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Analyzing the Latest Novocure 10-K Filing

Ever get annoyed when people ask you for money to cure breast cancer? We do too, but it’s not just because another one of the 1.5 million charities in the United States wants access to our wallet. Never mind there are more than 200 types of cancer, or that each person’s cancer is unique and needs to be treated as such. It’s because we already have a cure for most breast cancer occurrences, something we covered in our piece on Early Detection of Breast Cancer Cures Breast Cancer. Making sure all women are going through regular screenings goes a lot further than peddling pink ribbons on the high street.

A device that helps treat cancer is an intuitive investment thesis because we all know someone that’s been affected by the big “C.” Today, we’re going to talk about a company that’s involved in treating cancer called Novocure (NVCR). The only piece of collateral we’re using for this piece is their latest 10-K filing. This is to show investors how a 10-K can be effectively used to analyze any company.

What Does Novocure Do?

“What’s a 10-K?” some of you might ask. Good question. Make sure you click this link and subscribe to the Nanalyze YouTube channel as we’ll be dropping an instructional video shortly that shows you how to find a 10-K for any company and the basics of how to read one. The first thing we want to understand is what this company does, and the first sentence of the “Overview” section usually provides that information.

We are a global oncology company with a proprietary platform technology called Tumor Treating Fields (“TTFields”), which are electric fields that exert physical forces to kill cancer cells via a variety of mechanisms.

Credit: Novocure 10-K

Sounds like a medical device company we’re dealing with, so we’ll be looking for a razor-blade model that creates juicy recurring revenue streams with high margins. The term “global” points to the company not only having FDA approval to market their device in the United States, but equivalent approvals in the U.K., Germany, Japan, and Canada among others. The current approvals are for glioblastoma (GBM), one of the most complex, deadly, and treatment-resistant cancers. While other types of cancer may be approved down the line, we’re always concerned with how companies make their money today.

Further on in the Overview section we’re introduced to the product offering – a portable medical device that comes in two flavors.

TTFields therapy is delivered through a portable medical device. The complete devices, called Optune and Optune Lua (for GBM and MPM treatment, respectively), include a portable electric field generator, arrays, rechargeable batteries and accessories. 

Credit: Novocure 10-K

Another acronym has been introduced – MPM – which is a rare cancer that has been strongly linked to asbestos exposure. This is probably a good time to talk about what we’re not analyzing.

Patents and Studies

We’ve been doing this for decades, and it took a while to learn the most important thing – what not to focus on when analyzing companies. Life sciences companies can be very tricky to analyze because there’s a temptation to get into the technical details. Some basic facts on efficacy (how effective the therapy is) can be useful in understanding the significance. For example, to understand the gene editing investment thesis it’s helpful to know that Crispr Therapeutics cured people who had an incurable disease. However, when a company is generating meaningful revenues it’s a given they’re offering a service or product that people are willing to pay for. The best metric for adoption is always revenue growth.

Many more factors than efficacy determine success in the life sciences world, so we’re not overly interested in all the technical product details in the 10-K. Ditto for patents, because not even the patent attorneys can predict outcomes once something goes to trial. Look for lawsuits instead, and pay attention to who is leveling the suit. Johnson & Johnson is a much bigger legal threat than a Novocure peer of the same size. But take it all with a grain of salt. It’s common for patent wars to ensue when there’s a big piece of pie to be captured, and again, gene editing is a good example of this.

Looking for Red Flags

In addition to not falling down the rabbit hole of technical complexity, we also want to take the hiring manager approach to conserve time. Look for red flags, because as soon as you find enough of them, you’ve reached a showstopper. No need to continue unless these issues are resolved. Since we’re looking at a medical device company, a quick check for revenue growth and profitability is in order. Note that many growing companies aren’t profitable, which is just fine. To gauge profitability in growth companies we look at gross margin.

Novocure 10-K
Credit: Novocure 10-K and Nanalyze

Two key takeaways from the above table. Revenue growth has stalled and this is a consistently profitable business with gross margins approaching 80%.

Earlier in the 10-K, we noted the company’s estimates of total addressable market for the three primary geographies they operate in. Further on in the 10-K they tell us how many patients are being actively treated in various geographical regions. This allows us to estimate total market penetration – the percentage of patients captured vs total patients that are eligible for the therapy.

Novocure's estimated total market penetration

Given revenue growth has stalled, it’s no surprise that active patient growth has stalled as well which makes us wonder if the opportunity is as big as the company thinks. These devices seem expensive (see below table), and that must enter the equation when they’re being prescribed by physicians. That’s a good segue into total addressable market (TAM). If the opportunity isn’t large enough, why should disruptive growth investors be interested in it?

Now that we know the number of patients in various jurisdictions, we can assign a price per patient which allows us to calculate TAM. Note that the TAM estimates the company provides don’t include Canada, so the opportunity will be a bit larger.

Novocure's revenue by segment'region and patient

Even if the Canadian opportunity is as large as Germany, we’re still looking at a TAM that’s less than $2 billion for an expensive therapy that may have reached a saturation point. Sure, Novocure has a pipeline of other indications they might use the technology for, but we don’t invest in stories. Stalling revenue growth today and a small TAM means this isn’t a firm we’d be interested in exploring any further. But for those of you with more tolerance for risk, we’ll go a bit further.

Cash, Debt, and Size

One metric we can’t get from the 10-K is market cap. A quick trip to Yahoo Finance shows Novocure to be a $3.3 billion company, and one that’s been hyped a lot in the past. Shares of Novocure breached the $220 mark several years ago which would have given the company a market cap of around $23 billion – nearly the size of Illumina. That tells us the market had lofty expectations for the technology which may have been reined in by reality.

Today, Novocure sits on $940 million in cash which is offset by $587 million in long-term debt. Given the company’s gross margins, reining in expenses might be a better option than raising capital. While the company had positive operating cash flows over the past four years, the last several quarters have seen that turn negative. That simply means the company will start eating into their $940 million cash stockpile, but that’s a healthy buffer. All we’re looking for here is whether the company will survive and not pull an Amyris. We’ll typically use Yahoo Finance to look up these metrics as it’s easier than navigating the 63,000-word 10-K (that’s about 42 articles of this size).

If at this point everything looks good, we’ll then proceed to take a second read through of the 10-K paying attention to things like customer/geographic revenue concentration risks which can usually be found in the “Risk Factors” section which is always worth a skim. Additionally, we’ll want to look for any other items that might represent red flags. If all else looks good, we would then move on to looking at an investor deck and/or a latest earnings call to see what management’s talking points are. While there may be explanations and reasonings behind the revenue growth stall, the small size of the current opportunity doesn’t merit further investigation. We’ve hit our showstopper.

Conclusion

Novocure isn’t a company we’d be interested in for the reasons covered in the piece. The bigger takeaway from this exercise is how we might go about analyzing a company we know nothing about. First, we need to know how they make their money which is likely to differ from whatever broad industry label that’s assigned by the GICS folks. Then, we want to know how profitable the business is, how much it’s growing, and how big it could potentially get. Most of this information can be gleaned from the 10-K (or foreign equivalent called a 20-F) for any publicly traded company in the United States.