An Acquisition Opportunity For Small Players With The Right Stuff

Includes: A, ABT, ALK, CRA, DGX, JNJ, PFE
by: Alberto Savrieno

According to the College of America Pathologist, over 60% of all decisions related to a patient's treatment, hospital admission and discharge are based on laboratory results. Such laboratory results coupled by home based diagnostic testing has created a global diagnostic industry worth $26 billion. Cancer testing is estimated at over $2 billion a year, in addition to being one of the fastest growing sectors amongst the diagnostics testing market. A number of leading companies have been progressively flooding the market with increasingly effective and competitive technologies, capable of making a true difference in cancer detection, such as U.S.-based Johnson & Johnson (JNJ) and Abbott Laboratories (ABT).

With $65.0 billion in revenue in 2011, Johnson & Johnson remains the world's largest developer and manufacturer of medical treatment and diagnostic devices. According to their 2011 filings, Johnson & Johnson's Medical Devices and Diagnostics (MD&D) made $25.8 billion in sales in 2011, making them the largest medical device business in the world.

Abbott Laboratories is the largest company in the nutritional products market and the second largest company in the worldwide market for diagnostic products. In 2011, Abbott generated revenue of $38.9 billion. With shares trading at $66.46, as of July 17, 2012, the company's diagnostics division offers a wide range of tests, including systems designed for the screening and/or diagnosis of cancer. Last August, Abbott received FDA approval for a new molecular diagnostic test designed to detect rearrangements of the anaplastic lymphoma kinase (ALK) gene in non-small-cell lung cancer (NSCLC). Intended to identify ALK-positive NSCLC patients for Pfizer's (PFE) approved NSCLC therapy, Xalkori, Abbott's innovation marked an important step towards offering lung-cancer patients a treatment tailored to their genetic profile. Their total sales in their diagnostic prodtusts segment amounted to $1.1 billion in 2011 with gross profit margins at 60% of net sales..

As cancer detection technologies continue to rapidly improve, companies dedicated to cancer diagnosis alone are increasingly seen as highly appealing investment opportunities. Last April, U.S. clinical laboratory services company Quest Diagnostics (DGX) completed the acquisition of diagnostic testing firm Ameripath, with hopes of establishing its "leading position in cancer diagnostics," according to Chairman and CEO Surya N. Mohapatra. The deal sent Quest's stock price up to a high of $58.67. Two months later, California-based measurement equipment giant Agilent Technologies (A) announced the acquisition of Denmark's cancer diagnostics company Dako for $2.2 billion.

As the market continues to grow at a rapid pace, two companies have recently caught the eye of U.S. firms and medical specialists, leading to more financial opportunities. Israel's BioView (BIOV) signed a cooperation agreement with Silicon Valley-based laboratory OncoMDx last March, to develop a noninvasive diagnostic test for the early detection of NSCLC. If the clinical trial is successful, the test's market potential in the U.S. is estimated at $80-200 million annually. More recently, BioView entered into a cooperation agreement with France's ScreenCell. The announcement brought Bio View's shares up 3.8%. On the other side of the world, Canada-based Verisante Technology (VRSEF.PK) came into the spotlight when it renewed a promising Collaborative Research Agreement (CRA) with the British Columbia Cancer Agency (BCCA) to pursue the development of its Aura device for skin cancer detection and its Core system for the detection of lung, gastro-intestinal and cervical cancers.

Many of the challenges facing the drug industry are magnified in the biotech field. Without long track records to point to, a company's success is highly dependent on convincing investors that it's on to something new, interesting and marketable. Adequate capitalization to fund their operations, clinical studies, as well as production and distribution is a do or die no matter how good a product could be. Bio View's model alleviates the capitalization risk by keeping to its core competencies - R&D and aligning with strategic partners on the business side. In Verisante's case their 2011 financial statements show that it has sufficient cash resources available to meet its obligations for at least the next twelve months. That however, is not an indicator of adequate capitalization for the long haul. Should the Company 's Aura system (see below) get US FDA approval, they will no doubt have to raise a additional capital thereby diluting its current share base, or be forced to align with a large player that has an established production system and distribution channels already in place.

Verisante has a many good things going for it that may set the Company on an acquisition track. According to the Company's website the success of their pilot studies of their Aura and Core devices in 200 2011 clearly established the company as one of the leaders in its field. The Aura system found every case of melanoma in 274 lesions flagged for biopsy, while preneoplastic lesions were detected with a sensitivity of 96% and a specificity of 91% with the Core device. Additionally, Verisante initiated the FDA approval process for its Aura system, last year, after the device was first authorized for sale in Canada, Australia and the European Union. According to Zacks Equity Research, entry into the U.S. would increase Verisante's dermatology practice market alone by another 50% (in device sales and recurring revenue).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.