Investing in Biotech Diagnostics

Written By Jason Stutman

Posted March 24, 2014

Benjamin Moore sounds of nature 556.

The paint sample sat on top a stack of binders filled with countless others. It took John and Maria months to agree on the perfect color, but this was definitely the one. It was a warm and comforting shade of green, but most importantly, it was gender-neutral — the couple had always wanted the sex of their first child to be a surprise.

Yet tragically, this child never came. Maria suffered a stillbirth after six months of pregnancy and the couple’s hopes and dreams quickly transformed into grief and despair.

Sadly enough, this wasn’t the first time this had happened. Maria had suffered a baffling 14 miscarriages, a stillbirth, and the death of her premature son by the age of 32. It was an agonizing journey for her and John, but just when they were ready to throw in the towel a miracle happened.

After a total of 16 failed pregnancies over the course of 13 years, Maria finally gave birth to a healthy baby girl in 2012. In her own words “It goes to show you can never give up hope”.

While recurrent miscarriages of this magnitude are certainly rare, repeating miscarriages themselves are not: approximately 1 in every 20 women will experience at least two consecutive miscarriages while attempting to have a child.

The odds are alarming.

In Maria’s case, these miscarriages were determined to be the result a rare combination of personal health problems that caused blood to clot in her placenta. In many other instances, age, hormonal imbalance, and uterine size tend to be major factors of miscarriage.

In the majority of cases though, recurring miscarriages stem solely from genetic or chromosomal defects. In fact it’s been suggested that over 60% of failed pregnancies result from genetic abnormalities, usually in the form of a missing or duplicated chromosome. In other words, we’re looking at around 360,000 genetically-caused miscarriages in the U.S. alone every year.

With this information and many recent advancements in genetic medicine at hand, it’s no surprise that the demand for prenatal and post-miscarriage genetic analysis has begun to skyrocket.

Playing God, and the Market

Late last month the New England Journal of Medicine (NEJM) published a study titled DNA Sequencing versus Standard Prenatal Aneuploidy Screening. In short, the research showed that a DNA-sequencing blood based test recently developed by Illumina (NASDAQ: ILMN) could “significantly improve clinical practice by reducing the number of invasive procedures [required in standard screening].”

According to both Forbes and analysis from Cowen & Co., these findings now open the market to between $6 billion and $8 billion in annual revenue for Down Syndrome testing alone. As for the companies that provide these tests, there are only four on the market today: Ariosa, Natera, Sequenom, and of course Illumina.

Illumina is undoubtedly the forerunner with NEJM directly supporting their particular test, but the company is actually purposefully leaving the market open to its remaining three competitors by cutting it’s marketing expenses. Why? Because all three use Illumina’s genetic sequencing machines to complete these tests.

In other words, Illumina can pretty much sit back while its competitors absorb the cost of advertising. Talk about a stranglehold.

If you’ve been a devoted reader to Energy and Capital you may remember me recommending ILMN back when it was trading at about $99 a share. In just a few months, market sentiment has pushed that figure up as high as $183 with support currently being tested at about the $160 mark.

ilmn performance


At this point shareholders are no doubt questioning if the run-up can continue, and the answer to that question will likely be answered within the next 30-60 days. If Illumina hits $155, it’s time to take those gains. If it breaks through $180, you can expect another rally.

In either case though, Illumina no longer offers the attractive high growth scenario it once did. The company now boasts a $20.7 billion market cap and a P/E ratio approaching 200. There’s little doubt Illumina has a bright future ahead of it, but things are going to move a lot more slowly for shareholders at this point.

CombiMatrix (NASDAQ: CBMX) : The Comeback Kid

CombiMatrix Corp. is a small molecular diagnostics company focused primarily on prenatal diagnosis, miscarriage analysis, and pediatric developmental disorders. The company’s full scale genetic laboratory specializes in chromosomal microarray analysis (CMA) — an innovative process for interpreting the structure and function of DNA.

CombiMatrix received a slew of investor attention in 1999 after receiving a few promising government grants, but research on the company’s technology was undeniably premature. The market wasn’t ready to adopt CMA without the backing of clinical research and when the hype settled, the bubble popped.

For over a decade, shareholders suffered through high selling pressure as a result of share dilution, weak earnings, and a NASDAQ notice regarding minimum bid price. The constant deterioration resulted in a reliable pattern of shareholders dumping stock on positive news spikes, and eventually an influx of day traders taking advantage of the wild volatility.

With 4.74 million shares outstanding and an average daily volume of 951,000, the security is essentially trading hands once every five days. Generally speaking, any indication of a stock churning like this should be a strong warning to investors.

However, this warning isn’t necessarily a full on stop — it’s simply a yield. If a beaten down company such as CombiMatrix begins to offer sustainable growth, the stock will transform from a trading vehicle into a viable investment with pre-established institutional interest.

This is what’s currently happening with CombiMatrix.

Without getting into too much detail, the company uses a proprietary database of genomic variants to identify abnormalities that are too small for traditional testing known as Karyotyping.

In addition to the NEJM’s recent study on the benefits of genetic analysis in Down Syndrome screening mentioned above, the journal also released two other papers: Chromosomal Microarray versus Karyotyping for Prenatal Diagnosis and Karyotype versus Microarray Testing for Genetic Abnormalities after Stillbirth in 2012.

In combination, these two studies found that CMA is able to identify additional clinically significant genetic information for prenatal diagnosis as well as provide a more reliable genetic diagnosis that is “especially valuable in analyses of stillbirths”. Since their release, CombiMatrix has begun to penetrate the market and grow revenues at an impressive rate.

In the company’s Q4 2013 report, CombiMatrix announced a 172% increase in billable prenatal test volumes quarter-over-quarter and a 171% increase year-over-year. As for revenue, the company saw a 112% increase in prenatal microarray sales year to year and an 18% increase on the bottom line.

With this in mind, it’s worth pointing out that, in 2013, average revenue per test increased from $900 to $1,100 — a positive trend the company expects to continue in 2014. This means that the gap we’re currently seeing between test volume and revenue increases will begin to close. It also means that we can expect a positive impact on margins.

In the same 2012-2013 time frame, the company experienced many other milestones including the following:

  • Introduction of CEO Mark McDonough, a former VP of sales at LabCorp of America. McDonough brings well needed experience in diagnostic marketing and has aggressively expanded partnerships with network providers.
  • Pathology Inc. selects CombiMatrix as an exclusive provider of CMA for miscarriage diagnostic testing.
  • New York State Department of Health announces conditional approval for CombiMatrix to market prenatal testing in the New York Metropolitan area.
  • Contracts awarded by BlueCross Blue Shield of California and Kansas City, the Three Rivers Provider Network, FedMed National Provider Network, and America’s Choice Provider’s Network, giving access to an additional total of 68.8 million members.
  • CombiMatrix announces collaboration with Sequenom’s Center for Molecular Medicine. This puts pressure on ILMN to take advantage of CombiMatrix’s experience in non-invasive prenatal testing.
  • Rumors of buyout discussions with both ILMN and Sequenom.
  • $12 million public offering that raised cash to $14 million — a significant portion of the company’s $16.5 million market cap and enough to sustain current operations through mid 2016.

As for insider bullishness, here are a few statements from the most recent earnings call:

We believe there is no reason why we can’t keep this kind of growth going into 2014 and beyond.

The bottom line is that we are a vastly different company than we were a year ago. We have extended our reach to millions more patients are covered for CMA testing and numerous physician groups and testing labs are now on-board.

This prenatal microarray testing market is a huge and rapidly expanding market and we are the only publicly traded company specializing it.

As full disclosure, I’m personally loading up on shares of CBMX for the many reasons mentioned above. There is major growth potential in this company with the only significant downside being a history of hot-potato day trading. You can expect some volatility here in the short term with most of the action cooling off as CBMX continues to grow through 2015.

Turning progress to profits,

  JS Sig

Jason Stutman

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