RiverPark Large Growth Fund is bullish on EXACT Sciences Corporation (NASDAQ: EXAS), a molecular diagnostics firm focused on the early detection and prevention of colorectal cancer. In Q2’18 investor letter, RiverPark discussed EXACT, saying that the company could become “one of the highest profit, highest growth companies in healthcare.” Let’s take a look at the fund’s investment thesis on EXACT.
We initiated a new, small position during the quarter in Exact Sciences the developer of the Cologuard test for colon cancer. Colorectal cancer (CRC) is the leading cause of cancer deaths in the US among non-smokers and the second leading cause of cancer deaths overall. Cologuard is the first stool-based home test for early CRC detection and was FDA-approved in 2014, is currently reimbursed by Medicare, Medicaid and a growing number of private payers and is now available through most healthcare providers.
Through early detection, CRC is both preventable and curable and patients that are diagnosed early are both more likely to have a complete recovery and be treated less expensively. Unfortunately, most CRC cancers are diagnosed later in the disease’s progression due to a lack of early screening and only after tangible symptoms (blood in the stool, loss of appetite or change in bowel habits) appear which occur at the later stages of the disease (Stages 3 and 4) when treatment is invasive and expensive and prognosis is poor. All healthcare professionals agree that early detection is the key to both prevention and successful treatment. Of the screening test options available, Exact Sciences’ Cologuard is more accurate than the current blood test option (FIT) and as accurate and materially less expensive and invasive than a colonoscopy.
The current CRC screening market is estimated at $13 billion although that only accounts for the 47 million people in the average risk population currently getting screened. Many researchers believe an additional 36 million people should be included in the risk population for screening and that screening should possibly occur with greater frequency than the current protocol of once every 10 years. As a result, over time, the market could be substantially bigger.
As Cologuard has been FDA approved, added to screening guidelines and approved for reimbursement, Cologuard tests completed have grown exponentially from 4,000 in 1Q15 to 176,000 in 4Q17. For the full year, 571,000 tests were completed in 2017, an increase of 134% year-over-year. Growth in 2018 remains robust at +85% in the first quarter and is expected to remain well north of 50% for several more quarters and +30% for the next several years. The company also anticipates high profitability as it scales with 80% gross margins expected longer term (up from 75% last quarter which was up 1,000 bps year-over-year) and a greater-than 25% operating margin (from negative today) over time. Despite its impressive revenue growth, the company is not yet profitable as it has been investing aggressively to build its distribution and sales infrastructure. We expect a consistent improvement in margins, net income and free cash flow over the balance of this year with sustained profitability ramping into next year. EXAS shares have been extremely volatile and while they are up substantially this year (and over the past several years) they have weakened in recent weeks, affording us the opportunity to buy a small position in what we believe can be one of the highest profit, highest growth companies in healthcare. We would look to add to our position on further weakness or should our research indicate that our estimates of the company’s profit ramp remain too conservative.
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On the share market, EXACT Sciences Corporation (NASDAQ: EXAS) has been performing very well this year so far. Since the start of the year, the stock has moved up 55.63%. The share price of the company has increased 25.96% over the past three months and 75.91% over the past 12 months. The stock, which was closed at $80.60 on Tuesday, has a consensus average target price of $84.70 and a consensus average recommendation of ‘OVERWEIGHT’, according to analysts polled by FactSet Research.
Now take a look at our hedge fund database. We can see that EXACT isn’t a very popular stock among hedge funds tracked by Insider Monkey. There were 31 funds in our database as of the end of the second quarter of 2018 that held positions in the company. Whereas, at the end of the first quarter of 2018, 26 funds were holding shares of the company, according to the database.
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For example S&P 500 Index returned 43.4% in 1958. If Warren Buffett’s hedge fund didn’t generate any outperformance (i.e. secretly invested like a closet index fund), Warren Buffett would have pocketed a quarter of the 37.4% excess return. That would have been 9.35% in hedge fund “fees”.
Actually Warren Buffett failed to beat the S&P 500 Index in 1958, returned only 40.9% and pocketed 8.7 percentage of it as “fees”. His investors didn’t mind that he underperformed the market in 1958 because he beat the market by a large margin in 1957. That year Buffett’s hedge fund returned 10.4% and Buffett took only 1.1 percentage points of that as “fees”. S&P 500 Index lost 10.8% in 1957, so Buffett’s investors actually thrilled to beat the market by 20.1 percentage points in 1957.
Between 1957 and 1966 Warren Buffett’s hedge fund returned 23.5% annually after deducting Warren Buffett’s 5.5 percentage point annual fees. S&P 500 Index generated an average annual compounded return of only 9.2% during the same 10-year period. An investor who invested $10,000 in Warren Buffett’s hedge fund at the beginning of 1957 saw his capital turn into $103,000 before fees and $64,100 after fees (this means Warren Buffett made more than $36,000 in fees from this investor).
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