On January 7th 2013, Sequenom (NASDAQ:SQNM) was torpedoed when Illumina (NASDAQ:ILMN) announced their acquisition of Verinata and their prenatal diagnostic screen, Verifi. This decision was widely considered a head scratcher. Verifi at the time had around 7% US market share, yet Illumina paid $350 million plus an opportunity to earn another $100 million based upon certain deliverables. What made this announcement so curious was that Illumina already appeared to be in the driver's seat as the best derivative investment for this nascent market. Everyone else was fighting tooth and nail to survive. Patent survivability was being attacked in the courts and there was a constant fight for reimbursements. Illumina on the other hand, sold the sequencing equipment and reagents to Sequenom who was one of their largest customers. This recurring sale of consumables is extremely lucrative, generating $250 to $300 per test processed, at a gross margin of 80%. And they were selling to the other three competitors.
Two days later they added fuel to the fire by announcing an exclusive distribution agreement with Perkinelmer (NYSE:PKI) to accelerate market penetration of Verifi. Having these announcements rolled out during the prestigious JP Morgan healthcare conference clearly caught Sequenom off guard and in effect damaged the relationship beyond repair. This started a series of negative events that cratered the market cap of Sequenom.
The day before the Verinata announcement, Sequenom closed at $5.23 per share. Ten months later, the stock bottomed at $1.68 realizing a drop of 68%. There were many contributing factors to this decline, several likely more significant. They included:
- March 2013 Sequenom announced that they would have to delay filing their 10k due to internal control deficiencies and expected restatement of historical statements.
- May 2013 Natera announced a new round of venture funding of $54 million.
- July 2013 Sequenom released earnings that were well below expectations on both revenues and earnings. They placed the primary blame on CMS coding revisions and inadequate billing documentation at their contract billing service. Cash burn was well in excess of expectations, increasing the risk of a new dilutive cash raise.
- October 2013 a district court summary judgment was issued for Ariosa in their ongoing patent dispute.
- Repeatedly the company announced that they were further delaying the conversion to accrual basis revenue recognition.
Clearly this was a period of time that tested the mettle of the management team. They responded with substantive improvements to their operations. These changes included:
- Summer 2013 brought billing systems in house to improve controls and reporting which accelerate reimbursements.
- August 2013 laid off 75 employees as part of a company-wide effort to reduce discretionary spending by $13 million in 2014.
- September 2013 retained Jefferies to review strategic alternatives for the Bioscience segment in an effort to conserve cash.
- September 2013 stopped accepting samples from states where Medicaid reimbursement was not progressing.
- October 2013 filed Premarket 510(k) notification with FDA for IMPACT Dx. This was a company goal that had spanned almost two years.
- November 2013 released improved Q3 earnings that beat expectations for both revenues and earnings.
- January 2014 signed Nicox to an exclusive marketing and distribution agreement for their macular degeneration tests.
- January 2014 signed Mayo Medical network agreement for MaterniT21 Plus.
- January 2014 announced company goals that include becoming cash flow positive by Q4 2014.
- January 2014 announced that a low cost NIPT on a new platform would be available by Q4 2014.
- January and June 2014 signed two national coverage agreements that brought covered lives to over 140 million representing 100% increase from May 2013.
- May 2014 announced that there would be a partial conversion to accrual revenue recognition in Q2.
- June 2014 announced the sale of the Bioscience segment to Agena for approximately $35 million.
- June 2014 signed Quest to a distribution agreement, exclusive upon release of a new product in Q4. This agreement displaces Natera. The Quest territory includes Canada, Mexico and India.
- June 2014 received FDA clearance for the IMPACT Dx system.
- June 2014 both the CEO and CFO retired. Replacements were promoted from within. Since William Welch and Carolyn Beaver were announced as replacements, the company has appeared to be more decisive and open with respect to investor communications.
The stock has responded well to these actions by more than doubling over the past 8 months. Though fundamentally a more valuable company today, Sequenom is still well below the January 2013 valuation:
- The stock would need to appreciate another 45% just to complete the retracement. Should that be achieved, it would only represent a 25% premium to the price Illumina paid (with earn out) for Verinata. Market leadership demands a much greater valuation premium and Sequenom's market leadership has improved.
- The company will start the process of converting to accrual basis revenue recognition next quarter. That will accelerate cash flows and revenue recognition. Sequenom estimates there remains $42 to $46 million of unrecognized receivables that will eventually be recognized and collected. This was disclosed in the earnings relesase for the March 2014 quarter
- If the company goal of launching a low cost NIPT on a new platform by Q4 is accomplished, it will be a step toward increasing the total available market 5 fold. This represents the total annual birth rate in the US of 4 million compared to the high risk pregnancies estimated by the company to be 750,000. The global size of the NIPT market was discussed at length in this Market Outlook report.
- The infusion of $35 million from the sale of the Bioscience segment combined with improved free cash flow (March 2014 use of cash improved 69% compared to June 2013) have strengthened the balance sheet. Achievement of the company goal of positive cash flows by Q4 would virtually eliminate any risk of a dilutive equity or debt raise.
- The current quarter will have very favorable comps comparing to the June 2013 quarter.
- Natera will likely lose market share after the Quest displacement in Q4. The 8k filing by Sequenom discloses the exclusivity, conditioned upon the release of a "Future Testing Service".
- Ariosa attempted to source capital (preliminary S-1) but has had to delay. The delay could be due to the Labcorp (NYSE:LH) new contract that appeared to eliminate payments to Ariosa for low risk tests that were unreimbursed by payers. Ariosa is actively hiring sales and market employees to build a direct sales presence that had previously been provided by Labcorp.
The NIPT market is still in its infancy with many new chapters yet to be written. This chapter for Sequenom appears appropriately captioned: "A Reversal of Misfortune".
Disclosure: The author is long SQNM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.