A Potential Problem With the Recent CareDX IPO

Several months ago we highlighted a promising company called CareDX (NASDAQ:CDNA) which is dramatically simplifying the heart transplant process with their molecular diagnostics test for heart transplant patients. Instead of using a biopsy, an expensive and risky surgical procedure, to determine the immune system’s response to a heart transplant, the CareDX AlloMap blood test can be used instead. CareDX debuted their IPO  last week which raised $40 million in a downsized offering of 4 million shares at $10, well below the range of $15 to $17. The shares are currently trading right around the $10 range giving the company a market cap of around $115 million.

AlloMap has obtained 510(k) clearance from the FDA and more than 55,000 commercial AlloMap tests have been performed in total on 13,000 recipients. The AlloMap test has received positive coverage decisions for reimbursement from Medicare and many of the largest private payers, and as of March 31, 2014, the Company had been reimbursed for approximately 78% of AlloMap results delivered in the twelve months ended September 30, 2013. While the company is operating at a loss, from 2012 to 2013, testing revenue grew from $19.7 million to $21.7 million representing a compounded annual growth rate of approximately 9.8%.

While revenue growth is not spectacular, CareDX has an innovative niche product that could potentially capture a much larger market share especially when they move to sell it internationally. There is however, one concern though that is buried in the S-1 which investors may want to take notice of.

The Roche Issue

In 2004, CareDX entered into a license agreement with Roche for which granted them the right to use Roche’s patented PCR technology in connection with Allomap. In February of 2014, Roche filed a demand for arbitration stating that CareDX failed to report and pay royalties owed to Roche in respect to licensed services performed after July 1, 2011. The amount in question is estimated to be around $3 million. CareDX makes the following statement concerning this event:

We cannot assure you that Roche will not seek to terminate the license agreement, that we would ultimately prevail in the arbitration or that in the event that Roche were successful in terminating the license agreement, that it would not thereafter seek to enjoin us from selling AlloMap based upon a claim of patent infringement. If any of these things were to occur, we cannot assure you that we would not be materially adversely affected. Among other things, any inability by us to continue to perform AlloMap would have a material adverse effect on our business, financial condition and results of operations.

This is most concerning when you consider that Allomap is CareDX’s only product at this time.

The problem is not so much with the potential loss of $3 million of which CareDx has already reserved on their balance sheet. The concern is really twofold.

Firstly, how could CareDx not maintain an understanding with a key partner over royalties that were to be paid, and when there was a dispute, why did they have to seek an arbitrator as opposed to reaching a mutual agreement with Roche?

Secondly, CareDX has now aired their “dirty laundry” and in doing so, has probably raised some eyebrows from investors who realize that the one and only current product offering from CareDX is now at the mercy of Roche. Could this risk factor be behind the significant downsizing of their offering? A hearing for this matter has been scheduled for February 2, 2015, and the impact of that decision on the share price may answer this question.

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