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Nanosphere (NSPH), The Tiny Company With Great Upside Potential

|Includes: Nanosphere, Inc. (NSPH)

The primary source of the following is from materials on the company's website.

Market Opportunity

Nanosphere develops and sells microbiology products to quickly identify specific diseases. The traditional method of disease identification is via culture, which can take two days or more. The improved timeliness of the disease identification is the major attraction of company's products.

Patient treatment can be customized and pinpointed, enhancing the patient's recovery. Further the process saves money for the hospital, insurance company paying the bills, and even the patient by eliminating unneeded and expensive antibiotics.

Moreover the health care provider, usually a hospital, can take control steps, if necessary, for highly contagious disease. This action also applies to the general public, including school children, where exposure to contagious disease can be more quickly identified and appropriate action taken.

A major health issue in our country is the over-use of antibiotics. An example of this is when a new patient arrives a hospital. Cultures are taken but results take generally two to four days. During this time a broad spectrum of antibiotics is administered, since the hospital doesn't know what they are dealing with. Nanosphere's products reduce this critical diagnosis time from days to a few hours.

"Bugs" develop resistance to the prescribed antibiotics. A major worry is that insufficient new drugs are developed to combat new strains of infectious diseases. Major pharmaceutical companies are generally focused on "annuity" type products, where the patient has ongoing, life time needs. Obvious examples are drugs that deal with diabetes, coronary, etc. New drugs that combat new strains of infectious disease are needed but are used rather briefly, let's say, for 5-10 days. Therefore this kind of drug offers a lower return, even though the time and money to develop them is great.

The products of Nanosphere present a major step in the reduction of the use of antibiotics and therein reducing the threat of new disease strains. The cost of the company's products are comparable to the "traditional culture" methodology.

So why aren't hospitals racing to embrace the products of Nanoshere? The company ascribes this to slow acceptance to new technology and lack of awareness of the company's products. This is a huge change in diagnostic testing for hospitals, at a time when they are under wide-spread cost pressures, including from Medicare and Medicaid.

Nanosphere's current diagnostic products are referred to as "blood stream infection testing". The company hopes its diagnostic test array for "enteric" diseases will be approved by the FDA during 2014. Enteric includes food borne illnesses such as norovirus, salmonella, and many others. NSPH is also developing respiratory disease testing.

Competition and Financials

Nanosphere points out they have many competitors, including Luminex and BioFire. NSPH is a smaller player and has much less resources than larger competitors. For example, Luminex Corp (NASDAQ:LMNX) had sales during 2013 exceeding $ 200 million and spent about $ 45 million on research and development. Their fourth quarter revenues, 2013 were flat compared to prior year, a bit discouraging when looking at the overall sector.

NSPH reported revenues for 2013 of $ 10 million, about double those of the prior year. Revenues for fourth quarter 2013 were $ 3.4 million, about double those of the prior year quarter. Nanosphere is certainly doing something right. The company has given guidance for 2014 of $ 20 million, another double. The strong trend of this metric, a revenue growth rate of 100%, is the number one reason to consider buying this stock.

There is no good model for valuing developing companies, it's a matter of opportunity and likelihood of success. The company's market cap compared to sales is about 15, based on 2013 revenues, and about 8 based on projected 2014 revenues.

The company states that it has a relationship with about 200 customers, which is about 5% of the potential market. How much are these existing customers using NSPH products? I couldn't find this anywhere and it is unlikely anyone knows. There is certainly room for existing customers to utilize more NSPH products, as there is room for expansion into new customers. Approval of "enteric" diagnostics would immediately expand products available to existing and new customers. The company is also doing development in respiratory and in international markets, but results there would be in future years.

At year end 2013, the company had about $ 42 million in cash and equivalents, but incurred a loss of about $ 35 million during 2013, about the same as the losses in recent prior years. Therefore the company will need to continue raising funds, i.e., selling stock. Expected dilution in NSPH is a given, as in most developing companies.

During the past six years NSPH spent in aggregate over $ 100 million on research and development. Is the company a game changer in disease diagnosis? There is no way to know, but at least NSPH has put some real money into its technology.

Time for take off?

When looking at the yahoo finance price chart for NSPH,, the results are under-whelming. Investors over past years have been very disappointed. The stock price high was in late 2007 around $ 15, crashing to a low around $ 1 in 2011. Since then it as modestly rebounded as initial, small revenues were generated. There is certainly no guarantee this time will be different. But sharply increasing revenues to real customers makes this company highly attractive. Furthermore, FDA approval of "enteric" diagnostic tests would greatly enhance the market opportunity of NSPH.

The stocks of developing companies present mega-risk, but also offer great upside potential. I generally recommend a basket of maybe 10 such companies, with that basket in total representing perhaps 5% of a portfolio, depending on risk tolerance.

Disclaimers: My background is financial and I have little knowledge of microbiology nor of diseases and management thereof. As previously mentioned, virtually all the above is from materials on the company's website, especially its March 2014 investor presentation, This should be viewed in conjunction with the meeting transcript available on SA,

Disclosure: I am long NSPH.

Additional disclosure: I am not registered with the SEC. You should do your own due diligence. This article is not investment advice.