Why I Sold My PEB Shares

Yesterday I bought some PEB shares based on some logic around PEB’s total addressable market and a CM valuation relating to FPH’s price to revenue multiple. Today I’m selling those shares and this article explains why.

After buying my PEB shares yesterday, I read a post on ShareTrader which said:

“…If PEB became a buyout target in next 12-24 months, in order to justify a SP of >$1 it would need to generate annual revenue in the vicinity of USD$180M…”

Drcjp – ShareTrader

My first reaction to this was that it seemed ridiculous given the current share price, so I started looking at the numbers a different way to set about justifying my thinking to debunking the idea in my head.

I figured that a mature company would be priced on profits, rather than revenue, so I decided to turn to FPH to look at what sort of profits they make instead of looking at the lofty multiple of revenue comparison.

It seems that 23% (let’s pessimistically say 20% for the comparison) of FPH’s revenue translated into NPAT, so I decided to look at how much of the US market PEB would have to own in order to justify the current share price based on a multiple of NPAT (which I decided would have to be below 20 for a mature company [of 25 for a growing company], because no one would invest for years with the hope of earning 5% ROI because you can get that right now from a REIT or banking stock dividend).

Last night I did some hasty calculations and decided that I shouldn’t have bought my PEB shares because all the possible success is already priced in and my purchase was essentially a Greater Fool scenario and I was looking like the greater fool. Consequently I sold my small parcel of PEB shares today, and I was lucky enough to get what i paid for them (less brokerage fees). I don’t recall exactly how I arrived at that conclusion, but for the sake of my sanity, lets run some numbers to confirm that this was the right thing to do.

Based on the current Market Capitalization (MC) of $551 ($525m current MC + 5% for the upcoming dilution of stocks to be created for ANZ’s purchase), PEB would have to sell X Cxbladder tests to justify that MC, based on theoretical NPAT being 20% of revenue, and at a multiple of NPAT of 25 because they’re currently growing (we can reassess the basis for that multiple later if required).

To find the value of X (the number of tests needed to be sold to justify the current MC), we take the adjusted MC of $525, divide by 25, divide by 20, multiply by 100 and then divide by $760, which gives about 138,000 tests. If you want to follow the logic of that, I arrived at that formula by rearranging the formula to calculate NPAT as (revenue / 100) * 20, revenue was defined as number of tests multiplied by the cost of each test ($760), and MC = NPAT * 25.

138,000 tests is a lot of tests per year, given that the US market may be somewhere between 300,000 and 500,000 tests per year. Also given that it’s approaching market saturation (assuming that they don’t get all the business in the US – maybe they just get 50%, which would be a lot!), you could argue that target ROI should be a dividend of 10% of initial investment, at least! This would at best be a multiple of 10 instead of the multiple of 25 that I used. So realistically, to justify the current MC, PEB would have to sell about twice that number of tests within the next year or two.

I also looked into the size of markets in other affluent English speaking countries and decided that these were negligible compared to the US. For example, in the UK my research showed that they have only ~10,500 new cases of bladder cancer, which would equate to a requirement of about 50,000 tests a year (10% of the US market). Additionally, stats show that instances of bladder cancer are decreasing in the UK, though the articles I read didn’t say why that was.

In summary, I think that Drcjp of ShareTrader was correct (thank you very much, if you’re reading this). I shall try to be more careful next time and stick to less speculative investments that give me more comfort around my long term investment strategy and try to avoid Greater Fool investments.


Why I Bought Some PEB Shares Today

I’ve done a few pieces of analysis on PEB, and I’ll be honest – it’s been difficult: difficult to work out potential profit margins, difficult to guess future growth, and difficult to have predicted the surprise announcements that have come out recently. To this end, I have concluded that PEB is a speculative investment that I will stay away from as I don’t do speculative investing. Despite all this, I recently decided to buy a small parcel and here’s why:

  • PEB has a massive addressable market, of which I estimate they have only made (the equivalent of) inroads of about 3% in the US alone (for simplicity of modelling, I’ve assumed that all revenue has come from the US).
  • Despite this, I believe they are currently priced as though they have taken 8% of the US market (an assumption I have made in a former analysis based on FPH’s 16x revenue on a Comparable Market (CM) analysis). This could be measured as being priced as having ~40,000 tests sold a year.
  • The recent announcement of the ANZ bank investing $22m means that PEB should have enough money to either fund massive growth or exist in their current state without going begging to shareholders for a good amount of time.
  • The ANZ funding also heralds risk of other large institutions joining in and pushing the price up further.
  • This announcement will cause a significant amount of shareholder dilution, making the share price that I have paid effectively a lot higher (maybe they will have to do 50,000 tests next year to justify my buy in price? I didn’t bother to check how many new shares are going to be issued to calculate my dilution today, I did the maths yesterday and can’t remember the numbers – please leave a comment below if you have worked out how much dilution this represents). I did ponder whether or not to hold off for a bit, but decided that could be risky as the market seems quite fanatical about PEB lately, and an interest from the Sharesies crowd could cause the share price to be pushed to unreasonable high levels of buyer risk.
  • I figure that given the small amount of the market that PEB own, they still have room to become a multi-bagger, and the downside risk possibly isn’t that significant if I ensure that I exit on the first sight of bad news announced (such as not getting anything like the kind of growth that I expect, release of information that enables me to calculate potential profitability that doesn’t look attractive at any scale, a blow out of costs, or some unfavourable contractual or medical news).

So I bought myself a very small parcel of PEB shares at $0.77 each for a bit of a gamble (I still see this as a speculative investment, it’s just that the upside outweighs a managed downside). Perhaps I’ll increase this holding after information about sales growth has been released, which will help me value the company more accurately.


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…

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 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.


Pacific Edge (NZX:PEB) – Can This Turkey Fly?

Does Cxbladder Work?

A few years ago I did some fairly heavy research (trawling through medical journals and diving deep into test results, confirming sources, etc.) to confirm that Pacific Edge Ltd (PEB) wasn’t selling snake oil with its Cxbladder test.

From memory, I left feeling confident that someone (who was able to afford it, especially with the thousands of dollars mark up in the USA) would be mad not to use a Cxbladder test. In fact, based on the research, I would be inclined to take the Cxbladder test for a quicker answer (important when cancer is involved) and to cover the things the Cxbladder test is more accurate (and capable) at detecting (effecting a few percent of detectables). I would also take the incumbent test to cover the types the Cxbladder test didn’t do so well at.

This research is old and the playing field may well have changed, but this (and continued interest from medical practitioners) is enough for me to feel confident in the product.

How Is The Company Performing?

I’ve learnt a long time ago that a great product, make a company does not.

A great product, make a company does not.

Lewis Hurst

What does this mean? It means that just because you have a great product, doesn’t mean you have all the other pieces in place to make it work as a business. In fact, though it saddens me to say this, as an investor I’d rather invest in a successful company with a crap product than an unsuccessful one with a great product.

Getting back to PEB, they have failed to prove capable of turning a profit for years since their inception in 2001. This sounds pretty harsh as the industry they are in is a very difficult one with a lot of moving targets that need to be hit, and each target is different in different countries. They have the corrupt legal system in the USA to fight their way through, which may be supporting entrenched incumbent lobbyists; they have to win over doctors who are lazy and don’t want to learn about new things; they have to incentivize doctors to recommend the test to their patients; they have to make doctors feel comfortable that they won’t get any backlash from errors in the product, etc. It’s a steep, uphill struggle. To be fair to PEB, they’ve achieved a lot!

This brings me around to why I’m looking at PEB now. Well, the jump in the share price peaked my interest, so I thought I’d do a little investigation into what’s going on, since I’ve been out of the loop for years on this stock.

It seems that PEB have been making good progress and have recently been granted access to one of the largest non-profit healthcare providers in the US, Kaiser Permanente (KP). This enables them to sell to urologists across the 39 hospitals owned by KP. This looks promising because it’s an avenue for access into a market, which would give the credibility and fame required to access the wider US market.

What’s PEB Worth?

The obvious question to ask right now is what PEB shares are worth. I’ll be honest, I’m struggling with this one because it’s unclear how / when / if PEB will ever become profitable because I can’t see clearly how their costs will diminish as they scale.

Let’s first throw some numbers down and see where this goes. Let’s look at the size of the new opportunity in KP and the USA (Note: PEB are not limited to the USA, and in fact operate in a few other countries).

There are 6,146 hospitals in the USA, 39 of which are owned by KP. There are 12m members (I assume that the word “members” in the context of this PEB announcement means “patients”) across those 39 KP hospitals. Based on sample data in NZ from privately funded hospital discharges between 1 July 2016 to 30 June 2017, I will assume that urology departments represent 1.95% ([4,003 / 204,951] * 100) of hospital patients (members?). Let’s guess that 10% of these need cancer tests (here’s where the numbers get really sloppy!). That gives a total opportunity size across the 39 KP hospitals of ~23,000 patients. As each test retails for $760, this could equate to additional revenue of ~$17m, assuming they get all the doctors there to prescribe each theoretical potential cancer patient a Cxbladder test.

Based on last years Net Loss of $18.9m, even if all the urologists in all 39 KP hospitals pushed the Cxbladder test onto their customers, they still wouldn’t make a profit even if all new revenue was free of cost – which it wouldn’t be.

So for me, I would really love to see PEB fly, but I just don’t have enough information to be able to confidently say that PEB will make a profit one day, or how much that profit would be. As I only wish to invest in companies that I can measurably state their worth, related directly back to the capacity to give a return, I will not be investing in PEB today.

If I Was Forced To Value PEB Shares…

If I were to resort to placing a value on PEB, I would have to resort to other methods to value this company. Oh boy, how do you value a company that’s not profitable and have no discernible path to profitability? A Comparables Market analysis – comparing what other similar companies have sold for? You’d then have to calculate your exit after adding growth and deducting capital raises. Perhaps it could be done based on the value of the IP, but the how do you value the IP? Perhaps the valuation could be somehow related to the historic value of PEB vs. the prospective growth, minus dilution from capital raises?

I don’t even want to have a go at this, because a forward looking valuation is not only a guess on all the numbers, but also a guess on the sentiment of the market in a year’s time.

What the heck?! This valuation is going to be more sloppy that my punt at valuing KMD most recently. I’m not going to put much effort into this because as I previously stated, I’m not investing, but my guess will be that PEB will get 1/3 of the maximum sales from KP (about ~8k), which is 50% more than the FY announcement at the end of May. At that time PEB commanded a Market Capitalization (MC) of ~$83m so let’s add the annual 7% growth they’ve had in the previous year… actually let’s go 10% to represent the boost in sales they’ll get form the KP street cred plus the 50% makes 60% above the $83m MC. That gives a new MC of $132m. Now let’s dial that back by 19% to represent the 25m Capital Raise (CR) they’ll want to do, which gives a (effective) MC of about $100m (though in reality the MC will stay the same after a CR, I’m just reducing this so I can calculate the share price). Let’s add 20% to that to represent the potential market sentiment of new developments (you can tell this valuation is super scientific!). That gives a forward looking projected (effective) valuation of $120m, which is a share price of $0.23 on a MC of $158m.

To be clear, I’m guessing that the PEB share price will be $0.23 against a market capitalization of $120m $158m in a year’s time. Let’s see how that compares to the share price in a year’s time just after the FY results announcement – should be good for a laugh.

Please feel free to put your own guesses in the comments below this article.


Pacific Edge Ltd (NZX:PEB)

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