Year-End 2004 Update and Company Reports

 

Rising healthcare costs creates an expansive investment opportunity.  Billions of dollars of healthcare costs need to be controlled, and companies that introduce paradigm changes in healthcare productivity, in particular that also improve patient care, could have billion dollar revenue prospects, making them excellent investments.

 

One area of medical technology making strides in improving productivity and controlling costs is diagnostics.  Diagnostic tests help doctors isolate the ailment a patient is suffering from, thus speeding treatment and focusing care.  Accurate diagnoses reduce unnecessary hospitalizations, preventing unnecessary healthcare expenditures.  Innovations in proteomics, the identification of proteins involved in biological functions, are creating a revolution in emergency medicine.  Our bodies manufacture specific proteins in conjunction with each malady we encounter, and the relatively new science of detecting those proteins facilitates exceptionally accurate and rapid diagnoses, saving lives, and ascertaining that an expensive hospital admission is a necessary course of treatment.  We will discuss two companies at the cutting edge of protein diagnostics, Biosite and Ciphergen.

 

Biosite (BSTE $59) has successfully developed and launched several rapid diagnostic tests for use in the emergency departments of hospitals.  The company has been astute in targeting 1) tests for time-critical medical emergencies, where rapid and accurate diagnosis can literally be the difference between life-and-death, and 2) the part of the hospital that is the most overcrowded and overworked.  The accuracy of Biosite’s tests lowers the danger to patients of incorrect diagnoses, and corresponding liability costs to healthcare providers. “Point of care” is an important feature. It is expensive in terms of time, risk to the patient, and money to send tests out to a remote laboratory, and then wait around for the results.  Time elapsed from onset of the ailment to treatment for the most serious health problems, such as heart attack and stroke, is crucial to patient outcome.

 

Biosite’s leading product is called the Triage BNP Test, a test for congestive heart failure that can be administered at the point of care, giving an accurate result in 15-20 minutes. BNP stands for B-Type Natriuretic Peptide, a protein that correlates with heart failure.  Currently, more than 15 million patients have heart failure in North America and Europe, with 1.5 million new cases annually.  The direct cost of heart failure to the U.S. healthcare system in 2001 was $24 billion, most of which was composed of hospital costs.  Traditional diagnostic methods of electrocardiography and chest radiography often lead to an uncertain diagnosis, while the Triage BNP test, for only $47, has sensitivity and specificity in the high 90%’s.  BNP accuracy has been shown to reduce the total cost of treatment by 26%[1], reducing costs for the U.S. healthcare system.  This test is already used in nearly 3,000 U.S. hospitals, and eventually has a potential market of $800 million.

 

Biosite’s new stroke test could receive FDA approval for U.S. sale in early 2006.  It is already approved in Europe. This demonstrates another Biosite focus – providing accurate tests for serious ailments that evade concrete diagnosis.  It has particular clinical appeal, because 8 million patients visit emergency rooms annually presenting stroke-like symptoms, but only 10% have actually have had one.  The test consists of a five-protein array that has sensitivity of 100% and specificity (1-rate of false positives) of 92%.  These metrics are much better than those of expensive CT scans.  Stroke patients benefit from rapid treatment, which Biosite’s stroke test facilitates.  Strokes cost the healthcare system $14 billion per year.  The market size for this test is estimated at $265 million.

 

Other products, current and future:  The Triage D-Dimer test for pulmonary embolism, introduced in December 2004, can rule out pulmonary embolism, which accounts for 60% of all hospital deaths, because it is misdiagnosed in 70% of cases.  Triage Shortness of Breath will combine the established BNP test for CHF with the D-dimer test for pulmonary embolism.  Use of the combination test rather than BNP alone would give Biosite a considerable advantage over its BNP-only competition, while allowing it to charge for two tests instead of just one.  This is a big market: Of the 90 million Americans who present to emergency departments each year, 10% complain of chest pain or shortness of breath.  40% of acute myocardial infarction patients in the US each year are diagnosed too late to receive timely treatment.  This fast-acting test has shown impressive accuracy in clinical data and would confirm a heart attack more rapidly than prevalent methods.  Sepsis is another ideal candidate for a point of care test.  Difficulty of diagnosis and rapid onset causes a relatively high 25% mortality rate.  Early diagnosis is crucial to saving the patient’s life.  Patient monitoring creates additional opportunities for the sepsis test.

 

Biosite is self-sufficient.  It has an experienced sales and technical support organization, in-house facilities for manufacturing its tests, and internal discovery, research, and development capability.  Biosite is both making money and growing rapidly.  Over the next five years I anticipate revenue growth averaging over 20% per annum, as the company adds new tests, hospital utilization expands, foreign revenue grows, and inroads are made into the physician’s office.  The introduction of “test panels,” which stack several individual tests onto one test kit, presents an opportunity to multiply revenue per patient.  Earnings per share growth should exceed revenue growth, as more tests are sold into the existing emergency room presence, capitalizing on infrastructure already in place.  An admittedly difficult intrinsic value analysis produces an estimate of about $70.

 

Risks:  Biosite’s BNP test is currently reimbursed at $47.43 by CMS, while other cardiac tests cost $14 to $16.  The much higher reimbursement for Biosite’s test is a nice source of payment for hospitals that could be taken away by regulators, potentially reducing sales of the test.  The price also has attracted a couple of competitors, who are taking pieces of market share in a growing market.

 

Ciphergen (CIPH $3.00) is a small proteomics company with excellent scientific capabilities.  Unlike Biosite, the company historically has concentrated on laboratory testing equipment, a tough business with big competitors.  It has invented technologies named “ProteinChip”and “SELDI,” SurfaceEnhanced Laser Desorption/Ionization, that integrate the key steps of proteomics onto a single, miniature, and disposable biochip.  It has over 100 issued or pending patents in the U.S., has sold 300 systems, and has 350 publications.  Ciphergen machines can sift through 200 proteins in unpurified samples of blood, tissue, or saliva to find the 5 proteins that could be used to diagnose disease, guide therapy, and/or enhance drug development.  A combination of ProteinChip arrays, the ProteinChip Reader, and proprietary software give the company the ability to earn revenues on both the “razors and blades.” 

 

However, the hidden value of Ciphergen lies in the library of protein biomarkers it has accumulated through its company-owned laboratories, the Biomarker Discovery Centers.  Biomarkers can be used in diagnostic tests to predict the existence of disease with unprecedented accuracy and promptness.  This is particularly important in cancers, because early detection can allow surgical removal and cure.  The company is working on diagnostic tests for ovarian, prostate, breast, and other cancers.  It has demonstrated technology that detects cancerous tumors while they are still microscopic in size!  It also has programs detecting the early success of kidney transplants and distinguishing Alzheimer’s from other forms of dementia.

 

Ciphergen’s ovarian cancer test focuses on the presence of three proteins that the body produces as soon as ovarian cancer starts growing.[2]  Researchers have shown that ovarian cancer can be detected much earlier by combining the screening for these three proteins with the current CA125 test.  The death rate from ovarian cancer is tragically high, because by the time it is detected by current medical technology, it is usually too late to operate. Ciphergen’s test, with FDA approval expected late in 2005 or early in 2006, should enable timely detection and lower mortality rates.

 

The lack of specificity of the PSA marker for prostate cancer results in an uncomfortably high level of false positives.  Literally most PS-positive results are false.  Ciphergen is developing a three-protein prostate test that will accurately detect prostate cancer and indicate the aggressiveness of prostate tumor growth.  Approval is targeted for 2006.

 

Financially, Ciphergen is very risky.  It is unprofitable and burning cash as weak laboratory equipment sales fail to fund crucial investments in diagnostic test development.  With the clinical results so positive from its ovarian cancer test, it is likely to close a partnership/licensing deal in the next several months that will reduce risk and should help the stock price.  The stock is intrinsically worth its selling price.  Success with one diagnostic test will significantly increase the intrinsic value of the business, while failure could force a fire sale of valuable technology, or insolvency.

 

Steven L. Ré, CFA                                                                    January 25, 2005

 

The above is for information purposes only and is not to be construed as a recommendation to purchase or sell securities.  The above information is from sources deemed reliable but is not guaranteed.  It should not be assumed that investments in any of the above-mentioned securities will be profitable, and past performance is not a guarantee of future results.  Earnings projections often miss, and markets sometimes go down.  The employees and families of Quality Growth Management, Inc. may own the above-mentioned securities in their own accounts, and may trade them at any time without notice.