COVID-19 Bringing Positive Attention To GenMark Diagnostics… For Now (NASDAQ:GNMK)

Quite a lot has changed since my last update on GenMark (GNMK) back in January. COVID-19 has swept around the globe, leading to huge disruptions in people’s lives as governments try to cope with and limit the spread of the disease. It has also left the medical community scrambling for options, including testing options as the U.S. was unprepared (or at least under-prepared) for the outbreak here.

I had thought that COVID-19 could provide a boost to GenMark, and the company has actually seen a bigger lift than I expected. A key unknown now, though, is whether SARS-CoV-2/COVID-19 quickly fades into part of our baseline annual experience (particularly if there’s a vaccine) or whether it remains a significant driver for longer. While GenMark shares could still have some upside from here, particularly if COVID-19 proves to be a more persistent issue, I’d be careful about assuming that this is a “this changes everything” moment.

A Strong Lift From COVID-19

While it may seem to be in poor taste to talk about positives from a deadly virus, the reality is that COVID-19 has created new, or at least significantly expanded, business opportunities for GenMark, and that was evident in first-quarter results. GenMark had already tipped off the Street regarding first-quarter results, with revenue about 50% higher than initial Q1 expectations exiting the fourth-quarter report, but results still came in better than expected, particularly with respect to gross margin, where actual results exceeded management’s early announcement by almost two points.

Revenue rose 80% in the quarter, with ePlex revenue jumping 119%. Consumables revenue from the ePlex platform jumped to over $28M (almost three-quarters of total revenue), with the consumables annuity per system rising 29% yoy and 45% qoq to $214K. While revenue from the specific SARS-CoV-2 special test that GenMark rushed to the market was less than $2 million, GenMark saw significantly greater use of its standard respiratory panel as medical professionals used it to rule out potential causes of symptoms before proceeding to specific SARS-CoV-2/COVID-19 testing.

With a much larger amount of consumables revenue in the mix, gross margin jumped from a little more than 27% last year and 33.5% in the fourth quarter to just under 42%. While the company was still in a net operating loss on a GAAP basis, expenses tied to the replacement of the former CEO drove a lot of that, and the company was almost breakeven (loss of $0.4M) on an adjusted basis.

A Big Change In Placements

GenMark reported over 100 gross placements and 54 net new ePlex placements in the quarter, with about 80% of the placements driven primarily by COVID-19 testing. GenMark repositioned 55 previously-placed systems in the quarter, about half of which came from customers who weren’t intending to complete their installations and the rest from customers whose implementation plans were significantly impacted by the COVID-19 outbreak.

With the rush to add COVID-19 testing capability/capacity, GenMark added over 40 new customers, and management said that placements were made with an eye toward future long-term ongoing use.

I do still see some underlying issues in what was otherwise a strong placement quarter. That somewhere around 27 systems were moved because the customers decided not to go forward with implementation is not good news, and the company saw a lower than expected level of BCID-driven implementations (though it’s plausible the outbreak impacted this).

While I do expect GenMark can recover the other half of those 55 placements where COVID-19-related issues disrupted the plan, I think it’s worth asking why those other customers decided not to go forward. I haven’t really heard anything from my due diligence calls that would alarm me, and it’s possible that they felt the ePlex didn’t differentiate itself enough to be worth having another system on hand. It’s also possible that competitive pressures, including Luminex’s (LMNX) more flexible pricing strategy, played a role, and/or that they just weren’t happy with the system performance and value/benefit equation.

How Long Will The COVID-19 Impact Endure?

GenMark has benefited significantly from a shortage of available SARS-CoV-2/COVID-19 tests, with medical professionals and facilities using the company’s syndromic panels to rule out other potential causes (like influenza) before using their more limited store of COVID-19 tests. With companies like Abbott (ABT) and Roche (OTCQX:RHHBY) significantly ramping up their COVID-19 test production, I don’t expect that to remain as much of a driver in the coming quarters.

Likewise, it is unclear whether COVID-19 testing will become a more prominent and/or lasting issue. Investors who’ve followed GenMark may remember that one of the big challenges the company has faced is a relatively adverse reimbursement environment where payors have argued that the robust testing panels offered by companies like GenMark and bioMerieux (OTC:BMXXY) aren’t really necessary. That has gone out the window for the time being, but if an effective vaccine for COVID-19 is available in a year or two, it may well reset the reimbursement situation to where it was before this outbreak.

In the meantime, GenMark is pushing quickly to add SARS-CoV-2 to its syndromic panel, with the company targeting a June launch of its “RP2” panel (on an Emergency Use basis).

Long-Term Challenges Remain

Given the expansion of dedicated COVID-19 test production volumes, I don’t see this tailwind lasting indefinitely for GenMark, and there are still meaningful challenges for this company to overcome. Placements for 2019 were at the bottom end of management’s initial expectations, a meaningful number of customers have chosen not to pursue final implementation, and there are ongoing questions as to whether there will be enough demand for (and/or a favorable enough reimbursement environment) blood culture and respiratory testing to generate the level of revenue GenMark needs to produce attractive margins and cash flows.

Earlier this year, the company’s long-time CEO Hany Massarany stepped down, and the company has chosen to make interim CEO Scott Mendel the new CEO on a permanent basis. Mendel did some good things as COO after taking the position in February 2019 and I think a change in direction was arguably needed. Under Massarany, there were numerous disappointments regarding clinical timelines, revenue, and placements. It may be unfair to blame him for all of that, but the company has long struggled to meet its own targets and this seems like a reasonable response.

The Outlook

Modeling GenMark is quite difficult now given the uncertainties of how COVID-19 will fit into our future, and how that will change testing behavior and reimbursement. If COVID-19 proves to be a lingering issue (without an effective vaccine), there should be elevated demand for testing panels including SARS-CoV-2, particularly if there are drugs that are proven to prevent/reduce more severe outcomes. Without an effective vaccine, it’s plausible that could be a long-term, if not permanent, change. On the other hand, if vaccine and drug development alters COVID-19 to “just another flu”, it seems probable to me that old issues with reimbursement will come back.

This outbreak gives GenMark a chance to improve its cash flow situation, though, and while the testing and launch of the GI panel (a $600M opportunity according to management) may be delayed, it is possible that new customers exposed to the ePlex because of the COVID-19 outbreak will become enthusiastic long-term users of the platform. I’d also note that the company is altering its approach to OUS placements (likely the biggest source of the non-implementations), where consumables use has been far lower, and I believe this is a sound long-term move.

I’ve boosted my expectations for revenue and reduced my cash burn expectations over the next two years, but I have not made such significant changes to my long-term model given those aforementioned uncertainties regarding whether COVID-19 will create a permanent shift in behavior and GenMark’s revenue opportunity.

The Bottom Line

With the near-term improvements and another year closer to positive free cash flow, my discounted cash flow-based fair value moves up about $1/share, but is below the current share price. Looking at GenMark’s near-term revenue growth potential, I’m more comfortable using a much more robust EV/revenue multiple (7.5x), supporting a fair value around $13.50. I’ve previously used a discounted multiple due to GenMark’s execution challenges, but the market is now more focused on the near-term growth and margin opportunities.

While I do see further upside from here, particularly if COVID-19 drives a lasting change in the model, I’d caution investors that there is a real risk that this COVID-19 tailwind is unsustainable and that the shares could back to, or below, a valuation predicated on 5.5x forward revenue. The key now is to maintain strong placements and system utilization, driving the company toward a user/revenue base that can support long-term revenue growth in the high teens, with FCF margins in the 20%’s.

Disclosure: I am/we are long RHHBY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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