Sequenom's Potential Isn't Science Fiction

• ByJustin Ferayorni, RealMoney.com Contributor
• On 9:00 am EST, Wednesday December 31, 2008

Now only 10 seconds old, the exact time and cause of my death was already known.

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{"s" : "amgn,biib,celg,dna,genz,gild,sqnm","k" : "c10,l10,p20,t10","o" : "","j" : ""}

-- Vincent Freeman, Ethan Hawke's character in Gattaca, narrating his natural birth

Gattaca, the 1997 science fiction thriller, explored the notion that our digital genetic code can (and likely will) be manipulated. Those born without the benefit of a geneticist's skill could fall "victim" to chance, as did Ethan Hawke's character. The film presciently begins with the words "the not-too-distant future" underscoring the screen.

Fast-forward 11 years, and we no longer have to wait until a child is born to be able to determine its genetics. Sequenom has been instrumental in developing prenatal genetic analysis and has turned itself into what could be an incredible investment opportunity by doing so. The company's first genetic test determines whether a child has Down's syndrome, a $2 billion market alone in the U.S.

The Down's Opportunity

There may be no single event more joyful and miraculous than the birth of one's child. And while the nine months of anticipation brings all sorts of emotions, anxiety is one of them as expecting parents pray for their child's good health.

Anxiety, science and our wealthy health care system has driven demand for the triple test, which screens for several development abnormalities, the most common of which is Down's syndrome. The triple test is purely a screening tool -- women whose hormone levels are out of the appropriate range are referred to follow up, usually amniocentesis. The advantage of the triple test is its noninvasiveness -- it is merely a blood draw. Its lack of predictive value remains its disadvantage. Yet nearly 3 million triple tests at $600 each are performed in the U.S. each year according to Sequenom, nearly a $2 billion market.

Women deemed high-risk typically receive amniocentesis or CVS (chorionic villus sampling), and together are performed nearly 500,000 times each year in the U.S. Both procedures are invasive -- amnio collects the amniotic fluid, while CVS involves collecting placental tissue. Both procedures carry a risk of miscarriage and infection. These procedures are time-consuming and 2 to 3 times as costly as the triple test. CVS can be performed earlier in the pregnancy but can lead to false positives. Amnio is the most accurate test available today to determine Down's syndrome.

In total, these tests cost the U.S. health care system between $3 billion and $4 billion yearly (roughly $1,000 per baby) to determine whether a fetus has Down's syndrome. Given the drawbacks, the opportunity exists for a less invasive, more accurate test to help expecting parents through their pregnancy.

The Technology

Sequenom's SEQureDx test uses an elegant approach to fetal genetic screening. As it turns out, fetal DNA can be found circulating in the mother's blood. By using a standard blood draw, Sequenom can extract the fetal DNA and use its MassArray technology to determine whether the fetus has Down's syndrome or not. So far, the test has been 100% accurate. To be clear, the test does report "no calls," which as the name suggests do not determine a "yes" or a "no." These tend to be samples without enough genetic material to quantify an answer with high confidence.

This same genetic screening technology used on the same sample will eventually be expanded to test for other genetic disorders such as cystic fibrosis, thalassemia and sickle cell anemia, among many others. Each of these represents a new market opportunity for the SEQureDx platform.

The Stock

The company will unveil data of a larger study in Down's syndrome on Jan. 31, 2009. Not surprisingly, the data are highly anticipated by the investment community. Many investors are waiting on the sidelines to see what the data hold (if there are false negatives or false positives, or other confounding factors). Other investors expect that no matter the data, the stock will exhibit a sell-on-the-news reaction. This conclusion seems reasonable with a priori logic: If the company already reported 100% accuracy, how can it get any better? That is, the news will necessarily be as expected or worse than expected.

From my perch, I cannot blame any investor for waiting to see more data. Let's face it -- the data we have so far are from a relatively small set of patients. The question in my mind is, are more investors with more capital waiting for the data point to get a chance at an entry point (barring an outcome that puts the test at a disadvantage to currently available tests), or are there more "flippers" waiting for some great news to get out?

I tend to believe the former (of course with that large caveat on the data standing on their own), and I have put my money where my mouth is. But let's look beyond this data point and view the opportunity.

In my opinion, the opportunity is best examined through the eyes of a pregnant woman. While many investors point to amniocentesis as the appropriate market size, I believe a successful SEQureDx test will become the de facto screening test, as it is far more accurate than the current triple test. As with any test, I do not expect it to prove 100% accurate as the testing experience increases, but that will not be an impediment so long as this test is superior, cost-effective, and noninvasive when compared to current standard of care.

The hook for women is simple: noninvasive, more accurate. This test could truly revolutionize the screening practice, and the increased sense of confidence will encourage its use. Women will request this test if the data continue to stand the test of time, and doctors will not resist, as science would prevail in the courtroom if they guided incorrectly. I can imagine this test being discussed on Oprah and The Today Show and seen in women's magazines. If the data stand, resistance is futile.

So what is all this testing worth? Three million tests a year at $700 a test nets more than $2 billion in revenue in the U.S. alone. With only 15% cost of goods and only requiring a relatively small sales force, Sequenom should carry 60% operating margins. That works out to $720 million in after-tax profits per year, or more than $11 a share. A reasonable 20 multiple on the U.S. business alone yields a $200 stock in time.

Outrageous? It sure seems like it. But the key to me is the stock's asymmetry. I think the upside opportunity vastly exceeds the downside risk at this point in the company's development. If this test is only able to capture the U.S. amnio market, it would yield roughly $2 per share for the company.

So do your own homework. Make your own assumptions. Don't forget to include the rest-of-world value for this test and other tests like cystic fibrosis, which is another $1 billion market today. Listen to Jim Cramer's "Mad Money" segment on Sequenom. Most importantly, find a woman who has had a baby, an amnio or a triple blood test. Ask her which test she would choose. And remember, this is no longer science fiction.

Know what you own: Ferayorni mentions Sequenom. Other companies in the biotech industry include Genentech , Amgen , Gilead , Celgene , Genzyme and Biogen Idec .