GH - Exact Sciences' Shift In Strategy: Targeting Positive Adjusted EBITDA

Summary

• Exact Sciences is shifting its focus towards achieving positive adjusted EBITDA as a way to signal a path to eliminate cash burn.
• The company's long-term prospects look interesting with a pipeline spread across different timelines, including a MCED test and MRD testing.
• While the potential upside for Exact Sciences is interesting, its current valuation, product development and regulatory uncertainty poses a significant risk and could limit its potential.

In my May 2022 article on Exact Sciences Corporation ( EXAS ), titled " Exact Sciences Won't Likely Escape Consolidation in the Industry ," I pointed out the need for the company to turn its cash flow positive to avoid liquidity issues. Furthermore, the lack of game-changing products in the pipeline close to commercial stage posed a challenge. I also proposed that mergers and acquisitions could be a viable option for the company to scale up and reduce cash burn, but I cautioned that such a move would not be without its challenges. As enough time has passed, it's prudent to reassess my earlier analysis.

Shifting Exact Sciences Strategy: Aiming for Positive Adjusted EBITDA

During the conference cal l that followed the release of the company's 2022 financial statements, a few noteworthy points were raised. Of particular interest was the apparent shift in the company's strategy towards achieving positive adjusted EBITDA as a way to signal a path to eliminate the cash-burn. In fact, the company revealed its 2023 guidance, which includes a target of generating $25 million in adjusted EBITDA.

This is crucial for securing the company's financing requirements and ensuring its independence, particularly in an environment where cash-strapped tech firms are not receiving a warm reception from the market.

The 2023 guidance for adjusted EBITDA comes on the back of a year of significant achievements for Exact Sciences. In 2022, the company tested more than 12 million people for cancer, grew revenue by $380 million, and achieved adjusted EBITDA profitability in the fourth quarter. These accomplishments demonstrate a positive momentum for the company, let's have a closer look.

However, upon closer examination of the company's cash flow, some concerns emerge. Despite the positive developments, there are signs that Exact Sciences will face a harder task than it seemed at first glance.

In particular, a deeper analysis of the 2022 financial statements reveals that the company reported a negative adjusted EBITDA of $143 million for the year, but a review of the balance sheet indicates a reduction of approximately $450 million in assets and current assets, suggesting a more significant cash drain than what is conveyed by the EBITDA metric. Furthermore, the current ratio, which is a measure of a company's liquidity, indicates a cash position degradation. Specifically, the current ratio has decreased from 2.76 to 2.38.

These challenges do not necessarily mean that Exact Sciences will fail in its efforts. It's important to remember that turning points in a company's trajectory are rarely straightforward, and not all metrics will necessarily align at once.

While the current situation may not be ideal, it does not necessarily contradict the company's narrative. It merely suggests that the facts do not yet support the entire story, and we must continue to monitor and validate our thesis over time.

Regulatory and Insurance Approval: The Hurdles to Revenue Growth

The company's flagship products, Cologuard and Oncotype, are generating significant revenue through their respective screening testing and precision oncology offerings. Furthermore, the company has several incremental improvements to these products in its pipeline, such as Cologuard 2.0, which boasts increased specificity and advanced adenoma sensitivity. The company anticipates that the cancer sensitivity of this updated test will be 90% or higher, a notable improvement over the original Cologuard test.

Another promising product in development is OncoExTra, an ultra-comprehensive panel that can detect clinically actionable mutations and fusions, including whole transcriptome sequencing, and comes with an easy-to-interpret result report.

However, it's important to remember that upgrades to these products must go through rigorous approval processes from both regulators and insurance parties, which can be a lengthy and challenging process. As a result, we should not expect sudden spurts in revenue growth. Instead, the company's revenue will continue to grow through a gradual and deliberate process of obtaining regulatory approvals, working with insurers to secure and expand coverage for its tests, and expanding the use of existing tests into new patient populations.

That’s a time consuming process, spreading the revenue growth over a long period of time after the tests have been launched in the market. As a result, while the company has many promising products in its pipeline, the reality is that we should not expect rapid and significant growth in its top-line overnight. Rather, we should anticipate that the company's revenue growth will be steady and sustained over the long-term.

A pipeline with multiple timelines

While Exact Sciences may face short-term constraints on its revenue catalysts, its long-term prospects look hopeful. The company is focused on several exciting opportunities, with distinct timelines for development. One of the most immediate projects is improving the performance of its Cologuard test to reduce the false positive rate. To that end, Exact Sciences has completed enrollment of the multi-center BLUE-C study, which is expected to support FDA approval of the enhanced Cologuard test. This presents a short-term opportunity, and it seems the best case for small accelerations in revenue in the middle term.

Then, Exact Sciences is investing in the development of minimal residual disease ( ( MRD ) ) testing . The company plans to offer both tumor-informed and tumor-naive MRD tests, which can help detect small amounts of tumor DNA that may remain in patients' blood following initial cancer treatment. By monitoring MRD levels over time, doctors can identify when a patient's cancer cells are starting to grow again and intervene with additional treatments before the cancer has a chance to progress.

According to the 4Q22 earnings call, the company is planning to launch a laboratory developed test (LDT) for colorectal cancer later this year. This tumor-informed version of the MRD test represents an exciting opportunity for the company to expand its offering and improve patient outcomes. Exact Sciences also plans to submit retrospective prospective data to MolDx next year to secure positive reimbursement for the test. It's clear that the company is making progress in its MRD program, with studies underway for both colon and breast cancers.

Finally, aiming the long term, the company is developing a MCED (multi-cancer early detection) test. The company is seeking to develop a MCED test to help detect many different types of cancer from a single blood draw. They presented data at the European Society for Medical Oncology (“ESMO”) Congress in September 2022. They will then begin recruiting patients for the FDA registrational Study of All comeRs (“SOAR”) trial, which they expect to be the largest prospective, interventional MCED trial ever conducted in the United States.

The company has a pipeline spread across different timelines, which makes me believe that they have enough drivers to keep the growth engine running.

Valuation & Risks

In the following analysis, I chose to focus on Invitae ( NVTA ) and Guardant Health ( GH ) as potential benchmark companies for Exact Sciences. Invitae, for example, is now shifting its attention towards the oncology testing space, and has previously been mentioned as a potential merger partner for Exact Sciences. Guardant Health, on the other hand, is a direct competitor to Exact Sciences, and thus provides a useful benchmark for comparison.

It's important to bear in mind that the biotech industry is highly dynamic, with rapid changes occurring frequently. The field is full of examples of promising companies that have faltered along the way. Just look at some of Exact Sciences' peers to understand the volatility of this space.

It's worth noting that while EXAS stock price has increased by over 20% in the last 12 months, Invitae's stock price has declined by 80%, and Guardant Health has lost over 50%. This illustrates just how rapidly this field can change, and highlights the need for ongoing monitoring and analysis of companies in this sector.

The range of price to sales ratios among the companies is quite broad. Inviate, for instance, has faced challenges and is currently working to become cash-flow positive before it runs out of funding. On the other hand, Guardant and Exact Sciences appear to be a couple of steps ahead, even though they are facing similar pressures. While their stock performance has not been exceptional, they have been able to maintain robust multiples thus far.

By taking a closer look at these peers, we can develop a bull and bear scenario for Exact's valuation. In the bull scenario, the company achieves a 20% annual revenue growth rate until 2025 and earns a revenue multiple of 6, similar to Guardant's. However, in the bear scenario, the company is only able to achieve 5% growth, experiences a liquidity crunch, and is valued at only 1x revenue, similar to Invitae.

Please note that while the peers selected do not necessarily represent the entire industry, they do offer some useful context regarding the different realities within the same space. That being said, while the potential upside for Exact Sciences is certainly interesting, it is overshadowed by the potential downside. The current valuation poses a significant risk, and a re-rating of the company's stock price, similar to what happened with Invitae, would be quite punitive. In my view, the probability of the bull scenario is higher than that of the bear scenario, but it is difficult to say whether it is high enough to make a bet on the stock with a favorable risk-reward profile.

Additionally, regulatory challenges or setbacks in new product development could put a limit on Exact Sciences' potential. Competition is also not standing still, and there several companies, like Grail and Guardant, trying to get breakthroughs in the field. Furthermore, the company's cash position is not ideal, which makes me want to wait and see if they can achieve their goal of becoming cash-flow positive and stabilizing their balance sheet.

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