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NanoString Technologies Fundraising Signals Inflection Point In Strategy
Mar. 29, 2019 3:15 PM•NSTG
Summary
Record cash accumulation and sales growth indicate potential strategy shift toward consumables.
Expansion of Prosigna test to additional overseas markets.
Additional cancer tests sought to compliment Prosigna.
Razor blade model adopted with oncology driving future sales growth.
Prostate cancer tests sought to compliment Prosigna.
Editor's note: Seeking Alpha is proud to welcome Theodore Zucconi as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to the SA PRO archive. Click here to find out more »
NanoString Technologies (NSTG) sells its scientific equipment to research organizations and laboratories. The company has developed a technology platform that unlocks the code of biological material using a very efficient process of optically bar-coding molecules in the cell. In their latest quarter the business achieved record product and service revenue. Additionally, they have a robust backlog of 30+ machines going into their next product launch.
The market welcomed the news which propelled the stock price higher but then without warning, the company did a sizable offering to raise money. This left investors scratching their heads with regards to the timing and purpose. The timing was peculiar because NSTG has a credit facility of $100 million from Silicon Valley Bank and actually improved its cash position to $94.0 million as of year end. There were no financial danger signs, so it's reasonable to speculate that the timing must be related to some acquisition or licensing opportunities on the horizon that will achieve a high return on equity.
December 2018, the stock price was headed down with the rest of the market. It bottomed about $14/share when the company announced the United Kingdom's National Institute for Health and Care Excellence (NICE) was going to recommend NSTG's Prosigna Breast Cancer Assay. In about 2.5 months the stock more than doubled and hit new highs in January, February and March before pulling back to the 20 day moving average. The upward momentum might have continued, but one of their key investors, Clarus Ventures must have wanted to sell a sizable position they have been holding since 2012 to lock in a gain.
The recent offering including the over allotment added about $68.3 million to the company coffers which pushed their cash position over $158 million ($4.65/share cash). The company prospectus indicated the funds would be used to expand commercialization of products, fund operations, and to do further research and development, but the corporate presentation hints at a more exciting strategy.
Cowen Presentation
One look at their core nCounter business shows flat year over year unit sales, but solid growth in the consumables business. Brad Gray, CEO of NSTG, explained at the Cowen Conference that the company has employed a "razor/razor blade model" in executing their business plan because some of the machines "generate $75K - $80K of recurring revenue yearly." The more machines that get put into service the greater the revenue for consumables. Increasing their installed base of machines is vital to their future success.
The question on investor's minds is where exceptional growth will come from. An intelligent strategy would be to increase its installed base, then focus on increasing the consumables being purchased. However, to get the exceptional growth the Company should consider developing another test that can be performed on the same machine. An even more efficient tactic would be to buy/license an existing approved test.
Oncology
When we peel the onion back a little and do a deeper dive into their oncology business there seems to be some real potential here. Their Prosigna test had 40% year over year growth. The recommendation by NICE in the United Kingdom is likely the first domino to drop in what could be a very lucrative global business. In December, NanoString said "NICE is broadly considered to be the world leader in the assessment of clinical and cost effectiveness, and the quality and thoroughness of the work supporting the current guidance should be considered a gold-standard approach for the evaluation of diagnostic products worldwide."
The oncology world is moving in the direction of personalized medicine which tests whether the patient has the bio-markers that would lead to a favorable outcome. It can also be used to select the therapy that would be most effective. Adoption by other countries seems inevitable and will eventually drive new equipment sales and the possible explosion in consumable sales.
Cowen Presentation
Another possibility on the oncology side is that they expand their number of test assays beyond Prosigna. As many investors have seen, Exact Sciences (EXAS) has done extremely well marketing Cologuard®. Investors understand that eventually the existing market is going to become saturated and that the Company is going to need to have an answer for what test is next. Prosigna could be licensed to EXAS, but this is an $2600 test versus a $650 Cologuard® test and would require modifying their sales pitch. While this could be a profitable tactic, it doesn't explain the fundraising activity.
CytoDyn Corporate Presentation
Prostate Cancer Prognostic Test
CytoDyn Inc. (OTCQB:CYDY) has a prostate cancer prognostic test that might be an ideal match to expand NSTG's product offering. There is no formally announced partnership between the two companies. All that is known is the CYDY used NSTG's equipment to develop a prognostic test in prostate cancer and that they are filing a 510(k) with the FDA this year and planning on a licensing deal in the 1H 2019. CYDY has the intellectual property for detecting the aggressive form of prostate cancer. The test uses NSTG's technology to check the patient's biopsy for a specific aggressive prostate cancer gene signature. Removing a prostate has unwanted side effects of erectile dysfunction, incontinence, and dribbling. Since most prostate cancer is slow growing, removal is not indicated.
However, missing the presence for the aggressive form has serious consequences. The PSA test has many problems such as; false positives and not distinguishing between the slow and aggressive types of cancer. The current prostate cancer tests, besides the standard Gleason score is estimated by CYDY to cost about $3,500, but they really don't give actionable data. For example, the current tests (in the slide above) check whether or not the patient has the aggressive form of prostate cancer. If the patient tests negative the for the aggressive form, the patient has a 90% chance of living 10 years, but if the patient tests positive he has an 80% chance of living 10 years. The test doesn't give a definitive answer of whether or not to remove the prostate. CYDY's test using the NSTG array, really gives the patient actionable data.
For example, if the patient tests negative he has a 80% chance of living 10 years. If the patient tests positive for the aggressive prostate cancer there is a 100% chance he is going to die in 5 years. This is highlighted in the slide above. The decision is more black and white for the patient. CYDY has been very vocal about being in the final stages of a licensing deal with a potential partner. The amount and timing of the cash raise by NSTG seem to fit. CYDY estimates the potential market for the prostate cancer prognostic test is $750 million annually assuming 220,800 new cases of prostate cancer annually.
Although CYDY is the obvious choice of a strategic partner for NSTG, there are many contributors to NSTG's Technology Access Program (TAP), which could lead to many additional partnership opportunities. Since they already have the Prosigna test developed, the next cancer tests to logically develop will be based on large patient populations and medical need. The difficult to diagnose cancers are; lung cancer, brain cancer, and head and neck cancer. Another slide gives clues to the direction NSTG is headed. Peter Nelson from the Fred Hutch Cancer Research Center mapped the micro environment of metastatic prostate cancer. John McPherson from the University of California, Davis, resolved RNA bio-markers using the GeoMS spatial profiler. The specific mention on slide 27 of the Cowen presentation seems to indicate that the next upcoming test might be in prostate cancer.
The company points to a bifurcated sales force that sells either machines or consumables. NSTG uses the analogy of hunters that would find organizations that would achieve huge gains in productivity by utilizing the technology versus farmers that would cultivate greater use of the technology. While this might seem like a good strategy for increasing sales, it seem to be evident that focusing on developing and selling new tests is a better way to increase sales in a razor blade model.
Neuroscience
Another area of growth seems to center around neuroscience. NSTG announced that the Cowen conference that they had a 100% increase in nCounter systems sold for neuroscience and a 65% increase in sales for that category. Just recently (last week) Biogen Idec (BIIB) announced it was halting its trial in Alzheimer's disease (AD) and subsequently dropped almost $18 billion in market capitalization. Last year Eli Lilly (LLY) couldn't salvage solanezumab for early stage AD. There is a virtual graveyard in AD with only one company showing any sign of life. Neurotrope (NTRP) is the last company standing in AD with a highly anticipated readout in the summer of 2019. NTRP actually showed an improvement in Severe Impairment Battery (SIB) in a subset of patients that didn't take Memantine.
All AD trials measure the rate of decline in SIB, so for even a subset of patients in a clinical trial to show an increase is quite exceptional. NTRP uses a different target than plaque, the big pharmas' focus. Many trials involving amyloid plaque have failed. Any big pharma will need to play catch up and fast to stay in the race for AD therapy. This is where NSTG and it gene signature profiling could help AD research progress at a quicker pace. There is a huge market opportunity and the recent failures could be a boon to NSTG business.
New Cash Must Start Working
Funding biotech companies can be very difficult because of all the uncertain results associated with development. Brad Gray, the CEO of NSTG, likely made a conscious decision to improve the company's cash hoard even though they were at an inflection point of commercialization of its second product line. On the latest earnings call the company indicated a total cash burn of $55 to $60 million in 2019. With over 2 years of cash burn assuming no growth in sales, and the expected $20 million in R&D funding from Lam Research, they are in a very strong financial position. They are expecting to grow top line revenues to $118 to $123 million in 2019, and they enjoy a healthy 57 - 59% gross margin. With their cash hoard and their current trajectory of sales they have about 2.5 to 3 years to figure out how to become profitable.
Risks
Attaining profitability is perhaps the biggest risk investor's must consider. The science is sound and their installed base is growing, but they are pumping a huge percentage of cash into R&D as they roll out two new product lines. In 2018 R&D expense was 58% of sales, which also happens to be their gross margin. They have to find a way to stimulate sales or ensure their investment in technology will take root. On a positive front they had 30+ pre-orders for their next generation of machines, which reduces the risk that their investment in technology will fail.
Best Use of Cash
This article is primarily exploring alternate strategies the company may pursue with the backstop of a large cash horde. The consumable strategy seems to be the most intriguing. The prosigna test currently costs approximately $2600 per assay and they were able to do $9.4 million in sales. This works out to 3600 tests on a potential patient population of over 1.4 million breast cancer patients worldwide. If they tweak their strategy to really push the consumables they might exceed their sales goals.
The reason CYDY's test is so compelling for NSTG is because it is not necessarily a onetime test like prosigna. Men that test negative will still take the test in the future. This provides residual income streams for Cologuard. While there are a lot of competing prostate cancer tests outlined in the slide above, no test has a predictive value of 98-99%.The superiority of the test should lead to very rapid and widespread adoption. The CYDY test would be a much better value proposition to the testing lab. to sell the nCounter machines versus the prosigna test alone which is only done on the 30% of the women that test HR2+ for breast cancer.
A licensing agreement with CYDY for the prostate cancer prognostic test seems like the most rapid and profitable path forward. If the market size is $750 million, as CYDY estimates, and they are able to negotiate a 5% upfront licensing deal, that could mean $37.5 million to CYDY. NSTG would only need to sell approximately 21,000 tests at $3,500 to break even. That represents less than 10% market penetration of the 220,800 annual prostate cancer test market. This potential licensing deal makes a lot of economic sense and could be part of NSTG's plan, now that they have excess cash to make a deal.
Investment Summary
Before this last equity financing, NSTG had close to 2 years of operating funds in the form of cash and a credit facility. They could have held off on the fundraising and waited to get some traction in the market. This would have reduced the dilution and allowed continued stock appreciation. The stock had finally hit new highs after the NICE announcement, and selling shareholder Clarus Ventures wanted to lock in their return. The company may have thought a combined offering was the best way to avoid stock depreciation. The other option is that CEO Brad Gray saw the price appreciation as an opportunity to get less dilutive funding than he has gotten in the past.
The most logical answer, however, is that CEO Gray raised funds for a purpose other than general and administrative expenses. Whatever the rationale for the fundraising, the main objective is to ultimately increase sales. Gray's decision to bifurcate the sales force, and the detailed discussion on the earnings call about sales strategies, seems to demonstrate his commitment toward the company's sales goals versus its R&D goals. Positioning a $248,000 machine sale as a platform technology instead of relying on a single breast cancer test would be the most expeditious way to expand sales.
Instead of using the machine to just sell the Prosigna test they would be able to use it for other disease indications like; prostate cancer, lung cancer, brain cancer, and head and neck cancer. These additional indications would allow laboratories to recoup their investment sooner. A new cancer test seems inevitable, and a deal with CYDY seems to be the most expeditious way to get a new test into the market. This analysis is complete speculation based on NSTG's strategy to increase sales as soon as possible. It's also likely that this may be the last serious fundraising NSTG will do because whatever investments the company does make for boosting sales should be accretive quickly and yield a huge increase in revenue growth.
Disclosure: I am/we are long CYDY. 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.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
NanoString Technologies Fundraising Signals Inflection Point In Strategy
Mar. 29, 2019 3:15 PM•NSTG
Summary
Record cash accumulation and sales growth indicate potential strategy shift toward consumables.
Expansion of Prosigna test to additional overseas markets.
Additional cancer tests sought to compliment Prosigna.
Razor blade model adopted with oncology driving future sales growth.
Prostate cancer tests sought to compliment Prosigna.
Editor's note: Seeking Alpha is proud to welcome Theodore Zucconi as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to the SA PRO archive. Click here to find out more »
NanoString Technologies (NSTG) sells its scientific equipment to research organizations and laboratories. The company has developed a technology platform that unlocks the code of biological material using a very efficient process of optically bar-coding molecules in the cell. In their latest quarter the business achieved record product and service revenue. Additionally, they have a robust backlog of 30+ machines going into their next product launch.
The market welcomed the news which propelled the stock price higher but then without warning, the company did a sizable offering to raise money. This left investors scratching their heads with regards to the timing and purpose. The timing was peculiar because NSTG has a credit facility of $100 million from Silicon Valley Bank and actually improved its cash position to $94.0 million as of year end. There were no financial danger signs, so it's reasonable to speculate that the timing must be related to some acquisition or licensing opportunities on the horizon that will achieve a high return on equity.
December 2018, the stock price was headed down with the rest of the market. It bottomed about $14/share when the company announced the United Kingdom's National Institute for Health and Care Excellence (NICE) was going to recommend NSTG's Prosigna Breast Cancer Assay. In about 2.5 months the stock more than doubled and hit new highs in January, February and March before pulling back to the 20 day moving average. The upward momentum might have continued, but one of their key investors, Clarus Ventures must have wanted to sell a sizable position they have been holding since 2012 to lock in a gain.
The recent offering including the over allotment added about $68.3 million to the company coffers which pushed their cash position over $158 million ($4.65/share cash). The company prospectus indicated the funds would be used to expand commercialization of products, fund operations, and to do further research and development, but the corporate presentation hints at a more exciting strategy.
Cowen Presentation
One look at their core nCounter business shows flat year over year unit sales, but solid growth in the consumables business. Brad Gray, CEO of NSTG, explained at the Cowen Conference that the company has employed a "razor/razor blade model" in executing their business plan because some of the machines "generate $75K - $80K of recurring revenue yearly." The more machines that get put into service the greater the revenue for consumables. Increasing their installed base of machines is vital to their future success.
The question on investor's minds is where exceptional growth will come from. An intelligent strategy would be to increase its installed base, then focus on increasing the consumables being purchased. However, to get the exceptional growth the Company should consider developing another test that can be performed on the same machine. An even more efficient tactic would be to buy/license an existing approved test.
Oncology
When we peel the onion back a little and do a deeper dive into their oncology business there seems to be some real potential here. Their Prosigna test had 40% year over year growth. The recommendation by NICE in the United Kingdom is likely the first domino to drop in what could be a very lucrative global business. In December, NanoString said "NICE is broadly considered to be the world leader in the assessment of clinical and cost effectiveness, and the quality and thoroughness of the work supporting the current guidance should be considered a gold-standard approach for the evaluation of diagnostic products worldwide."
The oncology world is moving in the direction of personalized medicine which tests whether the patient has the bio-markers that would lead to a favorable outcome. It can also be used to select the therapy that would be most effective. Adoption by other countries seems inevitable and will eventually drive new equipment sales and the possible explosion in consumable sales.
Cowen Presentation
Another possibility on the oncology side is that they expand their number of test assays beyond Prosigna. As many investors have seen, Exact Sciences (EXAS) has done extremely well marketing Cologuard®. Investors understand that eventually the existing market is going to become saturated and that the Company is going to need to have an answer for what test is next. Prosigna could be licensed to EXAS, but this is an $2600 test versus a $650 Cologuard® test and would require modifying their sales pitch. While this could be a profitable tactic, it doesn't explain the fundraising activity.
CytoDyn Corporate Presentation
Prostate Cancer Prognostic Test
CytoDyn Inc. (OTCQB:CYDY) has a prostate cancer prognostic test that might be an ideal match to expand NSTG's product offering. There is no formally announced partnership between the two companies. All that is known is the CYDY used NSTG's equipment to develop a prognostic test in prostate cancer and that they are filing a 510(k) with the FDA this year and planning on a licensing deal in the 1H 2019. CYDY has the intellectual property for detecting the aggressive form of prostate cancer. The test uses NSTG's technology to check the patient's biopsy for a specific aggressive prostate cancer gene signature. Removing a prostate has unwanted side effects of erectile dysfunction, incontinence, and dribbling. Since most prostate cancer is slow growing, removal is not indicated.
However, missing the presence for the aggressive form has serious consequences. The PSA test has many problems such as; false positives and not distinguishing between the slow and aggressive types of cancer. The current prostate cancer tests, besides the standard Gleason score is estimated by CYDY to cost about $3,500, but they really don't give actionable data. For example, the current tests (in the slide above) check whether or not the patient has the aggressive form of prostate cancer. If the patient tests negative the for the aggressive form, the patient has a 90% chance of living 10 years, but if the patient tests positive he has an 80% chance of living 10 years. The test doesn't give a definitive answer of whether or not to remove the prostate. CYDY's test using the NSTG array, really gives the patient actionable data.
For example, if the patient tests negative he has a 80% chance of living 10 years. If the patient tests positive for the aggressive prostate cancer there is a 100% chance he is going to die in 5 years. This is highlighted in the slide above. The decision is more black and white for the patient. CYDY has been very vocal about being in the final stages of a licensing deal with a potential partner. The amount and timing of the cash raise by NSTG seem to fit. CYDY estimates the potential market for the prostate cancer prognostic test is $750 million annually assuming 220,800 new cases of prostate cancer annually.
Although CYDY is the obvious choice of a strategic partner for NSTG, there are many contributors to NSTG's Technology Access Program (TAP), which could lead to many additional partnership opportunities. Since they already have the Prosigna test developed, the next cancer tests to logically develop will be based on large patient populations and medical need. The difficult to diagnose cancers are; lung cancer, brain cancer, and head and neck cancer. Another slide gives clues to the direction NSTG is headed. Peter Nelson from the Fred Hutch Cancer Research Center mapped the micro environment of metastatic prostate cancer. John McPherson from the University of California, Davis, resolved RNA bio-markers using the GeoMS spatial profiler. The specific mention on slide 27 of the Cowen presentation seems to indicate that the next upcoming test might be in prostate cancer.
The company points to a bifurcated sales force that sells either machines or consumables. NSTG uses the analogy of hunters that would find organizations that would achieve huge gains in productivity by utilizing the technology versus farmers that would cultivate greater use of the technology. While this might seem like a good strategy for increasing sales, it seem to be evident that focusing on developing and selling new tests is a better way to increase sales in a razor blade model.
Neuroscience
Another area of growth seems to center around neuroscience. NSTG announced that the Cowen conference that they had a 100% increase in nCounter systems sold for neuroscience and a 65% increase in sales for that category. Just recently (last week) Biogen Idec (BIIB) announced it was halting its trial in Alzheimer's disease (AD) and subsequently dropped almost $18 billion in market capitalization. Last year Eli Lilly (LLY) couldn't salvage solanezumab for early stage AD. There is a virtual graveyard in AD with only one company showing any sign of life. Neurotrope (NTRP) is the last company standing in AD with a highly anticipated readout in the summer of 2019. NTRP actually showed an improvement in Severe Impairment Battery (SIB) in a subset of patients that didn't take Memantine.
All AD trials measure the rate of decline in SIB, so for even a subset of patients in a clinical trial to show an increase is quite exceptional. NTRP uses a different target than plaque, the big pharmas' focus. Many trials involving amyloid plaque have failed. Any big pharma will need to play catch up and fast to stay in the race for AD therapy. This is where NSTG and it gene signature profiling could help AD research progress at a quicker pace. There is a huge market opportunity and the recent failures could be a boon to NSTG business.
New Cash Must Start Working
Funding biotech companies can be very difficult because of all the uncertain results associated with development. Brad Gray, the CEO of NSTG, likely made a conscious decision to improve the company's cash hoard even though they were at an inflection point of commercialization of its second product line. On the latest earnings call the company indicated a total cash burn of $55 to $60 million in 2019. With over 2 years of cash burn assuming no growth in sales, and the expected $20 million in R&D funding from Lam Research, they are in a very strong financial position. They are expecting to grow top line revenues to $118 to $123 million in 2019, and they enjoy a healthy 57 - 59% gross margin. With their cash hoard and their current trajectory of sales they have about 2.5 to 3 years to figure out how to become profitable.
Risks
Attaining profitability is perhaps the biggest risk investor's must consider. The science is sound and their installed base is growing, but they are pumping a huge percentage of cash into R&D as they roll out two new product lines. In 2018 R&D expense was 58% of sales, which also happens to be their gross margin. They have to find a way to stimulate sales or ensure their investment in technology will take root. On a positive front they had 30+ pre-orders for their next generation of machines, which reduces the risk that their investment in technology will fail.
Best Use of Cash
This article is primarily exploring alternate strategies the company may pursue with the backstop of a large cash horde. The consumable strategy seems to be the most intriguing. The prosigna test currently costs approximately $2600 per assay and they were able to do $9.4 million in sales. This works out to 3600 tests on a potential patient population of over 1.4 million breast cancer patients worldwide. If they tweak their strategy to really push the consumables they might exceed their sales goals.
The reason CYDY's test is so compelling for NSTG is because it is not necessarily a onetime test like prosigna. Men that test negative will still take the test in the future. This provides residual income streams for Cologuard. While there are a lot of competing prostate cancer tests outlined in the slide above, no test has a predictive value of 98-99%.The superiority of the test should lead to very rapid and widespread adoption. The CYDY test would be a much better value proposition to the testing lab. to sell the nCounter machines versus the prosigna test alone which is only done on the 30% of the women that test HR2+ for breast cancer.
A licensing agreement with CYDY for the prostate cancer prognostic test seems like the most rapid and profitable path forward. If the market size is $750 million, as CYDY estimates, and they are able to negotiate a 5% upfront licensing deal, that could mean $37.5 million to CYDY. NSTG would only need to sell approximately 21,000 tests at $3,500 to break even. That represents less than 10% market penetration of the 220,800 annual prostate cancer test market. This potential licensing deal makes a lot of economic sense and could be part of NSTG's plan, now that they have excess cash to make a deal.
Investment Summary
Before this last equity financing, NSTG had close to 2 years of operating funds in the form of cash and a credit facility. They could have held off on the fundraising and waited to get some traction in the market. This would have reduced the dilution and allowed continued stock appreciation. The stock had finally hit new highs after the NICE announcement, and selling shareholder Clarus Ventures wanted to lock in their return. The company may have thought a combined offering was the best way to avoid stock depreciation. The other option is that CEO Brad Gray saw the price appreciation as an opportunity to get less dilutive funding than he has gotten in the past.
The most logical answer, however, is that CEO Gray raised funds for a purpose other than general and administrative expenses. Whatever the rationale for the fundraising, the main objective is to ultimately increase sales. Gray's decision to bifurcate the sales force, and the detailed discussion on the earnings call about sales strategies, seems to demonstrate his commitment toward the company's sales goals versus its R&D goals. Positioning a $248,000 machine sale as a platform technology instead of relying on a single breast cancer test would be the most expeditious way to expand sales.
Instead of using the machine to just sell the Prosigna test they would be able to use it for other disease indications like; prostate cancer, lung cancer, brain cancer, and head and neck cancer. These additional indications would allow laboratories to recoup their investment sooner. A new cancer test seems inevitable, and a deal with CYDY seems to be the most expeditious way to get a new test into the market. This analysis is complete speculation based on NSTG's strategy to increase sales as soon as possible. It's also likely that this may be the last serious fundraising NSTG will do because whatever investments the company does make for boosting sales should be accretive quickly and yield a huge increase in revenue growth.
Disclosure: I am/we are long CYDY. 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.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
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