Table of Contents
Investment Thesis
Adaptive Biotechnologies Corporation (ADPT) has just won its first-ever FDA approval for a blood-based cancer test. However, it’s Adaptive’s COVID-19 battle that has attracted investor interest with the share price outperforming the broader market and the leading developers in blood-based cancer tests. The company’s strategy against COVID-19 is diverse. The ImmunoSEQ® T-MAP™ COVID attempts to monitor T cell response to support the next-gen vaccine development. Highly sensitive, T cell-based test takes on more established antibody tests, while the most potent neutralizing antibodies are currently being identified to develop therapeutics. An equity offer has just raised the liquidity level to meet the rising R&D expenses, and counter the effects of revenue slowdown and sustain the operations.
Even though COVID-19 is a risky venture, the potential returns can be equally high. Therefore, the sharp discount implied in the 2021 price to forward sales multiple compared to the past year average looks unjustifiable. The current forward multiple with a modest discount to reflect the heightened risk highlights an undervalued stock with 2021 consensus sales estimates. Sizable enough to overcome short-term volatility, the premium unveils a ‘Buying’ opportunity in a company that is successfully pivoting to fight COVID-19 amid the revenue slowdown.
Source: The Company Investor Presentation – January 2020
COVID-19 Ventures Outclass the New FDA Approval
For any disease, a better clinical outcome hinges upon the early diagnosis, which in turn depends on convenient, affordable, and speedy investigations. The tissue-based tests are time-consuming and costly. Being invasive, they heighten patient inconvenience and lower the test compliance forcing the developers to push for blood-based testing. When Adaptive’s clonoSEQ Assay won the FDA approval last week to detect and monitor MRD (minimal residual disease) in CLL (chronic lymphocytic leukemia) from blood or bone marrow, the decision marked the company’s shift away from tissue-based testing.
Having won the FDA approval in 2018 to monitor MRD in MM (multiple myeloma) and ALL (B cell acute lymphoblastic leukemia) from bone marrow samples, Adaptive, with the new designation, doubles the size of its addressable population. It’s the latest in a series of developments that have propelled the company’s share price by ~32.0% in the year so far outperforming ~11.2% gain the NASDAQ Biotechnology Index. Even Guardant Health, Inc. (GH), a leading developer of liquid biopsy-based tests for cancer diagnosis, is trailing with only ~14.4% gain.
Source: Koyfin
As I highlighted in the previous article on Adaptive, the company’s foray into the COVID-19 space explains the premium. The multi-pronged strategy leverages the genetics of the adaptive immune system, an interplay between the antibodies produced by B cells and the cell-mediated response of T cells. As the early-stage trials of vaccine developers indicate, the antibody response against COVID-19 wanes with time, prompting scientists to speculate the importance of T cells in conferring the long-term immunity against the infection.
According to a study of COVID-19 positive individuals and their close contacts, as much as two-thirds of asymptomatic cases showed a positive T cell response, but no COVID-19 antibodies. Another study published in Nature suggests that the memory T cells in patients exposed to the first SARS outbreak in 2003 can respond to virus proteins and spring into action even seventeen years later to fight SARS-CoV-2. However, being quicker, easy to administer, and less expensive, the antibody tests have become the developers’ choice to quantify the immune response in vaccine trials.
A Multi-Pronged Strategy Against COVID-19
The developers’ emphasis on T Cell response in COVID-19 is far from adequate, unveiling an opportunity for Adaptive’s testing methodology. The immunoSEQ Dx, a diagnostic product under development in partnership with Microsoft Corporation (MSFT), has been broadened to detect the TCR (T cell receptor) response against the virus. According to the company, the quantification of T cells could be useful in the development of new diagnostic applications and for the assessment of the immune response in the experimental vaccines and other drugs.
The success of the initiative depends on the extent of TCR data the company can amass. The ImmuneCODE program has already been launched to collect, analyze, and publicize data about TCRs specific against SARS-CoV-2. The company’s own ImmuneRACE study and other global institutions also take part, and the sequencing data are publicly available in the ImmuneCODE database launched in June 2020.
This month, the company unveiled immunoSEQ® T-MAP™ COVID to help vaccine developers to measure T cell response and monitor its persistence over time. The ongoing vaccine development mainly targets the spike protein of SARS-Cov-2. With the ImmuneCODE database having already mapped TCRs against the spike proteins and ten other components of the virus, the new tool based on the database will support the development of the next generation of vaccines.
Meanwhile, the company is on track to seek Emergency Use Authorization for immunoSEQ Dx® SARS-CoV-2, its T-cell based answer to COVID-19 antibody tests. Compared to two leading serological tests, the test targeting past infections has already demonstrated a superior sensitivity, and the market launch of the product is expected in the fall. The company is also making its foray into COVID-19 therapeutics through its partnership with Amgen Inc. (AMGN). Leveraging the existing immune medicine platform, the company will select the most efficacious neutralizing antibodies in action during the COVID-19 infection or recovery. After completing the ongoing selection by this fall, Amgen is expected to proceed with the development of an antibody-based therapeutic candidate.
Pandemic Hurts Top Line Growth
With test volumes hurt by the pandemic’s impact, the company’s pivot to COVID-19 studies is no surprise. Following the industry trends at the height of the pandemic, the research sequencing has suffered more than the clinical test volumes dragging the overall sequencing revenue by 32.7% year-over-year (YoY) in Q2 2020 (second quarter of 2020). The research volumes, which made up ~77.7% of total test volumes of Adaptive in 2019, have fallen sharply with a decline of ~53.9% YoY even though clinical test volumes rose ~31.3% YoY. However, the overall test volumes have declined ~36.2% YoY, dragging the top line ~5.2% YoY despite a ~26.6% YoY growth in development revenue, which accounted for only ~48.8% revenue in 2019.
Since bottoming out in April, the clinical sequencing is picking up, according to the company. The July volumes have already surpassed the level in March. The research test volumes continue to be volatile and will remain so as long as the pandemic flares up across the country, forcing the laboratories to curtail operations. Even though the new FDA approval for CLL adds a new revenue catalyst for the year, the revenue guidance for 2020 remains withdrawn amid continuing uncertainty. However, a series of catalysts is bringing clarity to the 2021 outlook.
Revenue Catalysts for 2021
A data package for a TCR-based cellular therapy against cancer has already been delivered for Genentech. An IND filing in Q1 2021 will unlock the payments linked to development and regulatory milestones. The royalties will also follow, ranging from mid-single digits to mid-teens in global net sales. This year the company is gearing up for two FDA filings in blood: for ALL and acute Lyme disease. The current standard of care, replete with false negatives as high as 60-70% in the acute stage of the disease, will enable the T-cell based immunoSEQ Dx Lyme to take a sizable market share of an estimated 3.4 million of Lyme tests conducted annually.
Subject to FDA approval in early next year, we estimate the test at the midpoint of the projected price range of $600-800, could add ~$71.4-95.2 million for the company’s top line in 2021, assuming 3-4% of market share. The consensus revenue forecast for next year stands at ~$176.2 million, implying ~85.7% YoY growth, over a seven-fold acceleration from the growth estimate for 2020. More than ~$84.0 higher than the LTM (last-twelve-month) revenue of $92.2 million, the Wall Street forecast for 2021, therefore, looks to have already captured the revenue upside.
Equity Offer Further Reinforces Liquidity
Unable to make money at the operating level, Adaptive needs to ensure robust liquidity to advance its product portfolio for FDA approvals. Amid steady cash burn, the cash and equivalents in Q2 2020 stood more than a third higher than the pre-IPO level in June last year. However, in anticipation of the rising investments in TCR-Antigen Map and immunoSEQ Dx, the company topped up the liquidity last month with an equity offer of 8 million shares. The net proceeds of $271.7 million give the company with no net debt enough firepower to outlast the slowdown and advance the pipeline until the growth normalizes next year.
Source: The Author; Data from Seeking Alpha
2021 Multiple Highlights a Discount
The equity raise has impacted the share price, currently trading ~8.7% below the pre-issuance price. Yet, in terms of 2020 sales, the company trades at ~55.9x, a premium of ~35.5% to the past year average of ~41.2x reflecting the heightened prospects from COVID-19-related ventures and new FDA approval. Highlighting a discount of ~27.0% to the past year average, the multiple, however, slips to ~30.1x for 2021. Seemingly, the share price has yet to keep pace with the optimistic consensus estimates for a year of many catalysts. With a narrow discount to the current forward multiple accounting for the higher near-term volatility, we assume the stock to trade at ~41.2-48.1x in terms of 2021 sales, which, based on Wall Street revenue forecasts for 2021, highlights a premium of ~35.6-58.1%.
Source: Koyfin
New Venture Changes the Risk Profile
Though patient and long-term investors can look beyond the near-term volatility to reap the capital gains on the horizon, the upside, however, should not blind the short-term focused investors to the risks in money-losing biotech firms. As regards Adaptive, the company has yet to win the FDA approval for any of its cell-based therapeutics or immunoSEQ Dx. For the latter, only a proof-of-concept study has been established in acute Lyme disease. The potential upside notwithstanding, the COVID-19 detour further exacerbates the risks.
Much about the virus remains unknown, and with new studies taking place at breakneck speed, the new findings could make the past conclusions and the technologies driven by them quickly obsolete. If a successful vaccine happens to replace the antibody therapies, humanity will win, But the R&D costs Adaptive spent on COVID-19 therapeutics will remain sunk with no prospect of recovery. Meanwhile, the T cell-based tests are time-consuming and costly, questioning their efficacy as a mass-market product in a fast-spreading contagion like COVID-19.
Conclusion
Adaptive’s recent FDA win marks the company’s first in blood-based tests, giving a fresh impetus to shares already outperforming the broader market thanks to a multi-pronged COVID-19 battle. Backed by leading industry players, its response to the pandemic range from vaccine development to therapeutics while the recent equity offer reinforces the liquidity to power R&D. The sharp discount in the 2021 forward price to sales multiple hardly reflects a year full of catalysts. Assuming a modest discount to mirror the near-term volatility, the current forward multiple and the consensus sales estimate for next year highlight a ‘Buying’ opportunity as the upcoming catalysts offset the revenue headwinds.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.