The Australian Securities Exchange (ASX) has more to offer than capital gains in mining stocks – that was one of the messages the bourse conveyed to Asian investors during a recent roadshow with stops in Hong Kong and Singapore. Small and medium-cap companies in the healthcare field are especially making inroads in markets around the world, capturing segments with innovative technologies and strong multinational partners at their back. 

 

Share prices of these businesses are undervalued, analysts say, and may be at the beginning of a rally that reflects strong fundamentals and a favourable environment for the sector worldwide.  Two young companies that vied for Asian investors on these same grounds are Universal Biosensors and Nanosonics which have been listed on the ASX since 2006 and 2007, respectively.

 

At first sight, however, their business models seem to be on fragile ground, given that both currently depend on a single product for their revenue streams. UBI sells test strips used by diabetics to measure blood glucose levels with the help of small electronic meters distributed worldwide by their partner LifeScan, a Johnson & Johnson company. Nanosonics has developed a device called Trophon which disinfects heat-sensitive equipment with a newly developed technique that avoids the use of hazardous chemicals.

The company has won GE Healthcare (GEHC) as their global marketing and distribution partner and rolled out sales last year.

 

Both products have carved out a niche in the point-of-care (POC) healthcare market and have received updraft from regulatory measures in the US and Europe. In the US, for instance, new healthcare stipulations require hospitals to take financial responsibility for illnesses acquired by patients during their stay. In the UK and a number of states in the US, clinics must publish these so-called healthcare acquired illnesses (HAI) figures. Thorough disinfection of hospital equipment and accurate readings of tests are thus high on the agenda of hospitals. Ron Weinberger, CEO of Nanosonics, feels confident that share prices will honour the company’s favourable position in this market.

 

“We’ve got significant upside. There are huge growth opportunities for sales.  The market dynamics are changing and driving growth for us: there is regulatory, economic and commercial factors as well as occupational health and safety reasons as to why our product is accepted by customers,” he says.

 

Yet, profitability is still some way ahead. In 2012, Nanosonics had revenues of about US$12.7 million and incurred a net loss of US$4.87 million, down 58% from 2011. With a market capitalization of US$137 million and cash reserves of around US$30 million, the company is a tiny fragment in the healthcare industry at the moment. But with 600 million disinfection procedures performed a year – 20%-40% of which the Trophon device aims to capture – the company is seeing exponential sales growth of its product. Following acquisition of the device, revenue stream is generated from consumable peroxide chemicals required for operation as well as optional service plans.

 

Downside risks currently are posed by the market with biggest growth potential. While retaining the ‘buy’ recommendation, equity analyst Shane Storey at Wilson HTM comments that “the stock trades at a significant discount because GEHC has not done enough to demonstrate US demand at the customer level.”  Wilson HTM thus cut revenue growth forecast in fiscal year 2013 but remains confident the company will be net profitable by the second half of next year.

 

At Melbourne-based Universal Biosensors, revenue grew 133% year-on-year to reach nearly US$15 million at the end of the half year. The business model is synonymous with Nanosonics in that it depends on the success of a single technological innovation on which the company holds a monopoly. UBI has developed a new sensor technique that requires diabetes patients to take smaller blood samples with greater accuracy of readings.

 

Point-of-care testing is estimated to be a US$15.5 billion market with 11% growth per annum. Blood glucose testing makes up roughly US$10 billion and is expected to grow 10% annually. Paul Wright, CEO, likens to compare his business to that of the printer industry. In the case of UBI, handheld meters constitute the printers and cartridges are replaced with disposable test strips. “The industry is going to grow, so the only question in all of that is ‘Will LifeScan grow with it?’ As the number one or two in the industry, I don’t see why it wouldn’t. Not with good technology like ours” he believes.

 

With cash flows generated from a single product, UBI would naturally find itself in a tough spot should that assessment turn out false. Shareholders thus recently rejoiced when management announced a deal with Siemens over the development of a blood coagulation (clotting) test that uses UBI’s sensor technology and will diversify revenue sources. Additional POC tests are being developed.

 

“As a company, we might find it easier than others at the moment [in attracting investment] because we do have revenue and we do sell products. So investors have more visibility of the opportunity,” Wright concludes.

 

Still, until the partnership with Siemens materializes into a tangible product next year, sale of diabetes test strips will remain the core of UBI’s business. Brent Mitchell, equity analyst at Veritas Securities expects that “increasing profitability of the blood glucose sector of UBI’s business will move UBI to a cash flow positive and net profit position over the next 18 months, outweighing increasing R&D costs.”

 

Even if consumers buy the two companies’ products by the bulk, however, one challenge remains. New competitors offering similar or equal products will challenge the companies to a price war from which they could hardly divest themselves. Protection of intellectual property is thus a core concern for the two companies.

 

UBI owns 500 patents in 44 different families and also highlights that manufacturing of its products is safeguarded via trade secrets. Similarly at Nanosonics, patents across the world are complimented by high barriers for newcomers that would first have to get necessary approvals; second, make their products compatible with ultrasound equipment from a variety of healthcare providers; and thirdly, develop their own chemical mixture for the automated disinfection process.  Weinberger stresses that the combination of these three requirements was arduous and will deter possible competitors.

 

“Based on the information we have, I reckon we have a minimum of three to five years jump on any competitor in the market.  Unless there is an exceedingly good reason to do so, it is unlikely for clients to change to a new product. That is why I think it will be hard to dislodge us from the market,” Weinberger comments.