Cogstate Ltd. (CGS) 7 August, 2017 Outperform 4Q17: Slow Growth, but CGS is Well-Positioned Price Target: $1.27 Elyse Shapiro eshapiro@taylorcollison.com.au +61 4 9126 7142 Summary (AUD) Market Capitalisation $125M Share Price $1.08 52 week low $0.60 52 week high $1.39 Ave Monthly Vol (year rolling) 47.99K Key Financials (A$ million) Year End FY16 Act. FY17 Est. FY18 Est. Revenue ($m) 27.3 35 (Act.) 44.9 EBITDA ($m) 1.4 0.3 4.0 NPAT ($m) 2.6 1 4.4 EPS (c) 2.4 0.6 3.9 EPS Growth (%) 150% -76% 584% Diluted EPS PE (x) 2.3 21 0.5 116 3.6 26 EV ($M) 113 133 134 EV/EBITDA (x) 81 221 34 ROE 20% 7% 27% Share Price Graph (AUD) The Taylor Collison Insight CGS announced full year earnings for FY2017. Full year revenues were $35M, which was in line with our estimates of $34.5M. We remain optimistic about the mid and long term growth trajectory for CGS, given A$12M in sales contracts were delayed for reasons out of the company s control. We look forward to an improved 2018, especially if there is positive newsflow in the Alzheimer s space. FY2017 reported revenue of A$35M, which was in line with our expectations of $34.5M. 4Q17 new contract revenues signed were US$5.6M although there was a cancellation of a contract worth $US2.6M during the quarter. Recognized signed revenues for 4Q17 was A$7.3M. The total value of sales contracts during FY17 was US$29.5M, or A$39M. We like the growth in contracted revenue backlog, with US$28.7M (A$37.3M) expected to be recognized in FY18 and beyond, which is a 14% improvement over last year s revenue backlog. As of June 30, 2017, CGS had cash of A$9.3M. Net operating cash inflow as $0.2M in 4Q17. What we expect going forward. CGS announced that A$18.8M of revenue from existing contracts is expected to be recognised in FY18, and we model 2018 revenues at $44.9M, which we think is feasible if the company continues to win new business in early FY2018. There continues to be significant big-pharma interest in the Alzheimer s Disease (AD) space, but we anticipate Alzheimer sbased headwinds to growth, based on increased scrutiny around Alzheimer s trials, and a general reduction in preparedness for big pharma to make decisions to invest in new AD programs, especially following two key trial misses in the Alzheimer s space this year. However, we think that any positive data in the AD space could help be a catalyst to increase big pharma eagerness in the AD space. Full year numbers and more guidance expected 22 August 2017. We caution investors not to rely heavily on the recent update from CGS, since it provides little insight into details around revenue generation and spend. We expect the company to provide guidance around investments in the healthcare program, clinical trials business, and technologies. This should help us better model growth potential going forward in the clinical trials business, which we see as the key revenue generator for the foreseeable future, at least until the healthcare offering becomes commercialized and begins to grow, pending approval and uptake. We think the company is now in a period of investment, and is preparing itself for growth in its existing clinical trials business as well as expansion into the healthcare business. Given previous and near-term investment in the healthcare business, current expenditures are not directly proportional to earnings, but we think such investments are necessary for the future success of the company. Real upside in the broader healthcare market. CGS earned a Class II 510K approval for Cognigram, a cognitive assessment system which is designed to be used by the broader healthcare market. The company is evaluating commercial launch plans and target customers, and we are optimistic about the commercial potential of the product, since it has a broader applicability than the clinical trials business, with substantially improved margins. Management will provide an update on commercial plans on the FY2017 earnings call. Indications of success in ongoing AD trials will increase confidence in the healthcare offering, since the availability of a disease modifying drug would validate the need for a diagnostic tool which would impact treatment.
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Cogstate Ltd Page 3 of 6 Revised Price Target of $1.28, using blended DCF with EV/EBITDA multiple. We increased our 1-year price target to $1.27 from $1.20 based on a blended DCF and EV/EBITDA multiple of 11.8X, which is a standard CRO (Contract Research Organization) industry average multiple. The EV/EBITDA analysis implies a price target of $1.28, and the base case DCF implies a price target of $1.26. CGS EV/EBITDA Valuation We still only use revenues and costs from the clinical trials business as a base for EV/EBITDA the valuation, although we note updates on commercial plans for Cognigram, as well as indications of early sales growth, could trigger a re-rating, and we have included modest healthcare revenues in the DCF valuation. We think 11.8X is quite conservative, and that a more bullish valuation would fall in the higher end of the range (around 14X). This is because CGS offers a unique offering in the central nervous system therapeutic area (and more specifically, Alzheimer s space), and could make a meaningful addition to a larger CRO s core offering. A potential acquirer could expand their margin, by utilising their already existing infrastructure in combination with CGS s tech and expertise. Additionally, given the small size of CGS vs other CROs (contract research organization industry giants like Parexel, Quintiles, INC), a higher multiple could be feasibly achievable. (all figures in A$M) FY15 FY16 FY17E FY18E FY19E FY20E Revenue 15.7 27.1 34.8 45.5 59.2 76.9 Cost of sales -4.9-6.5-8.9-11.8-14.8-19.2 Cost of sales as % revenue -31% -24% -26% 26% 25% 25% growth -26% -34% -37% -40% -40% 60% Margin 10.8 20.6 25.9 33.7 44.4 57.7 Net recovery 0.2 0.0 0.1 0.1 0.1 0.1 SG&A -1.9-4.8-6.0-7.7-11.2-15.4 G&A as % revenue -12% -18% -17% -17% -19% -20% Direct Trials Contribution 9.1 15.8 20.0 26.0 33.2 42.4 Other (rent, marketing) -2.7-2.4-2.8-3.1-3.4-3.7 Other OpEx -6.7-7.9-9.5-11.4-13.1-15.1 Net Clinical Trials Contribution -0.4 5.4 7.6 11.6 16.8 23.6 EBITDA (X) 11.8 11.8 11.8 11.8 Implied EV 90.3 136.5 197.7 278.9 +Cash 99.6 145.8 207.0 288.2 Implied Market Cap 99.6 145.8 207.0 288.2 Implied price/share 0.89 1.28 1.79 2.44 CGS DCF We incorporate both clinical trials and modest healthcare revenues into the DCF calculation, although more information on the healthcare program, especially around costs and specific market targets, could trigger a revision. Based on the DCF, we reach a price target of $1.26.
Cogstate Ltd Page 4 of 6 Cogstate DCF Model (Base Case) (all figures in $M) 2018E 2019E 2020E 2021E 2022E 2023E Clinical Trials Revenues 45.5 59.2 76.9 100.0 130.0 168.9 Healthcare Revenues 0.0 2.0 4.0 8.0 12.0 20.0 Total Revenue 45.5 61.2 80.9 108.0 142.0 188.9 Revenue growth 30% 30% 30% 30% 30% 30% - cost of sales -19.6-23.6-28.4-40.0-52.0-59.1 Cost of sales as % of revenue 43% 40% 42% 40% 40% 35% Cost of sales growth 30% 21% 20% 41% 30% 40% - Trials employee benefits -13.3-15.5-19.1-21.0-23.1-25.4 Employee benefits as % of revenue 29% 26% 25% 21% 18% 15% - G&A -2.3-2.8-3.3-4.1-5.1-6.1 G&A as % of revenue 5% 5% 4% 4% 4% 4% G&A growth 9% 21% 15% 25% 25% 20% - Marketing -0.70-0.81-0.93-1.16-1.45-1.82 - Professional Fees -0.49-0.60-0.66-0.73-0.80-0.88 - Other -0.99-1.49-1.42-0.87-0.95-1.19 Net profit 8.25 16.58 27.34 40.42 58.85 94.62 Tax -2.06-4.15-6.84-10.11-14.71-23.65 Profit ($M) 9.19 12.44 20.51 30.32 44.13 70.96 DCF (Implied market cap, $M)) $138.08 Price Target (A$ per share) $1.26 We are optimistic following Cognigram approval, and await additional colour around commercial plans going forward from the company. CGS announced that its new healthcare product offering (COGNIGRAM) received a 510K approval for the cognitive assessment system which is designed to be used by the broader healthcare market. We like that the approval came in a few months earlier than expected, but do not think there is a reason to buy-in at least until we get a better idea of the commercial plan, potential size of contracts, leads that the company has already made in efforts to grow this business, and reimbursement from payors. Approval for the device was highly likely in our, management s, and the market s view, since it was a Class II device (ie doesn t require as much scrutiny as a Class III device such as an artificial heart valve). Nonetheless, we like that a robust body of data has been generated to develop Cognigram, and think that there is a real need for the test, especially in the primary care setting, where physicians may not be sufficiently equipped to deliver comprehensive cognitive tests to each of their at-risk patients on a regular basis. Cognigram, the product, is a digital, self-administered test, which can be used in the clinic or at home. The product can be used on a single occasion (for example, post-surgery, or after the delivery of a certain therapy which may have a negative impact on cognition), or periodically (for example, delivering the test every year in patients over the age of 65, to determine whether the patient is experiencing cognitive impairment potentially associated with Alzheimers). We are optimistic about the commercial potential for the healthcare product, since it has a much broader applicability than the clinical trials business, and gives the company a broader platform to operate on. The healthcare offering is much more scalable, and has better margins than the clinical trials business. Rather than the ~50% margins associated with the healthcare program, which requires a large amount of human capital, the healthcare offering, once commercialized, will likely rely on contracts from vendors that will require much less oversight. The company has already made key hires in the healthcare division, and we anticipate incremental costs to be added to sales and marketing for this product (although not nearly as high as that for the clinical trials component of the business). Good data in late-stage Alzheimers, and potential of a disease modifying drug would create a dramatic improvement the landscape for both the clinical trials business as well as the healthcare business, since data generated would have a direct impact on treatment. We look forward to additional color on the specific launch strategy for Cognigram on the earnings presentation in August. Based on our understanding of the product, there are multiple ways for the company to market the product. We think, initially, the company s priority will be to generate a body of data supporting the cost and clinical utility of the test, and management has indicated that it would offer initial customers access to the technology at a discount, in order to build brand name and generate a data package showing the impact Cognigram has on clinical outcomes and hospital expenditures. Below, we describe a few potential ways (or combination of ways) CGS could begin their commercialization plans:
Cogstate Ltd Page 5 of 6 1. Partner with electronic health record companies and integrate into their platforms. Revenues could be provided per-test or per-site administered. We think this would be the hardest for CGS to pull off, but it would provide the greatest benefit in terms of breadth of market and size of data package. 2. Market to specific large-scale US Healthcare systems. The product would have potential use in (but not limited to) Alzheimers, neuropsychiatric disorders, mood disorders, multiple sclerosis, Parkinson s, and to evaluate the effect of medication or surgery on cognition. Hospital systems could also opt to use Cognigram in their affiliated primary care groups at no additional cost. Management indicated that starting prices for a license to a healthcare system would be around $100K/year, which we think is quite low, but think that the low cost would make be appealing for hospital administrators to initially agree. 3. Smaller scale (guerrilla) marketing strategies to individual physician practices, elder care organizations, schools, and sports teams. We do not see this as the primary marketing tool, since it seems much more labor intensive for a smaller pay-off.
Cogstate Ltd Page 6 of 6 Disclaimer The following Warning, Disclaimer and Disclosure relate to all material presented in this document and should be read before making any investment decision. Warning (General Advice Only): Past performance is not a reliable indicator of future performance. This report is a private communication to clients and intending clients and is not intended for public circulation or publication or for the use of any third party, without the approval of Taylor Collison Limited ABN 53 008 172 450 ("Taylor Collison"), an Australian Financial Services Licensee and Participant of the ASX Group. TC Corporate Pty Ltd ABN 31 075 963 352 ( TC Corporate ) is a wholly owned subsidiary of Taylor Collison Limited. While the report is based on information from sources that Taylor Collison considers reliable, its accuracy and completeness cannot be guaranteed. This report does not take into account specific investment needs or other considerations, which may be pertinent to individual investors, and for this reason clients should contact Taylor Collison to discuss their individual needs before acting on this report. Those acting upon such information and recommendations without contacting one of our advisors do so entirely at their own risk. This report may contain forward-looking statements". The words "expect", "should", "could", "may", "predict", "plan" and other similar expressions are intended to identify forward-looking statements. Indications of and guidance on, future earnings and financial position and performance are also forward looking statements. Forward-looking statements, opinions and estimates provided in this report are based on assumptions and contingencies which are subject to change without notice, as are statements about market and industry trends, which are based on interpretations of current market conditions. Any opinions, conclusions, forecasts or recommendations are reasonably held at the time of compilation but are subject to change without notice and Taylor Collison assumes no obligation to update this document after it has been issued. Except for any liability which by law cannot be excluded, Taylor Collison, its directors, employees and agents disclaim all liability (whether in negligence or otherwise) for any error, inaccuracy in, or omission from the information contained in this document or any loss or damage suffered by the recipient or any other person directly or indirectly through relying upon the information. Disclosure: Analyst remuneration is not linked to the rating outcome. Taylor Collison may solicit business from any company mentioned in this report. For the securities discussed in this report, Taylor Collison may make a market and may sell or buy on a principal basis. Taylor Collison, or any individuals preparing this report, may at any time have a position in any securities or options of any of the issuers in this report and holdings may change during the life of this document. The preparation of this report was funded by ASX in accordance with the ASX Equity Research Scheme. This report was prepared by Taylor Collison and not by ASX. ASX does not provide financial product advice. The views expressed in this report do not necessarily reflect the views of ASX. No responsibility or liability is accepted by ASX in relation to this report. Analyst Interests: The Analyst(s) may hold the product(s) referred to in this document, but Taylor Collison Limited considers such holdings not to be sufficiently material to compromise the rating or advice. Analyst(s) holdings may change during the life of this document. Analyst Certification: The Analyst(s) certify that the views expressed in this document accurately reflect their personal, professional opinion about the financial product(s) to which this document refers. Date Prepared: August 2017 Analyst: Elyse Shapiro Release Authorised by: Campbell Taylor