Veracyte: Not Too Excited After Momentum Run

Summary

• Veracyte has a huge momentum run in 2021 thanks to accelerating operating and stock market momentum.
• I like the secular growth potential, yet fear that investors have gotten a bit too enthusiastic.
• The company is active in dealmaking and collaborations, and if shares fall a little further, I am happy to initiate a small position.
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Veracyte (NASDAQ:VCYT) has seen incredible momentum in spite, or better said, despite the pandemic. This was a less than $10 stock up to 2018. The pandemic and accelerating operating momentum and interest from investors have resulted in quite some enthusiasm.

Trip Down Memory Lane

When Veracyte went public in 2013, shares were trading at $13 and change on their opening day of trading. I concluded that shares looked interesting and might be worth a small allocation.

The company presented itself as a diagnostic company and a pioneer in molecular cytology. The company typically targets diseases which require invasive procedures and accurate diagnoses. The premise is that healthy patients undergo costly interventions which often turn out to be unnecessary.

By having an early diagnosis, actionable genomic information can be derived from cytology samples, basically the promise of Veracyte. This is done with Affirma which was launched in 2011 and, in the two years up to the public offering, already obtained coverage from large insurers like Aetna, Humana, and UnitedHealthcare.

The company generated $2.6 million in sales in 2011, a number which rose to nearly $12 million in 2012 and was set to run at a rate in the low $20 million in 2013, the year of the offering. Important to stress that this was just a small cap at the time, with shares trading at $13 and change, resulting in a $180 million equity valuation.

What Happened?

Since the public offering, the company has steadily grown its operations. 2013 sales came in at $22 million. Sales nearly doubled again to $38 million in 2014 as the company continued to lose some money. Losses and dilution meant that the share count continued to rise, something to be aware of.

Fast forwarding to early 2019, the 2018 results revealed that sales rose to $92 million, with revenues running at a run rate of $100 million already, although still accompanied by an operating loss of $22 million. This cash burn has been the major reason why the little over 40 million shares translated into a market value of just over half a billion dollar at $13-14, pretty much the same level at which the company went public in 2013 when the market value stood at less than $200 million, clearly illustrating the impact of continued dilution.

Despite the losses and perhaps thanks to narrowing revenue multiples, the stock started to obtain some momentum. This was furthermore driven by a guidance for 25% revenue growth in 2019. Solid financial results throughout 2019 and some real progress on various capabilities of the company pushed shares up to their twenties that year. Early in 2020, the numbers were stronger than expected with sales up 31% to $120 million and losses narrowing to $15 million.

The business grew more diversified besides the core genomics business as the company furthermore saw a rapid increase in pulmonology testing revenues, as well as closed more collaboration deals with big pharmaceutical names, including Johnson & Johnson (JNJ) to detect lung cancer.

All of this took place in February 2020 when the 50 million shares outstanding worked down to a billion dollar equity valuation at $20 per share, although that included over $150 million in net cash. With no pandemic yet in sight, at least not on the financial markets, the company guided for 2020 sales around $140 million at the time, with investors attaching a 6 times sales multiple to the operating assets.

The Pandemic

In April, the company reported preliminary first quarter results with growth slowing down dramatically because of an emerging impact of the pandemic on testing volumes, as in fact genomics volumes for the first two weeks of April were cut in half on an annual basis. This trend was extrapolated to a great extent in the second quarter, as quarterly revenues fell more than 31% to $20.7 million.

Shares held up well. In fact, in August of last year, the company used the momentum to issue quite a few shares again at $30 to finance the continued cash burn. Third quarter sales of $31.1 million were already up minimally year-over-year, driven by growth in testing volumes and a $2.0 million product revenue contribution from its Prosigna breast cancer test.

Shares still traded in the low forties when these results were reported early in November as solid operating momentum, many potential levers, a relentless rise in equity markets, and specialized ETFs focusing on genomics lifted this boat as well. A collaboration with Bayer (OTCPK:BAYZF) late in 2020 pushed shares higher to $50 by year-end, as shares rose to a high around $80 in Mid-February!

Early in February, the company guided for preliminary fourth quarter revenues of $34-$35 million, for a run rate of $140 million as it is important to stress that the company does not benefit from the pandemic so to see year-over-year growth again. In fact, it is quite an achievement to be able to grow despite the pandemic, which is a strong sign. This and a strong share price momentum prompted the company into raising more than half a billion at $74 in February.

Some Big Events?

Given the momentum in the stock of Veracyte and the equity raised, the company actually made use of these conditions to announce a substantial acquisition. In February, the company announced the purchase of Decipher Biosciences in a deal valued at $600 million, with the majority paid for in stock, based on a price of $54, resulting in another 6.4 million shares offered.

Decipher focuses on urologic cancers and its tests are set to generate $39-$40 million in 2020 sales. Based on the number for the fourth quarter, the revenue contribution runs at $48 million a year, which works down to a 12.5 times sales multiple. This multiple should be seen in combination with the growth, with 2020 sales up 130% year over year.

If we look at Veracyte, we see that the company had 58 million shares outstanding by year-end, trading at around $50 per share. This works down to a $2.9 billion equity valuation, or just over $2.5 billion enterprise valuation if we include the net cash position of the firm. Based on a revenue run rate of $140 million, Veracyte trades at around 17-18 times annualised sales. If we look at these multiples, the acquisition sound quite compelling.

Note that the valuation discussions regarding Veracyte are based on the situation as of the end of 2020. They do not yet factor in the latest deal and equity raise, as shares now trade at $58 per share. Some enthusiasm has cooled off a bit as the company sees 2021 revenues at $190-$200 million. With the Decipher deal set to close in May, that suggests continued organic revenue growth of Veracyte as well.

A Final Note

Given the big momentum seen in the share price so far this year, I am naturally very hesitant. Truth be told, the company has steadily grown the revenue base since its offering eight years ago, albeit that growth has been accompanied by continued losses and this situation. Furthermore, valuation multiples have continuously come down over time yet after a recent run higher, shares trade comfortably in the double-digit multiples again.

That said, I appreciate that we have seen some momentum induced pullback already at this point in time. If shares might pull back to the forties, I might be initiating small based on a relative reasonable sale multiple, given the secular growth opportunity, increased attention to the space and the active collaboration strategy with some of the largest names in the field.

Analyst’s 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.