Exact Sciences Corporation
October 2, 2014
(EXAS: NASDAQ--$18.75) John M. Putnam, CFA
BUY-- Target Price $34
Exact Sciences Corp. (EXAS-NASDAQ-$18.75-BUY)
Tackling a Major Killer-Colorectal Cancer-And Winning
WebVest is initiating coverage of Exact Sciences Corporation with a
BUY recommendation and a Target Price of $34.00 per share.
On August 12th , EXAS announced that the U.S. Food and Drug Administration (FDA) had approved Cologuard, the company’s stool-based DNA (sDNA), non-invasive colorectal cancer screening test. Cologuard is unique, the first and only such test of its kind.
Parallel approval by Centers for Medicare and Medicaid Services (CMS) for reimbursement should be finalized by October/November of this year, following a proposed coverage memorandum issued at the time of the FDA approval.
In the company’s 10,000-patient, 90-site DeeP-C pivotal trial—one of the largest clinical trials ever undertaken and the most extensive colorectal cancer screening studies ever conducted in the United States—Exact Sciences’ Cologuard found 92.3% of colorectal cancer in average risk patients based on a combination of nine DNA and hemoglobin markers.
Colorectal cancer is often considered the most preventable, yet least prevented cancer and, as a result, colorectal cancer remains the second-leading cancer killer in the United States (137,000 newly diagnosed cases and 50,300 U.S. deaths in 2013). Colorectal cancer is highly treatable if found early, making the detection of pre-cancerous polyps paramount. One out of 3 adults age 50 and older has not been screened as recommended.
Cologuard is a patient friendly test for screening large population of non-compliant patients.
The company is currently enrolling physicians who will be able to order the test for their patients.
On August 25th , EXAS announced that Mayo Clinic will be the first health system to offer Cologuard.
Exact Sciences on the Leading Edge of Colorectal Cancer Detection
It is our opinion that Exact Sciences has develop a stool based DNA screening test for colorectal cancer that could become the standard of care in a screening role prior to the confirmatory role of colonoscopy by detecting pre-cancerous and cancerous polyps. We believe that a more user friendly approach to colorectal screening than colonoscopy will become more widely adopted by persons over the age of 50 and that more regular screening, once every three years as compared to every 10 years for colonoscopy will result in program sensitivity comparable to colonoscopy, now considered the gold standard.
We estimate that a successful sDNA (stool DNA) test, administered to only 25% of the U.S. population over 50 years of age, once every three years would generate revenues to EXAS of over $3 billion. As such, we are initiating coverage with a BUY recommendation and a Target Price of $34.
The Granddaddy of Clinical Trials– DeeP-C–10,000 patients—90 Trial Sites
As reported in the New England Journal of Medicine, April 3 2014 issue, Cologuard was the subject of one of the largest clinical trials ever conducted. The study compared a noninvasive, multi-target stool DNA test, Cologuard, with a fecal immunochemical test (FIT) in persons at average risk for colorectal cancer.While over 10,000 patients participated, only 9,989 patients’ results were analyzed. The large trial size resulted from the need to generate a statistically significant number of colorectal cancer patients that could be confirmed by colonoscopy. Of those analyzed there were 65 (0.7%) cancers and 757 advanced precancerous lesions (7.6%). The sensitivity for detecting colorectal cancer was 92.3% with DNA testing and 73.8% with FIT (P=0.002).
The sensitivity for detecting advanced precancerous lesions was 42.4% with DNA testing and 23.8% with FIT (P<0.001). The rate of detection of polyps with high-grade dysplasia was 69.2% with DNA testing and 46.2% with FIT (P=0.004); the rates of detection of serrated sessile polyps measuring 1 cm or more were 42.4% and 5.1%, respectively (P<0.001).
DEEP-C Trial Results
Cologuard FIT Improvement Cancer Sensitivity 92% 73% 25%
Advanced Adenoma Sensitivity 42% 24% 78% Source: N Engl J Med 2014;370:1287-97. DOI: 10.1056/NEJMoa1311194 (Imperiale)
The conclusion: In asymptomatic persons at average risk for colorectal cancer, multi-target stool DNA testing detected significantly more cancers than did FIT but had more false positive results.
The Great Paradox-Second Most Deadly Cancer But Highly Survivable if Detected Early
Colorectal cancer (CRC) is the second most deadly form of cancer claiming over 50,000 lives in the U.S. every year and more than 655,000 lives worldwide. Only lung cancer causes more deaths in the U.S. annually-160,000. In the U.S. there are 150,000 new cases diagnosed annually despite detection methodologies that have very low patient compliance and which still remain subjective.
CRC is in the same circumstances as cervical cancer was in terms of mortality prior to the widespread use of the PAP smear in the late 1940’s and early 1950 when more than 35,000 women died annually. Today, thanks to frequent and highly improved screening, cervical cancer claims 3,900 lives annually.
The irony of CRC is that it is a slow growing cancer and takes between 10 and 15 years to metastasize to the point where it is fatal. Like other forms of cancer, CRC is staged depending on the size, frequency and invasiveness into the wall of the colon. Stage 3 and stage 4, the most
severe form of the cancer, account for 63% of the cancers that are found. Unfortunately, the five year survival rates for these stage cancers are 54% and 8% respectively. If detected early and especially in the adenoma stage, when the polyp is pre-cancerous and is removed there is a very low risk and even with stage 1 disease the cure rate is extremely high, on the order of 80% plus.
Figure 2.
The current guidelines, established jointly in 2008 by the American Cancer Society, the US Multi-Society Task Force on Colorectal Cancer, and the American College of Radiology calls for stool-based tests for the detection of cancer combined with an invasive procedure such as a colonoscopy to detect and remove polyps and to detect cancer.
Poor Compliance Causes Many Deaths
Outpatient Colonoscopy Procedure Rates,* by Age Group
August 27, 2010 / 59(33);1075
Figure 3.
Source: Centers for Disease Control and Prevention
The figure above shows outpatient colonoscopy procedure rates, by age group, in the United States for 1996 and 2006, based on results from the National Survey of Ambulatory Surgery. From 1996 to 2006, the rate of outpatient colonoscopy procedures increased for adults aged ≥50 years. For persons aged 50-64 years, the rate in 2006 was 3.5 times higher than the rate in 1996 (472.4 versus 132.2 procedures per 10,000 population), and for those aged 65-74 years, the rate was nearly three times higher (638.5 versus 216.2). For persons aged 75-84 years, the rate in 2006 was more than twice the rate in 1996 (517.3 versus 230.5), and for persons aged ≥85 years, the increase was approximately double (173.6 versus 96.9). Despite the higher rate of patients undergoing colonoscopy, the compliance rate remains alarmingly low.
The recommendation calls for persons over the age of 50 to receive a colonoscopy every 10 years. Despite the increase in the number of colonoscopies being performed annually as depicted in figure 3., the problem arises in the fact that patient compliance with these guidelines ranges widely based on familial history, age, race and even geographical location. We have seen compliance estimates range from a low of 25% to as high as 70% in the North Eastern U.S. EXAS generally quotes non-compliance at 40% resulting in an estimated 23 million Americans between the ages of 50 and 75 not being screened as recommended. The reason is that colonoscopy is invasive, not convenient requiring taking a day off from normal activities
and requires the patient to prepare the day before the procedure by altering his/her diet and cleansing the bowel using a laxative.
Colonoscopy, while usually covered by insurance, is expensive, averaging $2,000 to $2,500 and is usually performed under anesthesia. It carries some risk including perforation of the bowel which can be quite serious (1:1,700), reaction to anesthesia, bleeding from removing polyps, infection and on rare occasion, death.
Colonoscopy has a sensitivity of approximately 92% to 95% in detecting pre-cancerous and cancerous lesions when performed properly by a highly experienced physician. But the sensitivity can be less due to several factors including the degree that the bowel is clean, the experience of the operator, the ability to scope the entire colon and rectum and the ability to detect flat polyps which are the most difficult to visualize. The issue of detecting flat polyps is particularly troublesome and is the focus of current concerns as to the sensitivity of colonoscopy. It is also easier to detect polyps and cancer in the descending colon than in the ascending colon. Some experts believe that in approximately 10-15% of all colonoscopies, the scope is not advanced sufficiently to view the cecum, the very end of the colon which may be responsible for missing some disease.
Never-the-less, colonoscopy remains the gold-standard for diagnosing CRC and it is effective. In a study with patients that had undergone a colonoscopy in the past 10 years, as compared to patients that were receiving their first colonoscopy, the detection rate for advanced cancer was approximately 6.1% as compared to 11.4% in the latter group. As such, 15.0 million colonoscopies are performed in the U.S. annually which importantly, represents almost full capacity for the procedure given the number of gastroenterologists and facilities that perform them.
Tsunami Soon to Hit the Shores of Gastroenterology
About 30 per cent of bowel cancers arise from flat lesions and do not pass through a polyp stage. This particularly occurs with cancers of the proximal (right-sided) colon and caecum. The bowel cancers in affected individuals tend to develop as flat lesions rather than as polyps. The cancers more commonly affect the proximal (right sided) colon, whereas other cancers are more common in the distal colon (nearer the rectum) or rectum. They occur at a younger age and this condition should be suspected in anyone who develops bowel cancer before the age of 45.
About 1 per cent of bowel cancers occur in people who inherit a defect in the gene for familial polyposis coli. These people develop hundreds of adenomatous (pre-cancerous) polyps in the colon by the time they are in their teens and almost invariably develop bowel cancer by middle age unless the colon is removed.
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The Solution-Molecular Testing PLUS Colonoscopy
With a low and varied compliance rate for colonoscopy, the gastroenterology community is extremely interested in a more patient friendly, less expensive way of screening patients that has a high level of sensitivity (finding a high percentage of patients with pre-cancerous or early stage disease) and high specificity (identifying patients that are not diseased). High specificity is important because it is a measure of false positive patients that would needlessly go on to colonoscopy.
In the opinion of many gastroenterologists, the solution lies in a biomarker test that uses blood or in this case stool, to detect pre-cancerous and cancerous polyps. The wall of the colon, non-cancerous polyps and cancers are constantly shedding epithelial cells into the stool as it moves through the colon. These cells degrade and release DNA. In the case of polyps and cancers, these cells are altered and can be identified and quantified using DNA markers, the basis of Exact Sciences’ test.
Cologuard is the first noninvasive screening test for colorectal cancer that analyzes both stool DNA and blood biomarkers and has been proven to find 92 percent of cancers and 69 percent of the most advanced precancerous polyps in average risk patients. Cologuard, invented at the Mayo Clinic by co-inventor David Alquist, M.D., which is available through healthcare providers, offers people 50 and older at average risk for colorectal cancer an easy-to-use screening test they can do in the privacy of their own home. Cologuard is a stool based DNA CRC test withseven DNA mutation biomarkers, two DNA methylation markers, one hemoglobin marker andone beta actin, nine markers in total.
In 1990, Dr. Bert Vogelstein of Johns Hopkins University’s Sidney Kimmel Comprehensive Cancer Center, a well-known expert in cancer genetics, especially of the colon described the cascade of cancer of the colon in his now famous Vogelgram. It identifies the altered sDNA (stool DNA) that occurs at each step of the development of colon cancer. APC and K-ras have become well recognized as the genetic DNA markers used to detect each step of the cascade.
Figure 4.
The test Exact Sciences has developed is easy to use and requires no alteration of diet or cleansing of the bowel. A small stool sample, about the size of a grape, is collected using a proprietary container with a built-in scooping device. The vial contains a stabilizing buffer and is mailed to a lab where an automated process handles the vial and utilizing Invader PCR Single Nucleotide Mutation Detection licensed from Hologic (HOLX), will perform two parallel, but separate PCRs (polymerase chain reaction) which are used to amplify a single piece of DNA several orders of magnitude. This particular PCR amplification process was developed at Third Wave Technologies by EXAS’s current management and was sold to HOLX for $580 million in June 2008.
Figure 5.
Source: Exact Sciences Corporation
Why Stool and Not Blood?
Comparative Sensitivity in Blood vs. sDNA
Stage Blood sDNA (Expected) Pre-Cancers 18% >50%
Stage 1 36% >85% Stage 2 56% >85% Stage 3 65% >85% Stage 4 73% >85% Note: Sensitivity in peripheral blood based on Septin 9 DNA methylation assay. Test results from Grutzmann R. et. al., PLoS ONE, Nov 2008;’ 3(11)e3759. Figure 6.
A great deal has been made of developing a DNA screening test for colon and other cancers utilizing blood as the sample. While blood would appear to be a more convenient sample to obtain, in the case of colon cancer it suffers much lower sensitivity and specificity and very low sensitivity in detecting pre-cancerous polyps as described in the following table.
The reason for the variation in sensitivity in blood and the consistency of sensitivity in stool over the various stages of cancer is the result of the fact that cancer is constantly shedding cells into the colon which is swept down-stream in the patient’s stool. CRC cells do not enter the blood stream until the cancer is well advance to stage 4 and metastasizes to other organs. This is far too late in the cascade of the disease to be of any benefit to the patient because in stage 4 the five year survival rate is only 8%.
These findings are also confirmed in another study conducted by Dr. Vogelstein, et al., that appeared in the journal Gastroenterology in May of 2008 entitled, Analysis of Mutations in DNA Isolated From Plasma and Stool of Colorectal Cancer Patients. Using a technology called BEAMing, they assessed 25 stool samples and 16 plasma samples that were available from the same patients. In the stool samples, 23 or 92% contained DNA that was the same as that found in the corresponding patient’s tumor. The sensitivity in plasma was only 8 of 16 patients or 50%. The study concluded “, mutant DNA fragments are detectable in the stool of more than 90% of colorectal cancer patients. DNA purified from stool provides a better template for mutation testing than plasma.”
It is also important to note that sensitivity increases with the performance of subsequent tests and should reach the upper 90 percent range if the patient is compliant in having the test performed every three years. This is referred to as program sensitivity.
Management is Highly Seasoned
Two members of the senior management of EXAS Kevin Conroy CEO and Maneesh Arora CFO have been together for some time as the former management team of Third Wave Technologies which pioneered the Invader form of PCR. This team sold Third Wave Technologies to Hologic Inc. (HOLX) in June of 2008 for $580 million. At the time, Hologic desired to acquire Third Wave’s HPV testing business to augment its position in women’s health. The two scientific officers, Graham Lidgard, Ph.D. and Barry Berger, MD have extensive experience in molecular genetics and pathology respectively.
Kevin T. Conroy-President and Chief Executive Officer- Mr. Conroy has been President, Chief Executive Officer and a Director of Exact Sciences since April 2009. Prior to joining EXAS he was President and Chief Executive of Third Wave, and served in that position until the company’s acquisition by Hologic in July 2008. Before joining Third Wave in 2004, Mr. Conroy served as Intellectual Property counsel at GE Healthcare. Conroy was also Chief Operating Officer of two early-stage, venture-backed technology companies. Well versed in patent law, Conroy was an Intellectual Property litigator at two Chicago law firms. He has a B.S. degree in electrical engineering at Michigan State University, as well as a law degree.
Maneesh K. Arora-Chief Operating Officer- Appointed to his current position in February 2012. Prior to assuming this position, was SVP and CFO of EXAS. Along with Mr. Conroy, Mr. Arora served as Chief Financial Officer of Third Wave Technologies, from January 2006 until the company’s acquisition by Hologic in July 2008. He joined Third Wave in January 2003 as Director of Strategy. Prior to joining Third Wave, Mr. Arora was Director of Corporate Strategy for Nalco Chemical Company. Mr. Arora has a Bachelor’s degree in economics from the University of Chicago and a Master of Business Administration from the Kellogg Graduate School of Management.
Graham P. Lidgard, Ph.D.-Chief Science Officer-Dr. Lidgard joined Exact Sciences from Nanogen, Inc. in August 2009. A world renowned scientist, Dr. Lidgard is responsible form much of the R&D that forms Gen-Probe’s intellectual property including the company’s Procleix blood screening products and Aptima sexually transmitted disease products. Dr. Lidgard also created and led the system development group at Gen-Probe that developed its fully automated Tigris system. Before joining Gen-Probe, Dr. Lidgard was co-founder and Vice President of product development of Matritech Inc., a Cambridge, Massachusetts-based developer of diagnostic products for the early detection of bladder cancer which was sold to Inverness Medical Innovations (IMA-rated Buy) for $38 million in December of 2007. Prior to Matritech, Dr. Lidgard was at Ciba Corning Diagnostics Corp. co-developed more than 70 510(k)-cleared
products. Dr. Lidgard has a Bachelor’s degree with honors and a Doctorate in biological chemistry from the University of Manchester in England.
Affiliations and Partnerships are Numerous and Impressive
In addition to its management team, EXAS has formed a number of affiliations with key opinion leaders in the CRC community, who themselves are likewise affiliated with leading universities, medical schools and world renowned clinical organizations such as the Mayo Clinic.
In June of 2009, EXAS entered into a licensing agreement with the Mayo Clinic and David A. Ahlquist, M.D. for the development of a more user friendly colorectal cancer screening test. Dr. Ahlquist is Professor of Medicine at the Mayo Clinic Graduate School of Medicine and is recognized as a leading industry expert in the identification and evaluation of biomarkers for the detection and prognostication of colon cancer in stool and blood.
Since 2002, Dr. Ahlquist has authored more than 20 peer-reviewed journal articles including: Next-generation stool DNA testing: expanding the scope (Gastroenterology. 2009 Jun;136(7):2068-73. Epub 2009 Apr 18); High detection rates of colorectal neoplasia by stool DNA testing with a novel digital melt curve assay (Gastroenterology. 2009 Feb;136(2):459-70. Epub 2008 Oct 15); and A novel method to capture methylated human DNA from stool: implications for colorectal cancer screening (Clin Chem. 2007 Sep;53(9):1646-51). Dr. Ahlquist received his M.D. degree from the Mayo Clinic Graduate School of Medicine where he also performed his residencies and fellowship. In addition to licensing Dr. Ahlquist’s intellectual property, EXAS has access to a development team at Mayo and a library of over 3,000 stool samples.
Risk and Uncertainties Have Diminished With FDA Approval
Exact Sciences has achieved its most daunting challenge in becoming a commercially viable diagnostic company, that to gaining FDA approval for Cologuard which occurred on August 12thof this year. EXAS still faces the normal risk associated with gaining reimbursement from CMS (Centers for Medicare and Medicaid Services) and other insurers. We see no reason that should preclude EXAS from achieving reimbursement before year end and most likely in November.
We believe that the biggest challenge going forward is sales and marketing execution. There will likely remain significant skepticism among gastroenterologists as to the sensitivity of Cologuard vs. that of colonoscopy which they view as the gold standard. As such, EXAS’ task will be to convince other primary care physicians that represent the front line of doctor to patient contact, that there is significant benefit to performing Cologuard at regular intervals in order to achieve program sensitivity that will eventually be comparable to colonoscopy.
Exact Science’s success may also introduce other long-term potential risks such as those mentioned here.
• Other companies are attempting to develop competitive tests most of which would use blood as the sample medium. Although we would not rule out a breakthrough in using blood, we believe that stool is the more appropriate sample because of the presence and abundance of pre-cancerous and pre-cancerous DNA cells.
• The company has significant intellectual property and several key strategic partnerships which may need to be defended against much larger organizations with appreciably greater assets. In this matter, EXAS’ management, particularly Kevin Conroy, the company’s CEO, is particularly well experienced in IP matters having been the chief IP counsel at GE Medical.
Promising Pipeline–
In general, we believe that the risks EXAS may face are more than adequately offset by the current market potential for Cologuard and the development of subsequent cancer tests being developed in collaboration with the Mayo clinic which includes pancreas, esophagus and stomach. These upper gastric cancers collectively account for 145 million deaths in the U.S. annually. EXAS’ goal is to combine new disease markers with Cologuard in order to detect these cancers simultaneously. EXAS is developing these in conjunction with the Mayo Clinic.The Market Potential is Substantial—Over $2 Billion Annually
EXAS has established a list price for Cologuard at $599 per test. In its presentation to CMS it quoted a price of $502. We believe that these prices are reasonable and cost effective as compared to colonoscopy which ranges between $2,000 and $2,500 on average. Given the 3 year test interval, Cologuard still appears to be less expensive relative to the 10 year guideline for colonoscopy. Under various scenarios, at 25% penetration of the 100 million U.S. persons 50 years of age or older by 2019, and at an average price of $400 per test, EXAS could expect to generate almost $3 billion in annual revenue by 2019. This assumes that a subject is tested once every three years. We are confident that even with price discounting over time, if EXAS is able to penetrate only 15% of the available market, it can generate more than $2.0 billion in highly probability revenue.
In the most recent quarter ended June 2014, EXAS had an operating loss of $19.57 million. The company had no revenues and R&D expenses of $7.2 million, G&A expenses of $6.2 and S & M expenses of $6.2 million. Assuming in 2015 that R&D expenses remain constant, due further development of the new product pipeline and the other two expense categories increase due to the scale up of test volumes and the company is able to generate gross margin on sales of Cologuard of 50%, we estimate that EXAS will still post a loss in 2015 of approximately $0.97 on revenues of $79 million.
2017 The Breakout Year
We project that in 2016, with 300,000 tests sold, EXAS breaks even and that 2017 will be the year the company becomes significantly profitable with the sale of 1,500,000 tests. With projected revenues in 2017 of $750 million and a gross margin of 56%, EXAS could earn as much as $1.29 per share.
So, What is Exact Sciences Shares Worth?
Two Methods to Valuation– Recently Merck of Germany made an offer to acquire Sigma Aldrich (SIAL), a well-established U.S. supplier of laboratory testing materials, much of it used in biotechnology research. At $17 billion, Merck’s $140 per share cash offer, a 37% premium to
what SIAL’s shares were trading a before the offer, values the company at 5.7X its revenues of
$2.8 billion and 34X its trailing 12 month net income. Because EXAS’ management has a history of building companies and subsequently selling them to larger companies, we believe it is appropriate to use two valuation methods. First, based on the earnings prospects of EXAS, and using 2017 results of $1.29, the first year of significant earnings for the company, what are the shares worth? Discounting our projected results by 25% to take into account the uncertainty of the results and the time to achieve them, gives an earnings base of $1.00. Utilizing a P/E of 30X, a reasonable discount to the valuation afforded SIAL, produces a target price of $30 per share. Secondly, assuming EXAS were to be acquired by a large healthcare company and assuming it was done at 5.0X revenues, the shares would be valued at $38 per share. In the interest of controlling for unforeseeable risk, we believe a
blended target price of $ 34 is reasonable and appropriate and we would be buyers of the stock at the current price of $18.75.
John M. Putnam, CFA Director of Research WebVest Securities, Inc. October 2, 2014
As of this date, no persons associated with WebVest Securities, Inc. own any financial interest in Exact Sciences nor do they anticipate establishing a financial interest in the future.