The company has a lot of financial flexibility and does not need to rely on partnering the way other development-stage biotechs do, including Exelixis
And because Myriad's diagnostics products are booming, we can value the company based on hard cash -- and not need to cross our fingers that a drug will one day make it out of the Myriad pipeline and be a commercial success.
Scanning your genes
If your family has a history of cancer, you have higher risk of cancer yourself. Myriad sells five diagnostic products that assess whether a person has a high risk of cancer because of their genetic code. Myriad looks for the specific genes known to be involved in the development of cancer.
Being forewarned of a genetic disposition toward cancer enables health practitioners to keep cancer in check, by screening for it regularly and treating it at its earliest appearance. I expect that Myriad's products will become increasingly mainstream and sales should exhibit strong growth for years to come.
Myriad just launched a new product, TheraGuide 5-FU, and will introduce another test next year. The continued rollout of new products indicates a positive growth spurt.
For the quarter ended Sept. 30, Myriad's diagnostic revenues grew at a blistering 49% pace to reach $46 million. The company believes these revenues should be near $200 million for its fiscal year, and it has the manufacturing capacity to support $400 million in sales.
These products have eye-poppingly large margins. Gross margin came in at 84% last quarter, with operating margin of 40%. In other words, from sales of $46 million, the company came away with $18.5 million to reinvest. This cash generated from the diagnostics operations is the basis for my valuation.
Breaking it down
If Myriad maintains 40% operating margins on the expected $200 million in diagnostic product sales this fiscal year, that portion of the business would generate $80 million pre-tax. What is a business worth that generates this kind of cash?
I started with $80 million, then applied a 35% tax rate to the $80 million operating income, equaling $52 million in profit. Myriad had $12 million capital expenditures over the last 12 months, and I backed out a portion of that to arrive at a hypothetical $45 million free cash flow generated from diagnostic product revenue.
To keep things simple, I assumed that the cash flows from diagnostics would grow at 25% for 10 years, and then I applied a 3% terminal growth rate. While that sharp dropoff after 10 years isn't likely to reflect reality, the assumption keeps the exercise simple.
Using a discount rate of 12%, the value of the diagnostics business under these conditions is $2.4 billion. Note that the current market cap of the company is $2.1 billion, meaning that all of the company's pipeline drugs like Flurizan and Azixa are coming along for free. You could even draw the conclusion that Myriad's drug R&D is viewed as a drag on the company's diagnostic business.
Foolish take home
There is tremendous value in Myriad's diagnostic products. This segment of the business could be worth more than $2.4 billion -- I think it could exceed 25% growth over the next few years, and I expect robust growth to continue for well more than 10 years.
Myriad will report data from its first phase 3 trial with Flurizan in the treatment of Alzheimer's disease in the middle of next year. As owners of Atherogenics
As with any other high-growth company this is not a risk-free investment, but it's certainly got attractive prospects and shares that are available at a good price.