UBI : Not Universally Bad…

I have a love-hate relationship with diagnostics companies, especially point-of-care (PoC) diagnostics. Over the years I have probably looked a couple of hundred companies, always with interesting ideas and designs, often (sadly) with the usual unoriginal market opportunities (glucose, cardiac markers, troponin, hormones, etc.) and always where the core technology or innovation sits at the minor end of the value chain.

It’s a very tough space to commercialise a new innovation.

The fundamental issue with PoC diagnostics companies is that the large market opportunities (by procedure volume) that could theoretically be transitioned from centralised testing to home/personal/bedside testing don’t necessarily have a strong business case for that transition. Unless a patient is managing a condition on an acute basis, or there is real clinical benefit to continual monitoring, it is almost never worth “buying a little box” to displace the volume, efficiency, quality and multiplex nature of centralised testing platforms. Where technology involves reagents and some degree of user sophistication, the business case diminishes even further.

I am also not fond of companies that exist to respond to an “emerging market need” just because the type of testing infrastructure that we are generally used to doesn’t yet exist. If you have to go to the last mile to sell a product, it costs a lot to make that sale and to support it. You also have to intrinsically fight the centralised model that the major players prefer because the business model results in “captured” customers with a very high switching cost for what is effectively a razor/razorblade model.

But I don’t dislike Universal Biosensors (ASX : UBI). I realise that this company is not everyone’s cup of tea, and that there is some historical disclosure baggage in relation to commercial partnerships. But, you know, it can be tough to manage public information when you have a couple of large customers (Siemens & LifeScan/J&J) that are, at some level, competitors. Frankly, it irritates the shit out of me sometimes how shareholders of ASX listed companies feel that they are entitled to know every little detail about a company’s strategy when actually restriction and control of commercial information is one of the most important business weapons for a company trying to behave with some degree of sophistication.

There are lots of basic things to like about UBI. It has proper customers, with revenues that seem to be growing. It has revenues that are actually indicative of a technology platform that is starting to hit its stride in terms of traction. It is certainly not overpriced relative to its current revenue stream, in fact I would argue that on a comparable multiple basis, it is an extremely cheap equity. I like the fact that it manufactures its own technology – this kind of manufacturing is not labour intensive and so it doesn’t really matter where you do it (even Rowville, Australia). Great to see an Aussie company actually doing some added-value manufacturing. What does matter is quality, especially if you have some heavyweight customers. I even like the fact that it uses debt to partially finance its operations – something that certainly has the effect of keeping the management team focused on expenditure (and a totally acceptable WACC philosophy for manufacturing infrastructure).

Of course, there are some downsides. The company hasn’t really established a financial cycle yet where revenues are actually growing the balance sheet. Having a lot of cash on the balance sheet isn’t necessarily the sign of a well-managed micro-cap company, but it would certainly enable the company to make smarter decisions about how to deploy its platform if it were visibly cash generative. Despite being revenue generating, the current financial management of the company strongly suggests it is likely going to need to dip into the markets again fairly soon, and that seems to make shareholders edgy. Contrary to a lot of shareholder comments on trading forums, I don’t find the debt overhang an issue – I find the claims of “500+ patents either in-house or licensed” as the worrisome overhang. The prosecution and maintenance cost of that IP is enormous and current revenue projections challenge cost recovery. Frankly, I would always prefer to see a small number of intelligently necessary patents, than the rampant claim of such a vast portfolio.

But the most overwhelmingly positive thing about this company is that it has two “800lb gorilla” customers that are, to a greater or lesser extent, invested in the company’s technology. Companies like Siemens commit to very long product life-cycles for their diagnostic products and so once a product is launched, they tend to be fairly sticky customers. PoC diagnostics is also something that has not traditionally been done well by Siemens, so with the increasing interest in small-footprint diagnostic technologies from traditional rivals like Philips, it wouldn’t take much to perhaps instigate a little jealousy. A great way of accomplishing this is for UBI to sell – directly – an “orthogonal” PoC product, which is what it is doing with the prothrombin/coagulation testing (PT/INR) platform.

Smart.

One doesn’t provoke an 800lb gorilla by giving it bananas, but rather by taking them away… and if UBI can show that its small-footprint analyser takes centralised testing procedure away, then that is a strategically very interesting move. I also personally think PT/INR is a reasonably interesting focus area for PoC diagnostics. To be clear, there are plenty of companies going after this same market with their own technology variant, but by potentially being able to claim a similar level of accuracy to centralised testing through the use of a common technology platform (with Siemens no less), UBI has the potential to establish a strong brand for itself if it is careful and sophisticated about product positioning. PT/INR testing also has a very broad range of clinical applications, some of which are also clearly growth opportunities such as functional testing for hepatic diseases (hepatitis/cancer) in Asian markets.

I realise that I will be ridiculed for this post – “What? The Long Tail dislikes Prima, Neuren, Novogen and Invion but likes UBI???” I can just imagine the crap I am going to get from the usual punters on HotCopper. But yes, in fact this company has a lot of good attributes that, on a speculative basis, bode well for the future of the firm. At least, unlike companies such as Anteo, it is demonstrably making progress with customers that are clearly identifiable (i.e. with actual names), and selling products based on the proven productisation of the company’s technology.

UBI will be interesting to watch… and see whether any future performance milestones enables the market to overcome its apparent disdain for the company.

4 thoughts on “UBI : Not Universally Bad…

  1. Thanks Chris, a nice overview. However, do you really feel that it is reasonable that they have not communicated a clear strategy to drive strong growth that would justify a high-risk investment?

    Their best chance of success might be to position themselves for a complete buy-out by one of their current partners. This would provide the scale and direction that they need. I suspect that they have a small window of opportunity before this technology is superseded.

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  2. welcome back Chris – agree with your assessment but wonder if / when UBI can make money ? as a delaware corporation there are SEC filings if one has a spare day to read them : 6 month operating loss to 30 june was US$6m ; company had to pay LifeScan A$2.3m as its 50% of patent fees ; the loan facility with US$15m drawn down and $10m still available has an interest rate of 10,5% and early repayment penalties of between 15 and 20% ; the lenders get 30% of siemens milestones up to $600,000 ….. etc
    the bottom line could be a problem for a while ?

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    • There wouldn’t be anything in an SEC filing that wouldn’t also be in their ASX documentation. In fact, in general, Delaware law is more protective of company information than anything else. I’ve done the math too and I think they do just fine in terms of burden, I think the points that you make relates more to the optics/reality of alternative financing. So many little public companies that go out and do tranche after tranche of a few million bucks only demonstrate that they don’t understand the cost of capital. If you are a diagnostics company and you have some fairly baked-in revenue streams, you are far better (if you can get it) to use capital that has a 10% “IRR” expectation, than a 40% IRR expectation.

      But in your analysis above is an implied point which is very important, and that is focus. The company has this tendency drift from project to project without really knuckling down and making something produce cash. This is what it needs to do in the next 18 months. I don’t see the situation as financially precarious, I see the company as being in need of some discipline to make good on its potential. In truth, it probably needs some stronger management.

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