CareDx (CDNA) Under Fire From Short Seller
Every now and then one of our stocks is the target of a short report by a myriad of research houses that try to make the case that a company is garbage and its stock is wildly overvalued. Their playbook usually goes something like this:
1) Find a stock that’s done really well.
2) Short it.
3) Write a short thesis report and distribute it via the web for free.
4) In that report:
a. Try to figure out a few compelling angles from which to attack the business.
b. Make bold statements that are lightly supported, and keep themselves out of court by saying “in our opinion” over and over.
c. Ignore important aspects of the business because addressing them undermines their “thesis.”
d. Write a lot. Then write a lot more. This gives the impression of intensive research.
5) Wait for the stock to go down as many investors think the research is legit and wiser investors short it too, knowing that these types of attacks seem to work.
6) Wait for the selling to abate, then cover their short, make money, and look for the next target.
7) Watch the stock they attacked go back up.
The target right now is CareDx (CDNA), which you all know (if you’ve been reading my research) specializes in diagnostic blood tests for organ transplant, namely heart and kidney transplants.
The attacker is Kerrisdale Research. The piece is published on Seeking Alpha, where the editors continue to give articles like this their “Editor’s Pick” designation. I don’t know why.
Following the playbook, the article is long, full of what seem like well-researched details but are mostly big overstatements of dubious accuracy, and tries to hit it home with bold statements. Potential risks are overhyped; real qualities are denigrated.
For example, when describing the AlloSure test, the author writes, “But alas, as hard as CareDx has tried to finesse the numbers into telling a good story, it’s difficult to escape the simple fact that AlloSure is mostly useless, and potentially dangerous if used improperly, in our opinion.”
To which I respond, first, the numbers are what they are. Second, AlloSure (by Kerrisdale’s analysis) has generated almost $31 million in revenue over the last 12 months—does that mean clinicians are just grossly negligent across kidney transplant centers in the U.S.? And third, an organ transplant rejection diagnostic test is potentially dangerous if used improperly? Wow, that’s some hard-hitting research. Kudos!
Further down, on page 687, Kerrisdale offers this nugget when talking about CareDx’s Heart transplant test, AlloMap: “… on its own, AlloMap was never more than marginally profitable, and we think its stand-alone value is negligible.”
To which I respond: So you think that a test this company has been selling since 2008, that generates over $3,240 per test, is used in 115 of the 127 heart transplant management centers in the U.S, and which was used 16,116 times in 2018, generating well over $30 million in revenue, has “negligible” value? CareDx also generates over 20% of revenue from other products, including TrueSight HLA products that are licensed from Illumina. I suppose this revenue stream is of negligible value too.
The exhausting thing about these types of short reports is that there is enough there to make you concerned. You get the same feeling when your read through the “Risks” section of every company’s 10K and 10Q SEC filing, which explains every conceivable way the business could be negatively impacted (ironically, they don’t list potential short-seller attacks!).
The truth is no company we invest in is perfect. There are risks. And a lot of our small-cap opportunities are earlier stage than large caps, which have risks too! The diagnostic tests CareDx is developing today will evolve, get better, and, hopefully, help more people in the future than they do today. That’s called growth.
Revenue was up 60% last year, should be up 50% this year, and is expected to rise 33% in 2020. CareDx should also be more profitable this year ($0.08) than expected, then grow EPS by 625% to $0.58 in 2020. That’s why the stock is doing well.
It’s not practical to address everything Kerrisdale writes as potentially negative. Yes, CareDx has competition for its tests. True, the tests don’t work perfectly, 100% of the time, for 100% of patients that may be in need of, are in need of, or had, an organ transplant. And yes, some doctors will stop requesting the test. There is also a current limit on Medicare coverage for transplant patients after three years, which doesn’t help test volume as patients mature (the Department of Health And Human Services is working to extend this).
We’ve seen this before with other stocks. CareDx will go down. How far, I don’t know. I suspect no more than 25% from yesterday’s close before it will stabilize.
Then, after a little time passes, the stock will go back up. How far and how fast will be determined by the results it turns in. After a little while, if the business continues to do well, investors will forget completely about this report.
I’ve had CareDx at buy and am keeping it there for now. I suggest being cautious, watching, and waiting for some signs of leveling off. Then buying more.
As of mid-day Tuesday we’re down around 13% on the day, and 22% from the stock’s high. I think you can dip another toe here. But keep an eye on the 200-day line down near 29. If we go through that there will likely be a wave of selling from traders who follow that technical signal.
Ultimately, after the stock stabilizes and goes back up some, you can take partial gains on the extra shares you purchased around these levels and get back to a more normal position size.
As always, if something MATERIALLY negative happens, my rating will change. But it won’t be because of some hack research job that has a clear motive to drive the stock down!