MYRIAD GENETICS INC MYGN
January 09, 2011 - 10:00am EST by
spence774
2011 2012
Price: 20.30 EPS $1.54 $0.97
Shares Out. (in M): 92 P/E 13.2x 21.0x
Market Cap (in $M): 1,875 P/FCF 17.6x 16.0x
Net Debt (in $M): 0 EBIT 136 147
TEV ($): 1,367 TEV/EBIT 10.1x 9.3x

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Description

Myriad Genetics provides the gold standard genetic test for breast and ovarian cancer. The stock has been oversold due to the recent recession which caused soft physician visits on top of existing low utilization rates. In the long term, however, both physician visits and utilization will grow due to an aging, sicker population combined with expansion of access and advances in technology. The test is covered by all insurance companies with minimal out-of-pocket expense from patients, so the rate limiting step to future growth is physician education to properly identify and refer eligible patients that are currently being missed. Current utilization for eligible patients is a fraction of market potential, so even small improvements will move the needle.

At current share price, MYGN is trading at 15x fwd P/E (net excess cash), 9x EV/EBITDA and 8% FCF yield (net excess cash). Relative to their historical trading range, this is approximately a 50-70% discount to intrinsic value. 

MYGN has a strong balance sheet, high profitability, ROIC over 100% and durable competitive advantages. Using reasonable assumptions for near term growth in FCF, the current IRR is 19%- an attractive return for a business of this quality.

The Business

Approximately 90% of MYGN’s revenue is from the BRACAnalysis test, for the presence of BRCA genes, which assesses a patient’s risk of breast and ovarian cancer. MYGN is the only commercial provider of this test. Along with BRCA testing, MYGN also has other genetic tests targeted towards melanoma, colorectal, prostate and uterine cancers, along with tests used to monitor toxicity in chemotherapy.

The BRCA genes encode for proteins used to repair DNA, and mutated versions of the genes leave patients susceptible to unregulated DNA damage and subsequent cancer cell growth. BRCA gene mutations occur in 1 in 1000 people and are responsible for 5-10% of all breast cancers and 10-15% of all ovarian cancers. A BRCA mutation increases a woman’s risk of breast cancer by 85% by age 80 and 55% for ovarian cancer (for BRCA1 gene). MYGN’s test has backing from professional medical societies including the NCCN (National Comprehensive Cancer Network), the USPSTF (US Preventive Services Taskforce) and ACOG (American Congress of Obstetricians and Gynecologists) as being a standard of care in patients who meet criteria based on review of family history.

MYGN’s BRCA test is priced at $3340 and reimbursed at an average 92% of sticker price by insurance companies. It is covered by all insurance companies and 80% do not require preauthorization from physicians. The average out of pocket expense to the patient is $90. Approximately 96% of revenue is from insurance companies and 4% is from private payers, helping keep bad debt expense low with a slight improvement in 2010 to 4.7%.

MYGN’s BRCA’s sales should be thought of in two buckets:

The first is for patients who are actively diagnosed with confirmed breast or ovarian cancer. For these patients, testing is done as much for their relatives as for themselves, as it will help identify a cancer gene in the family. This market is represented mostly by sales via oncologists which currently comprise 70% of MYGN’s physician referral base. The company estimates Oncology referrals are 50% penetrated.

The second bucket is in the form of risk assessment, in which women are tested based on risk factors identified in a family history. Along with life-style modification to mitigate risk, some women opt for elective mastectomies or oophorectomies (removal of ovaries) based on a positive result. One notable recent example is the actress, Christina Applegate, who elected to have bilateral mastectomies following a positive BRCA test. These sales are made primarily via OB-Gyns and this subspecialty of physicians is estimated by MYGN to be 10% penetrated.

The Moat

Technology

MYGN’s tests are specialized and required significant investment in R&D. The test was first introduced to the market in 1996 after having been in development since 1990. The technology required to develop this test cannot be duplicated overnight. Currently there are no other commercial providers of BRCA testing.

Economies of Scale

MYGN has created a business based upon similar competitive advantages as Microsoft. They have invested in developing the technology needed to provide these complex DNA tests and can now simply plug samples into their system to generate impressive gross margins.

Brand/Customer Captivity/First to Market

MYGN provides a specialized portion of the treatment paradigm for cancer patients and the risk assessment of healthy patients. Physicians trust the results of MYGN’s tests and are unlikely to abandon MYGN for a low cost provider in the event competition arises down the road. Errors in tests for blood chemistry, liver panels or blood counts happen frequently and are often inconsequential. An erroneous BRCA test could result in unnecessary surgeries and anxiety for entire families for false positives, or missed risk factor stratification for false negatives, both potentially devastating consequences. All of MYGN’s genetic tests require a prescription from physicians so supplanting the business will require winning over physician trust, something that will not occur overnight.

Regulatory Barriers

The FDA regulates lab testing through CLIA (Clinical Laboratory Improvement Amendments), a regulation passed in 1988 to standardize quality for lab testing. While this is obviously nothing new, it is costly for companies to obtain this regulatory approval and provides a barrier to new entrants.

The Economics

 ·       ROIC average 130% over the past 3 years

·       Gross Margin 88%

ass="MsoNoSpacing">·       Operating Margin 38%

·       Net Margin 25%

·       CAPEX has historically been low, averaging 1-2% of sales while noncash expenses (D&A and share based comp) have averaged 5-7% of sales. CAPEX in 2010 was $7.9M compared to operating cash flow of $155M

·       MYGN was not profitable until 2008. Additionally, they had a pharmaceutical business which was recently spun off resulting in R&D tax credits.  They currently have NOL and R&D tax credits to offset taxes on $256M of future revenue, which at their normalized tax rate of 38% will amount to $97M in savings

·       MYGN had a net tax benefit of 12M in 2010 compared to a projected GAAP tax expense of ($56M) for FY 2011 based on guidance of 38% normalized GAAP tax rate

·       Cash and Marketable Securities = $428M

·       Long Term Securities = $80M

·       Gross Debt = $0

·       Net Cash = $508M (including $80M in long term securities)

The Contribution to Social Sustainability

MYGN provides valuable tools in the fight against cancer: information and education. It provides patients insight into their specific genetic risk for breast and ovarian cancer. MYGN’s BRCA test has been validated in over 100 peer-reviewed publications. Every year there are approximately 18,000 new cases of hereditary breast cancer and 1,900 new cases of hereditary ovarian cancer in the US. Of total patients with confirmed breast and ovarian cancer who are eligible for BRCA testing, approximately 50-70% are being tested, leaving room for growth in the core business of confirmed cancer cases. 

Despite the seemingly high price tag, MYGN is bringing down the cost of healthcare. Cost effective analysis is a method used by health economists to determine the greater societal value of an intervention. It is measured by calculating the incremental cost-effectiveness ratio, which is defined as the total net cost of the intervention divided by the total number of health outcomes prevented due to the intervention. In the case of MYGN, denominator consists of estimated total life-years saved due to BRCA tests. Cost effective therapy in the US is defined by insurance carriers as being <$50,000 per total life-years saved; MYGN’s BRCA test currently costs $32,000 per total life-years saved, which is likely the key driver behind universal coverage from insurance companies.

The Catalysts

 Massive Projected Growth in the Breast Cancer Risk Assessment Market

Recent data showed that total visits to Ob-Gyns were down 20% in 2010 with a 25% drop in compliance to preventive health. Despite this, MYGN was grew revenue 11% in 2010, mostly from volume- this trend has continued into 1Q 2011 with 6% YOY growth in volume. In a recent study, a retrospective review of charts from Loma Linda Medical Center revealed that of all patients referred to their center and deemed eligible for BRCA testing, almost 50% did not receive it, mostly due to a lack of appropriate counseling and education. The study revealed that insurance coverage was present in 90% of cases and was not a deciding factor when doing a regression analysis.

Another study showed that in a survey of 35,000 healthy adult women (> age 18) with no history of breast or ovarian cancer, approximately 1% were deemed high risk for BRCA mutation and eligible for risk assessment testing, based on review of family history8. Of these women, less than 5% had been advised to have the test and only 2% had actually done so. If this research is accurate and reflective of the US population on the whole, the current addressable market for breast cancer risk assessment alone is approximately 1.1M women. For perspective, MYGN sold approximately 107,000 BRCA tests in 2010 across both confirmed cancer and risk assessment* and has sold 500,000 units since the test was introduced in 1996. While management did not break out how many of these were specifically risk assessment (vs. confirmed cancer), the total addressable market for risk assessment alone could be 10X the total number of units sold in 2009, across both indications.

Quantifying the opportunity in just the risk assessment market reflects a robust runway of potential revenue growth using conservative projections: 

o   Assume the above estimate that 1.1M adult women in the US meet one or more accepted professional guidelines for risk assessment is accurate

o   Assume that of this total potential market, utilization for breast cancer risk assessment grows from the current estimated 5% to 20%, driven by growth in sales force, increased awareness from the current marketing campaigns, growth in the aging population and expansion of access to health insurance

o   Assume price is cut to $3000 (from the current $3340) and payout from insurance companies drops to 90% of sticker price (from the current 92%)

o   This would amount to incremental $200M revenue, or 60% top line growth, from breast cancer risk assessment alone. This does not factor contribution of revenue from the core business of confirmed genetic breast and ovarian cancer cases (growing at estimated 30,000 new cases per year, an $80M incremental annual revenue opportunity), international expansion, sales to pharmaceutical research, or any revenue from the any of the other 7 currently licensed and commercially available diagnostic products.

Other research indicates a potential market for breast cancer risk assessment to be much larger. According to a recently published paper, it is estimated that roughly 4% of adult women in the United States currently meet at least one of the current professional society guidelines for BRCA testing. The researchers in these papers estimated this to translate to 6.5M eligible women10.

MYGN has taken note of the opportunity in risk assessment and allocated resources towards further developing their Ob-Gyn sales force. They currently have 150 sales reps dedicated to Ob-Gyn and are growing this by approximately 30 per year, with a goal of 250 total sales reps dedicated to this subspecialty. MYGN has historically had good ROIC with regard to expansion of its sales force and averages 6.1 visits per MD to convert an Ob-Gyn vs. 4.9 visits per MD to convert an Oncologist into a referring physician. As utilization by Ob-Gyns increases, sales of BRCA tests for risk assessment will also increase, as they are generally the primary gate keepers to these patients.

In September 2010, they also launched a direct-to-physician (DTP) along with a direct-to-consumer (DTC) marketing campaign to increase awareness for breast and ovarian cancer risk assessment. A recent study from Brigham and Women’s Hospital surveyed geneticists who had been visited by patients seeking consultation after DTC marketing. The geneticists reported that BRCA testing was deemed clinically useful and indicated in 86% of consultations following both self-referral and physician-referral from DTC/DTP marketing.

With regard to ovarian cancer testing, the current utilization is not much better. A recent study from MD Anderson Cancer Center retrospectively reviewed 3700 charts of patients being treated for ovarian cancer from 1999-2007. In 1999, of all patients deemed eligible for BRCA testing only 12% were actually referred. By 2007 this number had improved, but to an abysmal 48% of eligible patients. On the aggregate, over the 8 year period of the study the test reached only 31% of total eligible patients for ovarian cancer testing. MD Anderson is one of the top cancer centers in the US, and this low rate suggests that other medical centers are most likely well below 50% utilization for confirmed ovarian cancer.

Additionally, updated guidelines published in ACOG in April 2009 further expanded the target market to which BRCA screening should be offered.

Wider Adoption of the Electronic Medical Record

The US government recently allocated $19B towards increasing adoption of electronic medical records (EMR). They are using a combined “carrot and stick” approach, with penalties beginning in 2012 in the form of decreased Medicare reimbursement rates. It may not be obvious why an EMR will boost business for MYGN, but the link is in the family history. The key driver to identifying patients for cancer risk assessment for BRCA is in the review of family history. The average primary care physician visit lasts 20 minutes and the family history is often skipped in a rush to get to the chief complaint. With EMRs, family histories are entered into the chart and will appear with every visit, without the need for redundant questioning by the clinician. This will translate to a boost for risk assessment testing as the information will be preloaded every time a patient is seen by that physician group.

The link between EMRs and preventive testing has been proven in other areas. One study, analyzing the referral rate for mammograms in an academic primary care setting, showed an increase from 29% to 56% referral rate just one year after implementation of EMR. A recent study estimated that among office based practices only 50% were using some form of EMR at the end of 2009. As EMRs become more widely adopted, BRCA tests will likely also be incorporated into programs and will have increased utilization due to improved dissemination of patient information.

Healthcare Reform

Along with expansion of access to healthcare, physician visits will normalize and in fact grow substantially in the coming decade due to growth in the aging population. Deaths from breast cancer have decreased since 1990, attributed primarily to improvements in screening and awareness. The continued growth in risk assessment will be aided by a key element in “The Patient Protection and Affordable Care Act”, passed on March 23 2010, which is the creation of task forces for Preventive Services and Community Preventive Services. These were both created to update and disseminate evidence based guidelines for clinical and community preventive health. Included in this will be education about risk stratification for BRCA testing and will provide free marketing for MYGN.

Many patients express concern over having BRCA test results in their file out of concern over discrimination. Under the new reform, effective January 1 2014 insurers will be prohibited from discriminating based on preexisting conditions. This is obviously a few years away, but more recent legislation passed in 2008, entitled “The Genetic Information Nondiscrimination Act”, prohibits discrimination from health insurance companies or employers based on genetic test results. As patients become more comfortable with the above changes, more will opt for BRCA risk assessment. 

Triple Negative Breast Cancer

Included in the workup of confirmed breast cancer is testing for HER2, ER and PR tumor receptors, which if all negative is referred to as “triple negative” (TN) breast cancer. TN is considered a subtype of breast cancer and is generally more aggressive with a worse prognosis. It disproportionately afflicts black and hispanic women (estimated 50% of all cases17) and is associated with a younger age of onset. The link to TN breast cancer and BRCA has been firmly established in literature and it is estimated that almost 90% of TN breast cancer cases are also positive for BRCA gene mutations17. TN is estimated to account for 15% of all breast cancer cases, which would have amounted to 38,000 new cases in 2009. MYGN is making strides to add TN breast cancer to the indications for BRCA testing, which could translate to an additional $50-100M opportunity in incremental annual revenue*.

European Expansion

MYGN has recently embarked on an international expansion effort in Europe. The market for BRCA testing in Europe is estimated to be 70% the size of the US, and the two combined are estimated to be a $6B market by 2015. Currently, less than 5% of total revenue is generated from international sales. MYGN has allocated $2M towards analyzing the European market with the goal of European sales by end 2012. Included in this was the recent new hire of a VP of International Business.  

Coupled Testing with Chemotherapy: PARP Inhibitors

Companion testing is a relatively new term used to describe diagnostic tests that are targeted towards specific therapeutics, i.e. INR testing for warfarin therapy. The FDA estimates that 50% of all new drugs currently in development have a companion diagnostic test. MYGN recently partnered with Abbott Laboratories for the development of a new class of drug known as PARP inhibitors. The PARP enzyme, like the BRCA enzyme, also repairs DNA breaks in both healthy and tumor cells.  In patients with normally functioning BRCA genes, PARP inhibitors convey no benefit as tumor cells maintain DNA repair abilities from functioning BRCA. However, in patients with BRCA gene mutations, PARP inhibitors are very effective in inhibiting tumor growth, as tumor cells are left without a mechanism for DNA repair. Abbott has capitalized on this proven research and is currently in Phase II clinical development of a PARP inhibitor. The study has utilized MYGN’s BRACAnalysis in identifying patients for therapy. Other companies such as Sanofi-Aventis and AstraZeneca are also far along in the clinical testing of PARP inhibitors. Clinical trial results thus far are promising. PARP inhibitors could make it to the market as soon as 2012 and, if successful, then all new breast cancer cases could be eligible for MYGN’s BRCA test which would translate to overnight exponential growth in their addressable market.

The Valuation

As the addressable market for MYGN’s test grows and clinical guidelines “catch up” to scientific literature, MYGN’s value will also adjust accordingly. MYGN’s addressable market is growing organically and if any of the above catalysts should prove true, the top line expansion opportunity will be robust.

MYGN is currently trading at a 50-70% discount to historical P/E and EV/EBITDA multiples. Net excess cash of $508M, MYGN’s core business is trading at 15x P/E 2011E.

In calculating proforma estimates, FCF was defined as EBIT less normalized tax rate of 38% + noncash expenses (D&A and share based comp) – CAPEX.

At current price, the estimated fwd EV/FCF yield is 8% and IRR is 19%. They announce 2Q results on Feb 1, 2011 and 2Q has historically been the strongest with 1Q historically being the weakest, so they are likely to have some near term positive news.

The Risk

1. The various indications for BRCA testing could result in double counting the total addressable market. For example, a woman who was risk stratified with BRCA testing and later developed TN breast cancer would not receive the test twice. Cases like this could over-estimate the addressable market.

While this is certainly true, and can result in over assumptions for the addressable market, the total number of women who are even aware of this test is miniscule so any “churn” from double counting will likely not impact volume growth to a noticeable degree.

2. A recent article by Aetna suggested that up to 20% of patients referred for BRCA testing are done so incorrectly and outside of professional guidelines. They plan to do a prospective study to identify whether BRCA testing is reaching the appropriate population of patients which could reveal the test to be over-utilized.

If the above statistic is accurate, than it is likely a result of lack of understanding by clinicians and patients. For every patient that is referred incorrectly, there are dozens others that are missed incorrectly. Aetna’s study will likely reveal what almost every other peer-reviewed scientific paper has suggested: that the test is reaching only a fraction of eligible patients.

3. MYGN’s BRCA test has been the subject of litigation regarding its patents, the first of which is due to expire in 2014. In March, 2010 a New York court ruled in favor of a suit brought on by The Association for Molecular Pathology, stating that 15 claims pertaining to 7 of MYGN’s patents for the BRCA test were invalid. Concerns over the outcome of this trial have been an overhang out of concern of patent invalidation and potential generic entry.

The ruling pertains to DNA sequences themselves and not the downstream products from those sequences. It is also important to note that this pertains to only 7 of 23 total patents for their BRCA test and management has stated repeatedly the outcome will not impact the business at all.

Following this suit The Department of Justice filed an amicus brief essentially siding with MYGN in defending their patents.

Should the US Court of Appeals side with the original ruling, this simply means the DNA sequence itself cannot be patented. Furthermore, it does not mean a new entrant will enter the market overnight- developing these tests requires extensive R&D, CLIA approval and most importantly broad physician adoption.

4. The new health reform law mandates an 85% medical loss ratio (MLR) for insurance companies which will compress their margins and put pricing pressure on big ticket items such as BRCA testing.

As detailed above, the growth for MYGN’s top line will not be through pricing and the company has instead chosen the lower hanging fruit of growth through volume. Additionally, despite the turbulent economy MYGN achieved 2% growth in pricing during FY 2010, showing their ability to navigate downward pricing pressure. Finally, their BRCA test has been proven to be cost effective therapy, so insurance companies will likely target other expensive therapies and tests that lack scientific evidence and backing by professional societies, and which won’t elicit the same level of bad PR.

5. 2011 could continue to see soft physician visits, and the company may stagnate at high single digit revenue growth into 2012.

It is very possible that unemployment may not improve, which is directly correlated to physician visits. Despite the recent 20% drop in Ob-Gyn visits along with reduced adherence to preventive health in 2010, the company still grew revenue by 11%, driven mostly by volume. Even the slightest recovery in physician visits will move the needle.

6. MYGN announced last week (Dec 8 2010) an acquisition of technology from Melanoma Diagnostics Inc.- the financial specifics of this deal have yet to be released

7. MYGN’s bylaws have antitakeover provisions including a poison pill, a classified staggered board and a required 70% supermajority requirement to amend bylaws. In the event the business is successful, they may refuse to sell the company when the time is right.

 

Catalyst

Massive Projected Growth in the Breast Cancer Risk Assessment Market
Wider Adoption of the Electronic Medical Record
Healthcare Reform / normalized physician visits
Triple Negative Breast Cancer
European Expansion
Coupled Testing with Chemotherapy: PARP Inhibitors
 
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