I believe shares in Aytu are worth substantially less than the market currently is pricing in at $1.39 per share. My valuation ranges between $0.35 and $0.75 a share.
Given Aytu has announced around 600,000 tests shipped since it entered the market in mid-March and that the manufacturer has accepted another order of 1 million tests, we can probably assume monthly manufacturing capacity between 600,000 and 1 million tests.
According to Stat, “A recent report from the American Enterprise Institute co-authored by former FDA Commissioner Scott Gottlieb puts the number of tests needed at 750,000 tests per week.” This means Aytu may have capacity to supply almost half the U.S. market with tests. But given the competition, including several dozen products the FDA has already issued EAUs for, I think a 3% market share would be generous for Aytu, because it would put this unknown player licensing a Chinese product on even footing with established companies marketing tests explicitly authorized by the FDA. (Again, 37 emergency use authorizations have already been listed on FDA's website.)
This New York Times article pegs Medicare payment per test between $36 and $51. We’ll call $45 a nice midpoint.
750,000 tests per week x 52 weeks per year x $45 per test x 3% market share = $52,650,000 in annual revenue.
Big, profitable testing players with long track records, services businesses, and recurring revenue – companies like Lab Corp (LH) and Quest Diagnostics (DGX) – trade at 1.1x and 1.4x sales respectively. Assuming similar profit margins (7% for Lab Corp, 11% for Quest) for Aytu BioSciences and similar long-term repeatability of the testing revenue stream, a 1.4x multiple on $52.7 million in sales gives us a $73.7 million valuation for the COVID-19 testing business. I think that’s a generous valuation given that viral pandemics eventually naturally recede and Aytu is a historical cash burner. The assumption of any annuity cash flows from this business is tenuous at best, but again, we're being generous.
Readers may be curious about Aytu's possible margins on test sales. I don't know the cost to manufacture a test in China, ship it, relabel it, and sell to practitioners (I assume it's well below $45 per test). My assumption is that Quest Diagnostics' 11% net income margin would be the absolute ceiling for Aytu, which has 78 employees listed on LinkedIn (lacking Quest's scale at 45,000 employees), has only one profitable quarter of the last ten, and has consistently shown triple digit negative net margins since 2013 (Quest has a been profitable over the same period and longer).
Aytu's 2019 SG&A, which is unlikely include any efforts related to COVID test sales (the licensing deal was announced in March 2020), was $19.2 million, already a meaningful proportion of our revenue estimates for the test. Meanwhile, in my opinion the announced sale of only 2,750 tests to Denver first responders illustrates a limited go-to-market strategy.
I think it's quite possible Aytu loses money on this venture even if it manages to sell through its test inventory in short order. To put a fine point on it, I expect net margins to range from -50% to 11%, for an implied net income on $52.7 million in sales of between -$26.4 million and $5.8 million. Neither justifies the current market cap, in my opinion.
In light of that, we could also simply assume the company sells through its existing booked test inventory of 1.6 million at a price of $45 per test. We arrive at $72,000,000 in testing sales as a one-time inflow. I would think a 1x sales multiple on a nonrecurring revenue stream would be laughably generous. At this valuation, that’s still around 43% downside.
A very pessimistic but plausible valuation of Aytu BioSciences would assume no profitable sales of its Coronavirus test. Given the market’s repricing of the shares is almost certainly attributable to the testing announcement, that approach yields a per-share pre-announcement price of around $0.35, or 75% downside. While an even lower price target may be justified by the company's lossmaking history and unimpressive pre-COVID product portfolio, I would tend to assume investor speculation would provide a floor to the share price in the $0.30-$0.40 range and would target an exit of a short position if the shares got there.
The particulars of the fundamental valuation are not the main point. The main point is that on an estimated price-sales basis the market has valued the company as though it will achieve outsized market share as a new entrant in a highly competitive market; that in short order it will achieve profitability for the first time, at comparable margins to much larger industry incumbents; and that its revenues will recur and possibly even grow – even though the COVID-19 testing market is likely a transitory one, where demand could recede within a year.
Conclusion
Before entering the Coronavirus testing market, Aytu BioSciences was an aggregator of marketed products with little penetration and, in my view, poor growth prospects. Its only existing testing product is an aid in the diagnosis of male infertility that is not approved for sale in the U.S. Management has quickly moved to bring a Chinese COVID-19 test to the U.S. market under emergency relaxed FDA guidelines. In my opinion there is little reason to believe the company will capture meaningful share of the diagnostic market. Even if it does, it will face overwhelming challenges as better-suited industry incumbents bring their the force of their knowhow to bear on the pandemic. The stock is priced for a near-impossibly rosy business scenario, and shares should trade at somewhere between half and a quarter of their current value.
[Update: Aytu has announced on April 20 a license to develop and commercialize Healight Platform Technology, a pre-clinical medical device that shines lights on COVID-19 infections in hopes of treating them. Quoting from the release:
The Healight technology employs proprietary methods of administering intermittent ultraviolet (UV) A light via a novel endotracheal medical device. [...]
Pre-clinical findings indicate the technology's significant impact on eradicating a wide range of viruses and bacteria, inclusive of coronavirus. The data have been the basis of discussions with the FDA for a near-term path to enable human use for the potential treatment of coronavirus in intubated patients in the intensive care unit (ICU).
I don't expect that running a tube down an infected patient's throat to shine radiation on COVID-19 infections is going to be a viable solution to the pandemic, but times are desperate, so we will see. My opinions regarding Aytu's lack of in-house knowhow regarding medical testing also apply to endotracheal UV medical devices. If anything, I believe this additional business activity will strain Aytu's limited resources and distract from its initial focus on sourcing and distributing medical tests - a task I was already concerned would be difficult for Aytu to achieve.]
