Monday, September 13, 1999

Cytyc Corp.
(Nasdaq: CYTC)
Phone: 800-442-9892
Website: www.cytyc.com
Price (9/10/99): $39 3/8


Imagine you've got a product that practically every adult female in the world should use on an annual basis. Imagine this product has been proven to work much better than previous products on the market, and that it is also cost effective. There's no need to imagine this when looking at Cytyc, since the company's ThinPrep Pap system has become the preeminent way to screen for cervical cancer. With patent protection, high margins on its products, and a huge potential market, Wall Street has awakened to the Cytyc story.

The positive news has been flowing from Cytyc in recent weeks. On July 8, the company announced that a study had found its ThinPrep Pap system was more effective than the traditional Pap screens in finding precursor lesions associated with cervical cancer. This was just the latest in a string of studies that have shown Cytyc's system to be significantly more sensitive than older systems in finding the telltale signs of cancer.

Where few have doubted that Cytyc's system worked better, convincing those who hold the purse strings for healthcare spending that the extra cost was warranted has been a different story. However, many insurance companies that had previously not covered the new test have started to agree to pay for Cytyc's system. On July 26, a fairly large public insurance organization in California, Family PACT, agreed to add ThinPrep to its formulary. Then on September 2, Aetna, the nation's largest health insurer and an organization that had originally balked at the extra up-front costs of Cytyc's system, agreed to cover several new tests for cervical cancer, including ThinPrep.

With Wall Street's realization that the Cytyc system is rapidly gaining acceptance and share in a market with excellent potential, Cytyc's stock has been on a roar. After trading below $14 last March, Cytyc shares have more than doubled over the past 6 months and have recently made new all-time highs.


Cytyc specializes in designing and producing sample-preparation systems used in medical testing. The lion's share of the company's revenue comes from its ThinPrep system used to screen tissue samples for a variety of cancers, most notably cervical cancer. Cytyc's ThinPrep Pap system was approved by the FDA in 1996 and can be used by doctors and laboratories in place of traditional Pap smears.

The company is based in Boxborough, Massachusetts, and came public in 1996.


Income Statement
12-month sales: $62.0 million
12-month income: $4.2 million
12-month EPS: $0.24
Profit Margin: 6.8%
Market Cap: $724.5 million

Balance Sheet
Cash: $43.2 million
Current Assets: $91.6 million
Total Assets: $103.4 million
Current Liabilities: $15.5 million
Long-term Debt: $0 million
Total Liabilities: $15.5 million
Shareholders' Equity: $88.0 million

Price-to-earnings: 164.1
Price-to-sales: 11.7


Women and physicians certainly had the advantage in finding Cytyc early since the average male probably does not even know what a Pap smear really involves. In the old Pap smear system that has been in use since the '40s, a culture of cells swabbed from a woman's cervix is immediately put on a slide and sprayed with a fixative to preserve the cells. The cells are then sent to the lab and looked at under a microscope for signs of cancer and other problems.

With the ThinPrep system, the swabbed cells are immediately put into a vial instead of onto a slide. At the lab, the cells of interest are separated from contaminants such as blood and mucous, giving the lab a much cleaner sample to examine. The fairly significant change of protocol from using slides to vials should have been a wake-up call for those who knew of the process.

Furthermore, after studies showed that ThinPrep was more sensitive to finding precancerous lesions than the older cervical screening methods, it would only make sense that it was just a matter of time before the medical community embraced the technology. Certainly the added cost per test for Cytyc's system made some reluctant to change, but a few extra dollars (ThinPrep typically costs about $15 more per test) for a better screen makes economic sense even if only a handful of additional cancer cases are nipped in the bud and treated early.


There are some 50 million Pap smears done annually in the United States, and the systematic screening of women for cervical cancer has cut the mortality rate of the once-common and deadly disease some 70%. Screening for cervical cancer is here to stay, and companies like Cytyc that can improve the process have a fertile market with which to sow both domestically and internationally.

Probably the largest risk factor to Cytyc is its competition. Cytyc is not alone in selling new cervical cancer screening devices, and the merger of AutoCyte (Nasdaq: ACYT) and NeoPath (Nasdaq: NPTH) will create a strong competitor. Where AutoCyte is a company also with a new screening system, NeoPath specializes in automated, computerized image-interpretation systems. AutoCyte and NeoPath are both relative newcomers to the market, and it is unclear which system (or systems) will become "standard." Either way, Cytyc investors should make sure to keep tabs on AutoCyte's products.

Another risk factor to Cytyc shareholders is the fact that the company is fairly small and has few other sources of revenue. The ThinPrep system certainly appears to have a bright future, but the consequences to the company would be severe if another system should come along and outperform Cytyc's system. This is one of the reasons it's important to assess the advantages and disadvantages of Cytyc's and AutoCyte's respective products.

On the valuation side, Cytyc has a typical balance sheet for a biotech company with a horde of cash, little debt, and copious amounts of accumulated losses. However, Cytyc has made it through the riskiest stage of research and development and now has a product that is bringing significant cash flow and profits to the company. At over 100x trailing earnings, the valuation may appear steep. Nevertheless, 1999 will be the first profitable year for the company, and significant earnings growth is expected. Next year, Cytyc is anticipated to earn $1.14 per share with long-term annual growth expected to be above 40%. If the company can maintain its heady growth, those seemingly lofty valuation multiples will come crashing down in a hurry.

In short, great change is afoot in the way women are screened for cervical cancer, and it's worth checking further into the companies that are saving lives by making the process more effective.

--Paul Larson

Related articles:
- News World: AutoCyte's PREP Gets Aetna OK (9/3/99)

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