Is This Ticking Time Bomb A Cornerstone of Your Portfolio?

Brendan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The Supreme Court is scheduled to hear a greatly anticipated case that will provide clarity on the patentability of human genes. Over the past thirty years, biotechnology innovators have secured patents on genes for purposes that are diverse ranging from medical to agricultural products. On Monday, a challenge to Myriad Genetics (NYSE: MYGN) will be heard contesting whether their patent is valid. The Association for Molecular Pathology is challenging the patentability of Myriad’s invention and this case is of huge significance to the industry at large and Myriad specifically.

According to Myriad’s 2012 10-Q filing with the SEC, BRAC testing analysis accounts for approximately 80% of the company’s revenue (Figure 1). This testing provides a comprehensive analysis of BRCA1 and BRCA2 genes in order to access a woman’s risk of hereditary breast and ovarian cancers. If Myriad is unsuccessful in defending its case this revenue will be subject to generic competition, likely resulting in a large decrease in the company's profitability. Because substantial financial resources are required to pursue the case challenging Myriad’s patent, it must be assumed that generic competition would swiftly ensue should the company lose this high profile case.

Figure 1: The Composition of Myriad's Revenue from their latest 10-Q Filing

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Myriad’s stock has significantly trailed the market over the past quarter as visibility of the case has increased. However, the decline in the share price from $27.67 on the first trading day of 2013 to $26.10 at the close of the market on Friday may not be sufficiently discounting the danger to the company if the defense of its patent is unsuccessful. At present Myriad’s TTM P/E is 32.2 not that far off it’s average of 33.0 over the past five years. If Myriad’s future earnings are called into question it is hard to believe that the market will not further discount these earnings and send the share price a good deal lower.

<table> <thead> <tr><th> <p>Company</p> </th><th> <p>TTM P/E</p> </th><th> <p>Price to Sales</p> </th><th> <p>Market Capitalization</p> </th><th> <p>Gross Profit Margin</p> </th><th> <p>ROE</p> </th><th> <p>Price to Book</p> </th><th> <p>YoY Revenue Growth</p> </th></tr> </thead> <tbody> <tr> <td> <p>MYGN</p> </td> <td> <p>32.22</p> </td> <td> <p>5.12</p> </td> <td> <p>2.13B</p> </td> <td> <p>86.7%</p> </td> <td> <p>19.3%</p> </td> <td> <p>3.21</p> </td> <td> <p>21.4%</p> </td> </tr> </tbody> </table>

One significant point in the case is that an amicus brief has been filed on behalf of the United States Government concerning Myriad’s case. This is highly significant because on average when the U.S. Government files such a brief the court very often sides in favor of the argument favored by the U.S. Government. In reading the brief, it seems that the office of the U.S. Solicitor General is quite critical of the scope of Myriad’s patent claim. Specifically the brief mentions that:

“Myriad’s patents have allowed it to dictate the cost of genetic testing, stopped other laboratories from creating and offering new and improved testing procedures, and made it impossible to obtain second opinions that could better inform patients.”

While the brief is technically in support of neither party it seems to cast the scope of Myriad’s patent in a dim light. This position may indicate that the U.S. Government wishes to walk a fine line, invalidating Myriad’s patent while leaving the door open to patentability of human genes in some cases.

Furthermore, it is also interesting to note the statements that the Supreme Court made upon taking the Myriad case. The case was first heard in the Southern District of New York, which ruled against Myriad finding the patent to be invalid. Later Myriad was appealed to the Federal Circuit, which reversed the lower court's decision, finding that human genes were in fact patentable. Upon considering the case, the U.S. Supreme Court initially remanded it back to the Federal Circuit – “For further consideration in light of Mayo Collaborative Services v. Prometheus Laboratories.”

Some further background is required to understand the context of this statement by the Supreme Court. In this case, Prometheus Laboratories claimed a method for administering a drug to patients based on monitoring of metabolites of that drug. They were sued by Mayo Collaborative Services a diagnostic lab and subsidiary of the Mayo Clinic, who did not wish to incur expenses for Prometheus’ method and challenged its patentability. The Supreme Court ruled that the correlation between naturally produced metabolites is part of natural law and is therefore not patentable, reversing the Federal Circuits opinion on the matter.

If you are unfamiliar with lawyer speak, I will translate:

U.S. District Court: We rule against Myriad, human genes are not patentable.

Federal Circuit: We reverse. Human genes are and should be patentable.

U.S. Supreme Court: We would like to call your attention to our Prometheus decision that laws of nature are not patentable. Why don’t you read Mayo v. Prometheus some more and think about it. You don’t really want to be overturned again, do you?

Federal Circuit: We still rule in favor of Myriad,

U.S. Supreme Court: Open up some time on the docket, this is going to be fun.

The fact that the case was remanded on consideration of Prometheus implies that the Supreme Court believes that the Prometheus decision is highly important to the Myriad case. In Prometheus, the Supreme Court ruled against the patentability of natural law, this implies Myriad’s chances for winning the case are low.

In conclusion, it seems at the present time that the market may be insufficiently discounting the danger to Myriad’s business model should they lose this case. It is recommended that investors may wish to exit long positions in either Myriad or other companies that derive the lion’s share of their revenues through genetic testing until more certainty comes to pass. At this time, the risks seem to far outweigh the rewards for Myriad Genetics.

No positions at this time.

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