Regulatory approval for a drug or diagnostic candidate is no doubt an important milestone, but investors often mistakenly overvalue the importance.

To be clear, regulatory approval marks the end of development activities, but only the beginning of commercial activities. The latter is almost always more important – barring a handful of examples that bias our perception of these de-risking events.

Guardant Health is an intriguing current example. The precision oncology company appears poised to earn U.S. Food and Drug Administration (FDA) approval for its Shield blood test for screening colon cancer, although there is one metric that could torpedo that expectation. A favorable regulatory decision would make Shield only the second blood test to earn FDA approval for colon cancer screening. It would mark the end of development activities.

Of course, those damned commercial activities always seem to be where living tech products get tripped up.

Getting Shield in front of patients requires reimbursement coverage. Getting it in front of a meaningful number of patients requires meaningful reimbursement coverage. Ay, there's the rub.

Although investors have enthusiastically rescued shares of Guardant Health from all-time lows in recent weeks in anticipation of an approval decision, failing to earn favorable reimbursement coverage for Shield in 2024 or 2025 could create an existential crisis for the business. That's not hyperbole if you parse through financial statements.

What Metrics Matter for a Colon Cancer Screening Test?

Sensitivity and specificity are important metrics for any diagnostic test. However, colorectal cancer (CRC) – "colon cancer" – is unique in that screening tests must also perform well on a third metric: the ability to detect precancerous lesions. This often-overlooked metric is crucial for a diagnostic test to be commercially competitive.

If we took a long gander into the colon of everyone reading this article (bear with me…), then many individuals would have small clusters of cells lining their colon called polyps. Almost all are harmless. But sometimes they aren't. If polyps develop into advanced adenomas (AA), then you might be at a higher risk of developing colon cancer. Catching these early could significantly reduce mortality rates for and treatment burdens of colon cancer.

Consider a little more context and nuance for the big three metrics of a colon cancer screening diagnostic candidate:

• Sensitivity of colon cancer: The ability to correctly identify individuals with colon cancer. Overall sensitivity is most often communicated, which is the rate of detecting cancer at any stage. Tests are differentiated by their ability to detect early-stage cancers (Stage I and Stage II). It's easier to detect advanced cancers, which makes early-stage detection the biggest driver of overall sensitivity.
• Specificity of colon cancer: The ability to correctly identify healthy individuals. It's generally not great to scare the shit out of people by telling them they have cancer when they don't. A positive result from a non-invasive diagnostic also requires a follow up colonoscopy, which wastes time and precious resources in an overburdened medical system if the result is a false positive.
• Sensitivity of precancerous lesions: The ability to detect benign masses that can become cancer. Precancerous lesions are more important for some cancers (cervical or colon) than others (lung).

Investors don't have to read too far into a Guardant Health press release to see how Shield performed on overall sensitivity or specificity in its pivotal clinical study, called ECLIPSE. But the company usually doesn't list the precancerous lesion sensitivity of Shield. That's probably because it's the worst screening test in the competitive landscape on this important metric, detecting advanced adenomas just 13% of the time.

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The Epi proColon blood test offers a cautious example for investors. It was the first blood-based screening test for colon cancer to earn FDA approval, but it was rejected by Medicare for reimbursement coverage due to low overall sensitivity and specificity. The company that developed the test, Epigenomics AG, pulled the product from the market in early 2023, but it's worth acknowledging Epi proColon performed significantly better than Shield on precancerous lesion sensitivity.

Will Shield Earn FDA Approval?

Shield is likely to earn FDA approval based on overall sensitivity and specificity, but it's not a slam dunk.

Guardant Health was required to have an Advisory Committee (AdCom) meeting before regulators make an approval decision. An AdCom meeting brings together stakeholders from various disciplines such as academic researchers, physicians, surgical oncologists, and patient advocacy groups. Participants weigh in on the pros and cons of a drug or diagnostic candidate, then hold an informal vote on whether they would approve it. The informal vote is non-binding, but the formal approval decision from the FDA usually mirrors an AdCom vote.

The AdCom meeting is likely to focus heavily on Shield's lackluster precancerous lesion detection rate of just 13%.

Does a relatively favorable overall sensitivity and specificity matter if Shield barely detects precancerous lesions? It could. The form factor of a blood-based test is important to improve CRC screening rates. Many individuals eligible for colon cancer screening receive blood tests for generic health checkups or various conditions, so adding an additional blood draw at the point-of-care is about the lowest bar you could set. The convenience factor is off the chart.

The issue is the commercially-failed Epi proColon test outperformed Shield by 61% on precancerous lesion detection. That proves blood-based tests can perform much better than Shield -- and investors might see that demonstrated sooner than later. Exact Sciences expects a data readout for its own blood-based screening test in 2024. However, the company has for several years positioned blood-based screening as a nice-to-have, but not necessarily competitive, screening option due to their low sensitivity.

The optimal blood-based test would have Shield's overall sensitivity and specificity and at least be in the ballpark of a generic FIT test for precancerous lesion detection, or near 24%, similar to Epi proColon. Significant breakthroughs in multi-omics measurement and detection are likely required to develop a truly competitive blood-based CRC screening tool.

Will Shield Earn Favorable Reimbursement Coverage?

It depends.

The Centers for Medicare & Medicaid Services (CMS) has established guidelines blood-based colon cancer screening tests must meet to earn reimbursement coverage. CMS coverage is usually the benchmark for private insurance coverage. Shield appears well positioned to meet at least two of the three requirements.

The three-pronged guideline to be considered for reimbursement requires:

• FDA approval. (Shield could meet this requirement)
• An overall sensitivity of at least 74% and an overall specificity of at least 90%. (Shield meets this requirement.)
• Inclusion as a recommended colon cancer screening test in at least one professional society guideline or consensus statement, or United States Preventive Services Task Force (USPSTF) recommendation. (Shield doesn't yet meet this requirement.)

There are no exceptions. If a colon cancer screening test doesn't meet all three requirements, then it will not receive CMS reimbursement coverage. This is where things get tricky.

CMS doesn't currently list precancerous lesion sensitivity among reimbursement criteria, but the metric is almost certain to heavily influence reimbursement rates. A blood-based CRC screening tool is unlikely to have competitive levels of reimbursement coverage. In a best-case scenario, these diagnostics might have half the coverage rate of a colonoscopy or Cologuard, or about $250 per test. That could make margins for such products relatively low.

Beyond that, Shield might not be included in a professional society guideline or USPSTF recommendation. The diagnostic must balance numerous factors against its competitive landscape -- and there are multiple accurate, precise, and affordable screening tools available for colon cancer. Meanwhile, USPSTF updates its guidelines in 2026, which could further complicate the competitive landscape.

Solt DB developed a combined CRC score for comparing screening tests and reimbursement levels. Simply multiplying all three metrics together correlates very well to reimbursement rates. Unfortunately for investors, Shield is the lowest-ranking test by this metric, primarily because it's dragged down by a low precancerous lesion sensitivity. It underperforms the Epi proColon liquid biopsy, but also generic FOBT and FIT tests. It's not even in the ballpark of Cologuard or colonoscopy. This correlation suggests Shield might not earn that best-case scenario level of reimbursement.

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Here's how the table above looks when visualized as a graph.

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To be fair, precancerous lesion detection is a difficult metric to rank highly on. A case control study -- evaluating a diagnostic candidate against preserved tissue samples -- for the next-generation Cologuard test, now called Cologuard Plus, demonstrated the ability to detect precancerous lesions 57% of the time. Delivering that result in a real-world setting could've legitimately put Cologuard Plus on near-equal diagnostic footing as a colonoscopy. It would've had a combined CRC score of 0.4982 compared to 0.4902 for a colonoscopy.

Alas, the real-world portion of the pivotal study demonstrated a precancerous lesion sensitivity of just 43%. Cologuard Plus marks a meaningful improvement from Cologuard, including on non-clinical factors such as having a lower cost of goods sold, but it missed the best-case scenario due to the challenges of detecting precancerous lesions.

Can Guardant Health Survive a Negative Outcome for Shield?

Maybe not.

It might seem odd to discuss an existential crisis for a business that ended 2023 with $1.17 billion in cash, but investors should focus on operating efficiency.

Guardant Health is a very inefficient business. Founded in 2012, the business has focused on revenue growth at the expense of the quality of revenue. The company reported record annual operating cash outflow of $325 million in 2023 as a result. At that rate, Guardant Health has just three years of cash left, which might not be enough to survive a negative FDA approval decision or CMS coverage decision for Shield.

Considering CMS coverage might not be in place until 2025 or 2026, this is more important than investors might realize.

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Investors frequently make the mistake of benchmarking biotech stocks to historic prices. The recent market downturn offers a long list of examples. Moderna, Ginkgo Bioworks, Intellia Therapeutics, and many others are well off highs of recent years. They must be great investments now, right? Not necessarily. Many recent or all-time highs were based on unsustainable growth projections and/or much lower share counts.

More importantly, revenue growth is no longer the end-all, be-all metric for investors. Cash flow, operating margins, and other signals that companies are actually benefitting from higher revenue totals will take on an elevated significance for the foreseeable future. Businesses built during the ultra-low interest rate environment, during which operating efficiency wasn't prioritized, could have a difficult time recalibrating.

That includes Guardant Health. If the company's Shield screening test fails to earn FDA approval and favorable CMS reimbursement (or gets outcompeted by Exact Sciences' blood-based screening tool and vast commercial infrastructure), then the business might not survive in its current form.

Disclosure: Maxx Chatsko owns shares of Exact Sciences.