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Here's Why Exact Sciences Stock Snapped Right Back Into Place

Cory Renauer, The Motley Fool

When Exact Sciences (NASDAQ: EXAS) told investors it booked 94% more revenue during the second quarter than a year earlier, the stock fell more than 12% before recovering by the end of the day. The market looked right past a glowing earnings report and focused on a rumor that many shareholders had hoped wasn't true.

On July 27, 2019, Bloomberg reported that Exact Sciences was in talks to acquire another cancer diagnostics company, and a couple of days later the pair made it official. Exact will acquire Genomic Health (NASDAQ: GHDX) for $2.8 billion in cash and stock. Here's why the official merger announcement sent Exact Sciences stock into the dirt, and the reasons it quickly recovered.

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What Exact Sciences is buying for $2.8 billion

The diagnostic business Exact Sciences bought markets the Oncotype DX suite of tests for prostate, breast, and colon cancers. The deal is certainly in Exact's wheelhouse. Exact's Cologuard test detects early stage colon cancer while Oncotype DX Colon is used for predicting how aggressively a specific patient's disease will advance after they've been diagnosed.

Oncologists with early stage cancer patients have a lot of important decisions to make, and erring on the side of caution really isn't an option. Treatment with a powerful round of chemotherapy given too early can do more harm than good and identifying the gene mutations driving a patient's disease first can inform this decision.

Why the stock fell

The biggest threat to Exact Sciences and Genomic Health comes from tiny DNA fragments in the bloodstream that have broken free from tumors. Guardant Health (NASDAQ: GH) successfully markets Guardant360, a blood test that detects those fragments and measures them against 74 validated cancer-related gene mutations. Investors weren't impressed with the Genomic Health acquisition because the tests Exact Sciences is acquiring look at fewer genes and require a biopsy procedure. As a result, the stock slipped more than 12%.

Trailing sales of Genomic Health's genome-profiling tools have grown a respectable 49% over the past five years, which looks paltry next to the potential competition. Trailing revenue at Guardant Health has risen 65% since it began trading publicly just over a year ago.

Guardant Health is also taking aim at many of the same healthy people Exact Sciences depends on to drive Cologuard sales. Guardant will begin a 10,000-person colon cancer screening study in 2019, and investors are worried that success will make the Cologuard screen irrelevant.

Most of all, though, the stock fell because investors aren't happy about the share dilution they'll have to swallow to pay for Genomic Health. Exact Sciences is still losing money, so in addition to handing over $1.1 billion in cash, Genomic Health shareholders will also receive $1.7 billion worth of Exact Sciences shares. Once the dust settles, Exact Sciences shareholders should own about 91% of the combined company. 

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Why the stock bounced back

Shares of Exact Sciences slid more than 12% on the morning of the acquisition announcement and completely recovered by the end of the day. Bargain shoppers swooped in because they see liquid biopsies as more of a supplement than a replacement.

Investors also remembered that physicians are unlikely to choose a new targeted therapy based solely on a blood-based test. That's because the parts of tumors most exposed to targeted therapies don't always express enough of the target. Elucidating this level of detail usually requires testing cells from different parts of the tumor separately, which means old-fashioned biopsies are probably here to stay.

Investors were also encouraged by a strong second-quarter earnings report. Cologuard sales are rocketing up faster than expected thanks in part to a commercialization partnership with Pfizer. Although Pfizer's taking a little off the top, the help is worth every penny.

In the second quarter, Exact Sciences screened 415,000 people, which was 93% more than a year earlier. As a result, the company raised revenue expectations from at least $725 million in 2019 to at least $800 million.

Liquid biopsies have a lot of advantages, but none of them have earned official recommendations that force insurers to cover 100% of Cologuard's price for everyone 50 years of age and older. It's going to be a long time before anyone developing blood-based cancer screens can say the same.

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A buy now?

Exact Sciences estimates its share of potential customers at just 6%, and reaching 40% would drive annual revenue above $7 billion. While there's a chance that a liquid biopsy that includes colorectal cancer will pinch Cologuard's sales, the company can look forward to at least a few more years of dominance in its niche.

Sales of Genomic Health's early stage breast cancer test aren't likely to suffer a great deal from blood-based tests, either. That's because the Oncotype DX biopsy procedure's safe enough that using one to confirm the other makes a lot of sense.

Although the uphill path in front of Exact Sciences is smoother than some might think, its $15.2 billion market cap at recent prices is 18.4 times expected revenue this year. That multiple is several times higher than Genomic Health's and the diagnostics industry in general.

If growth slows just a little, investors could suffer some swift losses. It's probably better to wait until a couple of quarters after the transaction takes place to make a purchase decision.

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Cory Renauer has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Genomic Health and Guardant Health. The Motley Fool has a disclosure policy.