Investment Summary

Initiating coverage of Genetic Technologies (GENE) with a BUY rating and $7.50 PT.  We view GENE as a relatively well capitalized potential consolidator in the small cap molecular diagnostic group. With the launch of its first test in the U.S. – BREVAGen for breast cancer risk associated with somatic mutations – and significant potential revenues from monetizing its intellectual property estate, we believe GENE is assembling both the commercial infrastructure and capital reserves to be an acquirer of niche products and specialty tests. Following the rapid expansion of molecular diagnostic products over the past five years, in our view, the sector suffers from a glut of content but a limited supply of companies with commercial infrastructure and regulatory expertise. In this environment we believe GENE’s strategy of acquiring and repositioning tests offers a more attractive return than internal development. We expect GENE to receive $45-55M of cash inflows from IP settlements over the next 5+ years. Our thesis calls for GENE to redeploy the potential windfall into the acquisition and revalidation of 1 to 2 new tests per year. If management can execute on this model, we believe GENE has an opportunity to grow revenue and EPS at a rate considerably above the industry mean. Our price target of $7.50 assumes 25x our 2014 estimate of $0.36 discounted back at 20%.

Cheaper to Buy than to Build a Molecular Diagnostics Business? The GENE business model is based on harvesting economics from mature assets – patents and certain testing businesses in Australia – and reallocating resources to oncology diagnostics. We expect the monetization strategy to result in $50M+ of proceeds over the next 5 years. Rather than build an integrated diagnostics business, GENE has opted to acquire tests nearing commercial launch. Given the glut of private companies with interesting technology but essentially no opportunity to tap public equity markets, limited access to private capital and inadequate scale to be acquired by larger players, we believe companies such as GENE are well positioned to acquire these assets at attractive valuations.

BREVAGen - Attractive Beachhead for U.S. Business; Peak Sales of $30M. BREVAGen combines a panel of 7 single nucleotide polymorphisms (SNPs) associated with non-hereditary risk of breast cancer with clinical risk measured by Gail score to refine a woman’s 5-year risk of breast cancer. We expect clinicians to use the test, which was launched in June 2011, to 1) support decisions to prescribe tamoxifen or aromatase inhibitors as prophylaxis, 2) better stage roughly 1.0M women receiving indeterminate results with biopsy, and 3) reduce the number of women classified as intermediate risk with Gail score alone. We expect validation in 2012 of a 2nd-generation test with an expanded SNP panel to improve predictive power for estrogen receptor positive (ER+) cancer and support numerous publications.

IP Licensing Strategy Provides Steady Cash Inflows to Fund Expansion. Granted patents describing the role of non-coding DNA and related applications in molecular diagnostics are core assets of the company and the primary source of revenue for much of its history. In 2010, management made a strategic decision to seek steadier flow licensing agreements (with more modest economics) rather than seeking a maximum payout for infringement. The shift resulted in $12.3M in revenues during fiscal 2011 and gives us comfort GENE will have access to a steady flow of license payments to fund growth.

For detailed information and disclosures, including risks pertaining to this specific recommendation, please see the full research report and refer to Appendix A – for important research disclosures.

Regards,

Kevin DeGeeter
Director, Equity Research Analyst
Ladenburg Thalmann & Co. Inc.
1.212.409.2027
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