Description
Vermillion Inc. is a post-bankruptcy equity, having had its plan confirmed on January 7th and declared effective on January 22nd. It endured a wild ride: unable to secure funding during the financial crisis and without any revenues or commercially viable products, Vermillion filed for bankruptcy protection on March 30, 2009. The company discovers, develops and commercializes high-value diagnostic blood tests, including one for ovarian cancer that was awaiting FDA approval. Almost all of the company's $30 million in liabilities was in the form of convertible debt, but creditors were focused solely on recouping their investment; all parties seem to have forgotten there might be any upside at all. The common stock traded as low as one penny on July 28th and did not rise above a nickel until September 11th, when the FDA approved Vermillion's ovarian cancer test. By year-end, Vermillion stock was $27.45. Extraordinary upside remains.
Ovarian cancer is relatively uncommon-there are approximately 23,000 new cases diagnosed annually in the US. It has an alarmingly high mortality rate, however, because by the time a woman presents with symptoms, the cancer has already metastasized. For this reason, ovarian cancer has been called the "silent killer" and, like terrorism, it raises fears disproportionate to its incidence. Diagnostic options include imaging studies (CT or ultrasound), colonoscopy to rule out gastroenterological etiologies and a blood test called CA-125, which detects increased levels of a cancer antigen. CA-125, every gynecologist and gynecological oncologist will tell you, is a wholly inadequate test, unable to predict with enough accuracy whether or not you have a malignancy. While a recent study questions if CA-125 is actually better than nothing, at least 5 million tests are ordered annually in the US at approximately $125 per test and another 5 million are ordered internationally. The vast majority of these tests are ordered off-label for uses not approved by the FDA. While the FDA has approved CA-125 only for women who have had ovarian surgery, it is frequently included in women's annual physical exams as an ovarian cancer screening test for which it is remarkably unsuited.
Vermillion's ovarian cancer test, called OVA1, represents a substantial improvement over CA-125. When OVA1 tells a woman she does not have a malignancy, it is correct 93% of the time, a metric called negative predictive value; in other words, "no means no." While OVA1 has not been approved by the FDA for use as a screening test, its high negative predictive value makes it possible that it will be ordered as one. Even limiting the potential market to high-risk screening only, including women with ovarian abnormalities and those with a family history of breast cancer, yields a potential market in the US of more than 10 million women. Vermillion is positioning OVA1 first for a smaller market segment-as a triage test to help discriminate between benign and malignant ovarian tumors prior to surgery so that women with malignancies can have surgery performed by a gynecological oncologist rather than a gynecologist. Triage is necessary because there are only approximately 1,100 gynecological oncologists in the US and many Americans live nowhere near one. According to one study, triage would increase 5-year survival by 10%. When I showed the data Vermillion submitted to the FDA to a gynecological oncologist, he responded "this may be revolutionary in diagnosis and management of ovarian cancer."
Prior to its bankruptcy filing, Vermillion entered into a marketing agreement with Quest Diagnostics Incorporated, one of the duopolists in the diagnostic lab market. The agreement was revised during the bankruptcy on terms more favorable to Vermillion, providing it with a 30% royalty on OVA1 tests ordered through Quest in the US (foreign partners are still needed and tests ordered through US hospitals are not covered under the agreement). Quest will market OVA1 to gynecologists and gynecological oncologists and will also market it directly to consumers, a sure sign they foresee demand as a screening test. Pricing for OVA1 has not been announced, but it should be noted that OVA1 uses five biomarkers versus CA-125's one, and diagnostic tests typically charge for each biomarker. Given that OVA1 has greater value to women than CA-125, it should also be expected to price at a premium. I assumed prices of $125 and $250-$300.
Vermillion does not manufacture the OVA1 kit; its manufacture is outsourced by Quest. Vermillion simply licenses its test and provides an algorithm to interpret the results. Other than a small sales force it is in the process of hiring, research and development it plans to conduct on other diagnostic tests using similar methodologies, and headquarters and public company costs, Vermillion has no costs. Its royalty-driven business model results in extremely high incremental profit margins, making profits very sensitive to volume assumptions. Even at 2 million tests priced at $125, royalties to Vermillion would be $75 million. Subtracting estimated costs and taxes would result in approximately $2.75 per share in earnings, or 8.5 times the current stock price ignoring $5 per share in cash on hand. If pricing were $250 per test, earnings would be approximately $6.85 per share in earnings, or less than 3.5 times the current stock price ignoring $5 per share in cash. At 5 million tests, earnings might exceed the current stock price. These numbers provide no value for Vermillion's other tests in development, including one for peripheral vascular disease, also known as peripheral artery disease (PAD).
Obviously, this is not a typical, downside-protected value investment. It does not, however, require the necessary (and self-delusional) predictive powers of growth stock investing at this price. Over the coming months, investors may benefit from several catalysts, including launching OVA1, becoming current in filing SEC financial statements, and moving from the pink sheets to the NASDAQ.
Catalyst
OVA1 launch
becoming current in SEC filings
NASDAQ listing