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.

High Upside Ideas that Will Take Time to Play Out: Natera and Quotient

It's been a while since I last wrote. Things have been good. I got out of market in September in anticipation of a downturn, only to scramble and buy back stock in October. Following the crowd has not been good for my ego, but it sure is great for my money! I also felt like there's not much to write about. 2017 is one of those years where you can randomly buy anything, as long as you cut your losses and let your winners ride, you'll be ok. It's a bull market after all!

I tried to do a couple write-ups the past few months, but didn't bother posting them because the stocks ran up while I was editing them (FSLR is one example). Here are a couple thesis that won't have that problem - they should take years to play out.

Natera (NTRA)

It’s a land grab right now in molecular diagnostics (the analysis of genome and DNA). Natera is a known player in non-invasive prenatal testing (NIPT) and carrier screening with their Panorama and Horizon tests, respectively.

When I read transcripts I like to scribble down sources of upsides at the edge. In the case of NTRA’s 2Q17 transcripts, I nearly ran out of room. I list them out below.

• Operating leverage from improving reimbursement - only 10% of microdeletion panel reimbursed so far. Management estimated that they can make $30mm more a quarter if all jobs are reimbursed jobs – keep in mind 2Q17 revenue was only $54mm! Since NTRA already incurs the costs for these tests, any reimbursement goes straight to the bottom line.

• Increasing uptake in carrier screening, and shift to multi-gene screening. The number of Horizon tests ordered went up 63% yoy in 2Q17. Some of that was from increased sales focus and crossed selling, but there’s also a secular trend in carrier screening. This year the American Congress of Obstetricians and Gynecologist (“ACOG”) issue updated guidelines recommending carrier screening more than cystic fibrosis.

• New/recent product launches
• Vistara (NIPT for additional conditions)
• Signatera (cancer diagnostics, for research use only for now, but will have clinical use product as early as next year)
• Evercord, this is a cord blood banking service (they offer to store baby’s cord blood after birth, which can be later used for genetic analysis and potential transplants). 

NTRA is an expensive looking, highly volatile stock that demands a long term investing mentality. At least its strategy makes sense to me. They have a strong position in the prenatal niche and they’re using that strong base to expand into neighboring areas.

In the coming years, I expect revenue to accelerate as mix shifts toward higher growth products. There’s potential for great operating leverage from additional reimbursement (remember this goes straight to the bottom line), and from improved sales productivity as they add new product to the same sales touch points (fertility doctors, OBGYN).

SG&A is currently a huge drag on profitability and cash flows. I suspect this is all easy synergy for potential acquirers.



Quotient (QTNT)

Quotient is making a new machine, MosaiQ for the blood transfusion process. MosaiQ promises to making donor blood typing (determine if your blood type is A, B, O, or AB), as well as testing (checking for diseases) more efficient and more affordable. The plan is to launch 2018 in E.U., then 2019 in U.S. They have a $3bn addressable market, with $1bn in just its top 10 prospective customers.

The new product has been in the work for years and there were plenty of setbacks on the way. But the finish line is near. I particularly like the support from Ortho Clinical Diagnostics, one of the largest players in blood testing. Ortho will distribute MosaiQ for the patient testing market (with donor testing market retained by Quotient), and will make milestone payments to QTNT.

The combination of a fairly concentrated customer base, support from one of its biggest industry players, and ability to lower customer costs makes me think the product should sell well.

Management expects 60% operating margin. Conservatively, I assume they take just 20% of top 10 customers. That’s $200mm sales x 60% margin = $120mm EBIT.

Quotient has financing lined up to get them through the finish line. This includes raising $36mm from issuance of senior secured notes, as well as $49mm in FY2019 from warrant exercise. At $5.2 a share, QTNT current has enterprise value of less than $300mm, but given these capital structure change, EV by 2020 (again using $5.2 a share) would be in the $400-450mm range. That is still very cheap in my opinion.