Cepheid: A Biothreat Bet

10/14/2005 12:00 am EST

Focus:

Michael Shulman

Editor, Short-Side Trader

For those aware of the risks inherent in biotechnology stocks, the ChangeWave Biotech Investor is a truly exciting advisory service. Here, editor Michael Shulman offers a look at Cepheid, a genetic testing firm involved in the emerging "biothreat" arena.

"I first came across Cepheid (CPHD NASDAQ) in mid-2004 while looking for potential winners in the homeland security market. Cepheid was a relatively obscure assembler of detection and testing systems when the anthrax attacks occurred in 2001. The company was in the right place at the right time and managed to quickly and successfully bid on a very large contract to install anthrax detectors in mail-sorting postal facilities, and it is still delivering systems under that contract.

"With funds generated from the Anthrax systems, Cepheid has developed into is a genetic-testing company. It now has more than 3,900 devices installed worldwide focused on medical, industrial, and security markets. It uses a ‘razor and blade’ business model. It sells the hardware unit (razor) with a moderate gross profit margin, and then supplies them with lots of test cartridges (blades) that are required by these systems and which have a much higher profit margin. For example, they have installed 282 systems for the Postal Service, but will ship 2.3 million anthrax cartridges to service these systems in the coming 14 months.

"The company is expanding its ‘biothreat product menu’ and will introduce numerous tests to the market in the next one to two years for smallpox, Ebola, Marburg hemorrhagic fever, Crimean-Congo fever, Venezuelan equine encephalitis, Burkholderia, and Brucella. This is a scary list. Medical tests due to ship in the first half of 2006 are for Group B streptococcus in pregnant women, viral meningitis, and for the superbugs found in hospitals. An important industrial test under development is one for Asian Avian Flu. The test is for poultry, not people.

"Cepheid's revenues were erratic due to spikes in the Postal Service contract, but are beginning to level off. In the past, Cepheid has been a tough stock to own. It has jumped up and down and is still trading in the same range it was in two years ago. But the time for a breakout is near. A pessimistic technician would say the stock could go as low as $5 before finding major support. If you want to gamble on a pullback to that level you can, but I am more concerned that we get in before the new tests are approved and the company begins generating higher margins sometime in first or second quarter of next year."

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