I think it was Jack Welch who said something like given the choice between an excellent product with a mediocre management team, and mediocre product led by an excellent management team, he’d prefer the latter. This is exactly how I feel about NanoSonics (ASX : NAN).
At the end of the day, what this company does is pretty simple. In a nutshell, NanoSonics sterilises ultrasound probes, at least that is the current incarnation of the company’s “unique” technology. With something like 600,000 ultrasound machines installed around the world (with a wide variety of vintages), and the probe being a non-disposable piece of electronics that comes into direct contact with patients (and sometimes patient’s nether-regions), this sounds a like a great opportunity. Traditionally, most ultrasound probe decontamination is treated as a low-level disinfection process using quaternary ammonium, mainly intended to kill bacteria. But in in high-risk applications such as trans-vaginal or trans-rectal ultrasound where there is mucous membrane contact, sterlisation (and effective barrier methods such as the use of a probe sheath or even a condom) has become a much more topical issue, with a real concerns about the potential of nosocomical infection.
There is little doubt that hospital infection is a huge area of public health concern. There is also little doubt that it will only take one lawsuit where someone was able to prove that they got an infection from an intra-cavity ultrasound probe and the standards will change in response to mass hysteria, particularly in the US. Therefore if you consider a product like NanoSonics’ “Trophon” system that can safely, effectively and with a high degree of automation/QC decontaminate a probe, the company looks like it is really onto something. Especially given that in a busy clinical or hospital ward, the ultrasound machine is used non-stop, and so reliable and fast sterlisation is important. Throughput absolutely matters.
To be clear though, I don’t like the “scare factor” of HPV that the company exploits in its marketing and investor positioning materials. It’s obviously the holy-grail of American consumer healthcare marketing to have a woman in an obstetrics clinic ask her physician or sonographer “has that probe been sterilised by NanoSonics?” But in fact the two most oft-cited papers by the company in relation to HPV risk after “conventional” disinfection (Casalegno et. al. and M’Zali et. al.), are actually misleading to this clinical case. The Casalegno paper only looked at DNA presence, it didn’t evaluate the presence of active virus. DNA presence is alarming (and not ideal), but it is also the byproduct of successful viral particle denaturing. Both the Casalegno and M’Zali paper relate to low-level decontamination protocols that are, quite simply, no longer the industry standard for high-risk probe usage. My personal opinion is that every paper I could read on this topic (and let’s face it, ultrasound probe sterilisation is a pretty niche topic) involved experiments and sample collection/control strategies designed to demonstrate the presence of a risk. Frankly, that’s what the world of hospital infection is all about. I could find very little meaningful evidence that current high-level decontamination protocols are inadequate.
Furthermore, it’s important to note that the majority of ultrasound machines (and probes) on the planet are not being used for intra-cavity ultrasound. Even if disinfection guidelines for low-risk use become more stringent and transition to something more akin to the high-risk guidelines, the impact is mostly going to be about using probe sheaths and stronger disinfectant solutions (i.e. peroxide). Although ultrasound imaging is a growth modality, a lot of recent commercial restructuring inside the major players like Siemens, Philips and GE reflects that the fact that historically high(ish) margin medical device segments are under huge pricing pressure, and ultrasound is just about the most price-sensitive segment of the clinical imaging market. Therefore anything you add to the total clinical operating cost of an ultrasound system, relative to current procedure reimbursement rates (in the US), basically starts to hit the pocketbook of the clinic. For the cost of a NanoSonics (or competitor – Germitec) system, you can buy a hell of a lot of peroxide and condoms. I mean, it’s not like you are trying to sterilise a complex geometric surface (like, say, an endoscope), we are talking about something that is designed to be “comfortably” placed into your anus.
So is NanoSonics a “must have” or a “nice to have?”
I think that there are certain critical care and high-throughput environments where a product like Trophon makes absolute sense, and where patient throughput and possible procedural breakdown (like an emergency department) may lead to the risk of inadequate sterilisation. Notwithstanding the “extensive” IP portfolio that NanoSonics’ claims to have, Trophon is basically a cabinet with a peroxide misting system but if their misting system is better than everyone else’s, then great. Though I do note that there are competitors and there isn’t much ambiguity around what are approved high-level disinfectants (and therefore not currently a point of differentiation for NanoSonics). Notwithstanding some investment in the company, GE also didn’t take an exclusive market position when it had the chance. Therefore at the end of the day, to a large extent, who cares?
The thing about thing about this company – hence the opening comment – is that it just seems to execute very well. The company has one of the more functional management teams I have seen for an ASX-listed company and when you look through any investor presentation that NanoSonics produces, you get a very clear sense of an organisation that understands what its purpose is, what issues concern its customer, and where the healthcare policy landscape is changing in a way that is relevant to its business. The company has also clearly built a robust and proven platform technology that could theoretically be expanded to sterilising other high-value instruments (maybe something nasty like gastrointestinal endoscopes?).
I think the name “NanoSonics” is sort of stupid, but the company certainly is not.
What this company is, however, is significantly overvalued. My cursory analysis is that it takes a relatively small number of units to hit a saturation point for the high-throughput, complex environments where this product is a must. I think NanoSonics has started to significantly penetrate those markets and this is a real testament to the company’s excellent execution. However, notwithstanding “changes in strategy” that have been articulated by the management team, the sales volume growth doesn’t reflect a market opportunity where the sky is the limit from where the company currently stands. I do realise that the company is still fairly early stage and “ramping up”, therefore applying EBIT multiples/comparables is a bit of a meaningless valuation strategy, however the company also isn’t showing breathtaking “hocky stick” sales growth either.
To be honest, I’m also not sure that the direct sales strategy in the US is really necessary given that the “big three” ultrasound companies have also significantly “de-verticalised” their medical imaging sales teams to push ultrasound harder into different clinical application areas. You want one of these systems being sold with new machines, or financed as part of an extended service contract for an existing installation, not having a NanoSonics rep passing a GE rep in the corridor. I realise that today the existing install base is the major commercial opportunity, but my fundamental position is that the “must have” portion of the install base is pretty small and the recurring revenues from selling the reagent cartridges and “proprietary” NanoSonics logbooks are not going to transform the company’s fortunes.
In summary, I like the company. I think what they have delivered to shareholders is impressive and if we had more companies that understood what was required to execute, the ASX bioscience sector would be very different than the mixed bag that it is today. I also think that there are clearly a variety of growth strategies for the company to build on what it has already accomplished. But a $400m+ market cap at this stage in the game?
You gotta be kidding…