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MagicDiligence (< 20)

A Myriad of Questions for MYGN

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July 03, 2013 – Comments (0) | RELATED TICKERS: MYGN

Myriad Genetics (MYGN) is no stranger to adherents of Magic Formula® Investing(MFI). The stock has been in and out of the screens numerous times over the past 5 years, trading in a wide and volatile range despite delivering steady compound revenue growth of 23% and operating earnings growth of 28% over that period. In fact, I even recommended it as a MagicDiligence Top Buy pick in late 2010 and it was quite successful, appreciating 47% in 3 monthsbefore we sold it.

Now the stock is again back in the screens and since it has been a few years, it is time to take another look. Is Myriad again worth considering for investment?

Myriad's business has not changed much over the years. 74% of revenue still comes fromBRACAnalysis, a proprietary diagnostic test that is used to identify gene mutations that significantly raise the risk of a woman developing breast or ovarian cancer. The BART test, which is an extension of BRACAnalysis, contributes another 11%, meaning 85% of sales are related to BRCA1/BRCA2 tests. COLARIS, a predictive colon cancer diagnostic, is about 9% of revenue. The rest comes from companion diagnostic deals, where Myriad partners with development firms to provide testing services during clinical trials of drug candidates.

For much of its history, Myriad's golden goose BRACAnalysis tests were protected by several patents, including ones that effectively awarded the company sole possession of the BRCA1 and BRCA2 genes. This protection effectively created a monopoly for Myriad, allowing it to charge high prices ($3-4,000 per test) and spend lightly on R&D, producing very high 37-39% operating margins. Myriad also enjoyed solid growth as the benefits of identifying cancer risks early continued to be espoused by doctors.

These protections are now in question after the Supreme Court recently ruled that naturally occurring genes (like BRCA1 and 2) are not patentable. The same ruling also upheld Myriad's synthetic DNA patents, which protects the Sanger sequencing and PCR processesbehind the BRACAnalysis tests. Given this, the initial reaction was positive, and Myriad's stock spiked intraday on June 13 to over $38.

However, that same day the stock retreated quickly to $32 and continuing to fall, all the way under $26 before stabilizing to around $28 today. So what happened?

Simple. Before the ink on the ruling was dry, numerous competitors announced their own BRCA1/2 tests, promising cheaper pricing, fast turnaround times, and potential coverage of more gene markers. These are made possible through so-called "Next Generation Sequencing" (NGS) techniques, which are a new technology that allows more extensive and faster gene sequencing than the older Sanger/PCR technique. I won't go into a lot of technical detail here (this article is a good place to look for that), but suffice to say that the removal of the natural gene patent barrier has opened the door for NGS methods of BRCA testing.

As a result, Myriad has likely lost its primary economic moat - regulatory protection. Over the medium-to-long term, I expect their market share of the BRCA testing market to wither, pricing power to lessen, margins to contract, and revenue growth to slow or even turn negative. Growth will have to come from PROLARIS and other existing tests, newly developed tests, and companion diagnostic deals. While these areas have been growing at 20%+ rates, they have a long way to go to make up for the possible difficulties BRACAnalysis may face. While the firm's entrenched position and familiarity with doctors provide it some near-term protections, price is going to be a key differentiator (particularly with insurance companies), and I see little chance that Myriad is able to maintain a $3,000 test against competitors pricingat or under $1,000.

The genie is out of the bottle here and I believe MFI investors are best to avoid Myriad at this point in time. The impact of competition is always uncertain, but in this case it looks potentially quite damaging. My range of valuations go from $16 to $28, and even the high end offers little margin-of-safety at current share prices.

 

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