JuSun
Investment Thesis
What started as a seemingly innocuous leadership transition at NeoGenomics, Inc. (NASDAQ:NEO) has evolved into something much more chaotic. After the departure of former CEO and company veteran Douglas VanOort last year, things quickly turned toxic after the abrupt departure of his successor Mark Mallon and the board’s search for his replacement in haste. After tumultuous months, the company has a new CEO, Chris Smith, who took the reins last August.
Third quarter results released last month offered little insight into how the new leadership will impact the company’s future, given that most of the decisions during the quarter were made by the company’s Chair and her emergency council formed of Bill Bonello, former CFO, and Doug Brown, former Chief Strategy Officer, both of which resigned after Smith’s appointment to the position, with the news of Mr. Bonello’s departure coming just yesterday.
In the previous article, I mentioned that, unlike the former CEO, Mr. Smith would likely make some leadership changes. How does this impact the business, and what can we infer from these changes, especially given the new CEO’s remarks on optimizing the portfolio? After all, Mr. Bonello helped drive the company’s strategy when he was part of the leadership team and founded the informatics division, the unprofitable segment which has long been touted as one of the company’s key growth drivers.
Are Write-Offs on the Horizon?
In the previous article, we mentioned the prospects of write-offs as a potential risk facing NEO in Q4 after Mr. Smith’s comments on portfolio optimization and what I saw as a critical remark about the entrepreneurial spirit built by his predecessors. His comments implied a strategic focus away from strategic value creation and instead focused on short-term value maximization. This is pretty significant for NEO, given that more than half of its assets consist of Goodwill and Intangible assets subject to potential write-downs depending on the outcome of their strategic review as we advance from here. Let’s look at the financial details to get a clearer picture of how this might play out.
As of September 2022, NEO recorded $523 million and $417 million in Goodwill and Intangible assets, respectively, on its balance sheet. Goodwill is related to what the company deems as indefinite intangible assets, including those related to synergies from its acquisitions, and thus are not amortized, unlike intangible assets. However, each quarter, this balance is assessed for impairment. Last quarter, the company wrote off $4.5 million due to an accounting error in the previous quarters. This amount is immaterial, and we won’t be discussing it in this piece.
The company allocates Goodwill across its two operating segments; Clinical services, which include its cytogenetics offerings such as FISH, Karyotyping, Fluorescent in-situ hybridization (FISH), Microarray, and other advanced molecular diagnostic tests such as Next-Generation-Sequencing including the liquid biopsy offerings it inherited from the Inivata acquisition. Below is a compiled table to show NEO’s Goodwill by segment:
Table 1: Goodwill Balance as of September 30, 2022. Figures in 000s
|
Clinical Services |
Pharma Services | Total | |
| Balance | $ 458,782 | $ 63,984 | $ 522,766 |
The majority of the Other Intangible assets recorded on the balance sheet relate to management’s estimates of future cash flows expected from developed technologies it acquired from its acquisitions, namely Inivata and Trapelo in 2021, HLI in 2020, Genesis in 2019 and Clariant in 2016. The balance also includes assets related to consumer relations, trademarks, and brand names, as shown in the table below:
Table 2: Intangible Assets Balance as of September 2022. Figures in 000s
| Balance | |
| Customer Relationships | $ 89,929 |
| Developed Technology | $ 282,439 |
| Marketing Assets | $ 345 |
| Trademarks | $ 28,774 |
| Trade Name | $ 1,914 |
| Trademark – Indefinite lived | $ 13,447 |
| Total | $ 416,848 |
One possible outcome of restructuring is shifting focus away from unprofitable biopharma accounts. The company might also reorient its focus geographically to the US, which entails winding down its European operations inherent from the Inivata acquisition. From my understanding, Bioinformatics is also unprofitable at this moment and is an unestablished business model with unclear reimbursement pathways. We see these dynamics in SOPHiA GENETICS (SOPH), the only pure bioinformatics pure-play publicly-traded company. Any of these changes could force management to revisit their profitability assumptions, leading to a possible asset write-down.
Finally, we see a shift in market position in the molecular diagnostic space, with Fulgent (FLGT) transitioning from a micro-cap to a billion-plus business in the past eighteen months, thanks to its COVID-testing business blooming in 2021 and early 2022. FLGT now sits on nearly $900 million of dry powder on top of its recent acquisitions in the molecular diagnostic space. As FLGT continues investing in its growth initiatives, one can imagine a scenario where it takes market share from NEO, which, again, could push the company to adjust the profitability assumptions of its intangible assets.
Where Can I be Wrong?
A significant portion of NEO’s intangible assets and Goodwill relates to Inivata, a high-growth company with a robust addressable market. The liquid biopsy platform for Minimal Residual Disease “MRD” under the RADAR brand and its tumor profiling business under the Invision brand is pretty scalable and can be expanded into multiple indications. NEO bought a purchase option for Inivata in May 2020, locking in a favorable price before the sector’s rally in 2021. Even today, with the stock market crashing, one cannot find a liquid biopsy platform at the same price NEO bought Inivata. Thus, a significant portion of NEO’s intangible assets is tied to a quality asset with significant market potential.
Secondly, NEO’s consumer-focused approach differentiates it from the competition, namely the up-and-coming FLGT, which I believe has a governance problem. There is a wide discrepancy in the two company’s approaches to unlocking synergies from M&A. NEO applies its successful playbook to acquired assets to unlock value. At the same time, I see FLGT doing the opposite, attempting board talent and operational blueprints to improve its core business operations.
Summary
After a tumultuous year, NeoGenomics, Inc. finally has a CEO who could offer some guidance into the company’s strategic direction in the coming years. It is too early to assess the impact of the new NeoGenomics, Inc. management team on the company’s performance, but I am cautiously optimistic. NeoGenomics, Inc. is a valuable asset with a strong, consumer-focused market position. However, management’s restructuring plans carry asset write-down risk on Goodwill and Other Intangible asset balances. Yesterday, another company veteran, Bill Bonello, left the company, adding more questions as to the future direction of the company.
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