FYI - For Your Innovation: Discussing Our Exact Sciences Valuation

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arc-invest.com. Welcome back to FYI, arc's four-year innovation podcast. Today I'm your host,

Tasha Keeney, director of investment analysis at arc and institutional strategies. I'm joined by

Simon Barnett, our director of life sciences, and today we're going to talk about exact sciences.

So, Simon, tell me, what does exact do, why do we care about this company?

Yeah, thanks, Tasha. I'm happy to talk about this. So, exact sciences for folks who don't know is a

cancer testing company. So, roughly 90% of Americans over 45 are actually familiar with

exacts largest testing franchise, which is called KolaGuard. It's an at-home colorectal cancer screening

test approved by the FDA, launched in about 2014, and has since scaled to now over 10 million units

sold. But exact does a lot more than this, right? So, exacts second largest test is called Oncotype,

and what people may not know is that this test actually guides medical care for roughly 70% of

women in the US who are diagnosed with certain forms of early stage breast cancer. So, exact,

you know, solely focused on oncology. They're continuing to grow from their core business,

like I mentioned, with KolaGuard and Oncotype, adding more new tests that are going to cut,

touch other parts of the cancer care continuum. And they've been around, you know, for several

decades now, but their first major products were approved, like I said, just a few years ago in 2014.

Gotcha. And, you know, taking a step back, okay, we understand a couple, like, what their business

model is about, but why do we care about, like, what is the market? How would you define the

market that exact is in? And why is it interesting to us at ARC? So, cancer is the main subject here,

and I really want to focus on oncology because it's such a universal thing. I think everybody,

to some extent, can relate to it, whether it's impacted them personally or maybe a family member.

And when we talk about oncology care, there are two big components of this, right? So,

there's diagnostics, and these are tests that are designed to detect cancer earlier, so that's

called screening, figure out how aggressive cancer is, that's called prognostics, monitor cancer

over a treatment cycle, and figure out, like, the best course of therapy. So, all of that,

collectively, is cancer diagnostics. And the reason we care about it and focus on it so much is

because it's a big problem, right? Not just in the US, but everywhere. So, if I zero in on some

numbers, roughly 2 million people every year in the United States are diagnosed with some form of

cancer. And the number of survivors, right, people living with cancer, some that are, you know,

many years away from treatment, but some that are, you know, just barely going into remission,

you know, we think that number can grow upwards of, you know, about 20 million people over the

course of this decade. So, it's a really pervasive problem, certainly a place that we really focus

on, it's a national priority to invest in and underwrite, you know, research into. And so, to,

I guess, sort of, you know, focus on the fact for a moment that cancer care is something that is

totally, you know, divorced from interest rate changes or consumer sentiment, it's something

that's very predictable and it's something that's very important. Especially now, as the community

has moved through the COVID-19 pandemic, where there was like a 20 or 30 percent drawdown in the

number of oncology visits that were happening around the world, which has resulted in a lot of,

like, late diagnoses, and also a ton of missed screenings. I think the most recent stat that we

found was, in the US alone, more than 30 million screening appointments were missed, you know,

whether it's mammography or colonoscopy, right, so it's a really pressing urgent issue to focus on it.

And I'll end by saying that, you know, currently, just in the US, we think that this market is around

five billion dollars in revenue, the molecular cancer testing market, which we think can continue

growing about 20 percent or north of that, year on year through the end of the decade,

getting to about 24 billion by 2030. And if you look at it today, it's interesting,

but just with exacts core business, right, so oncotype and coligarde, these two tests together

comprise, we believe, you know, more than a third of the entire market today is controlled by exact

sciences, so certainly in a pole position in terms of revenue and, you know, continuing to grow from

there. Got it. And if we wanted to learn more about that research stat that you just gave,

where would our listeners look? The best place would be to check our open source model for

exact sciences that we just published on our website a few weeks ago, so arc-invest.com.

You can search for exact sciences and you can find, you know, a overview of the market itself,

so we start by talking a lot about cancer testing, you know, some of the dynamics there,

how it was impacted by the pandemic and how it's recovered from some of the worst parts of,

you know, of that. And that's the best place for people to look and test our assumptions and try

to understand not just the market, but also exacts place in it and how they've pioneered the space

historically and where they're taking it. Great. And if our listeners want to look into more of

our top-down work, some of the great work that Simon's done, we just published our latest big

ideas report. So also check that out and Simon will be presenting that soon in a webcast,

so I'm excited for that. But okay, so you published this exact model. There's a blog that goes along

with it. There's a model that's on GitHub that people can use to play around with your assumptions.

Where do you start here with a company like this? Like, how do you value this company? What should

you be thinking about? So, yeah, let's just cut to the chase and kind of look at the company and

the valuation work. So, you know, like our other open-source models, we've published a price target,

you know, over the five-year investment time horizon that we really focus on. And we've also

provided base case, bull case, and bear case assumptions that any readers are free to kind

of toggle and challenge and adjust and see how that affects the valuation. So maybe what I'll do is

I'll focus on the base case briefly, go through the numbers, talk a little bit about how we get

there, and then we can sort of backstep and maybe get into more detail. So the headline is that we

believe shares of exact sciences could expand from, I believe, around $60 a share today to about

$140 per share by 2027 in our base case. So let's talk through this a little bit. I've already

mentioned some of the core on-market tests that the company has launched, right? So Colegard and

Oncotype are the two of them. We believe that those are going to continue to grow north of 15%

per year, reaching about $4 billion in revenue by 2027, right? So the company just passed $2

billion of revenue this year in 2022. So we think that can double in five years. We also think it's

really important that the company is able to achieve operating leverage and get to that EBITDA,

breakeven crossover point, and then continue on to be cashflow positive, obviously self-funding,

and continue to leverage the infrastructure that the company has built over the years.

Maybe one quick stat here, and we can circle back in more detail later, but it's really tremendous

that for every dollar invested in R&D over this company's lifetime, they've been able to generate

$6 of revenue. So there's a tremendous amount of leverage on the R&D line. And what we're looking

at now is to see how that's playing out with both sales and marketing and general and administrative

expenses. And we can look back to that. But to end with what's going on with the base case,

there's a couple other things that we're assuming here. And that's that the company, again,

continues to reinvest its earnings and its pipeline tests, which are really exciting,

and we'll get into those servicing the company's outstanding debt, as well as maintaining capital

equipment. And really, the diagnostics business is not as capital intensive as something where you

have to build out a lot of brick-and-mortar facilities. Diagnostics companies are really

heavily centralized and high volume, typically in a small number of concentrated places. And that's

what helps get leverage on the CAPEX component. And then lastly, we expect the company's pipeline

tests, and I can get into a revenue breakdown. But we would hope that the pipeline tests get to

about a billion dollars in revenue by 2027. And the thing to, I want to be really careful about

this, because a lot of times we hear pipeline in biotech and think about, these are like drugs,

right? These are really risky. Most of them fail. Most of them take a decade plus to commercialize.

That is not the case in diagnostics, right? So diagnostics tests generally are much lower in

terms of technical risk. The challenge is building up enough data on the clinical utility of a test

to get payers to underwrite and reimburse them. And so that does take time. But the important

thing to know here is that several of the company's pipeline tests are commercializing already in

2023. Many of them already have clinical utility data out there. In some cases, they're like the

largest prospective trials ever conducted in their class. So it's not something that looks

like a pipeline drug, right? It's a little bit different there. And to conclude on a revenue

breakdown, just to kind of give people a little bit of a zip code for what this looks like,

I mentioned today, the core business generates $2 billion in revenue, 70 plus percent gross margins,

which is really high for diagnostics. And just about 2% of revenue this year is coming from

pipeline or emerging tests. And in the future, in our base case, we believe that the vast majority

of that value is still going to come from core tests, right? So we think about 57% of revenue

is going to come from KolaGuard in 2027. Another 25% is going to come from Oncotype in 2027,

with that kind of remaining percent coming from various pipeline tests.

Got it. Okay. So $4 billion on the growth in the core business, another billion on these pipeline

products. Right. So just crossing about $5 billion in aggregate top line by 2027 in our base case,

that's right. Okay. So we're getting a picture of what the top line forecast of this company

looks like. How does that translate into your price target, ultimately? How do you get to

this $140? So indeed, yeah, the top line is really an important piece of it. But when we looked at

how to value the company, we wanted to not just focus on getting really good at kind of showing

where revenue could go in five years, but also understanding kind of the underlying profitability

of this company and how they're continuing to gain leverage. Because in our valuation framework,

as people can see in our model, what we've done here is we've modeled out really discreetly

unit growth, revenue growth, margin, gross margin growth over five years. And then what we've done

is we've taken a some of the parts method where we've tried to value the company according to

two multiples that we feel are fairly industry standard. So looking at it in terms of EV to Epida

and EV to sales. So maybe I'll quickly go through why we did that. And we can talk about the operating

margin structure of the business and how some of the revenue that they're generating on the top line

is falling down to the bottom line. So again, I use the word core and pipeline. And the reason

why I want to do that is because when you're thinking about the company, right? So Kolegaard

and Oncotype are already some of the largest FDA approved diagnostic franchises in the country,

if not the planet, and they generate a ton of gross profit. In fact, just those two tests alone,

we believe allows exact generate more than four times the gross profit of any of its closest

peers, which is a great kind of unique differentiator the company has to reinvest in its business.

And that's on a dollar basis. Exactly. Exactly. Yeah, not percentage basis on a pure absolute

dollar basis. And so I mentioned that stat earlier about R&D leverage. So the company, if you look

at a 70 plus percent gross margin product, you're in a great position to start generating actual net

income. The R&D line is pretty small relative to what that top line figure looks like. And then

you start thinking about, okay, well, now that these are commercialized, there's a ton of evidence

out there. How are they continuing to leverage their scale and really have more money fall down

to the bottom line? So I think I want to tackle this first on a sales and marketing perspective.

Like diagnostics is very expensive to get a product up and going. But if you think about

the relationships that the company has built here, more than 98% of oncologists in the country

have ordered a test from Exact Sciences. And about that same percentage of primary care doctors

have ordered Colegard. So there's a lot of brand recognition and physician goodwill

that the company has engendered over the years. And what we're seeing now, and it's really interesting,

especially with the most recent numbers coming out of the JPMorgan Healthcare Conference,

for two years in a row, the company has now lowered its sales and marketing spend, not just on a

percentage basis, but on an absolute basis. And still, they've put up more than 30% organic growth,

ex-COVID testing, in the core business. So we're at this point now where I think

we've crossed over from this being something where the company has to push under the system

and continue generating evidence to something that is becoming increasingly baked into the

standard of care for treating and preventing colorectal cancer in this country. And then the

second piece of the business, looking at pipeline. So the pipeline tests we think are going to be,

like I said, from a revenue basis, a lot smaller than that core business in 2027.

And so these businesses are going to be less profitable, certainly on a unit basis. They're

going to share a lot of the same underlying technologies, which is, again, part of why you

see such great R&D leverages. Each new pipeline test, it can be put on the same platform. Many

of them are actually sold into the same patient and physician population. So it gives your sales

team the great ability to be more productive in those conversations with their clients,

because they're able to actually offer a broader menu without having that customer

acquisition friction that you'd need for a totally new market segment. So that's one of

the places we're expecting a little bit more leverage there. And so essentially what we've

done is we've taken an EV to EBITOM multiple, applied that to the core business, which is

becoming increasingly profitable. And for the much smaller pipeline tests, we think that those are

going to be more evaluated on an EV to sales basis, where people are really focused on their growth,

less so their profitability when they're just coming out of the gate. If the company has already

demonstrated its ability to get those unit economics over its core business at this scale,

we think that it's very likely they'll be able to do the same thing with the emerging tests.

So we add those two things together, and that's the way that you get the five-year target.

Got it. So essentially, you think they get this great leverage from the platform they've already

established. This allows them to basically have with the same spend on sales and marketing,

or maybe even less spend, those dollars go further. That helps the pipeline products.

And you're using EV to sales for pipeline, EV to EBIT for the core business. I guess,

what do analysts in the industry typically look for as benchmarks for these types of companies

and in ARCs process? How do you think that our view might differ from the street view?

The first thing that I'll say about street consensus with diagnostics companies in general,

and exact in particular, is if you look at the number of people who've submitted price targets

for the company, it drops off precipitously after about two years, maybe three. And one challenge

with that is that something that penalizes, exact, is that anytime it's spending money,

stay on R&D to develop a new test, or on G&A to build up the infrastructure necessary to launch

more tests, those get penalized, or those are used to penalize the company, obviously,

because they're counted in OPEX, but there's no downstream benefit that is factored into the

modeling. And so I think one of the great things about having that five-year time horizon is that

we're able to capture and balance both sides of that. Like, yes, we're trying to model OPEX here,

and that's something that people can actually go in and change in the model. To be clear, we are

assuming that each component of OPEX increases, right? So that's in the model between single,

like mid to high single digits for each of the categories. We just have revenue growing a lot

higher than that. And on an absolute basis, you can start seeing actual net income start to fall

through by the end of our forecast, right? So that definitely is a factor. But where we might differ

is in a couple places. I think the first place that we see some differentiation

out at five years is when you're thinking about how the very highly-scaled core business

interacts with pipeline tests, like biologically speaking, or from a data perspective. So let me

try to unpack that a little bit using Oncotype actually as an example. So Oncotype, that test

is used to essentially tell women who are being treated for breast cancer if they're likely to

benefit from chemotherapy, or if they can avoid it and not have to undergo that cost and that

anguish without deriving any clinical benefit. So as I said, that is a standard of care in the

United States. It's backed by the largest amount of perspective peer reviewed evidence of any

prognostic test for that indication. And it's now being launched internationally in markets like

Japan, for example. So the thing about this though, when you're trying to develop, and let me talk

about a type of pipeline test, so one of the most exciting areas for them is an area called MRD,

or molecular residual disease testing. We estimate that this market can be north of about 25 billion

in aggregate, just in the US. And it's less than 1% penetrated today. A lot of companies working on

it, but it's very nascent. And we think exact can command a really important position in this market

as it grows. So what MRD testing is, is after you've gone through treatment and you've been given

chemotherapy, surgery, radiation, typically what happens is, you know, physicians will use

inner scanning medical imaging to kind of assess a person's response to treatment, which is great.

There are some drawbacks to that in that sometimes it's very difficult to catch if a cancer is going

to recur. So over the past few years, as the cost of doing DNA sequencing, which is a really

critical input for doing this type of testing, as that has like absolutely collapsed, this world

of MRD testing has exploded. And essentially all it is is a blood draw. So to you as a patient,

it would just look like a blood draw. It can even be done at your own home. But in the background,

we're sequencing that blood and looking for the smallest emergence of reemergence of cancer

after treatment. And so breast cancer is a huge market, colorectal is as well. And so the fact

that exact is already in, you know, has relationships and has built out the infrastructure to serve the

breast cancer community, both the patients and the physicians, I think the attach rate and the

knock on effect for launching, you know, a breast cancer MRD test, for example, is being kind of

underappreciated just on the commercial side. But from the test development side, another really

interesting thing is that something like 50 to 60% of all breast cancer samples that are being,

you know, biopsied and used to run Oncotype are going through exact doors, right? That is

an a tremendous advantage when it comes to understanding tumor biology with breast cancer,

being able to study it, analyze it, train the machine learning classifiers that are used to

distinguish between cancer, non cancer for an MRD test. It's not something where you can synthesize

the data or capture it another way, right? These are like biologically locked in, we know how many

cancers there are going to be each year. So it's a very finite resource. And that's just one example.

But to generalize it, I think there are a lot of commercial synergies that go a little under

appreciated between the existing business and the pipeline, you know, again, both on the commercial

side, you know, and on the R&D side. And that's where I think we're getting some of these slightly

higher than consensus numbers out at 2027, even though there's really not a lot of consensus

numbers in 27 to begin with. Yeah. So, you know, you're hitting on this point that we make a lot,

which is our arc is focused on this five year time horizon, which isn't that typical in the market.

And then what I also love that you said is you describe the why now, you know, why do we care

about these markets now? And, you know, to highlight Simon's research again, it's because the cost of

sequencing is coming down, or at least that's one of the doors that gets opened.

Yeah, that's right. If you think about like the supply side innovation, the ability for these

companies to be more profitable at scale is something that I think, you know, in a traditional

setting, like oftentimes you have people that are really focused on the hardware, like the

enabling hardware, and then the applied markets, right, like diagnostics. And there is definitely

communication between those two. But I think it's really important now because we're at

an amazing inflection point in the DNA sequencing industry, right? So we have

a situation where in the early 2000s, this type of test would be completely cost prohibited. It

would cost billions of dollars. In fact, it costs more than a billion dollars to sequence a human

genome in the early 2000s. And then in 2015, it was $1,000, and now it's circling in on 100,

right? And there's no reason to believe those costs are going to stop going down. And that is a main

component of cost of goods for certain types of molecular cancer tests, right? So sequencing

has really opened the floodgates and not only in our ability to like make these things actually

like economically feasible, but also make them profitable at scale, where they become even cheaper

than their legacy counterparts like medical imaging. In fact, we, you know, in our big ideas

presentation, which people can can now access, we look at something called multi-cancer earlier

detection, which we think can be actually the largest contributor to the overall cancer testing

market, you know, at maturity. So multi-cancer testing just quickly for those who don't know

is a blood test that instead of looking for a specific type of cancer, you know, screening for

a specific form like colorectal, looks for as many as 50 different types of cancer simultaneously

in the bloodstream. You know, we have done some health economic research on this. And essentially

what we've found is that for adults aged 45 and up, it becomes economical to screen these people

with a blood test that costs $500, right? So if that's the most you can charge and sequencing

is $1,000 just as recently as 2015, no one's going to enter that market, right? Because it's a negative

margin product. But now that we're at this point where we can generate this data for under that

$500 envelope, it starts becoming really attractive. And that's why we've seen so much company

formation in this space. An exact, you know, right along with companies like Grail and Freenome

are at the vanguard of multi-cancer earlier detection. So we're really excited about that as

well. Yeah. So does that top down thinking factor into how you think about the margin

structure here as well? Definitely. So the first thing that we're doing is trying to understand

the gross margin side of this business as well. And so if people take a look at the model, what

they'll actually see in our input table is a gross margin assumption around every product line.

And that is largely informed by the biology, right? So it's informed by how deeply, how much

sequencing you have to do, you know, how many gigabases of data you have to generate, what the

cost of sample prep and bioinformatics on the back end are. So that's one of the ways that we're

getting to the aggregate gross margin structure is trying to understand both product mixed when

these things come out, how quickly they're going to scale, how large their markets are.

But also to your point, what the cost of goods is going to be, right? So the top down modeling

absolutely informs market structure for specific companies. Yeah. So, you know, I'd love to talk

about, you know, we've talked a lot about the modeling work, how your top down modeling fits

in with this bottom up analysis that you've published online for everyone to see, recommend

checking it out. There's also a qualitative element to covering companies like this. Maybe

let's talk a little bit about, you know, the things that our looks for in our investments.

So you're definitely right. When we're looking at these investment opportunities,

we have a rubric that is certainly incorporating that five year

cagger, right? That price target over five years. And so for us, you know, we look at these investments

and say, you know, if they pass our 15% hurdle rate on a price target basis, that's, you know,

a definite qualifier for being interested in an opportunity. An exact definitely, you know,

qualifies and people can go and test that. In addition to that, we think about factors like

product leadership of a company, its track record of execution. If there are any moats for the

business, what type of moat there are, but we also really care about people management and culture.

And all of these things interweave to give us a more holistic view on how we think about these

companies, right? And so maybe I'll extend that to exact, for example, and kind of talk about a

few things in each of these categories, right? So for product leadership, I think that's definitely

the first place to start. I already mentioned that KolaGuard and Oncotype are together,

roughly a third of a market that we think is both extremely important for humanity,

but also in terms of its ability to grow over the next market cycle. So that's the first thing.

You know, these are tests that are very high margin. You know, they're backed by some of the

largest ever studies conducted in their class, especially longitudinal ones, right? So oftentimes

oncologists are typically pretty conservative. And in order to adopt a new thing, they want to see

five-year, even better, 10-year outcome data. And Exact has done those studies, right? So it's

difficult to speed up time. So that's one of the things that's really important here is just

understanding that these have been in the market for a while. They've gotten past that standard of

care point. And that's something that I think gives you leverage as a business. And then also the

performance of these tests, right? Like one of the things about KolaGuard is the performance of

the test, right? So it's got sensitivity, the ability to detect the cancer, specificity, the

ability to not throw off a bunch of false positives that are industry leading for a non-invasive test

for both of those, as well as the ability to detect what are called advanced adenomas or

pre-cancerous lesions. So the really interesting thing about that is that when you're able to

detect these pre-cancerous polyps, a screening test becomes more than just a screening test.

It actually allows you to prevent a cancer diagnosis in the first place, which is very

valuable to health systems. It's where a disproportionate amount of medical benefit

and utility comes from for these types of things. So we're assessing the products also in terms of

their technical performance, as well as how expensive they are to run, right? So I already

mentioned, even at a $500 average selling price for KolaGuard, the test is still at, you know,

70 plus percent gross margin, right? So these are some of the things that we think about there.

Track record of execution is another really important one. So trying to understand how the

company has, you know, contended with the need to publish clinical data to get it out there,

to design these studies really rigorously so they don't have to do them again,

which is a challenge in the diagnostics industry, especially with a very stringent FDA

and other regulatory bodies. So that's definitely a component of it.

The proof points around, hey, look, you know, we think we're going to get to cross over on this

point and actually proving that out and staying true to their word. I think something that was

very surprising for people was hearing just a few weeks ago at the JPMorgan conference,

you know, Exact was saying, look, you know, we think we're going to get to profitability

on an adjusted EBITDA basis, you know, in Q3 of 2023 was the target. They've been able to pull

that forward and actually get to that point, well, this past quarter, Q4 2022. So being able to kind

of meet those things and consistently do that over time is really important. On moat, you know,

I think there are a handful of different moats with Exact Sciences that we think are going to

allow the company to maintain its position as a leader in this market. But let's be clear before

I go deeper into that topic that, you know, Exact is not the only molecular cancer testing company

that we have exposure to in the funds. We don't necessarily view the market as totally zero sum

where like the success of one company has to come to the total detriment of the other.

There's a lot of room for this market to grow, right? We think the aggregate total

investable market or total addressable market for these tests in the US is about 95 billion,

right? And we're only at about five today. So there's plenty of room for everybody to continue

adding to that space. But for Exact, I really think that, you know, companies will come out and launch

colorectal cancer screening tests, you know, new ones will emerge, we're invested and excited about

some of these new ones. But to really dig into it, it's like, look, you know, the fact that Exact

has this ordering platform, has it some instance in electronic medical records that are adopted by

many health systems that most oncologists recognize the brand that more than, you know,

like I said at the very beginning, 90% of Americans over 45 have heard of Colagard.

These are just like intangible, unique advantages this company has that I think are going to bear

a lot of fruit as they continue to expand and grow and launch new tests that are going to be

very difficult for others to really compete with. And so those are some of the things that we think

are feathers in Exact cap. Got it. Yeah. So it sounds like they have this really strong moat.

You know, I want to touch on something else you said, which is, you know, execution is one of

the things that we look for when we monitor our companies as well. You know, for you, you're

watching this earnings crossover point that management has forecasted that happened sooner

than expected. I guess, how do your expectations for this company compare to what management

is expecting? I think they're fairly in line on a few different areas. And maybe I can mention

some specifics to try to juxtapose how we think versus how management thinks. So

I'll start with the core business because that's where we have the most, you know,

quantitative data to really dig into. Our model says that Colagard itself, both the stool based

version and the emerging blood based version together, which we don't split them apart in our

model. But together, we think that that can go to about 30 million unit by the latter half of

this decade. And that's roughly in line with what management has said. I think they drew a line

around 30 million, you know, in the waning years of the 2020s as well. And if you think about that,

and you start saying, okay, what are the ways that we're going to get there? There's a couple

things that I think people should be paying attention to, regardless of if their time horizon is,

you know, five or 10 years, or even if it's just as short as a year, that we think support this

conclusion and that we've arrived at, I think independently. So I'll go through a couple without

getting too long winded. But one of them is that just a few short months ago, the American Cancer

Society expanded guidelines for colorectal cancer screening, saying that people age 45 and older

should be screened, not just 50 and older. So this grew the market by about 20%, actually,

almost overnight. And it's a place where exact is already seeing a lot of initial wins. Another

area is that the Center for Medicare and Medicaid Services just this past year enacted

a new piece of essentially a new piece of reimbursement policy that made it to where people

that get tested with a test like ColaGuard and show up as as positive for having cancer,

can go and get a confirmatory test like a colonoscopy at no additional charge, you know,

if there are Medicare beneficiary. This was not the case as recently as 2022. In fact,

it was a reason why a lot of people had trepidation to even get screened is because if they were not

covered for colonoscopy, that's, you know, more than $1,000 plus, you know, co-pay and lost time

at work. Right. So these are some of the things that are real tailwinds that I think are getting us

to that similar estimation. In addition to that, you know, I think, frankly, I was surprised, you

know, oftentimes a company will want to be, you know, really aggressive and talk up the market

or its tests or, you know, to generate a lot of enthusiasm. But one thing I really appreciated,

I think about exact in some of our earlier conversations, especially over the course of,

you know, 2018, 2019, was that this multi-cancer testing paradigm that I've already talked about

a little bit would be a huge opportunity, but something that would take, you know, many years

to really pay out. I think, you know, latter half, last two years of the 2020s, maybe even

even into the 2030s before it gets real traction in the oncology community. And so I appreciated

kind of the candidness and the way that they've modeled that market. Right. So compared to other

companies in the space who have tried to, you know, create like patient pay services up front,

at least initially to kind of gain initial market traction, exact has had a much more,

I think, metered and, you know, frankly, kind of slower approach with engaging on that,

because I think that they understand how important it is to have a good relationship

with your regulators and with your payers, because undoing that takes a lot longer than

setting off, I think, on a good foot. And that's exactly how we've modeled it, you know, a little

more conservatively, I think, than some other companies in the space. And so on both sides,

I think they've just been very, very accurate and very candid when it comes to how long these

things take sometimes. And I guess, what do you think the biggest risks to what you're predicting

could be in this case? I think time is a really important one, like I was just talking about.

So with the pipeline business, there's still some unknowns when it comes to

acceptance and endorsement by guideline agencies like, you know, the National Comprehensive

Cancer Network or, you know, ACS or some of these other ones. So there's an element of time

where with a sufficiently new type of test, it can take a while before they get accepted into

guidelines. Same thing is true with payers, right? So it takes, you know, many, many years

for favorable reimbursement policies, even to happen locally within a small jurisdiction,

let alone nationally, right? And that's typically the order that happens. So the first component is

just thinking about time. And this is a place where people can go into the model and really

make a lot of changes is trying to understand how long the emergence of some of these pipeline

tests will take. So that's the first area that I would mention. I would definitely recognize

that there is a competition risk, absolutely. And I think I've alluded to, you know, a few

companies, I don't want to like say a laundry list of potential competitors. Obviously, we think

exact is still, you know, in a great position relative to those competitors based on how we've

allocated to it and how we've worked it up in our model. But that's certainly another one is

thinking about, okay, other very performant tests that come out, will they be able to take share,

will they be able to change the pricing model such that, you know, exact has to drop its prices

and thus, you know, lose some margin there. So that's something that we factor in into our model

is basically how much market share is exact and titled to win based off of its position

and on the strength of its tests individually. So those are our two big areas that I'd mention.

Finally, I think an important one for our model is getting to, you know, that cat flow positivity

standpoint, becoming self funding and being able to finance its debt, right? So I want to spend

a little bit of time on the financial side as well. I think the company has executed great on R&D

already. We're starting to see the same thing happen on sales and marketing in terms of leverage

on that line. We're going to need to see more of it in order to continue, you know, getting to that

point of true kind of cash flow neutrality and break even. So, you know, being able to consistently

execute, have productive sales cycles, you know, have positive data readouts that are done well,

that absorb, you know, some of that sales and marketing friction. That's one of the great

things about these tests is at some point your body of clinical data does the marketing for you,

right? It makes it a lot easier for your sales people to go out and win if you've armed them

with, you know, great data, right? So there's a lot of interplay between those two things. So we

hope to see more leverage on sales and marketing. We've taken a fully diluted approach with debt.

You know, the company has, I believe, three tranches of debt converts that mature in 2025,

2027, and 2028. And we've factored all three of those into our model in the form of, you know,

stock-based compensation and dilution. So that works against the price target, you know, with

further dilution. You know, we believe that the strike prices will be met at that time based on,

you know, equity appreciation. But that's something where people can go and change those,

you know, to think about, you know, how servicing that debt could affect the valuation. So those are

some places where we see risk to the model, absolutely. And these are the things that we're

most fixated on quarter to quarter when we get, you know, time with the company and we get to see

the new earnings reports. And, you know, the most recent data point is a great indicator.

You know, that's what we're seeing. We're seeing a lot of leverage on sales and marketing.

We're seeing an emphasis on business lines that are already profitable and continuing to be so. So,

yeah, those are the things that we're focused on.

And, you know, when we talk about risk at arc, you know, we also measure a thesis risk on all

of the companies that we invest in. And, you know, that's factored in in the difference between,

you know, our bear and our bull forecast. Tell me about sort of like the full range

of your price targets and kind of the elements that go into each of them.

Sure. Yeah. So on thesis risk, maybe quickly, qualitatively, and then I can get into some

of the numbers for people to look at. But one of the great things about health care and specifically

with something like cancer diagnostics is we're not necessarily burdened by is the market going

to go away or is it going to stop growing? It's a simple function of population growth and, you

know, cancer prevalence and incidence, which are things that are essentially immutable, right?

And so we get a little bit of a tailwind there in terms of thinking about, you know, risk to the

actual market. So let's maybe switch gears a little bit and talk about the company specifically

and some of the places that we've accounted, you know, for, you know, a bull case and a bear

case outcome. So first, I'll mention that the price targets there and get into some of the details.

So our bull case price target at this point is $208 a share and our bear case price target

is $74 a share. What we assume here on a high level is not too different, meaning

the bulk of the valuation still comes from steady growth and increasing profitability within the

core business, again, composed of Kola Garden Oncotype. The revenue figure is substantially

lower. I think it's about $6.2 billion in the bull case and just north of $4 billion

in aggregate in the bear case with a slightly lower, you know, kind of terminal growth rate.

So growing 17% in the bull case and 13% in the bear case. And the reason for that comes up in

a couple places. So in our bear case, we actually make the assumption that several products don't

commercialize at all. Okay. So single cancer screening tests for, you know, things like

esophageal or ovarian cancer, which we think the company, you know, has the capability to put out,

but may choose to deemphasize because they wouldn't be as profitable. And that's something that they've

already kind of done before is divesting less profitable, smaller business lines if they think

that it's not going to help them get to that self-funding standpoint. So that's one thing,

is the elimination of several pipeline products. In addition to that, we across the board assume

less market share, right? So less, you know, ability to capture large portions of the market due to,

you know, competition, for example, maybe it's because it just is not something that guideline

agencies are actually willing to underwrite and to encourage. And so you start to see

kind of a smaller peak for those things. And so for every different pipeline test,

that gets factored in as well. Time, you know, is a natural extension of that. So we have,

you know, a several year difference and when certain things will start to really accelerate

and grow between our bull case and our bear case. We also have kind of friction in the background

in terms of, like, for KolaGuard, for example, you know, how many people are actually willing to

go out and be adherent to cancer screening guidelines, right? It's one thing to get the

guideline enumerated. And it's another thing entirely to actually get the average person to

be able to go out there, get tested. And some of that stuff is outside of exact control, right?

It's a systemic problem. So a lot of different things are kind of factored in that cause you to

get that delta between the bull and the bear case. But generally speaking, I would put them in

commercialization friction, less ability to kind of maintain margin, some slowdown and adherence

to guidelines, as well as timing of some commercialization events. And finally, either go or no go

on certain pipeline assets that may get divested or shuttered, depending on if the company sees fit.

Got it. So the variance is primarily in the, would you say it's in the top line on these,

you know, sort of which products end up in the, you know, your end five year forecast?

Definitely top line. If you think about a lot of those, they make it a lot harder to continue

growing that top line figure. I think on a percentage basis, that's also one of the key

metrics that's the most different between the cases is the top line. But it doesn't end there,

right? So on margin structure, you know, if you assume basically like the ability to continue

growing cogs for, excuse me, shrink cogs, for example, and continue to gain margin, there's

definitely places where the margin structure has to change depending on if things go well.

And, you know, I think I mentioned this already, but we've got a lot of demonstrated history on R&D,

but it's a place where people can actually go in and make these changes to look at what is the growth

rate from here on out going to be for things like sales and marketing, you know, G&A, R&D.

And we think we've kind of adjusted our base case to be pretty conservative, actually, not assuming

a huge amount of like immediate leverage for the company. And they've continued at least over the

past two years to exceed our expectations. So we feel good that those numbers are, you know,

kind of creating a pricing floor rather than being super aspirational. So that's definitely a place

where you're able to actually see not just top line, but also changes to the bottom line that

are causing, you know, EBITDA to drop, for example, right? And do you expect this company to be

cash flow positive in your horizon? Yeah. Well, so let me be really clear on this, right? So the

company tracks, you know, the metric that they've given out publicly, so I'll start there and then

kind of tilt over to how we think about it. They've only formally guided to adjusted EBITDA

break even, right? So you're not accounting for things like stock based compensation or interest

payments or things like that, which are totally real expenses. And we've captured those here too,

right? So we've got stock based compensation adding to the share total and working against the price

target through dilution. But just to kind of give perspective, on a percentage basis,

what exact spends on both stock based compensation and CAPEX is I think about 10%,

which is half that of a lot of companies in its peer group, right? So it demonstrated some success

there, but that's definitely a place where those, you know, you know, gap numbers can

different. So it's important to take note of that. They've not given any formal guidance on

exactly when they expect, you know, sort of net income and cash flow to come through. I think we

definitely expect them to be within our five year time horizon, but we're not giving like an exact,

you know, it'll be in this date in the interim. I want to be really clear about something too.

We don't necessarily want the company to be driving towards something like, you know,

a dividend over the next five years or so. And part of the reason for that, which I think is,

you know, well appreciated for folks that are with the company for a long time,

is that they're really on the foothills of an extremely large addressable market that they have

the ability to capture a pretty large and substantial portion of. So what we'd like to

see them do is continue to reinvest in those activities to grow the business,

while at the same time giving themselves more financial flexibility by being self-funding

and kind of staying in that cash flow neutral position, which, you know, shoring up the debt,

making sure that they retain some flexibility on an M&A front if there were to be an opportunity

later on down the road are things that, you know, we really value and expect from the company over

the next five to 10 years. Great. Okay. Well, Simon, you've clearly done a lot of great work here.

You know, it's all available online again to our listeners, both in big ideas on our website,

the blog that Simon produced, as well as on GitHub, you can look at the model itself.

Also, everyone should check out Simon's Twitter account. It's sbarnetarc. He has a long thread

that he published about EXACT as well, but he's also, you know, just a great follow to hear sort

of more news on the space. I guess, you know, to leave everyone with what are you most excited

about? Like, what's the future? What's the next year, you know, what you're looking for in the

next five years that I should be paying attention to having just learned this story?

I hope a lot of the things that we've talked about today become more of household conversations.

You know, I think we were talking beforehand about how healthcare has the challenge of being not

something that people are like super excited to think about or contemplate, especially if they're

young. But now that we're getting, you know, cancer screening guidelines that are pushing earlier,

you know, for people in their mid 40s to potentially even early 40s, I hope the

conversation around healthcare shifts from something where people are very afraid of it,

don't want to talk about it, only think of it in terms of like high acuity, severe situations,

to taking more charge of their health and like preventing more serious illnesses, right? It's

less so about, you know, extending your life, you know, a certain period of time, more about

extending like the quality of life that you can have over a long period of time. And I think that

these molecular technologies, like yes, they are esoteric and highly technical, but the main change

in health that they're driving is this trend one, towards cost efficacy, so things that are cheaper,

more affordable, and two, less invasive, right? So a lot of these technologies we talked about today,

just a couple years ago would have required surgery being put under anesthesia, having to lose work,

over going and doing, and now we're able to get to the same quality and confidence and answer

purely from things like a blood test, which can be done at home in many cases. And so I'll just

end by saying that I think we're going to see a continuation and a trend in making, you know,

the major components of cancer diagnostics from prevention to diagnosis to treatment and monitoring,

something that is less invasive, more affordable, and more ubiquitous, right? And hopefully that's

something that will continue to accelerate over the next few years. So that's what I'm most excited

about. And people can definitely interact. And, you know, like Tasha mentioned, S-Barnet ARC is my

Twitter. I pinned the thread on exact to my profile, and I'm happy to take questions or answers or

feedback on there if people want to, you know, play around with the model and discuss.

Great. So yet another example of how, you know, innovation really democratizes access. And in

this case, you know, actually improves people's health and safe lives. So, okay, so follow ARC,

follow Simon on Twitter, check out our Bigger Ideas Report to hear more about his great research.

And I'll catch you next time on FYI. Thank you.

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