The Value of Myriad's Genes

Myriad Genetics (Nasdaq: MYGN  ) is unique in the biotech industry because it has a wildly profitable diagnostics business to support its drug research and development efforts.

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 (Nasdaq: EXEL  ) , Medarex (Nasdaq: MEDX  ) , or Seattle Genetics (Nasdaq: SGEN  ) .

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 (Nasdaq: AGIX  ) and Neurochem (Nasdaq: NRMX  ) can attest, the release of phase 3 trial data is a dangerous time for biotech investors. But with the value of Myriad's diagnostic products now supporting the entire market cap of the company, shares probably won't come crashing down if Flurizan fails.

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.


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