Check-Cap Ltd. (NASDAQ: CHEK), which produces the first preparation-free ingestible capsule for colon cancer screening, has been in business for 13 years, obtained CE Mark approval for its C-Scan system, inked a manufacturing contract with GE Healthcare, is debt free, and is projected to be less than a year away from commencing sales of a potentially game-changing product that has the potential to generate hundreds of millions in sales annually. Yet CHEK trades at 74% of last quarter’s net cash, implying that the market is ascribing a negative enterprise value to the company, a phenomenon that occurs infrequently.
CHEK’s C-Scan system uses ultra-low dose X-ray capsules to instantly create a 3D map of the colon, allowing doctors to identify cancerous and precancerous polyps. Many alternatives exist in the $25 billion colon cancer screening market, but none of them are effective in both detecting precancerous polyps and circumventing laxative bowel preparation. This opens up a significant potential market opportunity for a product like C-Scan.
Exact Sciences (NASDAQ: EXAS), is a $7.25 billion company that produces Cologuard, a non-invasive stool-based DNA screening test that utilizes a multi-target approach to detect colon cancer and precancerous polyps. Despite Cologuard’s significant success in the past 3 years, the product has some glaring flaws including low detection rates of serrated sessile polyps measuring 1 cm or more and elevated false positives that must be followed up by aggravating colonoscopies. Also, Exact Sciences acknowledges that, “For the foreseeable future, our ability to generate revenues will depend almost entirely on the commercial success of our Cologuard test.” Given Exact Sciences’ slowing growth rate and dependency on a single product, the company should focus on making acquisitions with its >$1 billion of cash and marketable securities to expand its pipeline.
Check-Cap is on track to commence sales of C-Scan in the first half of 2019, and several upcoming catalysts could propel the stock much higher starting with interim results on the company’s EU post approval study for C-Scan Version 3. Given the growing market for capsule endoscopy and C-Scan’s potential to generate strong sensitivity results without requiring bowel preparation, the company could generate $60 million in sales and attain a $480 million market cap by 2020. This would yield a stock price of $54, which is >16X CHEK’s current share price.
Exact Sciences should consider acquiring Check-Cap now. Assuming Exact Sciences were to take over Check-Cap, it could yield in excess of $1 billion in additional market cap within the next two years assuming that Check-Cap is able to generate the sales figures referenced above. This works out to $114 per CHEK share in value that would accrue to EXAS assuming full dilution from Check-Cap’s Series C warrants.
Colon Cancer Screening Market & Exact Sciences’ Cologuard
Colon Cancer is the third most common cause of cancer worldwide. Most cases of colon cancer evolve from small, noncancerous clumps of cells called adenomatous polyps. Polyps may be small, and in many cases they do not produce symptoms. Colon cancer can take up to 10-15 years to progress from a precancerous polyp to metastatic cancer and death. Patients who are diagnosed early though the identification of precancerous polyps or early-stage cancer are more likely to have a complete recovery. Hence the American Cancer Society recommends that all people age 50 and older undergo regular colon cancer screening.
The colon cancer screening market generates $25 billion in annual sales, with 35 million patients a year being tested. Approximately 38% of eligible adults, however, are not up to date with their colon cancer screening according to a CDC NHIS survey, and studies indicate that certain requirements of colon testing, such as laxative preparation, are considered obstacles by prospective patients.
There are a host of tests that detect colon cancer, but all of them have significant drawbacks. Colonoscopies are the most common screening test in the U.S. for colon cancer. They involve the insertion of a flexible tube, or colonoscope, into the rectum. There is a camera at the end of the colonoscope, enabling visualization of polyps. Though colonoscopies are generally perceived as the gold standard for colon cancer screening given their high sensitivity in identifying polyps, there are challenges associated with the perception of colonoscopies as being invasive and painful procedures.
Patients undergoing colonoscopies are sedated and need to take a day off for the procedure. Some patients cannot tolerate the pain, or they may react poorly to sedation. There is a paucity of endoscopists in many regions, and high patient costs in some plans result in a meaningful gap in colonoscopy usage among uninsured individuals. Colonoscopies also involve a risk of bowel tears or infections. Colonoscopies can miss some polyps, especially flat ones, referred to as sessile adenomas, from which 20% to 30% of colon cancers are believed to originate, and inadequate bowel preparation is often responsible for such failures. Given these problems associated with the gold standard of colon cancer screening, uptake is low compared with the high attendance rates of other cancer screening programs, such as those for breast and prostate cancer.
Stool screening tests are a somewhat effective alternative in detecting colon cancer. Fecal Immunochemical Tests (NYSE:FIT), which use antibodies to detect blood in a patient's stool that cannot be seen with the naked eye, are a common screening choice in many areas of the world. These tests often generate false positives, however, from hemorrhoids, anal fissures, or menstruation. While the FIT is a low-cost option, it needs to be repeated every year.
An increasingly popular option that has exploded onto the colon cancer screening scene in recent years is a non-invasive stool-based DNA screening test that utilizes a multi-target approach to detect DNA and hemoglobin biomarkers associated with colon cancer and pre-cancer. The only commercial product in this category is Exact Sciences’ Cologuard, which was approved by the US FDA in 2014 for screening of asymptomatic persons at average risk for colon cancer. Exact Sciences has made Cologuard seamless to use from the patient’s perspective. Providers order the test directly from the lab, and a collection kit is mailed from the lab to the patient’s home. The patient then collects stool in a container conveniently mounted on a toilet and mails it back to the lab using a prepaid air-bill.
In a large study with approximately 10,000 patients, Cologuard demonstrated 92.3% sensitivity in detecting colon cancer compared with 73.8% with FIT. Previous stool based DNA tests demonstrated only fair sensitivity for the detection of colon cancer and advanced adenomas, but Exact Sciences incorporated important advances, including the use of a stabilizing buffer, more sensitive analytic methods and more discriminating markers to significantly improve results. In 2015, the first full year in which Cologuard was commercially available, Exact Sciences generated $39 million of sales. Two years later, the company’s revenue soared to $266 million, capturing more than 1% of the global colon cancer screening market.
In spite of Cologuard’s success, however, the product has significant flaws. In its large multicenter study, for example, the rate of detection of serrated sessile polyps measuring 1 cm or more was only 42.4%. Hence the sensitivity of Cologuard for the detection of advanced precancerous lesions was approximately half that for the detection of colon cancer. Also, Cologuard’s false positives, which ranged from 10.2% to 13.4%, are significantly worse than those of FIT, which ranged from 3.6% to 5.1%. This means that up to 13.4% of patients tested were incorrectly diagnosed by Cologuard as having potentially cancerous polyps. As Dr. Bennett Roth, a professor of gastroenterology at UCLA, noted, "Maybe if you get a positive test with Cologuard, you'd be convinced to have the more definitive test. It doesn't replace the need for a colonoscopy."
Check Cap’s C-Scan
A novel screening alternative involves swallowing a video capsule, enabling direct visualization of colon polyps. Conventional capsule endoscopy, however, requires the same laxative bowl preparation as a colonoscopy. But unlike a standard colonoscopy, the pill capsule system is painless and requires no anesthesia. Patients do not have to take a day off or arrange for a driver to take them back and forth for the test.
In 2001, Given Imaging Ltd. launched its revolutionary PillCam COLON, a vitamin-sized capsule endoscope that is taken orally and directly visualizes the colon for the evaluation of polyps in patients who are at major risks for colonoscopy or moderate sedation. In February 2014, Given Imaging was acquired by Covidien plc. Covidien was subsequently acquired by Medtronic plc (NYSE: MDT).
At first, PillCam was cleared by the FDA for the detection of colon polyps in patients following an incomplete colonoscopy with adequate preparation where a complete evaluation of the colon was not technically possible. In 2016, however, the FDA provided PillCam with an expanded indication for patients who are at major risk for colonoscopies or moderate sedation. At around $500, PillCam costs less than a colonoscopy, which can run $800 to $4,000 or more, and it is nearly on par with Cologuard.
One of PillCam’s primary deficiencies is its failure to address what is arguably the most significant impediment to colon cancer screening, the requirement for bowel preparation. A clean colon is required to accurately image a patient’s colonic mucosa, and unfortunately PillCam is unable to suck or wash the mucosa.
Check-Cap Ltd. is a clinical-stage diagnostics company engaged in the development of C-Scan, the first ingestible capsule for colon cancer screening that does not require any advance preparation. The company was founded 13 years ago and went public in the US in 2015. Check-Cap is headquartered in Israel, and the company has a research and development team of experts in a range of fields including physics, algorithms, software, hardware and clinical science.
The C-Scan capsule uses ultra-low dose X-rays to generate images of the contours of the inside of the colon, which it passes through naturally. A patch is worn on the patient's back to track and record data, which is used to create a 3D map of the colon. This map allows physicians to easily look for polyps and other abnormalities without conducting an intrusive procedure.
C-Scan enables patients to circumvent laxative bowel preparation and sedation. In approximately 20% of cases using existing colon cancer screening tests, the standard bowel preparation is deficient, potentially precluding optimal diagnoses. Unlike the optical imaging embodied in PillCam, C-Scan uses X-rays that penetrate the colon contents, enabling it to map the inner topography of the colon surface irrespective of whether stool is present in the colon.
After 13 years of product development, C-Scan is finally approaching commercialization, and the company believes that sales are on track to commence in the first half of 2019. There are a plethora of upcoming catalysts over the remainder of 2018 that are likely to place Check-Cap more squarely on the radar screens of companies like Exact Sciences and Medtronic as an acquisition target.
On January 9, 2018, Check-Cap received CE Mark approval for C-Scan, indicating conformity with health, safety, and environmental protection standards for products sold within the European Union. In order to commence sales in Europe, however, the company will now be required to obtain applicable regulatory approvals in each country within the European Union.
Check-Cap completed a multi-center study of the C-Scan system in September 2017 in support of its CE Mark submission. The trial enrolled 66 patients, and no advance preparation was required. The study demonstrated a 44% sensitivity in identifying polyps accurately. This compares favorably to the sensitivity for advanced adenomas by stool tests, which demonstrate sensitivity ranges of 22% to 40%.
Embedded within C-Scan’s trial data, however, was a strong correlation between sensitivity and the percentage of the colon scanned (R-squared = 0.98). In 12 of the 66 procedures, for example, scan imaging density exceeded 70% and the corresponding sensitivity was 100%. In 19 procedures for which scan imaging density was greater than 50%, sensitivity was 78%. The C-Scan trial also yielded strong safety data, as the capsule passed safely from mouth to rectum and radiation exposure was equivalent to that of one chest X-ray or approximately 1/200th of a CT scan.
At the end of 2017, Check-Cap initiated a clinical study for its C-Scan system Version 3, which incorporates improved algorithms to enhance colon coverage. Based on the study’s evaluable results, Check-Cap already reported that C-Scan Version 3 demonstrated significant improvement in average colon imaging coverage compared with the C-Scan version used in the CE Mark study. In March of this year, Check-Cap reported interim clinical study results of C-Scan Version 3 with evaluable results of 21 patients that showed average colon imaging coverage of 64%, a whopping 40% improvement over the 46% average colon imaging coverage in its CE Mark study. Recall that sensitivity in the CE Mark trial was 78% (p<0.05) for subjects with greater than 50% colon imaging coverage and 100% (p<0.05) for subjects with greater than 70% colon imaging coverage. Hence it is highly likely that C-Scan’s impending sensitivity results that are expected to be reported this quarter will be significantly improved. This could not only be an important catalyst for Check-Cap’s stock price but also an impetus for Exact Sciences and Medtronic to scramble to acquire the company. C-Scan could soon emerge as the only high sensitivity colon cancer screening procedure that detects both cancerous and precancerous polyps accurately and does not require advance preparation.
Check-Cap submitted an application to register the C-Scan system for marketing and sale in Israel in February, and the company expects to begin selling the product in the second quarter of 2019. Check-Cap also anticipates launching its C-Scan system in Europe next year. The company has already conducted pre-submission meetings with the FDA, and it intends to initiate a pilot study in the U.S. this year. In November 2017, Check-Cap inked a collaboration with GE Healthcare in which GE will facilitate final assembly, packaging and shipping of C-Scan capsules to support the company’s U.S. pilot trial this year.
Like Exact Sciences, Check-Cap also has a pipeline of potential products utilizing its existing technologies. Such applications include localized drug delivery capsules, gastro intestinal motility diagnostics capsules, and small bowel video capsules that could compete with PillCam small bowel (NYSE:SB).
Potential Acquisition of Check-Cap by Exact Sciences
Exact Sciences’ mention of Check-Cap’s C-Scan as a primary competitor to Cologuard in its 2017 10-K makes it evident that Check-Cap is on EXAS’ radar screen:
Our Cologuard test faces competition from procedure‑based detection technologies such as flexible sigmoidoscopy, colonoscopy, and “virtual” colonoscopy… and newer screening technologies such as pill-based imaging solutions like PillCam COLON, cleared by the FDA in February 2014, and C-Scan, which recently obtained a CE Mark.
Exact Sciences sports a $7.25 billion market cap, which was achieved exclusively through the explosive sales of a single product, Cologuard. Despite Cologuard’s significant success in the past 3 years, however, the product has some glaring flaws including low detection rates of serrated sessile polyps measuring 1 cm or more and elevated false positives that must be followed up by aggravating colonoscopies. Also, Exact Sciences acknowledges that, “For the foreseeable future, our ability to generate revenues will depend almost entirely on the commercial success of our Cologuard test.” Given Exact Sciences’ slowing growth rate and dependency on a single product, the company should focus on making acquisitions with its $1 billion of cash and marketable securities to expand its pipeline.
Cologuard is a revolutionary solution for colon cancer screening, but its shortcomings may ultimately limit the product’s potential penetration. A total of 34 detailed reviews on Highya, for example, yielded only 2 out of 5 stars, as patients complained about denied claims, false positives resulting in “a nerve wracked six weeks” and unnecessary follow-up colonoscopies, a lack of transparency on test result details, and discomfort in filling a container with stool. If Exact Sciences acquires an alternative like C-Scan to market to patients and physicians, it could result in significantly increased sales for the company. Exact Sciences has built a brilliant marketing machine that it could plug C-Scan into.
Even with strong impending sensitivity results, C-Scan, like Cologuard, will not be the preferred solution for all patients. Some people, for example, may be averse to any solution that encompasses radiation. That being said, over 70 million CT scans are conducted in the U.S. each year and C-Scan has ~0.5% of the radiation of a CT Scan. If C-Scan were to attract just 1% of the global colon cancer screening market, Check-Cap could generate $250 million in revenue, comparable to that which Cologuard generated in 2017.
To project Check-Cap’s potential sales trajectory of C-Scan, it could be instructive to refer to the progress of Given Imaging prior to its acquisition by Covidien. In 2001, Given Imaging received Ministry of Health approval for PillCam SB in Israel. That year, the company was also granted approval for marketing PillCam SB in the EU and Australia. In the second half of 2001, Given Imaging generated its first sales, and in 2002, the first full year in which PillCam was sold, the company grew revenues significantly to $29 million. This is especially impressive given that capsule endoscopy was a brand new field with very limited awareness. In 2014, Covidien acquired Given Imaging for $860 million net of cash. The acquisition valued Given Imaging at 4.78X the $160 - $200 million in annual sales Covidien expected to immediately attain from the acquisition.
The capsule endoscopy market and corresponding reimbursement paradigm is much more advanced today than it was in 2001. Also, unlike PillCam COLON, C-Scan circumvents bowel preparation requirements and could soon be confirmed to detect precancerous polyps much more effectively. Lastly, PillCam’s success since its launch 17 years ago (primarily in small bowel screening) has resulted in capsule endoscopy having become a common screening option, and the number of U.S. patients with reimbursement coverage for capsule endoscopy has grown significantly since then. Hence it is reasonable to believe that Check-Cap’s C-Scan sales could scale more than twice as quickly as Given Imaging’s PillCam did since it launched its first product. This analysis yields potential sales for Check-Cap of more than $60 million in 2020. As a more recent frame of reference, Cologuard generated $26.5 million in sales in the first four quarters since the product launched, and it exceeded a $100 million annualized run-rate in the first 8 quarters since launch. In 2017, Cologuard’s sales jumped to $266 million.
If Exact Sciences were to ascribe an 8X revenue multiple to an estimated $60 million in 2020 sales for Check-Cap, this would yield a $480 million valuation and price target for CHEK of $54 per fully diluted share (which assumes full exercise of the Series C warrants), more than 16X CHEK’s current share price. Note that an 8X price/sales multiple is nearly double that at which Covidien acquired Given Imaging, but it is less than half that at which EXAS currently trades. Check-Cap’s C-Scan has notable advantages over Given Imaging’s PillCam, and by the time Covidien acquired Given Imaging, the acquiree’s revenue was approaching $200 million and its growth had slowed notably.
There are several reasons for which CHEK currently trades far below the price target articulated above. The company completed a $20.2 million public offering in May 2018, increasing its outstanding share count by >300%. Each share was purchased at $5.50 with a warrant attached that strikes at the same price. With the massive increase in CHEK's shares outstanding, lots of supply has deluged the market with little news flow to support the stock since then. The stock plunged almost 80% from its high in April as a result of the selling pressure and dilution from the offering. The offsetting positive development from the stock offering is that Check-Cap has ~$4.27 per share of net cash based on the current share count (and no debt).
Also, Check-Cap’s sensitivity results from its original CE Mark Study, while encouraging, were not great in aggregate. It was the dissection of the results in conjunction with the subsequent reported improvement in C-Scan's algorithms and colon coverage that was very exciting. The company, however, is underfollowed and covered only by a single low tier brokerage firm; so there probably weren’t many market participants who took the time to thoroughly analyze the data presented. Like many clinical stage biotech and medical devices companies, valuations can remain well below rational levels until catalytic events convince the market that their products are commercializable. For CHEK, it is likely that such an event will finally occur this quarter.
Assuming a $60 million sales projection in 2020 for Check-Cap is accurate, even a $54 per share acquisition by Exact Sciences would could generate significant upside for EXAS shareholders. Firstly, at EXAS’s current price/sales multiple, $60 million in sales would accrete in excess of $1 billion, more than double the suggested acquisition price of CHEK, to the company’s market cap. Secondly, such an acquisition could yield multiple expansion for EXAS, as it would significantly enhance the company’s pipeline.
Exact Sciences should consider acquiring Check-Cap before Medtronic targets the company. Assuming that C-Scan Version 3’s sensitivity and specificity in the upcoming EU post-approval study results are as encouraging as I expect, Medtronic could soon conclude that C-Scan is superior to PillCam. This development could threaten Medtronic’s leadership position in the capsule endoscopy market. Medtronic generates approximately $4 billion in annual net income, and if the company decides to spend just one month of net income to purchase Check-Cap as a defensive measure today, it would imply a fully diluted price per in excess of $37 per CHEK share.
EXAS is a great company, but it trades at 17X sales and is reliant on a single product. This product, while very successful, has a host of flaws and poor patient reviews. As Cologuard’s sales have soared, the company’s growth has been slowing from parabolic levels. If the company is unsuccessful in diversifying its product offerings or launching new successful commercial applications outside of colon cancer screening, the stock could decline significantly from current levels.
CHEK is a clinical-stage medical diagnostics company that has no current revenue and is burning through ~$2.5 million per quarter as it moves towards commercialization of C-Scan. Poor trial results or any hiccough in the final sprint towards commencing sales of C-Scan early next year could have a significant adverse effect on the share price. The stock is illiquid, and there may be additional selling pressure from shareholders who purchased shares in the May offering. Although the company’s $4.27 per share of net cash should provide support, the stock already trades significantly below this level and irrational selling pressure could cause it to decline further.
Disclosure: I am/we are long CHEK.
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.