Combimatrix (CBMX) is a micro-cap diagnostic company that has been excellent at losing money since it was spun-out of Acacia Research in mid-2007. In fact, it has lost approximately $50 million as it approaches its 10th birthday. Interestingly, on an undiscounted after-tax basis, its NOL would be worth approximately $23.5 million if the company was profitable (looking at SEC filings I do not believe there has been a change of control since the spin). Because it’s so small ($19 million market cap, $16m enterprise value on $13.7m of TTM revenue), it would be easy to overlook that management is projecting to be cash flow break-even within two quarters from now. The reversal of the valuation allowance, even if gradual, would be a significant boost to CBMX’s $6 million book value. Given this underappreciated tax-asset and a successful underlying business, I believe the equity will re-rate higher upon profitability. Taking into account dilution from warrants that are only slightly in-the-money today, CMBX could be worth 50% more in near term without heroic assumptions.
A detailed description of the company is available in the 10-K which I will not repeat here. While not a barnstorming growth story, CBMX has managed to nearly double its sales in three years. The company positions itself as a participant in the $725 million reproductive health market. In general, this includes both pre and post-natal diagnostic tests as well as pre-implantation screening within an IVF setting. The pre-natal business includes diagnosis of genetic disorders that account for 50% of early miscarriages. It would appear that CBMX is on the right side of a growing market as parents are having children later and payors are growing more comfortable with genetic testing. As part of this dynamic, the company has launched six tests since 2014 which are gaining traction. Recently, revenue growth has been driven both by test volume as well and improved pricing mix. Gross margins are approaching 60%.
From a technology perspective CBMX utilizes an Illumina platform which checks the box as some other platforms have come and gone. Illumina is the market leader in sequencing which will allow CBMX to pivot as more content is generated via whole exome or whole genome sequencing. This could happen within the next three to five years. Today, CBMX’s tests are predominantly on arrays where competitive platforms are offered by Agilent and ThermoFisher (via its 2016 Affymetrix acquisition).
CBMX’s EV/Sales multiple of 1.2x is undemanding relative to larger diagnostic companies. While bigger companies trade for multiples that would make a value-oriented investor run for the hills, Natera, a larger comp that also sells pre-natal tests, trades for 2.1x its $200 million of TTM revenues despite a massive cash burn and a 10% growth rate at the mid-point of guidance. Also, Sequenom was acquired by LabCorp for 3.25x sales in mid-2016 as it generated an operating loss and saw significant revenue decreases (granted its TTM revenue of $114m was an order of magnitude larger than CBMX). Could CBMX approach or exceed these multiples as it scales? Perhaps.
In thinking about the NOL, I have assumed a change of control took place as CBMX was spun-out of Acacia Research in 2007 but not since then. (Note that there were two 13Ds filed in 2011 which added up to 20% ownership. Also the current proxy indicates that there is a European entity with 9.9% ownership due to a blocker provision but beneficial ownership of 25%, the bulk of which is through 2016 issued warrants) Since the spin the NOL has grown from $48 million after-tax to $68 million after-tax (so $20 million of unlimited NOLs). Thinking about what the Section 382 limitation would be on the prior NOL, the mid-year market cap of CMBX in 2007 was $35 million and the risk-free rate was approximately 4.5% so with a 34% tax rate, the annual limitation would be $536k/year. I have assumed that these NOLs would expire in 10 years since the CoC was 10 years ago and Federal NOLs have a 20 year life. For what its worth, at an 8% discount rate (arbitrary), the pre-07 NOLs would be worth $3.6 million. Thus total NOLs are approximately $23.5 million.
Also notable is the presence of approximately 2.1m warrants with a strike price of $5.17 and 4 years of life. These slightly in-the-money warrants are significant on a 3 million common share base. but fortunately they do not contain any toxic anti-dilution provisions. Another item to mention is that free cash flow has approximately equaled net income over the last three years so from a nomenclature perspective, when the company guides to turning cash flow positive it is a proxy for taxable income.
So if the company grows the top line at 25% y/y (as it has done over the last several years) and trades for 1.5x revenues and we assume that 1) all of its current cash is utilized in reaching profitability; and 2) the market gives half credit to the NOL, then if we include $10.7m of warrant proceeds and all of the $5.17 warrants in the share count, CBMX would be worth over $9 per share for slightly more than 50% upside. (For reference on another year of 25% growth, a 2x sales multiple and full credit for the NOL, the stock could be worth $14.50). In a downside case, if the company raised another 12 months of cash at the current price (based on 1Q17 burn rate) it would issue approximately 500k shares. If the market assigned a 1x sales multiple to TTM sales then the stock could trade down to $3.88 (with the additional shares) which is approximately 35% downside. Of course, if CBMX never achieves profitability then further dilution is a certainty.
A final thought to keep in mind is that if corporate tax rates are somehow lowered than the future value of CBMX’s tax-shield would decrease.
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Positive Cash Flow and Resultant Increased Awareness of NOL, Continued Growth in an Attractive Industry Segment