Of the approximately $50 billion in IPOs this year, LipoScience (LPDX) is indisputably one of the most disappointing and underperforming. After being priced at $9 in January of this year, the shares quickly rose to $11 and have since fallen nearly 70%.
Every quarter this year has brought on more disappointment. While the company's operating expenses will increase nearly 25% in 2013 over the prior year, sales are expected to decline approximately 5%. Also, average selling price for the test has declined for three consecutive years. So what reason could I have to recommend investors purchase shares of this diagnostic company?
Background
LipoScience is a diagnostic company that develops and markets tests to identify the presence of cardiac and metabolic diseases. The NMRLipoProfile, a novel cardiac test, accounts for over 90% of the company's revenue. A quick look at the front of an investor presentation explains that the company's test goes beyond the standard LDL measurement to give doctors and patients a measure of LDL particles, which has shown to be a more accurate predictor of heart disease than LDL alone. Unlike many newcomer diagnostic companies, there is no issue for LPDX as to whether or not Doctors will use the test in their practice. In 2013, more than 2 million tests will have been ordered.
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The issue that LipoScience has run against is how to manage its growth. Prior to its IPO earlier this year, management decided that in addition to running the tests in the company's CLIA lab, they would pursue selling an instrument, the Vantera, so that labs could run the test themselves. Having followed the diagnostic sector for some time, this strategy struck me as peculiar, which is primarily why I stayed away from the story when the company first went public. Having the tests run by the labs themselves is not necessarily a bad strategy, however, it is both an expensive and unusual proposition. There are basically two types of blood tests, in terms of neccessary regulatory approval: FDA and LDT (Lab Developed Test). Pursuing an FDA approval is a costly, lengthy and high-risk proposition, which is why more companies have come to pursue the use of Lab Developed Tests, which only have to be approved by a state regulator.
LPDX's profile test contains separate results some of which are FDA approved and some of which are only considered LDT's. As a result, for labs running the tests on the Vantera, the second page of results will have to be transmitted from the company itself. This is not what makes the company's strategy high risk.
The issue is that of running two separate types of companies under the umbrella of one. Traditionally in the diagnostic sector, there are instrument companies, including Hologic (HOLX) and Danaher (DHR) and labs who purchase the instruments, including Quest Diagnostics (DGX) and LabCorp (LH). Instrument companies primarily sell to the labs while labs market and sell the tests to doctors. In the middle, there can be collaborations between the two to promote certain tests. LipoScience, in running in house tests and selling the instrument for their primary test, is trying to wear both hats. Largely as a result of this new structure, the company's operating expenses increased 25%, while sales have declined nearly 5% in 2013.
At the same time, while the company is trying to convince labs to take control of more of the testing, reimbursement has been declining steadily over the past three years, in spite of the company having obtained a category 1 CPT code for its flagship test. Additionally, a few of the larger commercial insurers still consider LipoScience's test out of network, creating a nuisance for doctors that order with those insurance companies as payers. Lab managers don't take adding instruments lightly, and as a result, may be waiting for the reimbursement situation to stabilize.
The company's CEO left the company in August of this year, after having been public for less than three quarters. The departing CEO, Richard Brajer, had been with the company for ten years, serving as the company's CEO during his entire tenure. In the meantime, Bob Greczyn, a board member since 2011, has been named interim CEO. His experience most notably and recently was as CEO of Blue Cross Blue Shield of North Carolina, perhaps making him uniquely qualified to help the company overcome the hurdles of acceptance by the insurance companies.
Thesis
Given all of the challenges the company faces, how can I recommend to investors that they buy shares of this beleaguered life sciences company in hopes it will reap significant rewards?
First, taking a look at the chart below, it's clear that while the company has faced its share of challenges, it has continued growing volume, which should give investors assurance that the company's test is being seen by the medical community as increasingly relevant.
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Second, the shares are trading near tangible book value at 1.1x. Taking a look at the table below, you'll see that this is below average and below any other peer I was able to find. Additionally, shares trade at 1/3 of sales, far below any other peer. This type of valuation is a positive for shares in two ways. First, it gives investors cover in case of bad news. While valuation can always be reduced further, most of the company's tangible book value is in cash, so this likely provides a reliable benchmark. Also, the low valuation could make the company an attractive takeover target. The fact that the company is targeting two different types of customers could end up attracting instrument providers, who could want to add the test to their offering and/or LDT companies who could plug the test into their existing corporate infrastructure.
| Company | Price/TBV | EV/Sales |
| Cancer Genetics (CGIX) | 28.8x | 19.2x |
| Chembio (CEMI) | 1.6x | 1.0x |
| Hologic | NM | 4.0x |
| LabCorp | NM | 1.95x |
| LipoScience | 1.1x | 0.35x |
| Neogenomics (NEO) | 10.0x | 2.5x |
| Quest Diagnostics | NM | 1.7x |
| TrovaGene (TROV) | 5.5x | NM |
Third, there are at least four different investment companies that own more than 5% of the company, which says two things: the company is appealing enough to draw large institutional interest shortly after going public (though some of the institutions were invested in the company when it was private) and the managers of these investments have a particular interest in seeing the company succeed. Additionally, the interim CEO recently purchased 10,000 shares.
Finally, so much has gone wrong for this company since going public, that if anything starts to turn in their favor, it could mean exponentially higher returns.
Conclusion
The major obstacle that management has to tackle is managing the expectations of providers (wanting to reimburse less) while pushing for volume growth. The company's last quarter was bad in that it was the lowest revenue quarter in at least 6 quarters and likely the quarter with the highest operating expenses in the company's history. What I am hoping for, and what I imagine the company will do, is to work hard at gaining broader coverage acceptance of the test, while at the same time better aligning revenues with expenses. If the company is able to do this, and revenues start to re-accelerate, the valuation should quickly march higher to at least 1.7x sales (the low end of industry acquisition multiples), which would be close to $8.
Disclosure: I am long LPDX, CEMI, NEO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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