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Myriad Genetics is a molecular diagnostics company that we were introduced to during some due diligence our firm was doing on a well-known company called Quest Diagnostics (NYSE:DGX). At the time we were meeting personally with a representative with Quest. In our conversation this person mentioned Myriad and some of the intriguing products they had. We reached out to a contact of ours at Myriad. We have spent time scrubbing this idea. Our research is based on a company passing the “3M’s” test. The 3 M’s are 1) Mispricing; there has to be a reason or many why we believe a certain company is mispriced in the marketplace, 2) Moat; there has to be a significant barrier to entry to keep others who start to see an industry or company is doing well from just jumping in with little start-up cost, and 3) Management; their management team has to be solid and have demonstrated a high degree of integrity and honesty and a track record of being shareholder friendly. The companies we invest in here at Cush Capital have to pass muster with all three of these characteristics; not two out of three but all three! We believe that Myriad Genetics possesses all three of these and we will lay that case out here.
Overview:
Myriad Genetics, Inc., a molecular diagnostic company, focuses on the development and marketing of novel predictive medicine, personalized medicine, and prognostic medicine products. Their main product is called BRACanalysis. I say main because of the nine tests that they currently have in the marketplace, BRACanalysis constitutes over 90% of their revenues. They are at this point a one-trick pony although they do have eight other tests and a goal of bringing at least one test out a year going forward, not to mention acquisitions. They are also setting their sights on expanding overseas in late 2011 which is their 2012 fiscal year.
“At Myriad Genetics, this information (from their test) is derived from each patient’s distinctive genetic makeup using our proprietary molecular diagnostic products. Whether determining if a patient has a gene mutation implicated in hereditary breast cancer, alerting men to the potential of prostate cancer recurrence, or aiding a physician in achieving optimal dosing of a particular chemotherapy, Myriad supports patients and their caregivers with critical data to help prevent disease, delay the onset of disease, catch disease at an early stage, and treat disease in the most effective manner.”1
This paragraph from the 2010 Annual Report is important because we have a fundamental macro belief that we as a country have to do a lot of things better if we are going to control or at least slow down the cost increases that seem to be a foregone conclusion with health care costs in this country. Myriad Genetics is working to make the diagnosis doctors come up with more accurate, the medicine they do prescribe more efficient and the ultimate, trying to alert one to the fact that they have the genetic marker for a particular disease. In the case of breast and ovarian cancer, “if one has the predisposition of hereditary breast and ovarian cancer then they have an 80+% chance of getting it.”2
A few of the initial metrics we look at with any investment idea were mixed in the case of MYGN. They are as follows:
MC/LFCF = 1.96B/96.38MM= 20.34
OCF/MC= 140.98MM/1.96B = 7% FCF yield
OCF/EV= 140.98MM/1.60B = 8.8% ADJ
Cash on hand: $419MM; down from $494MM at the time of starting this write-up. According to IR rep they used most of that cash to buy back shares. On August 15, 2011 the company announced a $200MM stock repurchase program: http://investor.myriad.com/releasedetail.cfm?ReleaseID=599414
Debt: 0
Insider ownership and insider buying: 1.68%
Beta= .13
P/B= 3.72
As you can see, the numbers are mixed from a value investor’s standpoint but we continued to be intrigued in our research as we moved to thinking about the “3M’s.” An interview we watched with Peter Meldrum, the founder, CEO and President, being interviewed by Dr. Charles Duncan from JMP Securities http://www.biobusiness.tv/uncat/mygn-myriad-genetics-ceo-peter-meldrum-interviewed-by-charles-duncan-500/ kept our interest as he talked about the potential they saw with their one product, let alone the other eight they have; several of those being relatively new tests that take time to ramp up. Educating physicians, especially on preventative tests, has proven to be a slow process.
This will take further explanation but the following numbers are just for one product, BRACanalysis, and just for the preventative piece of their thesis, not even including the oncology piece. Peter Meldrum stated “there are 156MM women in the US; 4% have a hereditary predisposition for breast and ovarian cancer making the market opportunity 6.5MM women. At roughly $3000/test this gives that product a $20B market opportunity. They think they can penetrate that market over a 30 year period for an annual market opportunity of $600MM.”
This caught our attention as the trailing twelve month revenue for the entire company was only $388MM. He was talking about a market opportunity over 65% bigger than their entire company and this was for one product, in one market, in one segment of their business in one year. We needed to keep digging.
Let’s get to the “3 M’s”:
M1: Mispricing:
The ACLU had a pending case against Myriad which was actually settled on July 29, 2011. This case had been called by some analysts “the 800-pound gorilla in the room” which subsequently we calculated should not pose much of an impact on MYGN, especially in the long run, if they were to lose this case which they did not. The case was settled positively for Myriad on July 29th but because of the uncertainty and negativity surrounding the stock market at this time MYGN did not get the pop in price that we thought would inevitably happen if they did win the case. Standard & Poor’s subsequently downgraded the AAA credit rating of the United States to AA+ on August 2nd so a ruling like this on a company not well followed has gotten “lost in the shuffle.” The ACLU filed this case against Myriad and other companies that try to patent genes. Mr. Meldrum called this an “important and probably a landmark case.” The ACLU thought that companies should not be able to patent genes because genes are a product of nature. Mr. Meldrum states that “Myriad did not invent the gene but what they did was to find out what the gene did and how you can use that medically to benefit people.” Over 3000 gene patents have been granted so far to several companies.
Myriad has 23 patents around their breast cancer test but the ACLU case only involved 7 of those patents and they were only challenging those claims that go to an isolated DNA sequence. Only 15 out of the 179 claims were being challenged. Correctly he thought the ACLU case would be struck down because intellectual property protection rights are so key to so many companies here in America. These rights are so crucial, especially for small companies because they need patent protection to allow them to grow and to get funding. Myriad holds patents on isolated DNA that it says holds genetic clues to treating diseases such as breast cancer. Last March, a federal judge in New York determined that our genes can’t be deemed intellectual property by a company, (http://www.aclu.org/files/assets/2010-3-29-AMPvUSPTO-Opinion.pdf, summary begins p.94) and he struck down some of Myriad’s patents related to breast and ovarian cancer. So Myriad lost the case but had appealed and that decision is the one they just won. The following is a link to the press release: http://investor.myriad.com/releasedetail.cfm?ReleaseID=595288. We determined that the hit to revenues were going to be negligible to their bottom line and/or their reputation; again because of the number of patents involved and the number of claims involved. The justices agreed June 20, 2011 to hear an appeal from the Mayo Clinic, which is challenging a lower court decision backing two patents for determining the dosage of medicines to treat stomach diseases. The ruling cleared the patents’ owner, Prometheus Laboratories Inc., to press an infringement suit against two Mayo units. You can read more about this here: http://www.supremecourt.gov/Search.aspx?FileName=/docketfiles/10-1150.htm
Myriad has the size and many competitive advantages because of the patents that they already have. They have an infrastructure that allows for their test to have a faster turn-around time (actual numbers talked about later) and to be more accurate (again, I’ll talk about this later). Myriad has a very good reputation in the oncology market. They also file all of the insurance paperwork for patients who want to use the BRACanalysis test.
More mispricing could come from the fact that Wall Street may have grown weary of the growth projections from Peter Meldrum. This company took 16 years to start to make money. We can only imagine what the original road shows sounded like and the subsequent years of promises that they would make money. We put that question to Rebecca Chambers, the Director of IR and Corporate Communications for Myriad. She proceeded to give us a brief history of the company which explained the reasons for the slow start. The story is long and drawn out so I won’t include it here but have added a snippet of that story at the end of this write up. Suffice it to say that the story seemed very plausible. The bottom line is that it took longer than they thought, a lot longer, but now they have a product with a potential market size 50 times the market size of MYGN and they are patent protected. Once they had developed the tests (the products) then they needed to develop the market. Myriad did this by educating physicians on what they had discovered and how it could medically benefit patients. I stated the growth projections earlier from Peter Meldrum so if we put a “margin of safety” on those projections with what they are doing now, this represents a great opportunity.
The next reason for mispricing could simply come from the fact that no one knows exactly how Obamacare will affect companies like Myriad. No one is sure if there will be downward pressure on diagnostic testing pricing, especially for one of the smaller companies in this space. The way the company feels about that issue is that with their longstanding history in this oncology market, along with the fact that their tests are currently covered by every major insurance plan including Medicare and Medicaid, they think that Myriad will actually flourish in this environment. With healthcare costs skyrocketing, Myriad, with its preventative tests, should be able to save the healthcare system countless dollars.
The next worry is that the oncology market for their main product has matured. That may be true but with that they are only 50% penetrated in that market. This is a reason that they are ramping up in the obstetrics/gynecology (ob/gyn) market. They currently have 165 reps and are looking to increase that to 225 or so. They need that many to visit and cover every ob/gyn in the country. They are only 10% penetrated in that market. We will closely monitor the expenses that are surely to grow from expanding out the sales force this quickly. One of the items we uncovered with respect to the oncology market was a product called OnDose. This was slated to be the next big product development. From the website, OnDose testing evaluates 5-FU exposure for patients undergoing continuous infusion 5-FU chemotherapy. OnDose allows physicians to make a pharmacokinetic determination of the Area Under the Curve (AUC) for each infusion cycle and provides insight to help the physician proactively adjust and optimize dosing to optimize efficacy and reduce toxicity. If you know someone who has had side effects related to chemo then you can understand that finding the right dose is a huge part of the battle. This product can really help with quality of life.
Our last item on our mispricing list comes from new reimbursement code changes that are coming up in 2012 or 2013. The reimbursement issue in Washington, with the AMA (American Medical Association) and the CPT needs some further discussion. CPT (Current Procedural Terminology) codes are numbers assigned to every task and service a medical practitioner may provide to a patient including medical, surgical and diagnostic services. They are then used by insurers to determine the amount of reimbursement that a practitioner will receive by an insurer. Since everyone uses the same codes to mean the same thing, they ensure uniformity. The CPT/CMS (Central Medicare Services) is changing the way they will be reimbursing for diagnostic testing. Instead of co-stacking or having a random way of billing, which is what is currently being done, they are going to be giving a code for each test. In the hope of understanding better what they are paying for; not to cut costs though. The codes have been set but unclear to when the timing of when the switchover will happen; that is the uncertainty. This change was expected to happen in 2012 but looks like it will be 2013. AMA is setting the code but CPT is setting the reimbursement rate for CMS (Medicare). This is only 10% of Myriad’s business. Wall Street is focused on this uncertainty but it is only a small percentage of their revenues. This is definitely an issue that is an overhang as Myriad is virtually, for now, a one-product company. We will be watching this issue closely but feel comfortable with it for now.
M2: Moat:
The moat for this business is pretty clear cut so I won’t belabor it here. This is a company that has multiple patents on each of its products. They own or have exclusive license rights to 24 issued U.S. patents relating to BRAC Analysis testing. These U.S. patents have terms that are expected to expire commencing in 2014, with the last patent expected to expire in 2028. They have been building a reputation in the oncology market over all of these years and they also have a strong relationship with the AMA and the CPT/CMS. Each of these takes years to develop. A great example of this is because of their work with the insurance companies and BRACanalysis, their contracts automatically cover any other tests that come from Myriad, from day one. So, from day one of any new product, it is already covered for over 100MM lives. It should also be noted that Myriad has more covered lives, over 100MM, than either Quest Diagnostics or LabCorp, the two largest laboratory-testing companies in the country.
M3: Management:
Although the progress with this company since its inception in May of 1991 has been slower than anyone imagined it would be; the founder of the company, Peter Meldrum, is still running this company and is a top 20 shareholder (we think he should be higher but…).
Although there isn’t a lot out there about this management team we have surfaced a couple of interviews with Mark Capone and also Richard March, their general counsel. Both seem extremely competent and have good reputations within the rank and file with the company. Our contact had some very good things to say about Mark Capone. They mentioned that he was “the real deal” and “that they would follow him wherever he was to go if he ever left Myriad.”
A link to the bios from the company website has been included here: http://investor.myriad.com/management.cfm
For those that are really in to this I have included a link to their Board of Directors which also seems to be a strong group: http://investor.myriad.com/directors.cfm
Some additional notes of interest that add to the case are listed below. There is so much to this story that it warrants some extra discussion beyond the 3 M’s:
· According to the National Cancer Institute, patients diagnosed with early stage cancer have more than a 90% change of surviving for five years while patients diagnosed with later stage cancer have less than a 30% chance of five year survival. This data underscores the need for early detection and early intervention in cancer.
· Myriad is aiming at establishing itself as a strong player in the companion diagnostic market. In April 2011, the company entered into an agreement with BioMarin Pharmaceuticals to conduct BRCA1 and BRCA2 mutation testing on patients to be enrolled in the latter’s phase I/II clinical study of BMN 673. To establish Bracanalysis as a companion diagnostic for PARP inhibitors, Myriad has also got into agreements with Abbott Laboratories and AstraZeneca.
· A recent acquisition of Texas based, privately-held Rules-Based Medicine (RBM) for $80 million in cash. This deal would expand the company’s portfolio to take into its ambit psychiatric disorders, infectious diseases and inflammatory diseases. According to Myriad, apart from strengthening its strong oncology pipeline it would also have access to RBM’s pipeline that includes tests for anti-psychotic drug safety, hepatitis C drug response and detection of kidney damage in diabetes patients. RBM’s most advanced product under development is in the neuroscience area – VeriPsych that assists physicians in identifying schizophrenics from normal individuals.
· The European molecular diagnostics market size is about 75% of the US market. Moreover, many US based diagnostic companies derive 30%−50% of overall revenue and profit from international operations. Based on these facts, Myriad is looking at establishing a European presence by early 2012. The company expects to initially target opportunities in Germany, France, Italy, Spain and Switzerland. The company conducted a market survey of 207 key persons and oncologists across the five targeted countries and found their response for the clinical value of the Bracanalysis, Colaris, Prezeon, OnDose and Prolaris products to be positive. So Europe is currently doing, in the 5 countries that Myriad has targeted, around 25-30K BRAC tests, just on the oncology side. There is not a commercial company doing these tests; the market is fragmented; they are doing testing in university and national laboratories, etc. Their turn-around time is slow; it takes them 6 months vs. Myriad’s 7-10 days. They don’t get an answer 30% of the time, vs. 2-3% for Myriad. So, partnering with them to get them better information is important. These university and national laboratories don’t make money on the test so it doesn’t change their financial outlook at all; no incentive for them. Furthermore, the OB/GYN side of the market is totally untapped. There is no asymptomatic or preventative testing being done in Europe today. So, those two reasons are why Myriad is excited to enter the market for BRACanalysis. The second reason is the pipeline of products they have in development. So, by going in to Europe today and building those relationships today, as that pipeline comes through, Myriad will have another distribution channel besides the US. Last summer Myriad hired Gary King from Biosite to run and develop the business. He did the same thing there quite successfully. He has the relationships and the experience and he is implementing a plan. The plan is to have a lab based in Munich which needs to get accredited. That should be complete first calendar quarter next year. They are also setting up a European HQ in Switzerland. They will have sales, marketing and clinical affairs individuals in each of the 5 countries. Those 5 countries are France, Germany, Switzerland, Italy and Spain.
Risks and Challenges:
The big overhang on this stock had been the ACLU case which I talked about. The other big uncertainty for a company like this that relies on insurance reimbursements for a large percentage of their revenues is Obamacare. How will this affect a company like this? Our thought is that a company that is in the business of saving the healthcare system money in the long run will be sustained through this, if not actually flourish. Another worry for this company is that the majority of their revenue currently comes from one product. We did not cover it here but the company has 8 other tests, along with a few other products that can go a long way to adding substantially to their revenues. They have an internal goal of adding one new patented-product per year going forward. They have tests for prostrate, breast and ovarian and colorectal cancer just to name a few. With the unfortunate growth in the number of cancer cases every year this bodes well for Myriad. We spoke a lot about their plans for a European expansion but with the instability in Europe this could cast a shadow over their expansion plans. Again, with the superiority of their product versus others currently in Europe we feel like this expansion will still be a good thing for Myriad. One last risk we worry about is the possibility that a competitor could come up with a significantly better test once specific patents related to their BRACanalysis product start expiring in 2014. We feel this is a very remote possibility, but still a risk.
Conclusion:
Myriad Genetics clearly passes our 3-M’s test. When we originally started working on this write up, July 8, 2011, the price is hovering right around 23. Our analysis tells us that the company is worth north of 30 and that in order to satisfy our margin of safety we should buy it at around 18. With the volatility in the market over the last couple of weeks of August we were able to establish a position in this company for less than our 18 buy price. Patent protection through 2028 gives MYGN's BRAC analysis a monopoly position in a market that (by company estimates) could be worth $20B. That is over 50x MYGN's market cap. They currently trade at an EV/EBITDA multiple of 7.6x; -- a dramatic discount to their peer group. Even our pessimistic viewpoint yields a price target of $22. Throw on an overly-bearish margin of safety, and we think investor's will be well served by buying at or near today's price of $18 and change.
