive analytics/artificial intelligence and we reach $60+ potential. I'll keep this brief and hit on the points that make me interested in this potential highly lucrative investment. (for simplicity in calculations preferred shares are equivalent to common)

Figure 1

Interpace testsSource: Interpace November presentation

Brief Background

Interpace Biosciences specializes in cancer diagnostics tests using next-generation sequencing and micro-RNA to rule out cancers, to perform early detection, or to aid in treatment course planning. 65% of the legacy IDXG revenue is from thyroid tests and the other 35% is from lung, pancreatic and esophageal tests (see Figures 1 and 2) with ample reimbursement.

Cancer diagnostics overall is a very attractive space as it is a direct application of the latest in genetic analysis/sequencing to find cancers early to both prolong life and save dollars in avoiding incorrect treatment. The company has solid coding and reimbursement for its current diagnostic tests from Medicare and large insurers including United Health, Blue Cross Blue Shield, Aetna (AET), Kaiser, Cigna (CI), etc. (Figure 1) Generally reimbursement has not been a problem and is in fact limited to only a 15% cut per year in Medicare (10-K page 28) which is relatively small compared to the roughly 210% increase its largest test just had proposed.

Figure 2Source: Interpace November Presentation

In July 2019, Interpace acquired the Biopharma services unit of Cancer Genetics (CGI) for $23.5m. CGI generates about $16m in revenue a year (2020 projection). The combination allows them to offer their expertise to assist biopharma in developing tests, particularly cancer, for personalized medicine. The revenue comes at a lower margin but is fairly visible with bookings set for next year. The company believes it will reach cash break even faster with this deal. CGI also gave them Response Genetics and solid tumor data to augment their push into data analytics, libraries and artificial intelligence. Importantly, this deal brought in the involvement of the first PE firm Ampersand Capital at an initial cost basis of $0.80 ($8.00 post split).

BarreGEN's Underappreciated Potential

Here's a little more on the molecular esophageal assay that excites me. I believe it is just starting to get noticed as the already FDA approved test has only generated nominal sales thus far as data to support reimbursement just started trickling in last year and we have more studies ahead. BarreGen for stratifying risk and determining the course of Barrett's esophageal cancer intervention is a potentially transformative product soft launched in 2018 (i.e. some coverage for investigational use) that addresses a large $1-1.5 billion market (see Figure 2) and is now collecting supporting clinical data to report in 2020 to support commercial launch and reimbursement. BarreGen alone could make IDXG an investment that could realize multiples of share appreciation as its market size is larger than all 3 other indications combined (Figure 3) and has no marketed competition from genetic tests for risk stratification. Currently, there is no test to risk stratify what patients need surveillance after a Barrett's diagnosis or not. Per the company, 3.3 million patients per year with Barrett's Esophagus are test candidates as this condition increases the risk of fatal esophageal cancer (only 19.9% survival rate over 5 years) by 30x, so the urgency is there.

The realization of this upside can start with data this year- a significant catalyst which is partially why the stock moved up almost 15% on the UNC collaboration announced this month with data later in 2020. There are no marketed genetic mutational load tests for Barrett's esophagus risk for cancer, only home-brew type tests, so this would be a first in class test in a large market. Early data in recent publications look quite promising at 100% sensitivity and 85% specificity for progression to more severe high grade dysplasia at certain mutational load levels, albeit small sample sizes. Just a 10% penetration at the low end of the $1-1.5B market opportunity could equate to $100 million of sales in 5 years, not unreasonable with no competition. Just using Thyroid testing as an example, competitor Veracyte reached 25,000 tests in 5 years post 2011 launch (even with ThyroSeq on the market) before ThyGenX launched in 2015 (Veracyte release). At $2,500 net revenue per test 25,000 tests translates to $63 million in a market one third ($350 million) the size of BarreGen's $1 billion market. This not so unlikely scenario of $100m sales could even take us as high as $80 per share just on low end market multiples of 5x in 5 years. Using the following calculation: ($100m of sales + existing revenues of $50m growing 15% a year for five years X 5 multiple / 11.7m shares+1.1m warrants)=($100m+($50m(1.15)^5) x 5)/ 12.8 million= $79 per share. If the test gains traction, the company would get much more than a 5x multiple at that point in my view. The announcement of a commercial partnership that could happen sometime this year would be positive news as well.

Figure 3

Source: Interpace Presentation

ThyGeNEXT Reimbursement to Possibly Double or More

On December 17, 2019, the company announced that reimbursement (press release) for its biggest selling test ThyGeNEXT received a draft local coverage decision (LCD) to increase reimbursement by $2,400 over previous coverage. This decision by Medicare contractor Novitas could be made final sometime in 1Q per press release and covers all Medicare. For further background, the thyroid franchise of ThyGeNEXT/ThyraMIR makes up 65% of the legacy Interpace revenue (from quarterly conference call). This reimbursement was cut July 2018 and is now proposed to be bumped back up again. As shown in Figure 1, the increase brings ThyGeNEXT to the reimbursement levels of Interpaces' other tests. Importantly, it seems likely to become final since it makes sense to increase reimbursement as the higher level brings ThyGeNEXT more inline with leading competitor Afirma which is ~$5,000 for a comparable panel if not more. Both inline reimbursement and a much higher positive predictive value (recent study) should set Interpace up for share gains as well. I believe some investors may be waiting on this reimbursement to finalize before getting too excited. The chances are high in my view.

The impact to numbers could look like this: The average net price per ThyGeNEXT test is $1,100 (Figure 1) and Medicare is roughly 40% of thyroid tests as noted by the company (company press release). If we take Interpace's $34m 2020 estimate for the legacy (ex-CGI) and apply 65% to get the Thyroid franchise contribution and multiply by 40% Medicare percent we get about $8.8m revenue as Medicare. If we assume Medicare is paying the net (Figure 1) for simplicity we get Thyroid combo test of ThyGeNEXT and ThyRaMIR at $3100. If we increase this amount by $2400 we get $5500 per test. We can multiply $8.8m by the ratio of prices or $5500/$3100 and we get ($8.8m x $5500/$3100) =$15.7m for new reimbursed Medicare contribution. This is an incremental $7m to annual estimates just on Medicare. Commercial payors often follow Medicare reimbursements and in many cases exceed them if coverage is granted. I do not see why this can't happen here. While an increase in reimbursement will take a year or two to flow through to most payors, it would be highly additive to company forecasts/street numbers. If commercial insurers (the other 60% of payors) also adopted the change at just Medicare rates today ex share gains we could get about $7m x (60%/40%)= $11.4m of total revenue from the reimbursement bump which is meaningful as it is not in numbers and high margin revenue (an incremental 30% over 2020 legacy revenue estimates). Net realized reimbursement can be complex to calculate exactly with payor mix, gross-net, particularly in this case considering the use of ThyRaMIR in combination after ThyGeNEXT in ~80% of cases, for illustrative purposes, the order of magnitude of reimbursement should result in a significant bump in revenue and importantly reduce cash burn.

Building Artificial Intelligence and Data Driven Analytics for the Long Term

There is another under-the-radar benefit from CGI that may have escaped investors focusing on the biopharma service. CGI may augment a potential green field opportunity in data collection and artificial intelligence (AI) as the Response Genetics component of CGI with solid tumors adds to data on thyroid and pancreatic cancer. There is a long term vision (CEO Jack Stover mentioned five years in last call) of the company becoming more of an AI or data driven company particularly with the collaboration last July with Helomics to build AI-driven thyroid cancer models, announced just 2 weeks after the CGI deal, very interesting timing.

"All that being said, and I've said this before, and I firmly believe it, that as we move forward and you look at us in five years, we may be more of an AI driven or data driven company than we are an assay driven company that part of the business is changing quickly." --CEO Jack Stover on 3Q19 conference call

Undoubtedly, AI could dominate treatment paradigms and whoever has the data and algorithms will become increasingly valuable. Here's some more AI info in an article on a recent fund launch. I would note upstart Tempus has already succeeded in raising a whopping $560 million in 4 years and recently partnered with CVS/Aetna in a cancer venture. As of May 2019, Tempus had a valuation of $3 billion, just incredible, after raising another $200 million and at last check only $7.5 million in annual revenue. Tempus focuses on creating a library of clinical and molecular data to drive cancer treatment and research--something Interpace would be in the sweet spot to do for its oncology focuses. There is literally nothing in Interpace's valuation for this despite its substantial amounts of data in thyroid, pancreatic, lung cancers and now solid tumors. Even a fraction of Tempus' valuation would vault Interpace into the stratosphere in stock price. The combination of Helomics/Interpace sounds a lot like Tempus (Artificial intelligence combined with data libraries in oncology). I wouldn't be surprised if Tempus IPO'd for a unicorn-type valuation and then immediately healthcare AI in cancer becomes a hot area and so would companies like Interpace with mountains of data from years of clinical experience. In fact, it might be the only pure play public comp at that point along with virtually unknown Predictive Oncology (POAI) which owns Helomics. It is hard to put a price or valuation on this seeing Tempus is $3 billion with $7.5 million in revenue but it would be massive upside obviously for IDXG. Interpace would also be able to cross sell its data for drug development on the Biopharm side. For now, I think there are plenty of catalysts near term and immediate concerns like streamlining and integrating CGI will take a precedent. I am highly encouraged Ampersand and 1315 Capital are involved near term to get through that before the AI aspirations can take off. I consider this AI/data driven concept to be a thick layer of icing on the cake that takes us into high IRR territory.

Valuation is Very Cheap: 1x EV/sales versus comps of 5x or higher

Adjusting for the 1-10 split, if we fully dilute the shares for the preferred stock (from the CGI financing by Ampersand adjusted for recent financing and 1315 Capital recent purchase) we arrive at about 11.7 million shares (3.8m shares outstanding, $19m/$6.00=3.2m shares for 1315 Capital, $28m/$6.00=4.7m shares for Ampersand) assuming conversion of preferred to common stock, giving IDXG a market cap of $70 million at $6 per share. There are about 0.8 million warrants that strike at $12.50 and 0.3 million at $18.00 although those may actually provide a source of internal financing and won't be dilutive until the stock is up over 100%. If we look at Invitae (NVTA) which I believe is a good comp with a similar margin and profitability profile in the cancer Dx sector we see it trades at 5x 2020 sales. Veracyte (VCYT) and Natera trade at 9x and 7x sales. Genomic Health was acquired for about 5x it's forward sales at $2.8 billion. Last year Foundation Medicine went for nearly 10x sales. These companies are also each growing in excess of 20% a year and are not profitable yet. Similarly, Interpace revenue growth projection from management is 45% and 57.5% for '19 and '20 (see Figure 5). Their core growth for 2020 is around 30%. If BarreGen gains traction, the growth could become 50% plus in a couple years. In my view, with this growth plus value of data/AI option the stock could trade to at least the low end 5x revenue. While none of these are perfect comparable companies, the point is there is a ton of room for multiple expansion. The company also noted this in their November presentation with some other comps (see Figure 4). (I do not think Quest/LabCorp are the right comps because they are diversified clinical labs with lower growth and profitability profile.)

For example, if the company does $60m in revenue and exercises 1.1m warrants for cash at a weighted average of $14.00 and considering $20m of new cash at 5x revenue we'd get ((5 multiple x $60m of revenue)+$20m of cash+(1.1m warrant shares x $14.00)) /(11.7m fully diluted shares+1.1m warrant shares) = $335m/12.8m=$26.20 per share. I would round out $3.80 cents or ~$50m of market value just for the upside of AI/data option for now to get a target of $26.20+$3.80 =$30 or 360% return, though AI/data valuation could be worth much more.

Figure 4

CompsSource: Interpace November presentation

Figure 5

Revenue growthSource: Interpace November presentation

Private Equity Involvement Provides Much Needed Activists With A Lot of Skin in the Game - They Want a Sizable Return Over these Prices

Ampersand, which owns roughly 38%, has been involved in the diagnostics and healthcare space for decades and backed takeouts Genoptix and Talecris. In fact, looking at their credentials, it would be hard to find a better operating partner as labs/diagnostics are their specialty. (link to Ampersand site). Encouragingly, Ampersand has invested in a very impressive 30+ companies that have been acquired. This is certainly a desirable exit for IDXG holders as well and likely something private equity is steering towards as an option. (Ampersand's exited companies) -click on realized companies on webpage, a nice list

1315 Capital, who recently purchased a roughly 27% stake, also specializes in healthcare and the size of this transaction is right in their sweet spot as well. (link to 1315 Capital site)

"We focus on EBITDA-positive companies that provide products or services within several key healthcare sectors, including laboratory testing services, laboratory products, contract manufacturing, pharma services, specialty pharma and healthcare services. Ampersand brings significant prior experience to each of these sectors, allowing us to partner with entrepreneurs in taking their companies to the next level." - Ampersand Capital website

"The firm targets $10 to $30 million investments in commercial healthcare businesses that have the potential to scale to $50 million to $150 million of revenue, a highly attractive level for acquisition or to access the public markets. In addition to experienced investing partners, 1315 Capital leverages an Operating Team model of CEO and longtime executive partner that work together to navigate diligence, drive decisions, and achieve premium exits." -1315 Capital website

The involvement of private equity is very positive as it places specialized healthcare PE firms (targeting lab testing and services) that actively want a return on their investment as majority holders compared to the previous 80% plus retail shareholder structure. In my view, the choice of another activist investor is positive for shareholders versus going to a passive hedgefund for financing, which they probably could have done for a high coupon convert or equity. While IDXG is not EBITDA-positive, I believe both PE firms do see the likely potential of fixing the costs and growing the business and becoming EBITDA-positive quickly, otherwise they would not be involved. Ampersand owns about 38% of the company through Series B (Assumes Series A is converted to Series B per recent financing) preferred stock which is convertible to about 4.7m shares of common stock at a conversion price of $6.00. For an investment with this size and risk profile, they are probably seeking multiples of their investment as a return. If both of these firms now have cost basis of $6.00 (and Ampersand's initial basis was even higher at $8.00 prior to adjustment), I feel great about buying at around the same price. On the negative side, the dilution from their involvement was substantial and that hurt earlier investors. However, the valuation discount more than accounts for this in my view and now Ampersand has no more cash dividends or anti-dilution rights. Importantly, the recent financing eliminates a huge overhang of a large capital raise and provides necessary additional liquidity for over two years at the current burn rates. The company headlined in their last release:

Investment expected to support achieving cash flow break-even and accelerate Interpace's growth plans and acquisition strategy.

If indeed this is the last raise until profitability, I feel good that we are getting in at the bottom. I realize serial dilution has hurt investors who are thinking twice about buying. However, now we have a solid 2-year cushion heading into BarreGEN and likely increased ThyGeNEXT reimbursement and, importantly, two activists to steer them on course. There is no dividend or anti-dilution protection in their shares so they are going to have to realize a return through common equity like everyone else.

Risks Outweighed by Upside at these Prices (How Did We Get Here?)

This company has a long history. Formerly a contract sales organization from 2002 called PDI, it has recreated itself into a cancer diagnostics company over the past 6 years by buying Asuragen's and Redpath's Thyroid, Pancreatic and Barrett's Esophageal tests. This is partially why internal R&D is relatively low. After paying off debt in 2017, it has a relatively liability-free balance sheet today. Interpace has been generating losses in this transition mostly from sales and marketing trying to secure payors and reimbursement for its tests and doing clinical support. Much of that heavy lifting with insurers seems to be behind the company and things finally appear to be coming together. If the company cannot manage its costs, this represents a risk as it would need to raise more capital. Management with their options all currently striking over $10 and without egregious pay, seems fairly incentivized to cut costs to avoid this scenario and Ampersand and 1315 most definitely would want to avoid this and can help to realize their investment.

Regarding liquidity and cash (more of a concern prior to this month's financing), the company had commented in its 10-Q for the 3rd quarter (page 9 under liquidity) that it had enough cash available to last through November 30, 2020. On its recent call, the company said its burn rate was about $1.5 million per month. On the balance sheet for September 30 is $2.3 million in cash. The company counts a $4 million credit line, a $4.8 million ATM, and collection of at least $2 million receivables, and about $3 million from the Ampersand Series A-1 financing in October to get them through to November 2020. With the $20 million financing just announced, at current burn rates we have another $20 million /$1.5 million monthly burn = 13 months or December 2021. I would positively note that this burn will very likely be lower with the help of cost savings from work with the PE firms to support achieving cash flow break even. This financing is a MAJOR overhang removed.

Regarding the stock price, it has recently fallen from 80c in November to as low as 41c (pre-split) I believe from quarter results and the contemplation of the reverse split exacerbated by year-end tax-loss selling. There are a few concerns that I believe have kept investors away lately. Last quarter, the company, in mid-November, lowered its 2019 annual guidance from $33-36m to $28-32m, implying a shortfall versus initial expectations for 4Q. When asked, they said it was both timing of revenue recognition and conservatism as they are in the midst of integration but reiterated that things are all on track and original 2020 sales guidance stands at $50m which I think is most important. In the CEO's words:

..."As you can imagine, we've been focused on wrapping up the September month end and quarter end activity. So that obviously has been a principal focus. But I think it's basically just recognition. And you probably know me by nature as being conservative and wanting to make sure that while we are on track and things are really moving forward as planned. And as we are reiterating guidance in 2020 - I mean, that's an unusual kind of a structure to be basically saying, hey, listen, we're going to be on the lower end of guidance in the remainder of 2019. But we're really on track for 2020. And basically, that's the transition process overall, in terms of that activity, but remember too, we took a $1.8 million charge in the quarter, and the methodology of how those effectively receivable reserves get accounted for they really hit top line revenue, under this ASC 606. So we just want to be cautious and careful and of course, we want to meet and exceed people's expectations."-- Jack Stover, Interpace CEO, 3Q19 quarterly conference call

Regarding the reverse-split, on January 13, the company confirmed it would do a 1-10 split to remain Nasdaq compliant and effected this split on January 15. While reverse splits aren't thought of as positive because they happen to companies that are generally in pretty bad shape, in this situation Interpace is heading in a positive direction and the involvement of two activists with operating experience at these prices makes me comfortable that this split will not result in material price deterioration. In fact, it may help to reduce the number of shares for trading purposes and institutions will be able to buy with a price over $5 (hence the choice of 1-10 at 60 cents for post split of $6.00 at today's prices, more reading here for why I think the split could be positive due to institutional buying). My guess is when IDXG volume thins out by a factor of 10 and institutions seeing the 2/3 ownership of activist PE firms, low valuation and fundamental drivers are going to want to buy and can finally do so over $5. I feel very comfortable owning the stock with the split.

Conclusion

I see 300%+ upside to this stock considering its discount to peers, growth rates and the potential of reimbursement increase for largest volume product ThyGeNEXT. Traction of BarreGen could make this a huge winner in a few years with its billion-dollar market opportunity. Right around the corner is also a move into artificial intelligence and data analytics in healthcare, the blue-sky opportunity of the future with enormous upside. At these prices, there doesn't seem to be much downside. Trading at such a low multiple reminds me a little of CareDX (CDNA) at <1x sales when it finally got higher reimbursement and added its kidney transplant test and did its overhang clearing financing and the stock ripped from $2 to $37. Also, thoughts of Tandem (TNDM) post-refinancing which went from $2 to $60 after trading at <1x sales and then underwent enormous multiple expansion. Bottom line, 2020 outlook looks intact and is likely a revenue timing issue and the reverse stock split may actually be positive, so not much really changed fundamentally from when Ampersand took its 47% stake at $8.00 and we can buy lower than that today. In fact, since Ampersand took its stake we have several new major positives in BarreGEN collaboration/future data, further development of data analytics, ThyGeNEXT reimbursement, an additional activist motivated to streamline the business in 2020 and generate a worthwhile return and an overhang clearing financing to address cash concerns. The time to buy is now at a bargain valuation with positive catalysts ahead.

This article was written by

Med Genie profile picture
140 Followers
Life sciences analyst with decades of healthcare stock picking experience at hedgefunds and asset managers. Fundamental research in all healthcare sectors with deep dives particularly on small/mid-cap, under-followed stocks. Science background from academia. Particular interest in magical creation of value out of thin air with equity to present long and short trade set-ups.

Disclosure: I am/we are long IDXG. 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.

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