Value Creation in Molecular Diagnostics: A Game of Luck or Skill?

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By Kristine C. Mechem Ph.D., Vice President; Emily Kong, Consultant; Vivek Mittal Ph.D., Partner
Executive Summary

What drives value creation in molecular diagnostics? Looking across 32 public diagnostic companies, clear value drivers differentiate strong vs. underperformers.

Two criteria stand out to evaluate performance: market capitalization/acquisition price and timeline to commercialization/$1B market cap. First, market capitalization and acquisition price were used to differentiate strong from underperformers in order to better understand the drivers of value creation.

Strong performers or “winners” were defined as market caps or acquisition prices of $1B; while underperformers were defined as market caps or acquisition prices less than $200MM. Since the billion-dollar market cap companies got to >$1B over different trajectories from their first raise, the analysis also looked at the timeline to commercialization and the timeline to $1B in market cap. This allowed a look through the lens of the initial investors to gauge how long it took before their investment significantly paid off.

Companies were grouped into three categories (oncology, reproductive health/genetics, and others). Five value creation drivers differentiated the winners from the underperformers.

Key Findings
Value creation for molecular diagnostic companies was highly variable in the three categories, spanning from very attractive to unattractive. In the end, value creation turns out to be a game of skill, not luck. Some companies evaluated went bankrupt, while others reached market caps of >$15B. This trend was consistently seen across the three categories of Oncology, Reproductive Health/Genetics, and Other diagnostic companies.

  • All three categories of companies had winners in the value creation race (defined as market caps or acquisition price points of $1B+) and underperformers (defined as market caps or acquisitions of less than $200MM).
  • Value creation is almost bimodal, with ~1/3 of companies defined as winners and ~1/2 of companies defined as underperformers. The remaining companies were clustered in the $200-300MM range.
  • Market capitalization for all companies in the analysis ranged from $18MM to $15B (based on July 2019 market caps).

Analyzing companies across the three categories and conducting a deeper dive into the oncology category revealed clear value creation drivers that distinguish winners from underperformers.

  1. Lead with a strong first product. The right first product is a strong driver of value creation within oncology and also differentiates winners from underperformers in the two other categories. Prioritizing use cases helps ensure that the lead product is the best foot forward for a company.
  2. Create barriers to entry to ensure sustainable competitive advantage. Barriers to entry (focusing on gene expression classifiers and conducting large clinical trials) increase the development costs and raise the bar on clinical trials, which effectively increase the hurdles for new entrants allowing the incumbent time to solidify their market position.
  3. Develop strong clinical evidence to increase adoption and the probability of reimbursement. Development of strong evidence through publications and conference proceedings increases the probability of reimbursement and adoption and raises the evidence bar for new entrants.
  4. Targeted commercial strategies ensure physician/patient loyalty. Strong commercial strategies, focused on minimizing the administrative burden for the clinician and the financial burden for the patient, reduce switching behavior to blunt the impact of new entrants.
  5. Robust pipeline ensures continued success. Portfolio management and launches of additional assays with strong use cases ensure that value creation continues beyond the first product.


Introduction  
At times, it seems that the molecular diagnostic market is a game of luck. Some companies yield significant value creation, while others struggle to create any shareholder value. The range of valuation creation for companies that get past the technical challenges to launch a product is quite large. This range, based on market cap or acquisition price, can span from tens of millions to billions of dollars.  In this analysis, we look at a number of publicly held molecular diagnostic companies to determine the strongest drivers of value creation for diagnostic companies. 

The analysis looked at the July 2019 market caps and acquisition prices of 32 diagnostic companies in Oncology, Reproductive Health/Genetics, and Other therapeutic areas.  These companies, typically specialty labs, went public either after their first product launch or when the company was still in its pre-commercial stage. 

The drivers of value creation are quite striking.  All categories (oncology, reproductive health, and other diagnostic areas) contain both companies that generate significant value and companies that struggle to create value for shareholders. Companies with commercial products or with assays in late-stage development are seen in all three categories of value creation but tend to cluster at the two ends (underperformers or winners). Companies were grouped into three categories:

  • Low value creation companies with market caps or acquisition prices of less than $200MM (which for this analysis are defined as underperformers)
  • Companies with market caps or acquisition prices between $200MM and $1B
  • High value creation companies with market caps or acquisition prices of $1B+ (which for this analysis are defined as winners).

Looking at the value creation of these diagnostic companies, one can see that it is almost a bimodal relationship. One-third of the companies were extremely successful in creating value; half were underperformers; with the remaining companies in the middle range with market caps or acquisitions of $270MM to $671MM.  In Figure 1, the right-hand side of the graphic depicts companies that generate high value for their investors.  These are companies where their July 2019 market cap was greater than $1B or who were acquired for more than $1B.  

Figure 1: Selected Diagnostic Companies Value Creation (IPO to mid-2019)image2

Oncology diagnostic companies that created the most value in the July 2019 timeframe analyzed include: 

  • Exact Sciences — market cap of $15B
  • Guardant Health — market cap of $8.6B
  • Foundation Medicine — acquired for $5.3B in two phases
  • Genomic Health — market cap of $2.4B, acquired after the analysis time period for $2.8B
  • Veracyte — market cap of $1.3B

The left-hand side of the Figure 1 graphic also shows oncology companies that struggled with value creation, as defined by those companies whose market cap or acquisition price was less than $200MM in the July 2019 timeframe or were acquired over the past few years for less than $200MM. The oncology-focused companies that are underperformers include:

  • Volition — market cap of $155MM*
  • OncoCyte — market cap of $98MM*
  • Vermillion — market cap of $73MM (2018 reported revenue of $3MM)
  • MDx Health — market cap of $61MM (2018 reported revenue of $28MM)
  • OncImmune — US assets sold for an estimated $38MM
  • Interpace — market cap $26MM (2018 reported revenue of $22MM)
  • Integrated Diagnostics — acquired for an estimated $20-30MM
  • Biocept — market cap of $19MM (2018 reported revenue of $3M                                  *Attractive market cap for a pre-commercial company

This range of value creation from low to high also can be seen with diagnostic companies in the Reproductive Health/Genetics and the All Others category as shown in Table 1.  This table shows the high value creators in the first row for Reproductive Health/Genetics and All Others category; while the last row has companies generating little to no value for their investors. The high value creators had market caps in July of 2019 that ranged from $1B to $2.3B. In the case of Ambry Genetics, it was acquired by Konica Minolta in 2017 for $1B.

Table 1: Low, Moderate and High Value Creatorsimage3

At the same time, these two diagnostic categories also saw a number of companies who were considered to be underperformers, i.e., creating little to no value for their investors. In the All Others category, there were three companies that went out of business (Atherotech in 2016, Singulex and CardioDx in 2019). Additionally, two other companies were acquired at relatively low valuations (Goodstart Genetics for $38MM and Combimatrix for $35MM).

Let’s take a closer look at those companies that hit the $1B milestone and see how long it took for them to get to two significant milestones (revenue generation and $1B market cap). One can see in Figure 2 that the paths to revenue generation can be quite different. Guardant Health and Invitae were fastest to revenue generation (~24 months and ~36 months respectively) with Natera and Veracyte taking two to three years longer.  Followed by CareDx, which took approximately 8 years and Exact Sciences, which took 13 years from IPO and 19 years from its founding in 1995 to generate revenue.   

However, Exact Sciences, had the shortest interval between revenue generation and the $1B market cap (it was effectively simultaneous), reflecting the very large market opportunity of colorectal screening and a very strong senior management team. They were followed by Guardant Health (about 4 years), Invitae (about 5 years) and Veracyte (about 8 years). For Natera and CareDx, the timeline between first revenue and $1B market cap was 9 to 10 years.    

Looking through this lens of how long it took a company to get to the $1B market cap, Guardant Health and Invitae are strong winners producing a market cap of $1B six to eight years after their 1st raise or company founding (Guardant Health and Invitae respectively). Exact Sciences and CareDx, on the other hand, took almost 20 years with both requiring some major strategic overhauling and some insightful leadership.  However in both cases, they became comeback kids recovering nicely, and in Exact’s case, reaching a $7B market cap in 2018 with strong revenue growth.

Figure 2: Timeline to Revenue and $1B Market Cap

image4

Value Drivers for Diagnostic Companies
Now that we have seen which companies are the most successful, what are the factors that differentiate the high value creators from the low value creators? The rest of the analysis will take a deeper dive in the oncology diagnostic companies and look at the five drivers of value creation, starting with use case prioritization.

(1) Use Case Prioritization – Leading with a Strong First Product
Figure 1 also highlights some striking examples of companies with the same use case or intended use in all three categories that span the value creation continuum (from low to high). See the stars in Figure 1 for a comparison of companies with like use cases. Why is this important for value creation? Companies with the same use case allow an apples to apples comparison. One would hypothesize that if one company in a specific category was a success, the market might have a more positive response to the second company.

In the oncology category, there are two sets of companies in the same use case. The first set of companies is Veracyte and Interpace with market caps of $1.3B and $26MM respectively – one a winner and one an underperformer. Biocept, Clarient, Foundation Medicine, and Guardant Health are in the second set of companies. All four companies were in the oncology targeted therapies category with market caps that ranged from $19MM to $8.6B. Two of these companies were classified as winners with acquisition price points of $5.3B (Foundation Medicine) and a market cap of $8.6B (Guardant Health), while the third company Biocept had a market cap of only $19MM.

This is also seen in the two other categories of diagnostic companies in the analysis.  For example, both Natera and Combimatrix are in the prenatal testing space; while CareDx and CardioDx both straddle the coronary category (the former with a heart transplant assay and the latter with an assay to tailor treatment for coronary heart disease). In the case of the companies in the prenatal space, Natera’s market cap by July 2019 was $1.9B; while Combimatrix was acquired in 2017 by Invitae for a total enterprise value of approximately $35 million.

Use cases (indication and intended use) are important drivers of value creation.  Companies that prioritize indications with high unmet needs tend to be more successful than companies that prioritize indications with lower unmet need. This is driven by potential revenue generation, which is a function of both physician adoption and payers’ willingness to cover and reimburse at an attractive price point. Unmet need oftentimes has a different focus when looking through the lens of a payer versus the lens of a clinician.  Both are looking for clinical utility, but payers tend to have a higher hurdle to meet in that they are typically looking for changes in clinical practice that result in improved health outcomes and cost savings.

As we mentioned, significant differences in market cap are seen to exist between companies that focus on the same indication and intended use. First Mover Advantage can play a role.  However, one cannot attribute all of the difference in value creation to a strong use case and being first to market. Other drivers are needed to explain the variance in value creation. These drivers are outlined in Figure 3. 

(2) Barriers to Entry – Delaying Competitive Inroads
As we have shown, indication/intended use prioritization is a factor in value creation, but it is not the only factor at play. Strong barriers to entry and sound commercial strategies are critical to significant revenue growth and sustainable competitive advantage. A key strategic move for a company to sustain competitive advantage is ensuring that there are barriers to entry for your competitors. With diagnostics, one way to do this is by focusing on the more complex, less easy to reproduce assays. Some examples of this are the companies that developed risk scores based on multiple biomarkers to classify low, medium or high risk or recurrence or low and high risk of a specific disease.

These assays require significantly more technical expertise in the development of the assay than a panel of somatic mutations or an assay that detects a germline mutation.  In addition to strong laboratory bench experience, these assays need the support of bioinformaticians to help determine which markers are the most predictive of the use case (malignant or benign, high probability or low probability of recurrence) and the predictive importance of each of the markers. Many are developed through machine learning where large panels of markers are searched to determine the best subset of markers to accurately predict the use case of interest. The assays are also typically trained using machine learning to generate the best algorithm of predictive biomarkers and optimal weighing factors in order to meet the highest levels of accuracy (e.g., sensitivity and specificity). Examples of these types of assays are Genomic Health’s Oncotype Dx Breast and Colon and Veracyte’s Afirma and Percepta.  

Figure 3: Value Creation Drivers

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So far, we have seen that use case prioritization is an important initial driver of value creation. Additionally, barriers to entry, as seen through developing gene classifiers comprised of multiple genes or large clinical trials (which is discussed in the next section), can limit the number of future competitors as well as increase the length of time for a “me too” assay to be commercially available. The slower entry of competitors allows the company to create the commercial infrastructure and evidence needed to create sustainable market leadership. At this point, the analysis is going to dive deeper into some of the oncology winners (Exact Sciences, Veracyte, and Genomic Health) and look closer at their evidence and reimbursement strategies. 

(3) Evidence Development and Reimbursement Strategies – Ensuring Adoption and Reimbursement
Another area where companies have created significant hurdles or barriers to entry is in their evidence development strategies, specifically in the number and size of clinical trials. Companies who are looking to use banked samples to do early validation may find that other companies have used up most of the banked samples in a particular tumor type.  For example, Genomic Health increased the barriers to entry for adjuvant chemotherapy validation studies and slowed down competitive inroads by depleting the public sources of breast cancer tissue in the United States. Additionally, Genomic Health and Exact Sciences set new standards for powering clinical validation studies through their TAILORx and DeeP-C studies respectively.  Genomic Health ran a 10,000 patient randomized prospective breast cancer clinical trial to measure the predictive ability of OncoTypeDx Breast with respect to adjuvant chemotherapy and Exact Sciences 10,000 patients study looked at Cologuard vis-à-vis the standard of care Fecal Immunochemical Test (FIT).1    

At this point, due to the precedent set by these companies, more and more payers, clinicians and guideline committees are starting to expect clinical validation trials based on samples of thousands of patients rather than hundreds of patients.  The USPSTF Guidelines have always had a high bar – with thousands of patients needed to garner just a B rating.  These actions have resulted in the clinical trials bar continuing to be raised as larger and larger studies are planned further impacting the expectations and evidence requirements of clinicians and payers. This is continuing as this analysis is being written. Exact Sciences announced in late 2019, that they would be doing a 150,000 patient trial with Cologuard.2  

Evidence development strategies not only raised the bar with clinical trials but also helped to generate revenue by increasing the likelihood of reimbursement and accelerating physician adoption. Market leadership does not continue to create value, unless one can show that the market leadership can generate year over year revenue growth. Strong commercial strategies that drive physician adoption and ensure adequate reimbursement also play a critical role in driving value creation. Both Veracyte and Genomic Health focused on gathering clinical evidence and enabling publications to garner guideline adoption and strengthen their CMS and private payer dossiers. This evidence included clinical validation, clinical utility studies and patient subset analyses that resulted in expanded intended use, growing physician adoption and increasing payer coverage.    

(4) Focused Commercial Launch Strategies – Gaiting Spend and Nailing Customer Service
Evidence development can help to create barriers to entry and accelerate reimbursement and adoption; however, an innovative publicly held diagnostic company needs to do much more to seed the market to manage investor expectations.

The three oncology stellar performers in the value creation race also developed commercial strategies that tied their commercial spend to publication and reimbursement milestones and managed the street expectations by focusing on leading indicators like physician awareness and physicians touched.   Genomic Health’s early messages to the street after the launch of their first product spoke to the number of physicians touched and tests ordered.  In their press releases around their 10Qs in 2007, they include sections on physician adoption (number of tests run and number of physicians ordering) and reimbursement, continuing the story that they started telling before they went public.3

Customer service centers were also used by many of the oncology winners to reduce the administrative burden of the clinical staff. Knowing that moments of truth (a service issue that could result in losing a customer) occur often when your customer is a physician who could be ordering many tests over time, they staffed customer service centers to answer physician, medical staff or patient questions on both the status of the test and the test report. Poor customer service (not getting an answer quickly or not getting the right answer) places a burden on a physician’s staff. These moments of truth can become the straw that breaks the camel’s back and cause a physician to switch.  When customer service is there to field and answer questions from physicians, payers, staff and patients, switching behavior is much less likely to occur.   

Another area that many high value creating companies excelled in was ensuring that for those patients who did not have insurance coverage or sufficient insurance coverage for the test, that out of pocket costs to the patient would be known upfront to the patient and manageable by the patient. All three companies have strong patient assistance programs and got them up and in running at launch or shortly afterward.  These patient assistance programs would often work with both the insurance company to get reimbursement for the patient and with the patient directly when there were out of pocket costs (co-pays, co-insurance or deductibles) for the patient.  Additionally, Genomic Health and Veractye offered financial assistance programs for eligible patients with financial hardship.  Since Cologuard has both Medicare coverage and is in USPSTF guidelines, which requires commercial payers to cover their test, their focus is more on the appeals support.1

(5) Portfolio Management – Today’s Value Creation Depends on Tomorrow’s Products
Finally, since so much of the value of any stock is based on future opportunities, the value of their pipeline must be considered. Companies that manage their pipeline with a track record of successful product launches every few years show stronger value creation than a one-trick pony company.

Genomic Health and Veracyte are examples of companies that increased their value creation through strong pipeline management. Exact has over the course of the last few years has also strengthened its pipeline. In the case of the first two, they focused their R&D on other unmet clinical needs to grow their portfolio of diagnostics. Veracyte expanded its indications to look at both lung cancer (Percepta and a nasal swab assay in development) and Envisia for idiopathic pulmonary fibrosis (IPF), leveraging its existing pulmonary sales footprint. Genomic Health broadened its breast cancer franchise by expanding its intended use to validating node positive patients and DCIS, while at the same time launching a colorectal assay and two prostate assays.  Genomic Health launched five products in its OncotypeDx portfolio from 2003 to 2018 covering multiple tumor types:  breast, prostate and colon. Veracyte was also very active from 2012 to 2018 launching four products (Afirma GEC, Afirma Atlas, Percepta, and Envisia). 

Conclusion
The game of value creation for diagnostic companies is a game of skill, not luck. As diagnostic companies plan for their futures, they should keep in mind the five value drivers that clearly drove value creation for these diagnostic companies. These drivers differentiated the ”winners” ($1B+ in market valuation) from the underperformers (<$200MM in market valuation). Use case or indication and intended use prioritization was found to be a strong driver of value creation, especially differentiating value creation in oncology companies. However, value creation is only sustainable with strong, focused commercial, and R&D strategies. Companies like Genomic Health and Veracyte quickly gained significant market leadership through being first to market and developing significant barriers to entry (difficult assays to reproduce and large clinical trials). Having barriers to entry helped them leverage their first-mover advantage by limiting the number of potential competitors and lengthening the time that it took to bring a comparable assay to market. Beyond this, they worked on strong evidence development to increase the probability of reimbursement and accelerate adoption. Focused commercial strategies like excellent customer service and patient assistance support programs helped to generate year over year revenue growth and minimize competitive inroads. Finally, high value creation companies also managed their portfolio to focus R&D on other products with high unmet clinical needs.

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Interested in understanding what R&D and commercial strategies are the most advantageous for your company’s value creation?

At Health Advances, we are focused on helping our clients unlock worldwide growth opportunities. Our Diagnostic Practice specializes in indication prioritization, global commercialization strategies, and reimbursement success. For more information on how we can help your company create value for your shareholders, please visit our website at https://healthadvances.com/.

About the Authors

Kristine C. Mechem, Ph.D. is a Vice President in the Health Advances San Francisco office.

Emily Kong is a Consultant in the Health Advances San Francisco office.

Vivek Mittal, Ph.D. is a Partner in the Health Advances San Francisco office. 

REFERENCES
[1] Company websites.
[2] https://www.fiercebiotech.com/medtech/exact-sciences-mayo-clinic-launch-150-000-strong-cologuard-study.
[3] 2006 and 2007 Press releases and 2007 SEC filings.

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