Biotech Values

[DewDiligence]

Re: FMI valuation model

FMI’s (clearly conservative) guidance for 2014 is 22-25K tests; currently, about half of the tests are being reimbursed (at an average reimbursement of $3,600). In 2015, I think FMI can do 40K tests with 75% reimbursed, and in 2016 I think they can do 60K tests with 90% or more of them reimbursed. (The average reimbursement price should remain close to the current level of $3,600, which includes a blend of FoundationOne and FoundationOne Heme.)

We can estimate the gross margin on reimbursed clinical tests by examining the 2Q14 financials. In 2Q14, FMI performed 5,908 tests; had they all of them been reimbursed, the clinical-testing revenue would have been (5,908)$3600 = $21.3M.

2Q14 COGS was $6.6M; let’s assume for the sake of simplicity that 35% of COGS pertained to the 35% of revenue derived from pharma partners. Then, the 2Q14 COGS attributable to clinical tests was (0.65)$6.6M or about $4.4M.

The key observation to make here is that COGS for a non-reimbursed test is the same as COGS for a reimbursed test, so the COGS for the pro forma $21.3M of revenue that would have resulted from full reimbursement in 2Q14 would have been only $4.4M, implying a gross margin of 79% for reimbursed clinical tests.

In 2016, let’s assume a 75% gross margin on clinical tests to allow for some (<10%) of tests still being non-reimbursed. Applying the 75% gross margin to the projected 60K tests performed during 2016 gives a 2016 gross profit from clinical testing of 60K($3,600)(0.75) = $162M.

Pharma-partnership revenue in 2016 should grow relative to 2014, but at a much slower rate than the growth in clinical-testing revenue. Still, it’s reasonable to assume that the gross profit from pharma-partnership revenue will offset much—or all—of FMI’s 2016 SG&A expenses, so that FMI’s 2016 operating profit before deducting R&D should be close to the $162M figure calculated above. If we assume $40M for 2016 R&D, this lowers operating profit to $122M, which would yield about $75M of net income on a fully-taxed basis (ignoring NOLs in order to be conservative).

Applying a 25x multiple to this $75M net income seems reasonable given the high growth rate of the revenue and income stream, which yields an enterprise value of $1.9B, or $55/sh based on 34M diluted shares I project to be outstanding in 2016 (vs. 28.1M shares and 2.3M options outstanding currently).

To get a bottom-line figure, add in a projection for FMI’s net cash in 2016 (not included in above analysis) and then discount 2016 share price for time and risk using a probability or discount rate of your choosing.

Of course, FMI has considerable buyout vig, so it may not exist as an independent company by the end of 2016.