LUMINEX CORP LMNX S
March 15, 2019 - 10:41am EST by
AtlanticD
2019 2020
Price: 24.23 EPS 0 0
Shares Out. (in M): 45 P/E 0 0
Market Cap (in $M): 1,086 P/FCF 0 0
Net Debt (in $M): -76 EBIT 0 0
TEV ($): 1,010 TEV/EBIT 0 0
Borrow Cost: General Collateral

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Description

EXECUTIVE SUMMARY

 

  • LMNX’s two primary businesses:
    • Licensing Technology Group (LTG) – primarily licenses its “multiplex” diagnostic technology to partners that sell into large reference labs; [1] [2]  
    • Molecular Diagnostic (MDx) [3] – sells automated and non-automated assays mostly to hospital inpatient settings for the testing of blood, respiratory, and gastrointestinal infectious disease.
  • In its fastest-growing MDx business, LMNX faces intense competition from BioFire (part of Biomerieux SA), with newer entrants about to enter the fray.
  • In its other MDx business, LMNX will have lost ~$48mm higher-margin revenues from Labcorp through YE19, with potential for $13mm in further losses.
  • In LTG, its revenues are “flat to declining” due to aging technology, competition from newer protein research advancements, and lower-margin automated MDx testing cannibalizing immunodiagnostics.
  • These headwinds are pressuring LMNX’s gross margins and organic sales growth.
  • Further, LMNX could be pulling forward revenues and could suffer from full distribution channels.
  • And yet, investors assign a “growthy”-healthcare ~3.5x EV/Sales multiple on rosy expectations (based on hope that new equipment launches in late ‘19 and ’20 will resume DD growth).
  • These launches are mere R&D “catch-up”, and competition will win the day.
  • Beyond a reset lower in earnings, LMNX’s lofty EV/Sales multiple also stands to re-rate lower, once the expected growth fails to materialize.

 

Background

 

Business:

 

LMNX makes and sells biological testing technologies used in various life sciences applications.

 

Products:

 

Licensing Technology Group – LTG ( $149mm in ’18 Revs):

 

Royalties and Consumables (Gross Margins ~100%):

  • LMNX’s “multiplexing technology” (i.e. xMAP), which it licenses out. This technology can generate multiple results by analyzing both proteins and nucleic acids from a single sample within a single test.
  • Used primarily for genetic and respiratory tests, primarily in large reference labs. These are lower volume tests that can take many hours to perform.
  • Used in protein research (~40% xMap revs), transplant diagnostics (40%), and immunodiagnostics (20%).

Systems and other (Gross Margins ~45-50%):

  • Sales of its Luminex 100/200; FLEXMAP, and; Magpix Systems.

 

Molecular Diagnostics – MDx[4] ($164mm in ’18 revs):

 

  • xTAG/NxTAG (“Other MDx”, or LMNX “non-S2A” MDx portfolio; Gross Margins ~45-50%):
    • Non-automated technology used in respiratory & GI tests.
    • These analyses can take up to 18 hours to perform, and are primarily used by large reference labs.
    • Also includes the CF genetic testing both for Labcorp and non-Labcorp customers (rev. we believe is going away).
  • VERIGENE (vast majority of “S2A” portfolio; Gross Margins ~45-50%):
    • Automated “Sample-to-answer” (S2A) molecular diagnostic platform enables rapid detection of respiratory, gastrointestinal and bloodstream infections, helping clinicians quickly and cheaply run tests and make treatment decisions, primarily in hospital inpatient settings.
  • ARIES (negligible portion of “S2A; Gross Margins ~45-50%):
    • Automated S2A testing of target-specific probes.
    • Very small portion of LMNX’s overall revs, and competitively challenged on multiple fronts.
    • LMNX acquired ARIES (July ’12 purchase of GenturaDX) and VERIGENE (July ’16 purchase of Nanosphere) as part of multi-year push to diversify away from its mature xMAP technology into faster growing MDx.

 

Flow Cytometry, i.e. Millipore acquisition ($40mm in ’18 Revs):  

 

  • With Jan. ‘19 Millipore deal, LMNX’s now sells flow cytometry product- a completely new (and slower-growing) market for LMNX.  
  • Used in the analysis of cells using laser imaging.

 

Customers:

 

Two go-to-market strategies:

  • Licensing of xMAP technology and systems:
    • LMNX has 70+ strategic partners, which together have sold ~16k xMAP-based instruments globally as of Dec. ’18. These partners sell primarily to large reference labs like Quest Diagnostics, etc.
    • Licensees of LMNX’s xMAP technology include: ThermoFisher; BIO-RAD; Immucor, and; others.
  • Selling its molecular diagnostic assays and services directly:
    • LMNX’s xTAG (which uses its own xMAP technology), VERIGENE, and ARIES systems are placed directly to ~600 customers (primarily inpatient hospital settings).
    • Typically monetized through sales of compatible Assays, reagent rental revenues and Services.

 

Addressable markets/Market growth:

Source: https://medium.com/genesis-program/navigating-the-diagnostics-market-9d4fd2ee8787

 

It’s three key IVD[5] end markets are experiencing different growth trajectories:

 

 

 

  • Molecular Diagnosis market: growing DD, but “automated” diagnostic technology subset is growing even faster:
    • Demand drivers: need for quicker diagnosis at point-of-care, advancements in technology, and consolidation of health networks providing the benefits of scale, and a desire to improve patient outcomes.[6]
    • The smaller “S2A” franchise portion of LMNX’s MDx revenues has been growing ~35%, but still ceding share to BioFire.  
    • Also, declines experienced in its “Other MDx” (i.e. xTAG and LH and non-LH genetic testing) are offsetting S2A gains; total MDx growth was more modest +1% y/y in ’18.
    • ‘19 guidance is for +15% y/y total MDx growth when “excluding Labcorp”. But implied total MDx guidance for FY19 is for negative 6% y/y, when including Labcorp – see 2018-19 “rev bridge” below.
  • Flow cytometry: growing HSD.
    • ‘19 guidance is DD growth to $45mm from ~$40mm in FY18.
  • LTG: MSD-growing “Immunoassay” market:
    • However, xMAP has been growing below the market in recent years, because it’s 10-years old and needs updating.
    • ‘19 guidance is for “flat to slight decline” y/y (but an implied -5%, based on other guidance items).
    • LMNX is banking on the launch of SENSIPLEX to return this segment to 5-6% sales growth p.a., which we believe is aspirational.[7]

 

Revenue breakdown


NOTE: Company talks to LTG and MDx revenues; but uses a 10-K segmentation of: Systems, Royalties, Consumables, Assays, Services and Other. {Consumables, Royalties, Systems and Other} roughly map to LTG. Note, there’s a small amount of Systems revenue that as of ’18 now includes Reagent rental revenue for VERIGENE.  {Assays and Services}, therefore, roughly maps to MDx.

 

 

 

MDx Growth Facing Mounting Competition

 

Compared to LMNX’s VERIGENE, BioFire’s FilmArray products are easier to operate, have quicker turnaround time, offer more panels per test, and save lab space. Consequently, BioFire has 80% market share in automated assays, and has been growing share vs. LMNX.

 

S2A MDx technology includes a processor and reader, i.e. the System (think the iPhone), and; the content/panels (analogous to the apps, or what tests the processor/reader can run). The goal is to have the most accurate and efficient phone that requires the least amount of manual intervention and can run the most amount of “apps”.

 

FilmArray is a “better phone” with “more apps” vs. VERIGENE. And LMNX knows this. This is why it’s trying to launch its VERIGENE II, and in the interim competing with BioFire on price, selling “Flex” pricing panels. LMNX also competes by targeting the lower-end of the market, i.e. regional and smaller hospitals that run less volume through their diagnostic labs.

 

This “de-bundling” strategy is one of necessity, given LMNX’s narrower menu and capabilities:  Blood infections, GI, and respiratory panels vs. BioFire that has same three plus meningitis and pneumonia. Also, LMNX’s Respiratory panel can test up to 10 pathogens vs. 20 for BioFire, and; VERIGENE is slower and more labor-intensive to run than BioFire’s FilmArray, requiring more manual intervention. Unable to compete on features, then, LMNX must compete on price.

 

 

 

 

 

Beyond these current dynamics, a cavalry of new entrants is coming. LMNX will soon also compete in S2A with QIAGEN. It entered the syndromic testing market with its acquisition of Stat-DX.[8] [9] QIAStat will begin in GI and respiratory and move later into Blood infection and oncology. QIAstat-DX will have the capability to process 48 targets at once.

 

 

Another upstart, and one that won’t rely on a cartridge-based system, is Applied BioCode, which in October ‘18 obtained FDA clearance for its 17-plex Gastrointestinal Pathogen Panel (GPP). Watch video here. This system will be able to run 94 patient samples and up to 3 panels simultaneously in < 5 hours.

 

QIAGEN and Applied BioCode are evidence of the technological arms-race in this fast-growing molecular diagnostic testing market. Relative to LMNX, deep-pocketed competitors are currently doing better at bringing new technology to market that can process more pathogens and more samples quicker than LMNX’s offerings.

Source: https://medium.com/genesis-program/navigating-the-diagnostics-market-9d4fd2ee8787

 

BioMeriux on the heating-up competition: [10]

 

… in the field of syndromic testing…there are many people, who are interested to…enter the space …we are expecting to see more and more players in that space, knowing that we are leading the race [i.e. with FilmArray] in the beginning and we want to keep on leading the race through our investment....

 

Competition within LMNX’s MDx business is not isolated to its sample-to-answer franchise. LMNX’s non-S2A revenues, or its xTAG business, comprised $100/164mm of MDx ’18 revs. xTAG is LMNX’s non-automated MDx business (that uses LMNX’s own xMAP technology internally). It’s primarily for GI and Respiratory pathogens within large reference lab locations. BioFire, given their leadership in GI and respiratory, is also after this business. The $100mm in sales also includes Labcorp and Non-Labcorp genetic testing revenues. This remaining CF genetic testing part of the non-S2A MDx business is going away.  

 

In short, well-heeled competition is coming from all angles at LMNX’s MDx business, and LMNX is fighting back with clearly inferior weapons.

 

 

xMAP in Need of a Refresh

 

40% of LMNX’s xMAP technology business comes from transplant diagnostics. This business is well-insulated according to our research. Another 40% comes from protein research. The final 20% from immunodiagnostics. This latter 60% of xMAP revs is up against some significant headwinds.

 

In protein research, LMNX’s xMAP must compete with superior next-generation sequencing and ultrasensitive protein research diagnostic equipment from SomaLogic and Olink - products that have the potential to eat into LMNX’s share over time.

 

In immunodiagnostics, xMAP technology faces a two-front attack. First, they stand to lose share in the large labs to technology like HOLX’s Panther Fusion.

 

Second, more tests are being brought back into hospital inpatient setting (and away from the large reference labs, partly because hospitals can bill Medicare and private insurance for these services as part of the hospital stay at a profit, all while improving patient outcomes).

 

While this latter trend represents potential revenue gains for LMNX’s VERIGENE panels, it will help BioFire’s FilmArray more and is a secular headwind for LMNX’s higher-margin xMAP revenues in immunodiagnostics. Note, on a May 2017 call, management said xMAP sales were roughly split 1/3rd for each of these three segments, before in 2018 saying the split was 40/40/20, suggesting immunodiagnostics business already experienced significant declines in '18.

Source: https://medium.com/genesis-program/navigating-the-diagnostics-market-9d4fd2ee8787

 

Flu season sets up for difficult comps

 

LMNX faces an upcoming difficult comp in Q119, where management warned gross margins would slip into “high 50s” due to integration headwinds from the acquired Millipore flow cytometry business. We believe this is not the whole story and margins could fair worse, if management’s aggressive target for its automated MDx S2A business fails to deliver.

 

In Q119, LMNX must compare to a Q118 period where S2A assay revs were up +49% y/y (due to tough flu season lingering into March). Management is guiding to S2A sales of $20mm (and exiting 2019 at a $25mm quarterly run-rate). We see risk to this ramp trajectory in S2A VERIGENE sales, especially in light of the 2018-19 flu season thus far tracking well below that of 2017-18.

 

Early indications from CDC are that in first part of January 2019 flu tests by US clinical labs are down significantly y/y:



Loss of Labcorp relationship (Consensus estimates underestimate full revenue and margin impact):

 

In June ‘11, LMNX began diversifying  from its aging, core xMAP technology into faster-growing molecular diagnostics (MDx), purchasing Eragen Biosciences for ~2x revenue, or $34mm.

 

This acquisition included a portfolio of women’s health diagnostics for Labcorp. But Labcorp discontinued this $36mm of biz in summer of ‘18. In late ‘18, LMNX announced another $12mm loss – this time of its “Other Ancillary” product sales to Labcorp. These two items will create an incremental loss of $35mm of Labcorp revenue in FY19, leaving only $13mm in CF of Labcorp revs for FY20.

 

According to LMNX, “LabCorp orders for our CF products are expected to continue through at least the end of 2019.” We believe these sales are likely gone in ’20, given next generation sequencing technology that’s streamlining and reducing the error rate of CF testing. Similarly, LMNX’s sales of cystic fibrosis diagnostics to customers beyond just LH are also under fire for this same reasons.

 

The total Labcorp revs alone amount to $61mm of higher-margin revs.[11] The street focused on the initial $48mm lost revs, but is not appreciating the final ~$13mm loss that could occur, and just how margin-dilutive the loss of all these sales will prove to be. The Street is speaking anecdotally to the risk of losing CF biz. For example, JPM notes, “Downside risks include…larger than anticipated headwind from the CF/NuSwab business…,” but the full magnitude of this risk is not reflected in consensus sales or gross margin estimates.

 

 

“Scrambling the egg” to plug the lost Labcorp sales

 

LMNX “scrambled the egg” and plugged the gap of is lost Labcorp revs in ’19 with an acquisition into a new arena, i.e. Millipore flow cytometry. This deal closed 1/2/19; but that acquisition is already not going according to plan (i.e. Q119 Gross Margin – which disappointed consensus expectations – will dip into the high 50s vs. ~63% normal, partly from acquisition integration headwinds).

 

We also question the logic of this deal. First, Flow Cytometry is growing slower than molecular diagnostics, which would be a better target for capital investment (so LMNX doesn’t fall further behind BioFire). LMNX’s deal logic for Millipore was “revenue synergies” between Millipore and its core xMAP LTG business.

 

LMNX hopes the acquired salesforce from the deal will help it go directly to market with its current LTG customers, and combine its xMAP bead technology with Millipore’s imaging technologies to enhance customer workflow. Also, LMNX wants to introduce more flow cytometry products for the middle market, and not just the high-end.[12] Paying ~2x sales, though, for a business in an end market that is growing HSD at best and one that pits LMNX against its own xMAP LTG customers will likely prove an ill-fated strategy.

 

 

False Hopes on New platforms (VERIGENE II and SENSIPLEX)

 

Consensus expects 10% y/y sales growth in ‘20; but this will require successful launch and uptake of LMNX’s VERIGENE II in 2H19 and its SENSIPLEX system with a targeted full release in ‘20.[13]  

 

There are a few reasons we don’t think VERIGENE II is the answer to LMNX’s prayers:

  • First, the test turnaround time on the VERIGENE II will still be longer than BioFire’s.
  • VERIGENE II will begin with GI panels followed by respiratory– and therefore will launch with very limited “apps”, so as to not address LMNX’s competitive disadvantage versus BioFire in this respect either.
  • Further, not only is end of ‘19 late for II to be launching, there’s also a chance it doesn’t launch then. It was originally supposed to “be available somewhere by the end of the summer.” But then in Feb. ’19, the language changed to the “second part of the year”. Launch is contingent on getting FDA approval after clinical trials.

Regarding the SENSIPLEX, the objective of this technology is to create “ultrasentive assays”, or updates to its FLEXMAP and Luminex 100/200 systems. But for LMNX to launch this product, its customers Thermo, Bio-RAD, and Millipore must validate the LMNX kits on their platforms. But the timing over which this will occur is currently based on hope, according to CEO Homi Shamir:

 

I'm hoping that before the end of the year, some of our partners will start buying internally…We'll know much more about it by the end of the second quarter when we…get their feedback and understanding how they want to take it to the market.[14]

 

 

LMNX’s inventory has been building relative to sales, suggesting full channels

 

LMNX results in ’19 must compare to a record flu season. Customers ahead of the 2018-19 flu season likely stocked diagnostic assays, given they were caught with a shortage during the prior year. But as mentioned earlier, this flu season has been far milder than last, leaving LMNX’s customers with excess stocking inventory.

 

Further, LMNX is facing raw material inflation from higher freight, tariffs, and general PPI inflation. This has caused raw materials inventory to grow much faster than volumes. Raw materials Days sales inventory “DSI” has spiked at an increasing rate over the last 4 quarters vs. its 3y average (and therefore so too have overall Days sales inventory).

 

The competitive and pricing dynamics we discussed earlier, along with decelerating volume growth, will likely inhibit LMNX’s ability to pass-through its higher raw material costs to the detriment of gross margins.

 

 

LMNX’s receivables-to-sales elevated with possible revenue pull forward

 

Accounts receivables relative to sales are also elevated. We attribute this to aggressive recognition of royalty revs, i.e. to when the sale or performance obligation has been satisfied from when the strategic partner reported sale to LMNX. This will exacerbate LMNX’s pending tough comps.

 

Further, our work in the channel corroborates that LMNX has been aggressive on pricing and end-of-quarter promotions in the past. Also, we believe LMNX may have stuffed its channel partners ahead of flu season. Finally, LMNX notes that some of its customer pre-bought supplies ahead of the anticipated Chinese tariffs.

 

Aggressive revenue recognition, promotional activity, stuffing customers with product ahead of flu season, and customer pre-buy activity ahead of anticipated tariffs have all lead to a period of overearning that will exacerbate its tough compares in coming quarters.

 

 

Valuation


Source: Factset

 

Management has promulgated the idea that stagnant growth and declining gross margins of ‘19 merely mark a “transition year”, rather than a canary in the coal mine. They argue ‘20 will mark a resumption of double-digit growth and increasing margins.

 

The aggressive assumptions underpinning this assertion include: LMNX will “stop the bleeding” in its LTG business; its anticipated 2H19 launch of VERIGENE II and ’20 launch of SENSIPLEX will go as planned; it will address the competitive challenges on both sides of its business; the LTM period is not one where it over-earned, and; its S2A growth, despite facing mounting competitive pressure from deep-pocketed foes, will continue unabated. Finally, bulls must adopt the aggressive practice of applying a >3x EV/Sales multiple to a mature life sciences company with aging technology, and a smaller business that’s growing fast, but that’s also facing mounting competitive pressures; all while ignoring how expensive LMNX trades on an EV/EBIT and P/FCF basis.  

 

Base case

 

Our base case is “flat to declining” LTG business through ‘21. The remaining ~$12mm of Labcorp CF genetic testing business plus the non-LH genetic testing business (also within MDx) are at risk for ‘20. This plus decelerating growth in syndromic S2A revs from mounting competition, tough compares, recent overearning, and declines in “Other MDx” will amount to total MDx revs in ‘21 only nominally higher than in ‘18. These topline trends mean adverse mix for gross margins – sending them down another ~200bps across 2020-21, after falling to 59% in ‘19.

 

Applying EV/EBIT multiple of 25x (vs. 20x historical median) and a more modest 2x EV/Sales to our ’21 estimates, and averaging the two approaches, gets a $11.50 target price as of end of ’20 (or 34% IRR from current price of $24.04). [15]

 

Risk case

 

Our risk case calls for: inflection higher to LSD growth for LTG after a “flat to declining” ‘19 thanks to success of SENSIPLEX; a strong VERIGENE II tailwind for MDx revs; no decline in xTAG or “Other MDx” revs; HSD growth for Flow Cytometry; no further degradation in gross margin beyond ‘19, and; continued application of lofty 3x EV/Sales multiple and 28 EV/EBIT, we get a ~$29 target price, or neg. -11% IRR out to 12/31/20, for ~3:1 risk/reward.

 

 

Insider behavior

 

Strengthening the mosaic here are some insider sales from Director Loewenbaum, who sold $11mm+ worth of shares over last 3 years at avg. price of $22.[16] There was also a spate of selling in May ’18 from the VP of R&D, Global Marketing and Global Sales & Ops, who at the time dumped 25%, 10%, and 10% of their stakes respectively at prices around $28.

 

 

Risks

 

Reimbursement trends drive VERIGENE adoption

 

Bulls argue the recent ruling from Palmetto, which stopped Medicare reimbursement for respiratory panels testing 5+ pathogens in outpatient settings, will drive demand for VERIGENE. Palmetto is 1/6 Medicare Area Contractors (MACs) that process Medicare fee-for-services claims. Since VERIGENE allows for “flex” pricing, or the running of less panels, this has led management of LMNX to argue the ruling will help drive higher VERIGENE adoption. But BioFire recently said they are seeing no impact from Palmetto as of yet.[17] Further, labs could just “down code” – or perform the higher amount of panels with BioFire, but seek reimbursement for the lower test amount.

 

VERIGENE II and SENSIPLEX are a success, allowing LMNX to better “catch-up” with BioFire and other competitors.

 

LMNX balance sheet capacity used to do more M&A that investors believe will be accretive and value enhancing.

 

 


 

[1] Use of magnetic beads to simultaneously measure multiple chemical species in one single experiment. 10-K LMNX, “To perform an assay using xMAP technology on our systems, a researcher attaches biomarker detectors such as antibodies or nucleic acid oligos to one or more sets of color-coded microspheres, which are then mixed with a test sample. This mixture is injected into the xMAP analyzer, such as the Luminex 200 instrument…”

[2] https://en.wikipedia.org/wiki/Immunoassay. Using antibodies and antigens to detect molecules, or analytes, which is in many cases a protein.

[3] https://en.wikipedia.org/wiki/Molecular_diagnostics. Collection of techniques used to analyse biological markers in the genome and proteome—the individual's genetic code and how their cells express their genes as proteins. This technique allows for more personalized medicine.

[5] LMNX’s products are in vitro diagnostics (IVDs), which are classified as “reagents, instruments, and systems intended for use in the diagnosis of disease or other conditions….,” and for analysis outside the body. https://medium.com/genesis-program/navigating-the-diagnostics-market-9d4fd2ee8787

[6] http://mdd.blogs.medicaldevicedaily.com/2017/04/24/statdx-challenges-major-players-2b-syndromic-testing-market-diagcore/

[7] Jan 9, 2019, “I think beyond 2020, we'll see again a huge – we'll see a nice increase in the instrument business. Obviously, we will have the SENSIPLEX in the market, so that will bring us back to the 5%, 6% that we are targeting for the LTG.”

[8] “In April 2018, QIAGEN entered the rapidly growing syndromic testing market by launching QIAstat-Dx for one-step, fully integrated molecular analysis of hard-to-diagnose syndromes. The European launch followed acquisition of STAT-Dx, developer of the unique cartridge-based PCR technology for multiplex molecular testing. QIAstat-Dx enables fast, cost-effective and easy-to-use syndromic testing with novel Sample to Insight solutions. QIAGEN expects a U.S. launch for QIAstat-Dx, following regulatory approvals, in 2019. QIAstat-Dx was launched initially with two CE-IVD marked syndromic tests, enabling clinicians to differentiate among pathogens that cause respiratory and gastrointestinal infections. In 2019, QIAGEN is launching CE-marked panels for hepatitis B and hepatitis C. The pipeline of planned assays for QIAstat-Dx spans infectious diseases, oncology, companion diagnostics and other areas.” QGEN 20F March 6, 2019

[9] https://medium.com/genesis-program/navigating-the-diagnostics-market-9d4fd2ee8787

[10] Feb. 27th, 2019, BIM. FR call

[11] “We posted gross margins of 60% and 62% for the quarter and full year, down by 4 percentage points from the fourth quarter 2017 and 3 percentage points from the prior full year. This decline is primarily attributable to the reduction in LabCorp women's health products, as these assays typically carry a much higher gross margin than our corporate averages.” Feb 4, 2019 call

[12] “[what the deal] allows us to do is to actually go to those same customers with a different flow technology that are already familiar with Luminex, already comfortable with the quality of the products that we provide, and provide another quality product that actually does different things and does the xMAP Technology. And again, it's more a one-stop shopping for our customers that are already comfortable with the Luminex name.” October 18, 2018 call

[13] “…we are bullish about LMNX’s growth acceleration potential…driven by: 1) the commercial launch of fully automated VERIGENE II targeted for 2H19,  along with the enteric and respiratory panels, sustaining double-digit growth for the S2A MDx business; 2) high single digit growth potential for the flow cytometry business over multiple years; and 3) the initiation of another instrument replacement cycle for the LTG business with the SENSIPLEX (next-gen xMAP platform) launch in 2020.” 2/7/19 BTIG report

[14] Feb. 4, 2018 call

[15] 3/14/19 closing price

[16] Source: InsiderScore

[17] “To be frank in Q4, we have not seen clear impact coming from Palmetto decision…Palmetto is only concerning, I would say, [with] ambulatory patients which are covered by Medicare. So, it's a limited fraction to the other population, which are being tested with FILMARRAY.” Feb. 27, 2018 BioMeriux earnings call

 

Disclaimer:

This report (this “Report”) on Luminex Corporation (the “Company”) has been prepared for informational purposes only. As of the date of this Report, we (collectively, the “Authors”) hold short positions tied to the securities of the Company described herein and stand to benefit from a decline in the price of the common stock of the Company. Following publication of this Report, and without further notice, the Authors may increase or reduce their short exposure to the Company’s securities or establish long positions based on changes in market price, market conditions, or the Authors’ opinions with respect to Company prospects. This Report is not designed to be applicable to the specific circumstances of any particular reader. All readers are responsible for conducting their own due diligence and making their own investment decisions with respect to the Company’s securities. Information contained herein was obtained from public sources believed to be accurate and reliable but is presented “as is,” without any warranty as to accuracy or completeness. The opinions expressed herein may change and the Authors undertake no obligation to update this Report. This Report contains certain forward-looking statements and projections which are inherently speculative and uncertain.

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 

Street starts to value off 2020, i.e. capturing: loss of all the LH revs; VERIGENE competitive struggles persist; excess inventories come to a head if not before, and; Millipore starts comparing vs. itself y/y.

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    Description

    EXECUTIVE SUMMARY

     

     

    Background

     

    Business:

     

    LMNX makes and sells biological testing technologies used in various life sciences applications.

     

    Products:

     

    Licensing Technology Group – LTG ( $149mm in ’18 Revs):

     

    Royalties and Consumables (Gross Margins ~100%):

    Systems and other (Gross Margins ~45-50%):

     

    Molecular Diagnostics – MDx[4] ($164mm in ’18 revs):

     

     

    Flow Cytometry, i.e. Millipore acquisition ($40mm in ’18 Revs):  

     

     

    Customers:

     

    Two go-to-market strategies:

     

    Addressable markets/Market growth:

    Source: https://medium.com/genesis-program/navigating-the-diagnostics-market-9d4fd2ee8787

     

    It’s three key IVD[5] end markets are experiencing different growth trajectories:

     

     

     

     

    Revenue breakdown


    NOTE: Company talks to LTG and MDx revenues; but uses a 10-K segmentation of: Systems, Royalties, Consumables, Assays, Services and Other. {Consumables, Royalties, Systems and Other} roughly map to LTG. Note, there’s a small amount of Systems revenue that as of ’18 now includes Reagent rental revenue for VERIGENE.  {Assays and Services}, therefore, roughly maps to MDx.

     

     

     

    MDx Growth Facing Mounting Competition

     

    Compared to LMNX’s VERIGENE, BioFire’s FilmArray products are easier to operate, have quicker turnaround time, offer more panels per test, and save lab space. Consequently, BioFire has 80% market share in automated assays, and has been growing share vs. LMNX.

     

    S2A MDx technology includes a processor and reader, i.e. the System (think the iPhone), and; the content/panels (analogous to the apps, or what tests the processor/reader can run). The goal is to have the most accurate and efficient phone that requires the least amount of manual intervention and can run the most amount of “apps”.

     

    FilmArray is a “better phone” with “more apps” vs. VERIGENE. And LMNX knows this. This is why it’s trying to launch its VERIGENE II, and in the interim competing with BioFire on price, selling “Flex” pricing panels. LMNX also competes by targeting the lower-end of the market, i.e. regional and smaller hospitals that run less volume through their diagnostic labs.

     

    This “de-bundling” strategy is one of necessity, given LMNX’s narrower menu and capabilities:  Blood infections, GI, and respiratory panels vs. BioFire that has same three plus meningitis and pneumonia. Also, LMNX’s Respiratory panel can test up to 10 pathogens vs. 20 for BioFire, and; VERIGENE is slower and more labor-intensive to run than BioFire’s FilmArray, requiring more manual intervention. Unable to compete on features, then, LMNX must compete on price.

     

     

     

     

     

    Beyond these current dynamics, a cavalry of new entrants is coming. LMNX will soon also compete in S2A with QIAGEN. It entered the syndromic testing market with its acquisition of Stat-DX.[8] [9] QIAStat will begin in GI and respiratory and move later into Blood infection and oncology. QIAstat-DX will have the capability to process 48 targets at once.

     

     

    Another upstart, and one that won’t rely on a cartridge-based system, is Applied BioCode, which in October ‘18 obtained FDA clearance for its 17-plex Gastrointestinal Pathogen Panel (GPP). Watch video here. This system will be able to run 94 patient samples and up to 3 panels simultaneously in < 5 hours.

     

    QIAGEN and Applied BioCode are evidence of the technological arms-race in this fast-growing molecular diagnostic testing market. Relative to LMNX, deep-pocketed competitors are currently doing better at bringing new technology to market that can process more pathogens and more samples quicker than LMNX’s offerings.

    Source: https://medium.com/genesis-program/navigating-the-diagnostics-market-9d4fd2ee8787

     

    BioMeriux on the heating-up competition: [10]

     

    … in the field of syndromic testing…there are many people, who are interested to…enter the space …we are expecting to see more and more players in that space, knowing that we are leading the race [i.e. with FilmArray] in the beginning and we want to keep on leading the race through our investment....

     

    Competition within LMNX’s MDx business is not isolated to its sample-to-answer franchise. LMNX’s non-S2A revenues, or its xTAG business, comprised $100/164mm of MDx ’18 revs. xTAG is LMNX’s non-automated MDx business (that uses LMNX’s own xMAP technology internally). It’s primarily for GI and Respiratory pathogens within large reference lab locations. BioFire, given their leadership in GI and respiratory, is also after this business. The $100mm in sales also includes Labcorp and Non-Labcorp genetic testing revenues. This remaining CF genetic testing part of the non-S2A MDx business is going away.  

     

    In short, well-heeled competition is coming from all angles at LMNX’s MDx business, and LMNX is fighting back with clearly inferior weapons.

     

     

    xMAP in Need of a Refresh

     

    40% of LMNX’s xMAP technology business comes from transplant diagnostics. This business is well-insulated according to our research. Another 40% comes from protein research. The final 20% from immunodiagnostics. This latter 60% of xMAP revs is up against some significant headwinds.

     

    In protein research, LMNX’s xMAP must compete with superior next-generation sequencing and ultrasensitive protein research diagnostic equipment from SomaLogic and Olink - products that have the potential to eat into LMNX’s share over time.

     

    In immunodiagnostics, xMAP technology faces a two-front attack. First, they stand to lose share in the large labs to technology like HOLX’s Panther Fusion.

     

    Second, more tests are being brought back into hospital inpatient setting (and away from the large reference labs, partly because hospitals can bill Medicare and private insurance for these services as part of the hospital stay at a profit, all while improving patient outcomes).

     

    While this latter trend represents potential revenue gains for LMNX’s VERIGENE panels, it will help BioFire’s FilmArray more and is a secular headwind for LMNX’s higher-margin xMAP revenues in immunodiagnostics. Note, on a May 2017 call, management said xMAP sales were roughly split 1/3rd for each of these three segments, before in 2018 saying the split was 40/40/20, suggesting immunodiagnostics business already experienced significant declines in '18.

    Source: https://medium.com/genesis-program/navigating-the-diagnostics-market-9d4fd2ee8787

     

    Flu season sets up for difficult comps

     

    LMNX faces an upcoming difficult comp in Q119, where management warned gross margins would slip into “high 50s” due to integration headwinds from the acquired Millipore flow cytometry business. We believe this is not the whole story and margins could fair worse, if management’s aggressive target for its automated MDx S2A business fails to deliver.

     

    In Q119, LMNX must compare to a Q118 period where S2A assay revs were up +49% y/y (due to tough flu season lingering into March). Management is guiding to S2A sales of $20mm (and exiting 2019 at a $25mm quarterly run-rate). We see risk to this ramp trajectory in S2A VERIGENE sales, especially in light of the 2018-19 flu season thus far tracking well below that of 2017-18.

     

    Early indications from CDC are that in first part of January 2019 flu tests by US clinical labs are down significantly y/y:



    Loss of Labcorp relationship (Consensus estimates underestimate full revenue and margin impact):

     

    In June ‘11, LMNX began diversifying  from its aging, core xMAP technology into faster-growing molecular diagnostics (MDx), purchasing Eragen Biosciences for ~2x revenue, or $34mm.

     

    This acquisition included a portfolio of women’s health diagnostics for Labcorp. But Labcorp discontinued this $36mm of biz in summer of ‘18. In late ‘18, LMNX announced another $12mm loss – this time of its “Other Ancillary” product sales to Labcorp. These two items will create an incremental loss of $35mm of Labcorp revenue in FY19, leaving only $13mm in CF of Labcorp revs for FY20.

     

    According to LMNX, “LabCorp orders for our CF products are expected to continue through at least the end of 2019.” We believe these sales are likely gone in ’20, given next generation sequencing technology that’s streamlining and reducing the error rate of CF testing. Similarly, LMNX’s sales of cystic fibrosis diagnostics to customers beyond just LH are also under fire for this same reasons.

     

    The total Labcorp revs alone amount to $61mm of higher-margin revs.[11] The street focused on the initial $48mm lost revs, but is not appreciating the final ~$13mm loss that could occur, and just how margin-dilutive the loss of all these sales will prove to be. The Street is speaking anecdotally to the risk of losing CF biz. For example, JPM notes, “Downside risks include…larger than anticipated headwind from the CF/NuSwab business…,” but the full magnitude of this risk is not reflected in consensus sales or gross margin estimates.

     

     

    “Scrambling the egg” to plug the lost Labcorp sales

     

    LMNX “scrambled the egg” and plugged the gap of is lost Labcorp revs in ’19 with an acquisition into a new arena, i.e. Millipore flow cytometry. This deal closed 1/2/19; but that acquisition is already not going according to plan (i.e. Q119 Gross Margin – which disappointed consensus expectations – will dip into the high 50s vs. ~63% normal, partly from acquisition integration headwinds).

     

    We also question the logic of this deal. First, Flow Cytometry is growing slower than molecular diagnostics, which would be a better target for capital investment (so LMNX doesn’t fall further behind BioFire). LMNX’s deal logic for Millipore was “revenue synergies” between Millipore and its core xMAP LTG business.

     

    LMNX hopes the acquired salesforce from the deal will help it go directly to market with its current LTG customers, and combine its xMAP bead technology with Millipore’s imaging technologies to enhance customer workflow. Also, LMNX wants to introduce more flow cytometry products for the middle market, and not just the high-end.[12] Paying ~2x sales, though, for a business in an end market that is growing HSD at best and one that pits LMNX against its own xMAP LTG customers will likely prove an ill-fated strategy.

     

     

    False Hopes on New platforms (VERIGENE II and SENSIPLEX)

     

    Consensus expects 10% y/y sales growth in ‘20; but this will require successful launch and uptake of LMNX’s VERIGENE II in 2H19 and its SENSIPLEX system with a targeted full release in ‘20.[13]  

     

    There are a few reasons we don’t think VERIGENE II is the answer to LMNX’s prayers:

    Regarding the SENSIPLEX, the objective of this technology is to create “ultrasentive assays”, or updates to its FLEXMAP and Luminex 100/200 systems. But for LMNX to launch this product, its customers Thermo, Bio-RAD, and Millipore must validate the LMNX kits on their platforms. But the timing over which this will occur is currently based on hope, according to CEO Homi Shamir:

     

    I'm hoping that before the end of the year, some of our partners will start buying internally…We'll know much more about it by the end of the second quarter when we…get their feedback and understanding how they want to take it to the market.[14]

     

     

    LMNX’s inventory has been building relative to sales, suggesting full channels

     

    LMNX results in ’19 must compare to a record flu season. Customers ahead of the 2018-19 flu season likely stocked diagnostic assays, given they were caught with a shortage during the prior year. But as mentioned earlier, this flu season has been far milder than last, leaving LMNX’s customers with excess stocking inventory.

     

    Further, LMNX is facing raw material inflation from higher freight, tariffs, and general PPI inflation. This has caused raw materials inventory to grow much faster than volumes. Raw materials Days sales inventory “DSI” has spiked at an increasing rate over the last 4 quarters vs. its 3y average (and therefore so too have overall Days sales inventory).

     

    The competitive and pricing dynamics we discussed earlier, along with decelerating volume growth, will likely inhibit LMNX’s ability to pass-through its higher raw material costs to the detriment of gross margins.

     

     

    LMNX’s receivables-to-sales elevated with possible revenue pull forward

     

    Accounts receivables relative to sales are also elevated. We attribute this to aggressive recognition of royalty revs, i.e. to when the sale or performance obligation has been satisfied from when the strategic partner reported sale to LMNX. This will exacerbate LMNX’s pending tough comps.

     

    Further, our work in the channel corroborates that LMNX has been aggressive on pricing and end-of-quarter promotions in the past. Also, we believe LMNX may have stuffed its channel partners ahead of flu season. Finally, LMNX notes that some of its customer pre-bought supplies ahead of the anticipated Chinese tariffs.

     

    Aggressive revenue recognition, promotional activity, stuffing customers with product ahead of flu season, and customer pre-buy activity ahead of anticipated tariffs have all lead to a period of overearning that will exacerbate its tough compares in coming quarters.

     

     

    Valuation


    Source: Factset

     

    Management has promulgated the idea that stagnant growth and declining gross margins of ‘19 merely mark a “transition year”, rather than a canary in the coal mine. They argue ‘20 will mark a resumption of double-digit growth and increasing margins.

     

    The aggressive assumptions underpinning this assertion include: LMNX will “stop the bleeding” in its LTG business; its anticipated 2H19 launch of VERIGENE II and ’20 launch of SENSIPLEX will go as planned; it will address the competitive challenges on both sides of its business; the LTM period is not one where it over-earned, and; its S2A growth, despite facing mounting competitive pressure from deep-pocketed foes, will continue unabated. Finally, bulls must adopt the aggressive practice of applying a >3x EV/Sales multiple to a mature life sciences company with aging technology, and a smaller business that’s growing fast, but that’s also facing mounting competitive pressures; all while ignoring how expensive LMNX trades on an EV/EBIT and P/FCF basis.  

     

    Base case

     

    Our base case is “flat to declining” LTG business through ‘21. The remaining ~$12mm of Labcorp CF genetic testing business plus the non-LH genetic testing business (also within MDx) are at risk for ‘20. This plus decelerating growth in syndromic S2A revs from mounting competition, tough compares, recent overearning, and declines in “Other MDx” will amount to total MDx revs in ‘21 only nominally higher than in ‘18. These topline trends mean adverse mix for gross margins – sending them down another ~200bps across 2020-21, after falling to 59% in ‘19.

     

    Applying EV/EBIT multiple of 25x (vs. 20x historical median) and a more modest 2x EV/Sales to our ’21 estimates, and averaging the two approaches, gets a $11.50 target price as of end of ’20 (or 34% IRR from current price of $24.04). [15]

     

    Risk case

     

    Our risk case calls for: inflection higher to LSD growth for LTG after a “flat to declining” ‘19 thanks to success of SENSIPLEX; a strong VERIGENE II tailwind for MDx revs; no decline in xTAG or “Other MDx” revs; HSD growth for Flow Cytometry; no further degradation in gross margin beyond ‘19, and; continued application of lofty 3x EV/Sales multiple and 28 EV/EBIT, we get a ~$29 target price, or neg. -11% IRR out to 12/31/20, for ~3:1 risk/reward.

     

     

    Insider behavior

     

    Strengthening the mosaic here are some insider sales from Director Loewenbaum, who sold $11mm+ worth of shares over last 3 years at avg. price of $22.[16] There was also a spate of selling in May ’18 from the VP of R&D, Global Marketing and Global Sales & Ops, who at the time dumped 25%, 10%, and 10% of their stakes respectively at prices around $28.

     

     

    Risks

     

    Reimbursement trends drive VERIGENE adoption

     

    Bulls argue the recent ruling from Palmetto, which stopped Medicare reimbursement for respiratory panels testing 5+ pathogens in outpatient settings, will drive demand for VERIGENE. Palmetto is 1/6 Medicare Area Contractors (MACs) that process Medicare fee-for-services claims. Since VERIGENE allows for “flex” pricing, or the running of less panels, this has led management of LMNX to argue the ruling will help drive higher VERIGENE adoption. But BioFire recently said they are seeing no impact from Palmetto as of yet.[17] Further, labs could just “down code” – or perform the higher amount of panels with BioFire, but seek reimbursement for the lower test amount.

     

    VERIGENE II and SENSIPLEX are a success, allowing LMNX to better “catch-up” with BioFire and other competitors.

     

    LMNX balance sheet capacity used to do more M&A that investors believe will be accretive and value enhancing.

     

     


     

    [1] Use of magnetic beads to simultaneously measure multiple chemical species in one single experiment. 10-K LMNX, “To perform an assay using xMAP technology on our systems, a researcher attaches biomarker detectors such as antibodies or nucleic acid oligos to one or more sets of color-coded microspheres, which are then mixed with a test sample. This mixture is injected into the xMAP analyzer, such as the Luminex 200 instrument…”

    [2] https://en.wikipedia.org/wiki/Immunoassay. Using antibodies and antigens to detect molecules, or analytes, which is in many cases a protein.

    [3] https://en.wikipedia.org/wiki/Molecular_diagnostics. Collection of techniques used to analyse biological markers in the genome and proteome—the individual's genetic code and how their cells express their genes as proteins. This technique allows for more personalized medicine.

    [5] LMNX’s products are in vitro diagnostics (IVDs), which are classified as “reagents, instruments, and systems intended for use in the diagnosis of disease or other conditions….,” and for analysis outside the body. https://medium.com/genesis-program/navigating-the-diagnostics-market-9d4fd2ee8787

    [6] http://mdd.blogs.medicaldevicedaily.com/2017/04/24/statdx-challenges-major-players-2b-syndromic-testing-market-diagcore/

    [7] Jan 9, 2019, “I think beyond 2020, we'll see again a huge – we'll see a nice increase in the instrument business. Obviously, we will have the SENSIPLEX in the market, so that will bring us back to the 5%, 6% that we are targeting for the LTG.”

    [8] “In April 2018, QIAGEN entered the rapidly growing syndromic testing market by launching QIAstat-Dx for one-step, fully integrated molecular analysis of hard-to-diagnose syndromes. The European launch followed acquisition of STAT-Dx, developer of the unique cartridge-based PCR technology for multiplex molecular testing. QIAstat-Dx enables fast, cost-effective and easy-to-use syndromic testing with novel Sample to Insight solutions. QIAGEN expects a U.S. launch for QIAstat-Dx, following regulatory approvals, in 2019. QIAstat-Dx was launched initially with two CE-IVD marked syndromic tests, enabling clinicians to differentiate among pathogens that cause respiratory and gastrointestinal infections. In 2019, QIAGEN is launching CE-marked panels for hepatitis B and hepatitis C. The pipeline of planned assays for QIAstat-Dx spans infectious diseases, oncology, companion diagnostics and other areas.” QGEN 20F March 6, 2019

    [9] https://medium.com/genesis-program/navigating-the-diagnostics-market-9d4fd2ee8787

    [10] Feb. 27th, 2019, BIM. FR call

    [11] “We posted gross margins of 60% and 62% for the quarter and full year, down by 4 percentage points from the fourth quarter 2017 and 3 percentage points from the prior full year. This decline is primarily attributable to the reduction in LabCorp women's health products, as these assays typically carry a much higher gross margin than our corporate averages.” Feb 4, 2019 call

    [12] “[what the deal] allows us to do is to actually go to those same customers with a different flow technology that are already familiar with Luminex, already comfortable with the quality of the products that we provide, and provide another quality product that actually does different things and does the xMAP Technology. And again, it's more a one-stop shopping for our customers that are already comfortable with the Luminex name.” October 18, 2018 call

    [13] “…we are bullish about LMNX’s growth acceleration potential…driven by: 1) the commercial launch of fully automated VERIGENE II targeted for 2H19,  along with the enteric and respiratory panels, sustaining double-digit growth for the S2A MDx business; 2) high single digit growth potential for the flow cytometry business over multiple years; and 3) the initiation of another instrument replacement cycle for the LTG business with the SENSIPLEX (next-gen xMAP platform) launch in 2020.” 2/7/19 BTIG report

    [14] Feb. 4, 2018 call

    [15] 3/14/19 closing price

    [16] Source: InsiderScore

    [17] “To be frank in Q4, we have not seen clear impact coming from Palmetto decision…Palmetto is only concerning, I would say, [with] ambulatory patients which are covered by Medicare. So, it's a limited fraction to the other population, which are being tested with FILMARRAY.” Feb. 27, 2018 BioMeriux earnings call

     

    Disclaimer:

    This report (this “Report”) on Luminex Corporation (the “Company”) has been prepared for informational purposes only. As of the date of this Report, we (collectively, the “Authors”) hold short positions tied to the securities of the Company described herein and stand to benefit from a decline in the price of the common stock of the Company. Following publication of this Report, and without further notice, the Authors may increase or reduce their short exposure to the Company’s securities or establish long positions based on changes in market price, market conditions, or the Authors’ opinions with respect to Company prospects. This Report is not designed to be applicable to the specific circumstances of any particular reader. All readers are responsible for conducting their own due diligence and making their own investment decisions with respect to the Company’s securities. Information contained herein was obtained from public sources believed to be accurate and reliable but is presented “as is,” without any warranty as to accuracy or completeness. The opinions expressed herein may change and the Authors undertake no obligation to update this Report. This Report contains certain forward-looking statements and projections which are inherently speculative and uncertain.

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

     

    Street starts to value off 2020, i.e. capturing: loss of all the LH revs; VERIGENE competitive struggles persist; excess inventories come to a head if not before, and; Millipore starts comparing vs. itself y/y.

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