CDNA - CareDx's Turmoil: Risks Appear Priced In

2023-12-28 05:23:01 ET

Summary

• CareDx specializes in solutions for transplant patients, but faces challenges, including legal setbacks and regulatory hurdles.
• The company won Medicare coverage for its HeartCare Multimodality Service and raised its revenue guidance for 2023.
• However, ongoing legal disputes and management changes overshadow the positive financial results, and the stock appears fairly valued for now.
• Therefore, I rate CDNA a "hold" for now.

CareDx, Inc. (CDNA) specializes in innovative solutions for transplant patients, offering products and services in various stages of solid organs, cell therapy, and bone marrow transplants. Recently, CDNA has navigated through challenges such as legal setbacks and regulatory hurdles involving MolDX's revision of requirements for Medicare reimbursements. But, on a positive note, CDNA also won Medicare coverage for its HeartCare Multimodality Service. Notably, CDNA applied a mitigation plan and raised its full-year 2023 revenue guidance. Yet, overall, the company's challenging legal headwinds and ongoing management changes overshadow its seemingly upbeat financial results. In my valuation analysis, I conclude that CDNA does appear to trade at a discount, but such a discount seems warranted given CDNA's embedded headline risks. Thus, as a whole, I believe the company is a "hold," but its outlook should improve after a new management team is in place, and we get a well-defined update on its potentially new strategic direction. But for now, the stock appears fairly valued.

Business Overview

CareDx, Inc., founded in 1998, is based in Brisbane, California, and specializes in solutions for transplant patients. CDNA offers services and products tailored for transplant innovation in four areas: testing services, transplant lab products, digital transplant solutions, and pharma solutions. The testing services comprise AlloMap Heart, AlloSure, HeartCare, HistoMap, and UroMap. The transplant lab includes Human Leukocyte Antigen [HLA] typing solutions to match donor organs with recipients. The digital transplant solutions include software and supporting transplant services. The pharma solutions segment supports pharmaceutical companies in researching new drugs and therapies in transplant and precision medicine.

CDNA research also focuses on transplant management with a product pipeline for solid organ transplants for kidney, heart, lung, and other organs, cell therapy products, and hematopoietic cell and bone marrow transplant studies. The care for transplant patients extends to pre-transplant, peri-transplant, and post-transplant. This is particularly noteworthy because it broadens CDNA's market potential, adding optionality to its upside valuation.

Moreover, CDNA's digital platforms used for pre-transplants are TxAccess, XynCare, MediGO, and support for the pre-transplant phase to execute organ matching and patient care logistics. The products include high-resolution HLA typing. In the peri-transplant phase, the products: AlloSeq Tx helps to identify the best possible organ donor for a patient, Qtype provides information for donor and recipient HLA features, Liquid Biopsy is a non-invasive testing method to detect dd-cfDNA in the blood to identify organ rejection in an early GEP is used as a combination of techniques to monitor the organs post-transplant, and a suite of digital health, data management, and patient support applications for post-transplant care.

CareDx´s Patent Disputes, Regulatory Hurdles, and Executive Changes

Nevertheless, CDNA's broader context seems prone to headline risks. Concretely, in October 2023, the US Supreme Court ruled to maintain a legal victory for CDNA's competitor, Natera (NTRA), regarding a patent infringement invalidated by a Delaware federal court. AlloSure is a test that detects possible kidney transplant rejection, which has been the subject of several lawsuits between Natera and CDNA related to false advertising . Here is a good overview of the ongoing legal disputes between CDNA and Natera. However, from an investment perspective, this introduces headline risk into CNDA, which should ostensibly be reflected in a lower valuation multiple. After all, legal updates regarding the ongoing dispute could impact CDNA's long-term profitability. Originally, CDNA was expected to receive $45 million in damages from Natera, only to be later reviewed and denied. For context, according to Seeking Alpha's CDNA dashboard, the company is forecasted to generate roughly $254.44 million in 2024, so this was a material amount.

Also, CDNA previously faced regulatory challenges related to billing its molecular transplant tests. In March, Molecular Diagnostics Services [MolDX], a Medicare Administrative Contractor [MAC], revised the billing requirements and coverage for Medicare reimbursement. In response, CDNA adjusted its operational and billing processes as part of a mitigation plan to ensure compliance with the new policies to maintain revenues. Fortunately, the HeartCare Multimodality Service received Medicare coverage for heart transplant monitoring in August. The decision came after studies showed that using AlloMap and AlloSure reduced dependency on endomyocardial biopsies [EMBs]. HeartCare Multimodality Service combines both tests and currently, it is used in at least 1 in 2 transplanted patients in more than 90% of US heart transplant centers. Theoretically, this clears the path toward relatively safe repeat revenues for CNDA. But it also showcases how sensitive the company's prospects can be to headline risks.

Furthermore, on the first day of November, CDNA's CEO stepped down from his role, and the company formed an interim CEO office composed of board members and the president of patient and testing services. Currently, CDNA is searching for a new CEO. According to the board chairperson in the last earnings call, this search could take six to nine months. All of these developments show a company in turmoil, in my opinion. While I believe the product portfolio is exciting, CDNA's business profile is evidently messy.

Priced-in Risks: Valuation Analysis

Despite the headwinds, in Q3 2023 , CDNA raised its full-year 2023 revenue guidance due to Medicare reimbursement and the increased volume of testing products and services. The new revenue guidance ranges from $274 million to $278 million. Yet, in my view, it's not a huge guidance raise, making it seem more of a vote of confidence in their results going forward.

Moreover, in their latest earnings call, CDNA's executives announced that the company does not expect to raise cash soon. Naturally, they reiterated their focus on financial stability, strategic growth, and successfully addressing regulatory challenges. As to the latter, I'd say those were mostly boilerplate phrases, which are expected for a company during management changes. However, their comments regarding their cash position are key. Indeed, CDNA's cash reserves seem to imply a healthy cash runway. Using the latest quarterly figures, I estimate CDNA's quarterly cash burn to be $14.8 million, which is about $59.2 million if we annualize that figure. Since its current cash reserves are $268.2 million, that results in 4.5 years of cash runway.

I believe this should be enough time for CDNA to navigate its ongoing legal disputes, mitigating its long-term risk profile. It also gives CDNA room to maneuver under the new management team coming in 2024, so a lot will depend on their unique vision for CDNA. However, such uncertainties should be discounted in CDNA's valuation.

Hence, it's quite challenging to value CDNA by looking at its current business prospects. We can't know its strategic direction under the new management team until 2024. However, I believe a multiples-based valuation can give us some cues. As I previously mentioned, CDNA is forecasted to generate about $257.4 million in revenues in 2024. The current market cap of $667.0 million implies a P/S ratio of about 2.6, well below the sector's median P/S ratio of 4.1. In fact, at the sector's P/S multiple, CDNA would be priced at approximately a $1.1 billion market cap, about 58.2% higher than today's CDNA stock price. Thus, clearly, there's an embedded discount in the shares. However, this doesn't mean it's undervalued, as I think CDNA indeed deserves a discount at this stage. So, given its current context, I lean towards it being fairly valued, which is why I rate it a "hold" for now.

Conclusion

Overall, CDNA operates in a promising sector, focusing on transplants. This is a potentially big market for CDNA. However, the company's legal disputes show that its IP isn't easy to defend, which throws a question mark on its long-term revenue capabilities. After all, IP is supposed to be a business moat, and to the extent that it's challenged, it also reduces its competitiveness in the sector. Not to mention the ongoing legal costs and headline risks, which by themselves are a challenge, but in CDNA, they are further compounded by its CEO leaving in November 2023. Yet, from a valuation perspective, CDNA does appear to trade at a discount, so I believe its current price tag already factors in these uncertainties and headwinds. Therefore, I feel a "hold" rating makes sense for the company. However, after a new management team takes over and we get a well-defined update on their strategic direction, CDNA could become an attractive investment opportunity in the sector.

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