Universal Biosensors awaits transfusion

The device maker has good upside, but delays are constraining price growth.

To say this is a big year for Universal Biosensors’ chief executive Paul Wright and his team would be an understatement. The medical device maker is either going from “zero to hero” before the year is out, or it will discover how lonely it can be in the doghouse.

Wright is already getting a taste of life in the doghouse, with shares in Universal Biosensors (UBI) crashing to a record low of 29 cents earlier this month. The stock has bounced a little since to 37.5 cents, but it is still down by around 40% over the past year.

These are testing times for UBI. The key reason behind the stock’s fall from grace is “uncertainty”, and investors in the life science space have a far lower tolerance to this than the average investor given the binomial outcomes for most stocks in the sector.

You only need to look at the freefall in the share prices of QRxPharma (QRX), Acrux (ACR), REVA Medical (RVA) and Prana Biotechnology (PBT) over the past few weeks to see what I mean. Investors have lost more than $2 billion from these four names alone in just a month.

This is why shareholders in UBI reacted badly to the delay in the launch of the new blood coagulation testing device to the third quarter of this calendar year from the end of 2013. The later launch date theoretically cuts the value of the stock by around 30%, based on my calculations.

Shareholders were already grappling with earlier news that UBI would stop manufacturing test strips used in LifeScan’s blood glucose testing device as the Johnson & Johnson subsidiary decided to undertake manufacturing itself in Scotland.

UBI will continue to receive a service fee (which is essentially a royalty payment) of around US1 cent for each strip sold, as LifeScan’s device is based on its technology. But investors barely had time to digest that news when they were hit with news of the delay of the coagulation device, which UBI is developing with Siemens.

My “outperform” recommendation on UBI feels at odds with the company’s recent chequered past, and the stock is the worst performer among on my buy list.

But UBI is still worth buying for those with a healthy appetite for risk for a number of reasons. First are the increasing sales of LifeScan’s test strips. Sales of the strips have grown slower than what many had expected.

In the first two years from 2010, LifeScan had sold around 122.4 million strips based on UBI’s technology, a tiny fraction of the $US8.5 billion market opportunity where LifeScan holds around a 30% market share with its legacy products.

LifeScan’s fear of cannibalising existing sales with UBI’s superior product is very likely the key reason behind the slow adoption rate of the newer device and related consumables.

But LifeScan seems to be finally facing up to the inevitable and is giving the UBI product a bigger push, with the service fee for the latest March quarter hitting a record $1.2 million, or a 44% rise over the same time last year. Sales of the strip since 2013 has surged to nearly four times the level of 2010 and 2011 combined, and the pickup still reflects the tip of the iceberg in terms of the addressable market opportunity for the UBI system.

What is perhaps more interesting is the value of the stock if the company only had the LifeScan strips in its portfolio. This means UBI would become a holding company that collects and distributes dividend cheques from LifeScan.

Under that drastic scenario, the stock could be worth about 50 cents if I assumed that all plant and equipment are sold off at a 50% discount to book value, management repaid all debt and aggressively cut overheads.

That should provide some comfort to those who have little confidence in the future of the coagulation device.

However, management is confident that the Siemens product, which will be sold to medical professionals, will make it to market by the September quarter, if not before. Siemens has a reputation of aiming to be number one or two in any market it competes in, and this implies it will want to have at least a 20% share of the $US1 billion market.

UBI is also pursuing the in-home coagulation testing market on its own. That market is valued at between $US200 million and $US300 million and I would be surprised if Wright isn’t aiming for around a 20% market share as well.

Forecasting if and when Siemens and UBI will reach their goals is like guessing the length of a string. What’s making things even more complicated is that a relatively modest change in timing either or adoption rate has a material impact on my target price for UBI.

Having said that, I am inclined to give Wright the benefit of the doubt because of his background. Before joining UBI in 2011, he led the diagnostic equipment manufacturing arm of Vision Systems, which was sold to Danaher Corporation for more than $800 million, and the chief executive of international product development consultancy Invetech.

But to err on the side of caution, I am only assuming Siemens will achieve a 12% market share and that it will take the company four years to reach that goal. I believe it will take UBI around the same amount of time to gain a similar market share in the in-home category.

Ignoring currency effects, these assumptions put an 87 cent a share price target on UBI. Before you get tempted by the potential upside, just remember that UBI is not for the fainthearted and you should ensure the stock only accounts for a relatively modest percentage of your portfolio.

To see UBI’s earnings forecasts and financial summary, click here.

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