The bull case for Foundation Medicine

I have been receiving a lot of questions about Foundation Medicine (FMI), which is one of my favorite stocks right now. Below is a list of typical questions I receive and my answers to them.

What’s your investment thesis for FMI?

Foundation Medicine’s investment thesis relies on the realization that cancer treatment is undergoing a fundamental change. Instead of treating patients based on tumor type (breast, lung, skin etc.), treatment decisions are guided by the tumor’s genomic profile. Mutations identified in each tumor will serve as the basis for choosing the right drugs for a given patient (often referred to as personalized or precision medicine).

In order to fully realize the potential of precision medicine, two elements are required: (i) An arsenal of drugs against the various “driver” mutations, and (ii) A cost-effective tool for identifying these mutations.

Foundation Medicine utilizes next-gen sequencing (NGS) for identifying the different mutations in a single test, which is becoming a huge advantage given the expected increase in the amount of drugs that require patient selection. As tumor profiling is expected to become a $5B market within a decade, Foundation Medicine is ideally positioned as the market leader and the only company with meaningful commercial traction.

To date, driver mutations have been identified without FMI’s tests, why would the oncology community switch to FMI’s expensive tests (~$3500 per test)?

Theoretically, there are other ways to identify mutations and there are several marketed products sold as companion diagnostics for approved drugs (Abbott’s Vysis for ALK, Roche’s cobas for BRAF etc.). The problem is that each of these tests evaluates a single gene, whereas Foundation Medicine to identify many mutations (hundreds) in a single test. As the number of mutations for which there are relevant drugs is expected to surge (discussed in my ASCO recap), the single-test/single-gene approach becomes unfeasible. FMI’s multi-gene approach provides an elegant solution to this problem, and will be highly cost effective since it will replace many single-gene labor-intensive tests.

What about valuation? How can you justify FMI’s market cap ($700M) based on sales of only $60M in 2014?

I can’t. I view FMI as a biotech investment that should be valued by its long term potential and scarcity value as an acquisition target. Just like small biotechs are not valued based on their income statement but on future sales upon approval, Foundation Medicine should be valued by its ability to generate annual sales of $1B+ in 7-10 years.

In order to grow sales meaningfully, FMI must obtain reimbursement. Doesn’t this add a lot of risk to the equation?

Reimbursement is clearly a big issue for FMI (or any other company that would like to sell tumor profiling tests). In my opinion, concerns regarding this matter are overblown because eventually payors will realize (some already have) that multi-gene tests are a necessity. They will not only lead to better treatment outcomes but also to better economics and logistics (specimen availability, time to treatment decision and labor) relatively to single-gene tests.

The route to broad global reimbursement will be a long and gradual one, and reimbursers will probably start with populations for which the need to find rare driver mutations is greater. This is illustrated by the recent decision by Priority Health, which became the first US payor to cover Foundation Medicine’s tests. Initial coverage will be for specific populations (rare tumors, cancer of unknown primary, chemo-resistant tumors and NSCLC).

Lung cancer (NSCLC) appears to be the ideal bridgehead for multi-gene tests as the number of subsets for which there are approved drugs could reach 10 by 2020. (These include KRAS, EGFR, ALK, ROS, RET, HER2, TRK, AXL, BRAF and MET).

If meaningful sales are still 2-3 years away, why hold the stock now? Does FMI have any near-term growth engines?

In the near-term, a lot of the upside potential is tied to clinical stage drugs for which patients are selected with FMI’s tests. This should be viewed as a fast route to reimbursement, assuming an FMI test is approved by the FDA as a companion diagnostic. In that case, reimbursement should be automatic although pricing is an open question.

The most notable near term opportunity is Agios’ (AGIO) IDH1 (AG-120) and IDH2 (AG-221) inhibitors. Both drugs utilize FoundationOne to identify patients with IDH1 or IDH2 mutated tumors. AG-221 already generated encouraging results in AML and AG-120 will have data later this month, which are also expected to be positive (Based Agios’ decision to present them so early).

So should FMI be viewed as an Agios “derivative”?

To some extent yes, because Agios represents a significant near-term opportunity for getting FDA approval and recognition as the first NGS-based companion diagnostic test. Market penetration is expected to be fast given the unmet need and lack of treatment options in AML. Agios could file for accelerated approval for both drugs as soon as 2H:15, which should result in an uptick in commercial revenues for Foundation Medicine in 2H:16.           

And how big is the Agios opportunity?     

It depends on the indications in which AG-120 and AG-221 will be approved. So far, activity was seen only in AML but IDH mutations occur in additional tumor types. AML has a US incidence of 19,000 and 15-20% of cases are expected to be IDH1+ or IDH2+. 10% of AML cases are APML that have very good treatment options and are not likely to be candidates for Agios’ drugs which results in a relevant population of 17,000. Assuming a price of $3000 per test (both mutations should be assessed in the same test) and an incidence of 17,000, Foundation Medicine’s opportunity is $51M per year in the US. To put this in perspective, Agios’ (and partner Celgene) opportunity in AML should be $350M assuming 3500 eligible patients and an average cost of $100k per patient.

Any use beyond AML is pure upside for both companies.

Are there additional industry collaborations with a significant near-term impact?

Another partner of note is Clovis (CLVS), which uses a panel developed with Foundation Medicine to identify patients who are sensitive to Clovis’ PARP inhibitor, rucaparib (BRCAness). Results from a phase II ovarian cancer study (ARIEL2) should validate the genes included by Clovis in the “BRCAness” panel and inform patient selection in an ongoing phase III. Phase III readout is expected in the 1H:16, with commercial revenues for Foundation Medicine expected in 2017.

Foundation Medicine is working with additional pharma and biotech partners. Some of these collaborations are likely to result in inclusion of Foundation Medicine’s tests as companion Dx.

What about competition? Other companies must have realized that NGS-based tumor profiling represents a huge opportunity.

Multiple diagnostics companies are expected to enter the tumor profiling field, some already announced products or plans to develop NGS-based panels. Activity ranges from broad panels from traditional diagnostic players such as LabCorp and Quest, to more focused panels usually pursued by pharma companies. It is important to note that FMI has the broadest and most clinically validated test on the market. It also has a significant first-mover advantage and appears to be the undisputed market leader.

So aren’t you concerned about intensifying competition? Are you sure a small company could compete with giants such as LabCorp and Quest?

I am not naive enough to think FMI will have 80% of the market down the road but I strongly believe its first-mover advantage and market experience will enable it to be a meaningful player and capture a ~20% market share. This should translate to annual revenues of >$1B, similar to a successful biotech product. Importantly, FMI’s products could be more successful in the hands of a large diagnostics company, which make the acquisition scenario very likely in my opinion.

But why would one of the diagnostics giants prefer to acquire FMI over supporting its internal products?

The NGS tumor profiling market is still nascent with multiple companies working on several fronts. As with any evolving field, some companies will be more successful than others in penetrating the market due to a myriad of factors (logistics, number of genes covered, time to market, web interface etc.). In such a competitive environment, if one or two players feel they are left behind they might try to leapfrog competition by buying the market leading product. Such a deal will be complimentary: FMI will tap into a global marketing infrastructure whereas the acquirer will have the most popular and clinically validated NGS test. In this scenario, market share for FMI’s products could be higher than on a standalone basis (40-50%).

An acquirer may also be interested in the genomic database Foundation Medicine is generating. With thousands of samples analyzed being added every quarter, this database is a valuable tool for guiding target selection and drug development.

Who is the company most likely to acquire Foundation Medicine?

My guess is as good as anybody else’s but my bet is on Roche Diagnostics or Abbott (ABT). Both companies have a strong presence in cancer diagnostics but neither have commercially available NGS-based tumor profiling panels. Importantly, both companies have companion diagnostics based on FISH (Abbott) and PCR (Roche), which may become obsolete in a market dominated by NGS tests.

Is there a way to hedge the investment in FMI via a position in a competing company?

Not really. FMI represents a unique opportunity: It is the only company which is 100% focused on NGS-based tumor profiling and also the undisputed leader in the field. It reminds me of the ADC field 5 years ago, when the market was dominated by Seattle Genetics (SGEN) and Immunogen (IMGN). The two companies worked on ADCs almost exclusively (they had naked antibodies as well) and were the only ones with attractive clinical stage ADCs in development. If an investor believed in ADCs, all he/she had to do is buy both stocks to get maximal exposure to the ADC segment.

What are the major catalysts for FMI in 2015?

On top of quarterly commercial performance, the most significant catalysts in 2015 are:

‒      Reimbursement by additional payors

‒      Data for Agios’ IDH1/2 inhibitors – should increase visibility regarding likelihood of success and commercial opportunity (based on indications pursued).

‒      Data for Clovis’ rucaparib in BRCAness+ patients (preliminary results next week) – should increase confidence and likelihood of approval.

‒      Additional partnerships with biotech companies and emergence of more companion Dx collaborations.

‒      Progress for drugs targeting rare mutations in lung cancer – expected to illustrate the need for multi-gene tumor profiling for this indication (annual US incidence of ~200k).

Biotech portfolio – Nov 9th, 2014

biotech portfolio - Nov 9 2014biotech etfs - Nov 9 2014

55 thoughts on “The bull case for Foundation Medicine

  1. Thanks for the insights into FMI, it was an interesting read.

    Do you feel that in the sub-$1000 genome sequencing environment that’s fast approaching a $3,500+ NGS test will continue to feasible?
    My understanding is that FMI does not really have significant IP. Their mutation-therapy database builds on publicly available research papers, and it’s unclear how valuable the data they are gathering from sequencing is at this time. In a sense they’re true service is the easy-to-read report, which might not be very difficult to duplicate.
    They’re also treading some dangerous regulatory grounds, and if the FDA decides they’re report guides treatment it could require a PMA, which I’m not sure FMI will be fully prepared for.

    Happy Holidays!


  2. Elijah – Thanks.
    The way I see it, the continued drop in NGS prices is important for the widespread adoption of products like FoundationOne. FMI is like a company developing Apps for mobile phones, what matters is not the hardware that is getting cheaper and better all the time or the fact that on paper anybody can create another FoundationOne. What matters is the “software” (in their case, adequately capturing genomic data and analyzing it in light of known actionable drivers). I am no NGS expert but it appears to me that providing a broad, robust and reliable tumor profiling test is not trivial even for companies that do NGS for a living.

    IMO the bull case for FMI does not rely on IP but on being the market leader with a clear 2 year head start + expertise gained in commercial operations. This should be enough for Roche/Abbott/ILMN to acquire FMI.



  3. Ohad

    Do you attribute the continued weakness in Foundation Medicine to year end tax selling or perhaps the reluctancy of other healthcare insurers to cover the tests.Or do you have another reason?


  4. david – It’s always hard to explain a stock’s behavior in the absence of important news. Reimbursement and competition are two major overhangs but I don’t think anything changed recently.



  5. Ohad – thanks for the insights on FMI. How does this compare with Nanostring? NSTG’s screening technology seems to be well suited for cancer R&D (uses FFPE samples), they have an FDA approved Rx for breast cancer, and their recent deal with Celgene seems to put them squarely in the CDx business. I appreciate your thoughts!


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