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Regulatory Uncertainty, Reimbursement Challenges Seen Harming Investments in LDT Developers

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NEW YORK (GenomeWeb) – Biotech has been an attractive sector for investors over the past few years, but omics and molecular diagnostics companies have encountered regulatory uncertainty and reimbursement headwinds that have led some investors to divert capital to more certain sources of return.

While investors and executives in the omics tools and molecular diagnostics sector who have spoken with GenomeWeb are optimistic about the future, they are also cautious because of these regulatory and pricing headwinds. The executives of these firms are considering innovative ways to deal with the uncertainty.

"By and large, the top-tier companies in the molecular lab space are growing and addressing important clinical needs," Evan Jones, CEO of Gaithersburg, Maryland-based OpGen, told GenomeWeb. "From the viewpoint of an investor, these companies appear to be undervalued in the public markets."

Through jVen Capital, a life sciences investment company he founded, Jones has been supporting the development of companies in the LDT space for close to a decade, ranging from startups to later-stage investments. Jones was co-founder and CEO of Digene Corporation, a company focused on women's health and molecular diagnostic testing that Qiagen purchased in 2007 for approximately $1.6 billion, and he is a board member of Fluidigm, Foundation Medicine, and Veracyte.

Jones said that when he speaks to fund managers and investment bankers, they say constraints for life sciences companies in general are driven by reimbursement risk, including political dialog around over-inflated drug prices. This has an effect on all life sciences segments, he said, including the omics and MDx space. 

In looking at molecular test company investments, there are a couple of key factors. "One is reimbursement headwinds and lack of predictability," Jones said. "That is probably number one on the list for investors, and that has caused capital intensity for the business that probably was not predicted. Companies are growing but probably not as fast as they could, because they can't get appropriate payments from third-party payors."

He cautioned that announcements by CMS regarding reducing test price reimbursements, even if they are later reversed, also can have a long-term negative impact on company valuations.

Investors and executives acknowledge that regulatory uncertainty for companies making LDTs is a second key factor, he said. "It probably hasn't impacted company performance," Jones added, "but if you are looking for reasons to not invest, that potential overhang can certainly weigh on people."

In a research note that addressed a recent sharp sell-off in Myriad Genetics shares (the company is down 38 percent in the past three months), Wells Fargo analyst Tim Evans, analyzing MDx company valuations, wrote that while each diagnostic story is different on a company-specific level, reimbursement, regulatory, and competitive issues are similar across the industry.

"We are left to draw one of three conclusions," he wrote. "Either (1) [Myriad Genetics] is undervalued relative to peers, (2) investors are counting on several companies to buck the difficulties experienced across the industry over time, or (3) several companies other than [Myriad Genetics] have become overvalued to various degrees as investors are left without profitability metrics to ground valuations. Given our underweight rating on the diagnostics industry and our view that the industry is likely to struggle with profitability, we think the second explanation is more likely."   

After several years of public debate and deliberation, the US Food and Drug Administration in October 2014 took active steps toward regulating LDTs, a responsibility that has been under the purview of the Centers for Medicare and Medicaid Services through the Clinical Laboratory Improvement Amendments.

In its draft guidance on regulating LDTs, released in 2014, the FDA proposed a risk-based regulatory framework. The agency said it planned to continue to exercise enforcement discretion for Class I devices, as well as for LDTs for rare diseases and for unmet medical needs. For Class II and Class III LDTs, or moderate- to high-risk tests, FDA would phase in registration, listing, adverse events reporting, as well as 510(k) and premarket review requirements, over a nine-year period.

As of now, the FDA still has not released the final rule.  

"We now believe that the final draft of the FDA LDT regulations are unlikely to come out this year," Piper Jaffray analyst William Quirk told GenomeWeb. "We suspect that some political pressure internally may be holding it up. Institutions such as the Mayo Clinic have estimated the costs to come into compliance and, candidly, they are quite high, and it is my suspicion that a legislative option is probably the most likely outcome."

If that were to be the case, he said, he expects that the release of the final draft would take place during the congressional session in 2017.

In what many lab professionals see as a related development, the FDA in July released two draft guidance documents outlining how it might review the analytical and clinical validity of next-generation sequencing tests, which encompass technology that is quickly dominating genetic testing.

The FDA has tried to keep this work separate from the ongoing controversy surrounding its proposal to regulate LDTs. However, lab industry professionals fundamentally opposed to FDA oversight of activities and processes they consider to be the practice of medicine and beyond the agency's statutory authority said that they were not interested in softening their stance.

Perhaps in an attempt to keep the LDT controversy from derailing its efforts to advance standards for NGS, at public workshops to discuss regulatory approaches the FDA requested participants not bring up the LDT issue. The agency even took to Twitter to distance the two draft NGS guidances from the LDT debate.

But this attempted separation seems contrived to lab professionals on the ground.

"This is an issue that I have lived with personally now for 10 years," Kevin Krenitsky, OpGen's president, told GenomeWeb. "Now, [FDA] have released a couple of documents that I would say clears the way for them to get into beginning to regulate some of these LDTs, and I think they are going to start with those that fall into a higher risk category. My sense of this, even throughout my years at Foundation Medicine [as chief commercial officer], was that it causes companies to engage in meaningful discussions with the FDA, and companies that are doing good science and producing high quality tests engage the FDA in discussions earlier.

"My experience on the investment side shows that the regulation debate hasn't really affected investment into omics companies as much as broader issues such as the third-party reimbursement for diagnostics," he said. "There are literally dozens of venture capital groups that have said they are not investing in diagnostic companies any more until the reimbursement issue is fixed."

Because of restraints such as the pending LDT regulations, pricing, and investment uncertainty, firms developing LDTs have to come up with innovative growth strategies.  

"Uncertainty related to lab developed tests is having a profound effect on the way that a lot of companies are thinking about their strategies," Kevin Hrusovsky, CEO of Quanterix, told GenomeWeb. In 2011, Hrusovsky was CEO of Caliper Life Sciences, a producer of imaging and detection solutions for life sciences research, diagnostics, and environmental markets, when PerkinElmer acquired the company for approximately $600 million in cash.

"I think this issue is causing a lot of executives to think carefully about the kinds of tests they want to launch," he said. "One executive I spoke to recently said that their whole strategy was to rule out versus rule in — they are going to focus on using their test to rule out the possibility that someone has a disease versus saying that someone has a disease. Their belief is that, in this way, they are going to be in a much better position to get reimbursement and not be as regulated," he said.

"I think it is a tightrope walk that you'll probably see people doing in LDT markets," Hrusovsky added. "It seems that the reimbursement authorities are more willing to pay if a test is going to reduce cost associated with knowing whether a person has a certain disease or not."

Another strategy that Hrusovsky sees taking shape is one in which LDT companies try to minimize risk by also minimizing the test's claims. In this scenario, the test results provide a level or reading for a certain biomarker, for example, and the test company leaves it to a separate party — potentially the person ordering the test, which could be a physician — to interpret its meaning based on relevant information in scientific literature.   

For its part Quanterix is also exploring a relatively new approach that allows it to avoid the risks associated with the potential for FDA regulation of LDTs, Hrusovsky said. "We are exploring pharma services, where pharma companies are doing trials related to how certain biomarkers are affected by certain drugs of interest," he said. "In those cases, while having CLIA certification is certainly important, not much regulatory approval is required on the part of the lab-developed test company because the pharma companies are running the clinical trials."

As for industry winners and losers when and if LDT companies become more regulated, Hrusovsky said he believes that the large reference labs, such as Quest Diagnostics and Laboratory Corporation of America, will probably see increased regulation as a barrier to entry that they will be able to leverage as an advantage. Smaller labs are going to be less willing or able to take the regulatory path, he said, because of the level of scientific rigor they need to navigate as well as the expense associated with that path.

"Although it will cost [the larger reference labs] money to participate, because they will need to do more clinical studies and get FDA clearances, I don't think they will mind that extra investment because they will be able to reap the return," Hrusovsky said.

Quest Diagnostics didn't reply to that suggestion directly, but in a statement to GenomeWeb said that it believes that lab-developed tests are critical to keeping pace with the changing landscape of medicine, and its position on LDT regulation is aligned with that of its trade association, the American Clinical Laboratory Association, which asserts that LDTs are not medical devices and the agency lacks statutory authority to regulate them.

Quirk said he certainly respects the viewpoint that the larger reference labs could stand to gain from the implementation of regulations on lab-developed tests, but "based on the preliminary FDA draft guidelines — which may or may not, and we are leaning towards may not, be released [as the final guideline] — there was an important provision where the FDA would allow published data to be included in their submissions, and in that case certain smaller, specialty labs have several peer-reviewed publications."

These specialty labs include Genomic Health, Myriad, Veracyte, CareDx, and Natera, for example. "Thus, we assume under the draft guidance these labs would indeed be allowed to include the publications in their submission," Quirk said, "which implies that the overall cost of receiving FDA clearance would in some instances be less. In other words, these labs don't have to reinvent the wheel as part of their submission."

Peter Maag, CEO at CareDx, said that at the present time he sees hesitation in the molecular diagnostics industry in general with respect to additional funding coming in. "The original venture funding model is challenged in molecular diagnostics," he said, "as reimbursement for tests will require pharma-like clinical utility studies. The turnaround time for these investments tends to be longer than in the past, and the shift from a CLIA lab into a different regulatory and reimbursement environment is a key hurdle for the industry right now.

"I would believe that money is being diverted into other areas of biotech as a result of the challenging regulatory and reimbursement environment," said Maag. "Four or five years ago, the FDA regulatory environment was the center piece. Right now, CMS is having a significant effect on decision making."

Piper Jaffray's Quirk sees the pending LDT rule as having a variety of effects on the omics and molecular diagnostics space. "For LDTs currently in development, we believe labs will need to conduct analytical and clinical validity studies to receive FDA approval," he said. "We estimate R&D expense for these trials is ~$500K-$5M. Additionally, clinical trial setbacks could delay a test's launch, potentially impacting revenue forecasts."