Short-sellers think Exact Sciences' (EXAS +0.01%) colon cancer screening test, Cologuard, will get further away from turning a profit when rules kick in next year that require Medicare to pay less for the test. They also argue that Cologuard's advantages over competing screening methods aren't as great as they appear and that trends suggest Exact Sciences' growth is more the result of hefty spending on marketing than doctors' interest in ordering the test.
Since short-sellers have recently become more vocal about the company's challenges, let's discuss these risks in more depth to see if Exact Sciences can overcome them.
What's the backstory?
Colon cancer is the third most common cancer in America, and it's the second-leading cause of cancer death in the United States. An estimated 134,000 patients are diagnosed with colorectal cancer annually and 49,000 Americans die from this cancer every year.
IMAGE SOURCE: EXACT SCIENCES.
A big reason why so many people die from this cancer is because it's often diagnosed in late stages, when it's tough to treat. Colon cancer is a slow-growing cancer, so when patients stick to a screening schedule, it can be caught early on. Unfortunately, millions of Americans have never been screened for colon cancer or they're not up to date on guidelines for screening.
According to the U.S. Preventative Services Task Force's (USPSTF), everyone age 50 to 74 should be screened for colon cancer (about 80 million people in the United States) but roughly one-third of them aren't. The USPSTF estimates that if more people were screened, it could save up to 18,000 lives per year.
Enter Cologuard
In a bid to screen more patients for colon cancer, Exact Sciences developed Cologuard, a test that allows patients to mail a stool sample to Exact Sciences' labs for study.
Its ease of use has helped Cologuard test volume grow steadily since launching in 2015. However, short-sellers argue that Cologuard is inferior to alternatives, including fecal immunochemical tests (FIT) and colonoscopy. They back up this claim by referencing an Exact Sciences' funded study that was conducted by Stanford University Medical Center. In that study, FIT and colonoscopy were found to be "more effective and less costly than the MT-sDNA (Cologuard) test when participation rates were equal for all strategies."
Short-sellers are correct that, on an apples-to-apples basis, the study's conclusion favors other screening options. However, investors ought to consider the inclusion of the words "when participation rates were equal." Patient participation rates for colon cancer screening are anything but equal in real-world settings, and given that 45% of the Cologuard tests have been for patients who have never been previously screened, an apples-to-apples comparison might undersell Cologuard's value.
It's also important to know that the USPSTF screening guidelines include Cologuard alongside FIT and colonoscopy in its recommendations, despite study results. Cologuard testing every three years doesn't add as many life years per 1,000 screenings as FIT or colonoscopy, but it does result in fewer patient complications per 1,000 screenings. Since Cologuard doesn't trail FIT and colonoscopy by much in years gained, and it can reduce complications in patients, the USPSTF appears to view it as an important option, especially in patients who would otherwise avoid screening.
Short-sellers also point to UnitedHealth Group's (UNH +0.05%) decision (so far) not to cover Cologuard as evidence that it isn't worth ordering. Last month, UnitedHealth Group -- the nation's largest health insurer -- questioned the value of fecal testing.
UnitedHealth Group members represent an important pool of patients, but investors might want to take the insurer's comments with a grain of salt. After all, it's not uncommon for insurers to push back on coverage that can cause healthcare spending per member to climb in the short term, and UnitedHealth may be negotiating with Exact Sciences for a lower price per test before including it in their coverage.
Are doctors ordering less Cologuard?
In the first quarter, the average doctor ordered 1.4 Cologuard tests, an order rate that short-sellers argue hasn't changed much since the test's launch. If doctors were truly impressed by Cologuard, wouldn't ordering rates be growing?
It's true that the 1.43 order rate per physician last quarter is about in line with June 2015. It's also true, though, that rate has climbed in four consecutive quarters, and that one year ago, the rate stood at 1.25. If you look at order rates on a year-over-year basis, they're up about 14.4%.
The problem with looking at this metric is that it's likely to be very volatile, and it can be influenced by many factors, including, for example, the development of USPSTF guidelines in 2015. Initially, there was debate on whether Cologuard would be included on equal footing in these guidelines with FIT and colonoscopy, and that debate might have negatively influenced doctors order rates until official guidelines were released in June 2016.
A pending price drop
Bearishness also stems from the PAMA Act, which goes into effect in January and reduces how much Medicare pays for lab tests like Cologuard.
According to the PAMA Act, how much Medicare pays for lab tests next year will be determined by a weighted median of prices charged to private payers. Labs were supposed to submit their data to Medicare by the end of March, and Exact Sciences appears to have met that timeline based on management comments on CNBC on Monday.
Medicare won't announce how much it will pay for Cologuard until November, but some short-sellers estimate prices could drop to less than $300 per test from over $500 per test now. Management disputed that during its CNBC appearance, saying those calculations were incorrect. However, we won't know how incorrect those estimates are until later this year.
If final Medicare prices are significantly lower than they are now, then it will put more pressure on Exact Sciences' income statement. The tests only cost the company about $170, so there's plenty of gross margin, but Exact Sciences is spending a tremendous sum on marketing, and that's causing it to lose a lot of money. In the past 12 months, SG&A expenses totaled $205 million and revenue totaled only $133 million.
Looking ahead
Poor colon cancer screening rates suggest there's an important need for additional screening options, and Cologuard's total test volume growth suggests it's filling an important void. Exact Sciences expects to complete 470,000 tests this year, up from 244,000 last year. If the company hits that target, sales are forecast to reach $195 million, up from $99 million in 2016.
Its future performance will depend a great deal on Medicare pricing, and that's undeniably a wild card that could move shares higher or lower. Investors will want to watch closely how pricing plays out. It will also depend on whether private-payer coverage transitions from out of network to in-network coverage. If it does, then volume should benefit in the private market as patient out-of-pocket costs drop.
It's anyone's guess if Exact Sciences can eventually grow to serve a significant share of this market, but until we get more insight into Medicare prices for 2018, this is likely to be a volatile stock.
