On Thursday, Foundation Medicine (FMI +0.00%) won a green light for its comprehensive DNA test, FoundationOne CDx. The approval clears the way for healthcare providers to quickly determine what cancer therapies may work best based on next-generation sequencing (NGS) that can detect genetic mutations in 324 genes and two genomic signatures in solid tumors. The approval marks a major advance in genetic cancer screening, and it could accelerate the development of additional precision cancer drugs. Is now a good time to buy shares in Foundation Medicine?
Changing how we treat cancer
Advances in genetic sequencing have resulted in an explosion of research geared at creating increasingly targeted precision medicines. Already, there are more than 70 FDA-approved personalized therapies, and that number should climb substantially in the coming years, given that there are currently over 3,000 ongoing clinical trials evaluating precision cancer approaches.
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As more of these medicines become available, demand for tests that can screen patients for genetic mutations could grow rapidly. We're already beginning to see this play out. Despite limited insurer reimbursement, about 150,000 advanced-cancer patients are being screened annually to determine which cancer therapy is most appropriate.
The majority of these screenings, however, are limited in scope, and that creates an opportunity for Foundation Medicine to leverage the comprehensiveness of FoundationOne Cdx to drive market growth. According to Foundation Medicine, there are currently about 1 million patients who could benefit from genetic screening -- and that reflects the size of the opportunity just in the advanced-cancer patient population. Eventually, I expect every patient who gets diagnosed with cancer will undergo genetic screening.
Driving revenue higher
The approval is a coup for Foundation Medicine. Following FoundationOne CDx's launch, doctors will be able to rely on FoundationOne CDx as a one-stop shop for genetic insight. Doctors who screen their patients with this system will receive a report detailing a patient's genetic profile, existing treatments that match up to it, and a list of ongoing clinical trials that the patient can be enrolled in.
Importantly, the approval was granted on a parallel pathway with Medicare that provides clarity, for the first time, into the direct cost of genetic screening for patients. Medicare granted a positive preliminary national coverage determination (NCD) that should be finalized early next year. When that happens, Medicare will cover FoundationOne CDx for five of the most common solid-tumor indications nationally. It also provides a pathway for other Medicare patients to be covered under specific circumstances, and it clears the way for expanded coverage as FoundationOne CDx's capabilities increase.
Since cancer is often diagnosed later in life, when patients are enrolled in Medicare, the potential for national Medicare coverage to significantly expand demand for this test shouldn't be underestimated. Currently, Medicare patients make up roughly 40% of Foundation Medicine's existing market. Medicare's decision may also lead to more commercial insurers covering FoundationOne Cdx because, historically, commercial insurers follow in Medicare's footsteps.
An expanding market could juice Foundation Medicine's already-rapid top- and bottom-line growth. In the third quarter, revenue grew 45% year over year to nearly $43 million.
That revenue was generated both from patient screenings and from services provided to biopharma companies that rely on Foundation Medicine's products for genetic insight when developing new personalized medicines.
On the testing side of its business, it collected $2,600 per test last quarter, up slightly from Q2 2017. On the biopharma research and development side of its business, revenue of $14.3 million was up nicely from $10.7 million in Q3, 2016. The FDA and Medicare parallel decision yesterday should encourage biopharma to increase its business with Foundation Medicine, providing an additional tailwind.
What's next?
If you believe that precision and personalized medicine is the future (I sure do), then owning Foundation Medicine in a long-term growth portfolio would be logical. What makes Foundation Medicine additionally intriguing is its close relationship with Roche Holding (RHHBY 0.45%).
In 2015, Roche acquired 59% of Foundation Medicine as part of a collaboration agreement. Roche has three members on Foundation Medicine's board of directors and is responsible for selling Foundation Medicine's products overseas.
Next year, a stand-still agreement signed by Roche Holding ends. At that time, Roche Holding can sell or buy more shares in Foundation Medicine, or continue to hold on to its existing stake.
There's no telling what Roche will do, but I don't expect it to sell its shares. Foundation Medicine's full-year 2017 guidance is for sales between $135 million to $145 million, up from $116.9 million in 2016. That means it's already posting solid growth without considering tailwinds associated with the FDA and Medicare win. Since Foundation Medicine is arguably on in the early innings of what it believes to be a $12 billion to $15 billion per-year opportunity, I think it's a stock worth owning.
