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Second Analysis Of The PEB Share Price (Updated)

Last week I did an analysis of the PEB share price after a big announcement was made, causing the share price to explode. In that analysis I concluded that someone would be mad not to use a Cxbladder test. Despite this I summated that due to PEB’s loss making position, even after having been granted access to one of the largest non-profit healthcare providers in the US (the cause for the previous share price increase), PEB would likely still be in a loss making position; therefore the share price was unjustified. On Friday (within 1 week of my analysis) the share price increased by ~100%.

What happened, and was my last analysis wrong?

I’m not so egotistical that I can’t admit when I got it wrong (we all have the right to change our minds, right?), but on this case the answer is: No, I don’t believe my last analysis was wrong. The analysis was correct at the time, then there was some shock information released to the market which changed the playing field. Namely PEB announced that there was a “Positive LCD Decision in USA”. Yes, I think my earlier analysis could be considered wrong because upon re-reading the shareholder letter published on the 26th (just before I did my analysis), I saw a note that PEB had submitted an updated dossier of clinical evidence which was accepted for formal review by the CMS, as part of the process for inclusion in the Local Coverage Determination (LCD). Given my former research into Cxbladder, I imagine that I might have taken a punt that they would be accepted by CMS. Had I read that small note more thoroughly, I could have predicted the stock market’s reaction. Then again, I can’t be sure that I wouldn’t have brushed it off as just another endeavour from a company that has been struggling against a tight market.

Nevertheless, the mistake has been made and it is what it is. Looking forward, let’s try to analyse the announcement in more detail to analyse the current opportunity.

…New Zealand bladder cancer diagnostics provider, Pacific Edge Limited (NZX: PEB), has been notified by Novitas that the LCD: Biomarkers for Oncology (L35396) provides coverage for Cxbladder, CPT codes 0012M (Cxbladder Detect) and 0013M (Cxbladder Monitor), for tests performed on or after July 1, 2020 that are medically necessary…

https://www.nzx.com/announcements/355757

In trying to understand this announcement, we need to know a few things:

  • What / who is Novitas? According to Google Finance, Novitas provides high-quality, innovative, administrative services for government-sponsored healthcare programs and serves as a Part A/B Medicare Administrative Contractor (MAC) under multiple contracts for the Centers for Medicare and Medicaid Services (CMS).
  • What is CMS? According to Wikipedia, “…the Centers for Medicare & Medicaid Services (CMS), is a federal agency within the United States Department of Health and Human Services (HHS) that administers the Medicare program and works in partnership with state governments to administer Medicaid, the Children’s Health Insurance Program (CHIP), and health insurance portability standards. In addition to these programs, CMS has other responsibilities, including the administrative simplification standards from the Health Insurance Portability and Accountability Act of 1996 (HIPAA), quality standards in long-term care facilities (more commonly referred to as nursing homes) through its survey and certification process, clinical laboratory quality standards under the Clinical Laboratory Improvement Amendments, and oversight of HealthCare.gov. CMS was previously known as the Health Care Financing Administration (HCFA) until 2001…”. As I understand it, CMS is basically the government department that administers America’s welfare system for healthcare, giving assistance to low income families and those over 65, etc.
  • What Is LCD? LCD stands for Local Coverage Determination, and relates to whether a product such as Cxbladder will be included in the list of products that CMS will pay for.

So it seems that PEB’s Cxbladder test has been deemed eligible to be included as a treatment that is covered by CMS at a rate of $760 per test. This should massively increase the amount of people using the test, because it is free (or possibly partly subsidized, if other doctors want to add their markup?).

PEB have also stated that they will seek subsidy for tests that have already been performed, for which they didn’t get paid. PEB also mention in this announcement that this “…will unlock access to the CMS revenue which currently represents approximately 40% of Pacific Edge’s commercial sales in the US…”. Honestly, I don’t understand how PEB have been doing tests and not getting paid for them – perhaps there has been problems collecting money for goods sold? Reading into the announcement (PDF version) it seems that they’ve been testing CMS patients and invoicing CMS, who haven’t been paying because I guess they weren’t approved products? Perhaps they intended to have a go at charging CMS then fall back to charging the patients if that didn’t work. Doesn’t seem like a great way to run a business if that’s what’s been happening – perhaps they should have set up a charity structure if that’s the case? In any case, I imagine that will not be happening in the future (at least not in the USA). I should probably try to work out from the finances how much is getting written off, which will now represent additional revenue.

What Are PEB Worth?

Previously I reluctantly valued PEB with a target share price of $0.23 with a MC of $158 in one year’s time. This was based on previous year’s growth, estimated growth from the new KP contract and the assumption of an upcoming Capital Raise (CR). I expected the share price to drop over time, as it had done each year, prior to that.

PEB now has access to a larger market, and that market has less barriers to entry because the product is essentially free to the customer / decision maker. Given this, PEB can now be valued less pessimistically. You might choose to value PEB based on their access to the US market as a whole because their recent developments give them more credibility, or you might choose to value them based on their access to the CMS section of the market because that’s the addressable market.

Whatever your view on this, the stats on bladder cancer suggest that “Ninety percent (90%) of people with bladder cancer are older than 55, and the average age people are diagnosed with bladder cancer is 73” and “this year, an estimated 81,400 adults (62,100 men and 19,300 women) in the United States will be diagnosed with bladder cancer”.

These stats are of particular interest because we can essentially assume that since CMS is for people over 65 in the USA, PEB basically now have access to the whole market in the USA and most of their customers are eligible to get the Cxbladder test paid for by the government.

As bladder cancer has a recurrence rate of 50-80%, it’s something that requires ongoing, lifelong testing. Stats from the same source state that survival rate of bladder cancer is a 77% chance to live for 5 year, 70% to live for 10 years and 65% to live for 15 years. From this we could pessimistically assume that the annual demand for testing in the USA is about 250,000 (81,000 x 5 years – (100-65)%) tests per year. 100% of that market would represent $190m (250,000 x $760) revenue for PEB. For the purpose of valuations, let’s assume that an optimistic number of tests is 1m because people might need a few tests a year.

Given the above, I think that PEB have now earned themselves more attention in my analysis. That said, it’s quite impossible for me to value them based on future prospects because I have no way to work out their rate of growth. Clearly it will be greater than historic values, but I have no idea how much. Once again I find myself trying to value an entirely speculative stock.

Perhaps I’ll look at it another way. Instead of trying to do a business valuation on something that I have insufficient data to value, I’ll look at what assumptions the stock market has made based on the current Market Capitalization (MC) of $379.3m and have a guess at how realistic those assumptions are.

Unfortunately I still cannot see any way to calculate how many tests PEB would need to sell under their current structure to reach profitability. As I have no other way to look at this, I will use multiples of revenue. I’m really not fond this type of business valuation because there’s no link to profit and therefore no way to calculate ROI.

FPH (another healthcare company on the NZX) could be used as a comparable revenue multiple as they are currently priced for large growth. FPHs MC is currently nearly 16 times revenue, and about 20% of their revenue is NPAT. It’s unlikely that PEB could achieve the same, but let’s use this as an optimistic approach because I suspect that the market will have an optimistic view for years, until the Cost Of Goods Sold (COGS) become clearer.

PEBs current MC represents about 75 times current revenue. To reach a revenue that is 1/16 of their MC, they will need to sell an additional 25,000 tests. In other words, the current share price expects PEB to get an additional 2.5-10% of the total US bladder cancer market, depending on whether you use the optimistic or (overly) pessimistic bladder cancer test estimates stated earlier in this article. My gut feeling is that this number would more likely be 2-3% of the US market to justify the current share price.

Will I Invest?

Based on these assumptions, there could be a case for investing in PEB at the current price. In fact, there’s the possibility for PEB to become a multi- bagger (2, 10, 20, maybe more, but less probable) within the next few years.

My gut feeling though, is that PEB is still a speculative investment because there’s not enough data to show growth, and there’s not any data to show how profitable they can be, so it’s impossible to work out ROI.

Because of the lack of predictability of growth, it’s possible that PEB could either half in value on the next announcement or double. My gut feeling is that PEBs shareholders have an optimistic view and would reward wins more than they would punish losses.

Because of the lack of data around profitability, the share price will get rerated as soon as an announcement is made that gives clues around COGS. This makes it all a bit of a gamble because the price will likely be optimistic up until it isn’t. This might make PEB a Greater Fool investment (good for a number of years, then suddenly drop).

So, will I be investing? Hmmm it’s a gamble at these prices, and I have more reliable options through EBO that I feel confident will give me 16% ROI in a years time, and ATM (a touch above fair value, currently) which has the chance to outperform without the downside risk that PEB has.

I think I’ll wait to see if the PEB price drops back or for more evidence of a trend in growth with which I can more confidently invest at today’s prices. It feels a bit too much like gambling at the moment, and less like investing.

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