Testing, Testing: Analyst Kevin DeGeeter on Five Good Bets in Cancer Diagnostics


Kevin DeGeeter Because margins in diagnostics and life sciences tools tend to decline over time, the industry is all about scale. The goal is either to develop novel products or tests with high profit potential, or to acquire them. Another strategy is to develop economies of scale through consolidation. In this interview with The Life Sciences Report, Kevin DeGeeter, senior analyst and director of healthcare research for Ladenburg Thalmann, has singled out five important companies with exciting business models or products.

The Life Sciences Report: It feels like we have seen a continual wave of new prognostic biomarkers come to market. Have we come to a point of diminishing returns? Does the new data really affect a clinician's treatment plan or patient behavior?

Kevin DeGeeter: There has always been this question with diagnostics. There is information that's nice to have and seems interesting, and then there's information that is actionable. This has always been the crux of what generates value for clinicians, patients and, ultimately, for investors.

Some biomarkers tell you what your risk is—usually risk of recurrence with cancer—but it could be prognostic for other purposes as well. The issue is just how powerful the prognostic marker is.

We find very few silver bullets or single prognostic markers that rise to a level of getting doctors to change their opinions. However, combinations of various biomarkers using certain algorithms to make sense of patterns can be incredibly powerful. The quintessential example of that in our industry has been Genomic Health Inc.'s (GHDX:NASDAQ) Oncotype DX test for breast cancer, which employs a series of biomarkers.

TLSR: Is the burden on the developer to show payers how a test is of value?

KD: Yes. The most powerful metric to show a test's value is a clinical study. Getting a commercial model fully developed is very data-centric. It's not simply a question of getting the product to market, but the ability to show payers evidence, in the form of organized studies, that a test is valuable. That generates the reimbursement that will drive a company to real revenue growth. The process of winning reimbursement for a test from payers can look and feel like a biotechnology company business model.

TLSR: Do you feel that developers of biomarkers, particularly the prognostic type, are fearful of investing in these projects because of uncertainty about reimbursement?

KD: I do—particularly for the prognostic side, as opposed to a predictive biomarker that predicts response to a treatment like a chemotherapy. We may have reached a peak of investor appetite for demand because two different issues are coming to bear. First, it's becoming harder to win reimbursement because of the level of evidence a company needs to show to get a payer to reimburse for the test. Second, intellectual property is a real issue.

TLSR: We have seen a wave of consolidation in the lab tools, diagnostic and prognostic space. We've seen General Electric Co. (GE:NYSE) acquire Clarient Inc. (CLRT:NASDAQ); Laboratory Corporation of America Holdings (LH:NYSE) (aka LabCorp) acquire Genzyme Corp. (GENZ:NASDAQ); Novartis AG (NVS:NYSE) purchase Genoptix Inc. (GXDX:NASDAQ), and others. What is the trend currently? Has it slowed a bit?

KD: The pace of consolidation is slowing but I do see the trend continuing. The diagnostic business can be broken into pieces. One group of companies is primarily developing novel products, such as Myriad Genetics Inc. (MYGN:NASDAQ), with its BRACAnalysis gene mutation test, or Genomic Health (both involved in breast cancer diagnostics). They are examples of product-oriented companies. Other companies offer a menu of tests. They may be specialty providers, an example being Genoptix, which is primarily in hematology.

"It's not simply a question of getting the product to market, but the ability to show payers evidence, in the form of organized studies, that a test is valuable."

When you get to the service side of the industry, the largest players in diagnostic services are still LabCorp and Quest Diagnostics (DGX:NYSE). These two companies have essentially posted no growth to low single-digit revenue growth for the last couple of years. They will continue to be interested in acquisition candidates that can provide a higher level of growth and a stronger reimbursement profile than their current businesses.

Once the larger players have had an opportunity to digest transactions from this recent wave of consolidation, there is likely to be another wave in the service-oriented companies. On the product side, it will proceed case by case.

TLSR: As an analyst you are looking for ways to add value to portfolios. Do you find that it scares investors when companies acquire?

KD: In certain instances it does, although I would be hesitant to make a blanket statement.

TLSR: Back in February, when we last spoke, I asked you what the sweet spot was in personalized medicine from a shareholder/investment perspective. I'll ask the same question today.

KD: I still think it is in companies that have a service model, that sell products where reimbursement is well understood and that can take advantage of growing test volumes. Investors want companies that can gain market share from the dislocation associated with the merger activity we have been discussing.

One of the companies I liked back when we last spoke has performed well, and I continue to like it. NeoGenomics Laboratories (NGNM:OTCBB) is a specialty lab focused on oncology testing. Bringing innovative new products to market continues to be a challenging proposition in terms of winning reimbursement. Doctors can think a test is wonderful—the most useful in the world—but it's not going to get wide adoption until reimbursement is in place. NeoGenomics doesn't have to worry about the vagaries of trying to win reimbursement for a new test. Most of its revenue comes from tests that others may perform. But this company's focus on fast turnaround time and customer service has allowed the business to gain market share in healthy markets with strong growth rates.

TLSR: Let's stay with NeoGenomics for a moment. This stock blew through the $2 price target that you set back in midsummer. Are you still rating it a Buy?

KD: I'm still rating it a Buy, and we have increased our price target subsequently to $3.50. We continue to like the stock. We see its growth rate moderating from 50–70% in H1/12 to a 20–25% internal growth rate over the next several years.

"It's becoming harder to win reimbursement because of the level of evidence a company needs to show to get a payer to reimburse for the test."

In the diagnostics industry there is a threshold of around $100 million ($100M) in annual revenue. At that critical mass a company can generate more efficiencies in the lab because it is running more tests. Also, from a valuation perspective, companies that have $100M or more in revenue are more attractive to larger players as potential acquisition candidates. They do enough business to impact the profit and loss statement of the larger company. NeoGenomics currently has a run rate of about $65M/year in revenue, and I believe the company may step up to $100M over the next couple of years. Then NeoGenomics may appear on the radar screen of larger players.

TLSR: NeoGenomics has a large tech-only component, with which it provides service to the community-based pathologist instead of trying to run him or her out of the business. Is that model still working well?

KD: It is working well. The nature of the model shares the economics of analyzing a sample between the lab and the pathologist—NeoGenomics performs analysis of the sample and the pathologist interprets the result. The gross economics are smaller for the lab company. This type of business model generates a 45–50% gross margin, as opposed to the 60–70% margin that may be found in other parts of the industry. Overall it's an extremely attractive model, but it can be challenging for companies that either don't have critical mass or don't have a strong customer service orientation.

TLSR: NeoGenomics is up 66% over the past six months and up 25% over the past three months. It has been an outstanding performer. What was the catalyst for this?

KD: NeoGenomics was able to demonstrate its strong revenue growth rate was sustainable. We began seeing an acceleration in Q4/11, after it made changes to its sales model and changes in its senior commercial leadership. Another meaningful piece of the company's performance was greater visibility as it moved closer to that magic revenue number of $100M.

TLSR: Can you talk about another company that you like?

KD: I really like Navidea Biopharmaceuticals Inc. (NAVB:NYSE). The company has an interesting story: Its product is a diagnostic, but it's a different kind of diagnostic. Navidea is bringing a radiopharmaceutical product called Lymphoseek (technetium Tc99m tilmanocept) to the market. It's a radiotracer, not a therapeutic, and allows a surgeon, using a gamma detector during surgery, to determine whether or not there is any cancer in the lymph nodes.

"Once the larger players have had an opportunity to digest transactions from this recent wave of consolidation, there is likely to be another wave in service-oriented companies."

Lymphoseek has been in front of the U.S. Food and Drug Administration (FDA) for a little while. The company just resubmitted its new drug application after getting a complete response letter (CRL) from the FDA in September. I feel good about that product being approved, most likely in Q1/13. It has the potential to be a new standard of care, used primarily in patients with breast cancer and melanoma to determine whether or not the patient's cancer has metastasized to the lymph nodes.

TLSR: Are other markers on the market used intraoperatively?

KD: There are two other products on the market. One is FDA cleared, and one is used off-label and not approved for any indications in this area. The product that's approved is known as vital blue dye, which has been around for a long time and was used as a comparator to Lymphoseek for its phase 3 study.

TLSR: What is the value proposition of Lymphoseek versus vital blue dye?

KD: Compared to blue dye, Lymphoseek can detect more cancerous nodes. It has higher sensitivity, and that's the core value proposition. There is also increased ease of use for the surgeon, who can inject Lymphoseek several hours prior to surgery. Blue dye needs to be injected 15 to 20 minutes before surgery, and it stays in the lymph nodes for a very limited period of time. Part of the reason blue dye doesn't have higher sensitivity is that the surgeon doesn't have as much control over how long the agent stays in the lymphatic system. That is Lymphoseek's core benefit: Surgeons will be able to detect the spread of cancer in more patients.

TLSR: You have an impressive target price of $7.50 on Navidea. That's an implied triple from where it is today. Are we past the repercussions of the CRL that the company was issued and has now answered?

KD: I don't think we are. In the current environment on Wall Street, a company doesn't get full credit until it gets through the FDA. The stock has potential for a nice move upon FDA clearance. In addition, this product could have a very nice commercial ramp, which is unappreciated by some investors and makes this story more interesting. Navidea's commercial partner and distributor is Cardinal Health Inc. (CAH:NYSE), which has the dominant market share in the radiopharmaceutical industry. It's a pretty tightly defined distribution channel as well. There is a real potential for Cardinal to convert a number of its accounts to Lymphoseek in a timely manner. With the strength of Cardinal's distribution network, we could see strong uptake right out of the box. The economics are also favorable, with Navidea receiving 45–50% of the gross revenue. It is only responsible for manufacturing and production.

TLSR: Is there another company you would like to discuss?

KD: I'd like to continue talking about oncology because it is the most interesting segment of my universe. One company likely to bring something interesting to market in H2/13 is Exact Sciences Corp (EXAS:NASDAQ), with its new Cologuard test to screen for risk of colorectal cancer. In early November we saw validation data, which looks promising. The test is meant to be used in conjunction with, or potentially as an alternative to, colonoscopy, which has relatively poor compliance due to the high level of patient discomfort. The test adds a new and potentially interesting value proposition in that it is able to provide meaningful, although by no means perfect, sensitivity for precancerous adenomas.

TLSR: When the gastroenterologist is examining the patient via colonoscopy, adenomas are routinely clipped and sent to the pathologist. How is Cologuard used?

KD: Cologuard is a stool test, so in that regard it is noninvasive. Clinicians take a stool sample to detect cells with DNA mutations.

TLSR: You follow OPKO Health Inc. (OPK:NYSE) and have an $8.50 price target on the company, which is almost a double from where it was recently trading. What is your value proposition for OPKO?

KD: There are several components to the OPKO story. I think of it as a smaller-cap, discovery-stage healthcare conglomerate. Most of the company's programs are in development stages. It has commercial revenues, primarily from pharmaceutical distribution businesses in Latin America. But most of the company's value is in its product pipeline, where it is developing both diagnostics and some biotech products.

"The sweet spot is still in companies that have a service model, that sell products where reimbursement is well understood and that can take advantage of growing test volumes."

I have focused much of my attention on the company's diagnostic programs, which could be novel and bring unique value. The company's lead commercial product on the diagnostic side is a test for prostate cancer, which is being positioned as a potential alternative to the prostate-specific antigen (PSA) test. We see a very high rate of false positives with PSA and treat a lot of patients when, in fact, they don't have disease. The value of OPKO's lead test is reduced overtreatment of patients.

TLSR: That is the kallikrein test, right?

KD: Yes. It's called 4Kscore. The next product out the door is likely a PSA test that would run alongside the 4Kscore test. Currently, all FDA-approved PSA tests must be sent to a central lab, like a LabCorp or a Quest, but OPKO's PSA test is unique because it would run on a point-of-care platform, meaning that it could be performed right in the office. The benefit is that doctors can give patients an answer 10–15 minutes after taking the blood draw, as opposed to having to call back later to provide an answer. The doctor also receives all revenues from the test instead of giving those revenues to Quest or LabCorp.

TLSR: You have written about OPKO's recent acquisition of Prost-Data Inc., a specialty pathology lab. How will that be accretive for the company?

KD: At the core of OPKO's strategy is the desire to have a fully integrated model. That means encompassing everything from discovery of new content to sales and marketing. OPKO did not have commercial infrastructure in place for urology testing. This acquisition brings in a well-respected commercial organization with a national distribution and sales channel that calls primarily on urologists, and primarily for oncology-oriented testing. What we have found, almost universally in the diagnostic world, is that it's easier to buy commercial infrastructure than to build it.

TLSR: This was a $40M acquisition. Part of Prost-Data's value proposition is that the company's pathologists, even the founder, will get on the phone and speak with a urologist who calls about a patient's biopsy. Is this a scalable model?

KD: It is. OPKO's focus will be less on adding to the customer base and more on building deeper relationships with more proprietary content. I expect the menu will continue to grow within the Prost-Data franchise.

TLSR: Thank you, Kevin. I've really enjoyed speaking with you.

KD: I've enjoyed it too. Thank you.

Kevin DeGeeter is a director at Ladenburg Thalmann & Co. Inc. responsible for equity research coverage of personalized medicine and medical device companies with market capitalization between $50M and $5 billion. His coverage focuses on molecular diagnostics and medical equipment used in treating oncology, cardiovascular disease, infectious disease and related research markets. Prior to joining Ladenburg Thalmann, he was an analyst at Oppenheimer & Co., with responsibility for small-cap molecular diagnostics and biotechnology stocks. He has 10 years of buyside and sellside research experience, including positions with J.P. Morgan, PaineWebber, Natexis Bleichroeder and Manning & Napier Advisors. DeGeeter received a bachelor's degree in economics from Colgate University.

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1) George S. Mack of The Life Sciences Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Life Sciences Report: NeoGenomics Laboratories, OPKO Health Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Kevin DeGeeter: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.
4) Ladenburg Thalmann & Co. Inc. makes a market in Genomic Health Inc. (GHDX), Myriad Genetic Laboratories Inc. (MYGN), and NeoGenomics Laboratories (NGNM). Ladenburg Thalmann & Co. Inc. has neither had an investment banking relationship nor received compensation for investment banking services from any of the companies under coverage noted in this article in the last 12 months. Ladenburg Thalmann & Co. Inc. expects to receive or intends to seek compensation for investment banking services from all companies under coverage during the next three months for all companies noted. Neither the analyst, nor members of the analyst's household, own any securities issued by any company mentioned in this article. Genomic Health Inc. (GHDX) and Teva Pharmaceuticals Industries (TEVA) have joint distribution interests. The chairman of LadenburgThalmann Financial Services Inc. is also chairman of Teva. The chairman of the board and controlling shareholder of Ladenburg Thalmann Financial Services Inc., the parent company of Ladenburg Thalmann & Co. Inc., is the chairman of the board, CEO and director and controlling shareholder of OPKO Health Inc. (OPK). Members of the board of directors of OPK have a noninvestment banking securities-related relationship with Ladenburg Thalmann & Co. Inc. Ladenburg Thalmann & Co. Inc. does not cover Quest, LabCorp or Cardinal Health.

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