The exact sciences will probably not escape consolidation in industry
Biotech stocks have collapsed in recent months. The implication is simple, in a tight credit environment, unprofitable businesses will need to focus on reducing cash burn, which will likely lead to consolidation.
Exact Sciences (NASDAQ: EXAS) is in this batch. The stock price has crashed more than 50% in the past few months. What was an expensive business trading at an inflated price/sales multiple is now much closer to a sober price.
The company is growing by nearly 20% per year. However, embedded in this multiple of thirteen times sales, there was an expectation of more revenue from new product offerings.
The overall conclusion of Exact’s earnings call was an earnings beat. However, under the hood, the sentiment is not so optimistic. The management team expanded their outlook for colon cancer blood screening, and they were very sober.
The management team compared the path of a possible blood test to the approval of Cologuard. Since the test will be less accurate than Cologuard, the company is unlikely to get an equivalent claim. They concluded by saying that it will be difficult to get doctors to order a less accurate test.
Also, the FDA tends to dislike performance degradation in new technologies. Even when they endorse less precise tests, they do so with a limited label. Basically, patients must first be offered other tests, and only after refusal can they be offered a less accurate one. Or, in other cases, only when the patient cannot complete the main test.
However, the main problem comes from the years of life gained. It is a measure in health economics that expresses the number of years a person gains after receiving a particular treatment. This measure is convenient because it puts the number on a middle ground and theoretically allows for apples-to-apples comparisons.
The problem is that this measurement puts a CRC blood test at a disadvantage. Basically, patients will have to take the test every year, which involves a price of between $100 and $200. Given the sequencing costs, this will be difficult to obtain in the medium term.
It goes a long way to say that a breakthrough product that can significantly accelerate revenue, like a blood test for colon cancer, is years away. As a result, the company’s primary revenue drivers will continue to be the Cologuard and Precision Oncology offerings. On the Cologuard front, we can expect progressive improvement in false positive rates and pre-cancer detection rates with Cologuard 2.0. However, this will not be a game changer and it will still take time.
The cold enthusiasm of the management team reveals that even for a multicancer early detection test, the road will be long. The company bought Thrive in 2021 because it already has a working version of the blood test. However, the headwinds in colon cancer blood screening should temper our enthusiasm for a multi-cancer test.
In the medium term, the company can only count on its current offers to ensure its growth. In the first quarter, revenues increased by approximately 20%. Do not expect much better than this in the years to come. If we add slower growth expectations to the debacle that has hit the genome space over the past year, then the time for consolidation has arrived.
We could see two possible outcomes: healthcare blue chips buying up small biotechs or small biotechs merging in order to scale up and create synergies.
Consolidation in industry
Arguably, the lack of faster growth and falling valuation (Exact is currently trading at 4x sells versus 13x at the top) makes the company a possible target. The Cologuard and Precision Oncology offerings are valuable segments, and the company should become profitable if it chooses to focus on these segments. Therefore, a large healthcare company might want to step in and add the two main revenue-generating offerings to their business while selling the cancer screening moonshots in exchange for cash.
On the other hand, the company could proactively seek companies that match their technology stack and market segments and pursue a merger to strengthen the strategic position. This might be pure speculation, but a few months ago Exact approached Invitae (NVTA) in order to explore a merger.
In my opinion, this is one of the most interesting possibilities. The current stock market performance of the two companies makes any fundraising highly dilutive. Therefore, both companies need to improve their respective cash burn rates. They will need to improve COGS, SG&A and R&D costs. The fact that there may be technology overlaps could help improve COGS. The ability to generate cost synergies from the SG&A and R&D structures is also very attractive. Something that could help make these companies cash flow positive.
The current tight monetary environment, coupled with the lack of breakthrough products, is a problem for Exact. The company’s current cash burn rate is an issue, especially in an environment where financing will be difficult to obtain. In my opinion, the solution for companies in this situation is to turn cash flow positive as soon as possible.
Since the problem is mostly on the OPEX side, companies like Exact need to move as fast as possible to dilute those costs. Absent a rapid growth engine, such as the colon cancer blood test, the company may have to turn to the M&A market. Revisiting a potential merger with Invitae may make a lot of sense given the technology overlaps and potential cost synergies. Finally, Invitae is now trading at historically low levels.
On the negative side, we have the typical difficulties of integrating two different companies and realizing the synergies. Additionally, Invitae is bringing in $1.5 billion in debt, while Exact is bringing in $2 billion, which could make a merger hard to stomach for two fast-paced cash-burning companies.