• Brett Schafer

Fulgent Genetics: Not So Deep Dive

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Show Notes

(Ryan) What they do: Fulgent Genetics is a genetic testing company focused on transforming patient care for oncology (which is the study or treatment of diseases), infectious diseases, and reproductive health. The way I understand it, Fulgent has proprietary testing technology that can help identify and pattern match gene sequences. 

So let’s take a trip back to high school biology. Let’s say someone takes a nasal swab. On that nasal swab, there are DNA molecules comprised of different chemical building blocks. Remember the double helix structure with a sequence of nucleotides. (Adenine, thymine, cytosine, and guanine). I knew I’d use this eventually. Well, those sequences can highlight changes in a gene that may cause disease.

Fulgent Genetics offers an enormous test menu. They have more than 18,000 single-gene tests and more than 900 panels that collectively test for more than 5,700 genetic conditions. The tests results are referenced against a massive gene library using Fulgent’s ‘sophisticated proprietary’ data comparison and suppression algorithms. The reason Fulgent became somewhat popular as of late is that they offer tests to detect COVID and they grew rapidly. 

And they classify their customers into 3 different payor types. 1) Insurance 2) Institutional (hospitals, medical institutions, laboratories, government bodies, municipalities, and large corporations) 3)Patients who pay directly. I assume that is people without insurance.

(Ryan) History: Fulgent was initially founded in 2011 by Ming Hsieh. The company launched its first commercial genetic tests focused on rare pediatric diseases in 2013 and its tests covered more than 1,000 genes in 100 panels. Today the company can test for various cancers, cardiovascular diseases, and neurological disorders. Hsieh has served as a trustee at USC since 2007, so I believe he was well off prior to founding Fulgent which is usually a decent sign. 

In 2016 the company did a reorganization where they acquired their subsidiaries. This seems like it was just to build a holding company and a better corporate structure. And they went public shortly after that in 2016.

(Brett) Industry/Landscape/Competition:

  1. Two industries: COVID-19 testing and Next Generation Sequencing (NGS)

  2. NGS industry: projected to grow to $35 billion a year by 2030. Caveat this that all of these reports expect every industry to grow fast

  3. NGS competitors: Myriad Genetics, Progenity, Guardant Health (Cancer testing/diagnostics), Castle Biosciences, and plenty others. 23andme is not a competitor since Fulgent is focused on physicians, not individuals

  4. COVID-19 testing industry: Estimated at $60 – $85 billion in global spend in 2020. Uncertainty surrounding the durability of this market

  5. There are hundreds of COVID-19 testing companies. Abbot is a big one. Fulgent has won some sizable deals though

  6. Fulgent is a customer of Illumina

(Ian) Management and Ownership:

  1. Ming Hsieh (Shay) is the founder, chairman and CEO

  2. Prior to Fulgent he founded a biometric id company called Cogent which he sold to 3M for nearly $1B

  3. Hsieh is from China and his family was persecuted during the cultural revolution. He and his family fled to Taiwan when he was around 10 years old. It marked a pause in his formal education. His father, however, was an electrical engineer and assigned to bringing power to a remote village. Hsieh worked with him and learned by doing. He later went to USC and got a degree in electrical engineering

  4. He has made some generous gifts to USC including naming the engineering department

  5. Hsieh owns ~27% of shares outstanding, insider ownership equals about 30%

  6. Blackrock is the biggest institutional owner with ~10%

(Brett) Valuation:

  1. Market cap of $2.68 billion, ticker FLGT

  2. EV of around $2 billion due to heavy cash position

  3. EV/s of 2.2

  4. EV/gp of 2.77

  5. Ev/OCF of 4.4

  6. Excluding COVID testing sales, forward EV/s of 18

  7. Share count going up a lot. They raised a lot of cash. I would expect this to continue being a headwind

(Ryan) Earnings: Best to give Q2 revenue since it’s the most timely

  1. But just for general knowledge, they did about $909M in TTM revenue, which was up nearly 2,000% from the year prior.

  2. On that they generate about 80% gross margins and about 73% operating margins

Q2:

  1. Total revenue of $153.6M, up 790% YoY

  2. Core revenue which excludes Covid testing was $25.7M

  3. They are guiding for $110M in core revenue for 2021, which would be 201% growth vs 2020

  4. OCF was $76.1M for the quarter

  5. That’s an OCF margin of 50%

  6. Gross margin improved YoY as well by 21 percentage points

(Ian) Balance sheet and liquidity:

  1. ~$715mm in cash and marketable securities, taking into account the CSI acquisition

  2. Marketable securities are basically all bonds

  3. Should have plenty of cash available for more acquisitions

  4. Only ~$5mm in notes payable and about $15mm of a margin loan at 1% interest, not concerning

  5. This is a cash rich company, taken advantage of rise in share price to become a major player in ngs

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Anecdotal Evidence:

  1. (Ryan)

  2. (Brett)

  3. (Ian) Moving back to LA this week so might have some soon

Future growth opportunities:

  1. (Ryan) Ming Hsieh stated on the Q4 CC last year that they expect M&A to be a potential avenue for growth. They demonstrated that this quarter with the acquisition of CSI Laboratories. CSI provides cancer diagnostic testing. Just an easy way to expand their testing menu to offer anything. They’ve got $776M in cash and marketable securities, probably can’t use all of that, but expect more acquisitions just like this.

  2. (Brett) Taking controlling stake of FF Gene Biotech, the Chinese joint venture. This will bring the same US tools to China. That market is projected to hit $4.5 billion in spending by 2030. The JV has done $10 million in sales so fairly small vs. Fulgent as a whole.They believe they can get $5 – $10 million in Chinese sales in back half of the year

  3. (Ian) Virus testing. They were able to capitalize on the need for COVID-19 testing. It seems to me like virus testing will continue to exist for coronaviruses and that some segment of the population will always want to be tested for viruses. This growth opportunity doesn’t necessarily mean that Fulgent revenue will grow YoY, but it does mean that the current revenue might not need to be discounted as much as it is

Highlights and lowlights:

  1. (Ryan) Highlights: They were in the right place at the right time. That one disease may have fueled the balance sheet with enough cash to go in several directions. Whether it’s M&A or testing out new product lines. Also the growth of core revenue has been really strong. Lowlights: I know this sounds like a copout, but the industry seems really unpredictable to me. I don’t know what innovations there might be in this space but also I’m not sure what potential regulatory changes could mean for the business.

  2. (Brett) Highlights: Industry tailwind, strong operating leverage, great track record of execution getting after the COVID-19 market. Lowlights: Obvious one is uncertainty of COVID-19 testing revenue, but then also the uncertainty around a Chinese JV and the highly dynamic genetic testing industry which has hundreds of the smartest people in the world tackling the problem as competitors to Fulgent.

  3. (Ian) Highlights: Ming Hsieh. I like his story and his past experience running the business. Also very opportunistic with COVID testing. Lowlights: Customer concentration (LA: 28% and SB: 10%), decreasing, though, in the last few quarters. The uncertainty of COVID revenues.

Bull case:

  1. (Ryan) A non-zero endpoint for COVID testing, which feels very realistic. I think this is something that stays with us for the next decade. Especially with variants. Then of course they have to grow their Next Generation Sequencing testing (NGS) segment. Perhaps the covid tests gave new leads to cross-sell their NGS segment to. Heading into 2021, they expected $70M in revenue from NGS and as of the 2nd quarter they’re now expecting $110M in revenue.

  2. (Brett) At these prices, it seems like you need to believe in COVID-19 lingering a bit longer than people expect (which has been a great bet so far), and for the new acquisitions/partnerships to help propel its NGS segment to $1 billion in sales this decade

  3. (Ian) Fulgent is just scratching the surface of Next Generation Sequencing (NGS), the market propels them forward, and they emerge as one of the major companies in a massive industry. “Next-generation sequencing makes large-scale whole-genome sequencing (WGS) accessible and practical for the average researcher.”

Bear case:

  1. (Ryan) COVID revenue dwindles. I don’t think it’ll hit zero ever, but if it drops and the NGS segment doesn’t grow enough the company won’t be deserving of its valuation. Now I think they’ll try to grow it inorganically, but I don’t know what sort of regulatory issues they could face with that. 

  2. (Brett) Easy one is COVID-19 profits falling off of a cliff. I’d also worry about competition on pricing for NGS, and the failure of the Chinese JV since it is an industry the CCP is focused on winning with domestic companies.

  3. (Ian) 18x forward sales excluding COVID is pretty steep. They need significant growth in the core business (admittedly strong in 2021 Q2 296%). But growth does not continue at this rate and smart acquisitions are harder to come by. Excluding COVID revenue, this is a very small company. Somewhat fragile

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Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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