Natera's NIPT Upside

Back in late 2017, I wrote about Natera here. I bought it but got shaken out with very little gain. The stock then almost quadrupled and I've been kicking myself from the sidelines. All I can do now is do the work and be ready when a better buying opportunity presents itself.

Natera (NTRA) is a genetic testing / diagnostic company. Current revenues mostly come from its reproductive health business which includes NIPT (Non-Invasive Prenatal Testing) as well as carrier screening. Two other promising areas where NTRA has pipelines are oncology, and organ transplants.

I will focus on reproductive health business here. 

Upside from Additional Reimbursement and Penetration

Like some other diagnostic companies, Natera's NIPT business performs a bunch of tests they don't get paid for. This is some low hanging fruit upside, as getting insurance coverage on those tests would be revenue that falls straight to the bottom line. 

NIPT patients can be segmented into high risk and average risk. The former is mostly reimbursed, while the latter that is mostly unreimbursed, and thus also suffer from low penetration. (Quick note: "high risk" and "average risk" here refers to risk of Down Syndrome and other abnormalities. So a woman above age 35 might be considered "high risk", and below that is "average risk".)

Back in 3Q19, the company estimate that it can have additional $60mm in revenue if their average risk NIPT patients get reimbursed. This is essentially another $60mm in EBIT because they already incur the costs. 

But that's not counting additional penetration in the average risk segment, which is likely to happen with reimbursement. So I went about estimating that number. 

As luck would have it, NTRA gave a virtual presentation at an UBS conference in May, and they gave out some numbers that made this estimation much easier.

Here are the relevant paragraphs from the presentation:

"...it's about 60-40 mix between average risk and high risk. And so then drilling down a little bit more into that average risk bucket, we're getting paid -- right now, we're getting paid about 35% of the time."

"Right now, that's the case for high-risk women, it's about 65% penetrated among high-risk women. It's only like 20%, 25% penetrated among average risk women."

"So contracted rates right now are in the, call it, $700 to $900 range as a general rule. And those have been very stable for the last 4-plus years since we went in network with most of the payers. In return for a huge growth in volume, I wouldn't be surprised if contracted rates eroded and then kind of got to kind of that more kind of slow single-digit heavy erosion you just alluded to"

"when I'm calculating that $60 million number, I'm actually just taking the units and I'm multiplying it by $450. Now like I said, contractor rates are much higher than that, and I actually think that -- there's no reason for them to come down all that rapidly, but I feel like that's a good, conservative long-term ASP number, presuming kind of broad reimbursement for average risk NIPT."

 

I found a couple things when I tried to tie out the numbers. First, it seems that it's actually 60/40 between high risk/average risk, not the other way around as they stated. Second, management said (shown above) that contracted rate is $700-$900 but they assumed $450 to be conservative. My calculations show that Natera is already getting paid $460 for each reimbursed test right now. 

With ASP in hand, we can work out the upside. I'm assuming volume for high risk patients remain the same while average risk volume scales up from 25% penetration to 65%. Then I assume 85% of average risk tests get reimbursed.

As seen above, Natera can get $40mm of additional revenue per quarter - from average risk NIPT tests getting more reimbursement and more penetration. 

Keep in mind I'm not assuming any upside from NTRA's microdeletion products getting reimbursed - I've seen sell side estimates that those could be worth another $50mm per year.

The $77mm quarterly revenue (bottom right of table above) annualizes to $310mm a year. 

Here's a sensitivity table I did for NTRA's reproductive health business, assuming $200 unit cost and $180mm opex (which is referenced in one of the transcripts).

 

I ran these sensitivities because management said the current contracted rate is much higher than their $450 assumption. This is contrary to my own calculations - which show they're actually already being paid at $460 rate. So the higher priced scenarios are unrealistic in my opinion. With volume growth and competition, I would expect the rate to go down, not up. 

At over $45/share, NTRA now has market cap and enterprise value of ~$3.6bn and $3.3bn, respectively. Conservatively speaking, the valuation can no longer be justified with reproductive health business alone. Not unless you want to assume a higher price than the company does, and add in another $50mm EBIT in the case microdeletion gets reimbursed. I'm not going to do that. 

At this valuation NTRA has to be successful in its oncology and transplant business. I'm quite positive on the former as Signatera looks like a potential home run.

Themes From Roku and Trade Desk Earnings

Roku and Trade Desk ("TTD") both reported earnings last week. 1Q results were strong but 2Q does not sound that great, especially for TTD which mentioned that during the last 10 days of April, "total spend improved to a negative high teens year-over-year decline."

But this post is not about near term puts and takes. I want to outline the big picture themes that stood out to me.


TV Upfronts

Both TTD and Roku talked about how failure of traditional TV "upfront" season can accelerate movement toward connected TV ("CTV").

Here's Roku in its 1Q20 call:



Here's TTD:

"Often, the majority of TV ads are sold in the upfront process. The upfronts are usually done in late April and early May, and those events are largely suspended this year."

"For advertisers, this can be liberating. I hear it from brands and agencies every day. For them, the upfronts are a bit of a burden. They're asked to commit billions of dollars to content they don't know that much about and chasing audiences that they can't measure quite as well as anywhere else. Now they have the freedom to be more deliberate, agile and data-driven in their TV ad investments."

That's an interesting point about advertisers not liking the upfront format. It reminds me of Bruce Greenwald's views of upfronts - as a scheme for media to collaborate against advertisers. 

"Behind the glitz is a highly successful, closely coordinated system to ensure the highest prices possible for advertising with the least incentive among networks to undercut one another."

"The up-front season occurs in the context of a general industry agreement on capacity developed under the guise of a public interest code of conduct to 'protect' viewers from too many advertisements...With the limited number of minutes available for sale preagreed, the tight time frames of the season make it relatively difficult for advertisers to successfully pit the networks against one another on price."

      - from "Curse of the Mogul" by Seave, Greenwald, and Knee


So traditional media is already declining, and now its implicitly anti-competitive/collaboration scheme is being exposed.

The question is what replaces the upfronts? Will there be another process that protects the bargaining power of publishers? Or does the leverage shift to ad buyers from now on?


CTV Now Exceeds Linear TV in Reach


I find it hard to believe but this is what TTD is saying. Jeff Green actually goes further and compares TTD alone to traditional TV!

"As I said, according to eMarketer, our total U.S. households with cable would fall below 82.9 million this year. Our research suggests it could be below 80 million. This year, we expect to reach well over 80 million households via CTV in the United States."

"This is an important point. The Trade Desk is the largest aggregator of CTV ad impressions across every major content provider, and that massive scale is a great leading indicator of future spend on our platform. All of this means that in 2020, The Trade Desk will likely surpass traditional TV in reach capabilities for the first time in our history. We're already seeing this shift as brands strategize on our platform."

Of course, larger reach does not mean larger monetization, but things are certainly looking bright for CTV. 

I don't like how TTD use the word "aggregator" to describe itself. It may be technically true, but broadcasting your ambition this way will likely make your clients wary and try to reign in your dominant position.

Strategic Role of Roku Channel, and CTV Fragmentation

In its quarterly letter, Roku mentioned that in the UK, the Roku Channel works on NOW TV (Sky) and Sky Q Devices.

Sky is part of Comcast which has Peacock. Peacock works on Roku. The Roku Channel works on certain Comcast devices. 

Are we going into a world where every channel works on every device, and the market for smart TV devices/software/platform gets commoditized? We now have Apple TV, Amazon Fire, Roku, Android TV (and its variants), Comcast Flex, Samsung smart TV, and it looks like XBox is getting into the game too. 

So where's the strategic point in the value chain? If CTV platforms like Roku and Apple TV become commodities, then the next point of aggregation are aggregate channels like Roku Channel, Peacock, Netflix, Hulu…etc. 

For Roku, there's a possible scenario where its importance in the value chain (and its profit potential) comes not from Roku the platform, but from Roku the Channel.