The Novacyt (LSE: NCYT) share price plunged by a double-digit percentage this morning after the company provided an update on its dispute with the Department of Health and Social Care (DHSC).
Shares in the diagnostic business have surged over the past 18 months as demand for its testing equipment exploded. The stock has increased in value by more than 2,400% since the end of 2014.
Revenue increased 900% year-on-year in the second quarter of 2020 to €36m. In a trading update issued at the beginning of April, management announced revenues had increased further to €83m in the first quarter of 2021.
DHSC contract
The company’s agreement with the DHSC has been responsible for a large chunk of this growth. At the end of April 2020, Novacyt committed to supplying 288,000 of its coronavirus tests per week to the DHSC for use in the NHS.
In April 2020, Novacyt’s Primerdesign division received orders totalling €103m for its coronavirus test. This surge sent the Novacyt share price skyrocketing.
At the time, the company didn’t break out how much of this was due to the government contract. However, according to its latest trading update, management revealed that 50% of Q1 2021 revenue was driven by sales to the DHSC.
After the initial government contract was awarded, the two parties signed an extension in September. Management claimed this contract had a minimum value of £150m for the first 14 weeks. It said a further £100m of revenue could be expected in the following 10 weeks.
After agreeing on this second contract, in January, Novacyt told investors it was in “active discussions” regarding an extension.
Unfortunately, this extension wasn’t agreed upon, even though the company continued to supply testing equipment in line with DHSC demand.
Novacyt has now decided to take legal action against the government to enforce the contract. It has warned this “may have a material impact” on Q4 2020 and Q1 2021 revenues from the DHSC. The company believes it has “strong grounds to assert its contractual rights.”
Novacyt share price outlook
Considering all of the above, it’s clear why the Novacyt share price is sliding. If the company loses the court battle, it could have to write off a double-digit percentage of revenues for those Q4 and Q1 periods. That would undoubtedly justify a lower share price. It may also alienate what looks to be its largest single customer.
On the other hand, if Novacyt wins the court battle, the company may be able to achieve windfall profits. It may be able to keep already-reported revenues and generate more income off the back of a contract extension. This will provide more funding to support the firm’s expansion in other areas. That’s the best-case scenario.
Personally, I don’t particularly want to invest in companies embroiled in large lawsuits. Court battles can distract managements and cost significant sums, which can be disruptive even if the entity wins. Moreover, the uncertainty could hang over the Novacyt share price for months, or even years.
As such, I wouldn’t buy the stock today. I think there are other companies out there that look more attractive from a risk/return perspective.
