Sensera (ASX: SE1) – Sensing strong growth

Article written by Pitt Street Research. For the full report click here

Sensera Limited (ASX:SE1) is an ASX-listed technology company with two distinct revenue pillars; Micro Devices (Micro Electro Mechanical Systems or MEMS) and location-aware wireless networked sensors and systems that comprise solutions for the Internet of Things (IoT).

Clients’ product roll out is driving growth of MEMS

Rapidly advancing MEMS technology facilitates usage of MEMS devices across Industrial and Medical industries, in products such as pressure sensors, organ-on-a-chip (OoC) and electrooptic devices. The global microfluidics market alone is predicted to grow at an 8-year CAGR of 18.7% to US$23.4bn in 2025. As OEM customers ramp up production, SE1 should be able to grow on the back of their commercial success.

Increasing recurring revenues to drive Nanotron’s growth

SE1’s is shifting towards becoming a systems provider rather than just a component supplier. This is changing its revenue model and customers will be charged a recurring monthly fee rather than a one-time licencing fee and product sales. The share of recurring revenue is expected to be in the range of 5% to 10% by the end of FY2020 and is anticipated to reach >50% over the next 3–5 years. We believe a higher share of recurring revenue should lead to better predictability of revenues, and hence a higher valuation of the shares.

Valuation range of A$0.50–0.58 per share

We believe that as the company scales up operations and production, cuts back on R&D expenses and moves towards a recurring revenue stream, margins should expand significantly. Our DCF-based valuation projects an intrinsic value of A$0.50–0.58 per share.

Key reasons to look at Sensera

1) SE1’s MEMS customers are starting to significantly ramp up production, especially in the Medical Devices space. The company should be able to significantly increase revenues on the back of its customers’ revenue growth in the next few years.

2) SE1’s Nanotron unit (IOT Systems) is strategically shifting from being a component supplier to becoming a systems supplier, charging monthly recurring fees rather than one-off upfront fees. This should result in a higher share of recurring revenues, leading to greater predictability of revenues. The recurring fee structure is expected to grow from the current 5 – 10% of revenue to >50% in 3-5 years’ time.

3) The strong R&D backing available to SE1, as a result of its partnerships with prestigious institutes such as Harvard University and MIT, enables the company to keep pace with innovations in this fast-paced technology segment despite its relatively small size.

4) As SE1’s MEMS unit is often involved in a customer’s product design straight from the start, its relationship with these customers is expected to remain robust and non-detachable during the lifetime of the product. This is expected to result in high client retention.

5) SE1 is exploring new applications for its sensor technology, such as gas sensors used for animal health, mining safety and to monitor food wastage. Big players,such as Ahold and Walmart, are working in this field, which can provide SE1 an opportunity to expand its scope of business.

6) The strong ramp up in revenues from MEMS and Nanotron, combined with the expected cash flow positive nature of the operations from FY20 onwards, lead us to believe SE1 is substantially undervalued at the company’s current share price.

MEMS for Microfluidic devices driving growth

MEMS are micro devices that consist of miniaturized mechanical and electromechanical components and can be used to measure a wide range of different variables, such as pressure, vibration, acceleration, angles of inclination, temperatures etc., and set off a signal to another system in response to that measurement. For instance, in crash sensing in cars, MEMS can sense a fast deceleration of a car and send off a response to the airbag in order for it to deploy if that deceleration is deemed to be too fast and can be associated with a crash of the car.

Countless application areas for MEMS

Application areas for MEMS are plentiful. Just in Automotive, MEMS are used for things like crash sensing, seat belt tension, suspension control, vehicle roll, brake pressure, in-car microphones, tire pressure, fuel injection systems etc. In Medical System, MEMS are mostly used in pressure sensors, such as for coronary pressure measurements and blood pressure. But MEMS have also increasingly found their way into other devices, such as micro pumps, and measurement tools, e.g. to measure glucose levels, enzymes and antibodies. Additionally, MEMS have enabled Medical Devices to become more sophisticated over time. For instance, MEMS-based pacemakers and defibrillators can adjust their electrical shocks to a patient’s activity level, rather than being set to just one heartrate, regardless of activity level, which was the case with older pacemakers.

SE1 is currently developing Organ-on-a-Chip and Lab-on-a-Chip types of MEMS that can replicate the functioning of a human organ and perform diagnostics functions respectively. The company also develops other fluidic sensors for products such as heart pumps and nebulizers. Optical MEMS are widely used in opto-electronics, such as optical switches and micro mirrors used in fibre optic systems and optical shutters as well as laser scanners. Many Consumer Electronics products make use of MEMS as well, such as accelerometers and gyroscopes used in mobile phones.


Microfluidics is a highly attractive niche for SE1

The advent of MEMS structures has catapulted the practical usage of microfluidics devices. Microfluidics, the process of manipulating fluids at a micron level, is one of the major beneficiaries of the rapid development of MEMS technology. SE1 has leveraged this technology in bringing custom devices from concept to market.

The combination of MEMS and microfluidics enables execution of processes on a micro scale in a much more cost and time effective manner when compared to today’s methods. This enables applications in various highmargin verticals within healthcare, including in-vitro diagnostics, pharmaceutical research, drug delivery and laboratory testing (Figure 2). As
per a report by Data Bridge Market Research, the global microfluidics market is predicted to grow at a CAGR of 18.7% to US$23.4bn in 2025 (from US$5.9bn in 2017). SE1, through its growing expertise in unique microfluidic-based MEMS structures, is expected to grow substantially in this segment.

The lucrative business opportunity has attracted many large industry players, such as STMicroelectronics, Knowles, InvenSense and Bosch, to this niche market. In our opinion, medical and industrial applications of MEMS, coupled with the customisable nature of solutions offered, should bring SE1 more market opportunities.

Partnership with Harvard University to unlock significant technological potential

SE1 recently announced a vital customer–partner engagement with Harvard University’s Wyss Institute for Biologically Inspired Engineering. The partnership entails development of microfluidic devices with applications in the high-growth precision medical technology market. As per a recent intelligence report by BIS Research, the market for precision medical technology is projected to grow at a CAGR of 10.64% in the 10 years from 2018, reaching a market size of US$216.8bn by 2028.

Through this partnership, SE1 is expected to enhance its capability in the fabrication of silicon as well as glass-based micro-molds that are used in various applications, including Organ-on-a-Chip and Lab-on-a-Chip. These chips essentially mimic the process of the movement of fluids in an organ, thereby opening up numerous possibilities and use cases, including drug development and toxicity testing, while simultaneously eliminating the need for testing of products on animals.

Organ-on-a-Chip (OoC): Next big thing in drug development

Due to their ability to reconstitute the architecture of an organ at a microlevel, OoC’s are highly viable for conducting drug tests that cannot be performed on animals or human patients. The biggest advantage of OoC is the high precision level of the shape and surface pattern of the organ that allows for controlled microfluidic flow on the chip’s surface. Moreover, the OoC’s ability to control the microenvironment and provide high-resolution optical access, along with real-time data collection through biosensors, makes it more efficient than traditional models for drug development and toxicity testing.

The OoC industry is still at a nascent stage, but many large companies (such as AstraZeneca and J&J) are entering the domain to leverage the multitude of opportunities that OoC’s present in the areas of pharmaceutical, cosmetics and biotechnology. As per a recent research by Market Study Report LLC, the global OoC market is expected to grow at a CAGR of 39.9%, from US$21m in 2018 to US$220m in 2025, driven by the substantial cost-saving potential of OoC’s in the drug development process by reducing the gap between preclinical and clinical studies.

For smaller companies such as SE1 to remain relevant in this competitive but highly lucrative market, they need to offer a unique quotient and value-add to the end products. Through its MEMS structures, SE1 can stay ahead of the competition and can leverage it to gain a strong client base. Consequently, we view SE1’s partnership with Wyss Institute as vital for the company’s growth in this segment – positioning it to benefit from strong collaborations with pharmaceutical giants such as AstraZeneca, Roche, Takeda and Merck, powered by the R&D capabilities of Harvard University, and ably supported by its MEMS expertise.

Lab-on-a-Chip (LoC): Next-generation diagnostic test methodology

Like OoC, LoC is a microfluidic device that allows for diagnostic tests that are generally performed in a lab setting to be executed on a micro-scale by monitoring and controlling fluids through millions of micro channels designed on a single chip. As the tests are carried out on a micro-scale, they require significantly less quantity of the sample and reagents. This represents a huge advantage in terms of cost savings.

Moreover, as the tests are conducted in a controlled environment, i.e. inside the device, the time taken to execute them is considerably lower than the time it would take in an ordinary setting, such as a lab. E.g. diagnostic tests using LoC’s can potentially be conducted in a GP’s office, or even at home, rather than having to take a sample (e.g. blood) and sending that off to a lab. It has also been observed that these tests provide a greater level of accuracy than the ones carried out in a traditional setting.

The global LoC market is expected to grow at a CAGR of 8.9% over 2017–2025 to US$9.1bn. SE1 has the potential to capture a leading share in this growing market segment.

Deteriorating global health drives the need for faster diagnostic techniques

According to World Health Organization (WHO) data, every year, ~41m people die of non-communicable diseases (NCDs), accounting for 71% of global deaths. The increasing prevalence of these diseases is a result of the changing lifestyles of people, which includes physical inactivity, excessive use of tobacco and alcohol, as well as unhealthy diets. As people become more
prone to NCDs, such as diabetes, cardiovascular diseases, cancers and chronic respiratory ailments, the need for faster diagnostic techniques increases. Moreover, in case of most diseases, early detection is literally a matter of life and death, and this is where point-of-care (PoC) devices come into play. PoC devices dramatically reduce the time it takes for healthcare professionals and patients to receive test results compared to the time taken to perform the test in a laboratory setting. This can result in faster diagnosis as well as deployment of befitting treatment. Moreover, PoC devices allow for the tests to be carried out in a multitude of settings, from hospital wards to physicians’ offices.

Notably, as per the Global PoC Diagnostics Market report by Data Bridge Market Research, the PoC testing market is expected to grow at a CAGR of 9.1% from US$5.6bn in 2018 to US$17.2bn by 2026. We believe that with SE1’s new PoC MEMS devices, developed in partnership with Wyss Institute, with capabilities for detecting and measuring specific biomarkers for diagnostic purposes, the company has a strong footing in this high-growth vertical.

LoC devices should see strong ramp up

SE1’s newly introduced products in the LoC domain allow it to transition from simply being a designing partner to a customised component supplier for end products. Moreover, as these products are mostly for one-time use, we believe that they entail a huge potential for SE1 to ramp up revenues, and to meaningfully translate into top-line growth starting later in FY2020.
In the LoC devices supply chain, SE1 plays a prominent role by providing the technology needed for capturing the fluid. SE1 receives ~US$25–50 per device, the total market price of which can be in the hundreds of dollars.

Though the market value of these devices is on the higher end, in our view, the value that they unlock for end users – by allowing them to avoid going to a physician – compensates for the relatively high price. This mark-up also provides a buffer to the company, which can substantially reduce the price as it achieves economies of scale if competition intensifies.

IP protection secures SE1’s position in the supply chain

SE1 operates as a design partner for most of its customers, and thereby has the required funding for building MEMS structures. This exposes the company to threat of technology theft, but SE1’s base technology, on which each MEMS structure is based, is well protected by patents.

Foot in the door into mainstream pharmaceutical applications

Although the microfluidics industry is still in a nascent stage, with most companies in the early trial phases, SE1 has 5 to 6 clients operating in this space – some of which are looking to place orders in CY2020 as they begin deployments. Some of these clients, who are medical OEMs, have big customers such as Roche and AstraZeneca to sell their products to, providing SE1 the opportunity to get a slice of this substantial pie. However, it should be noted that these customers, typically based in the Boston area, mostly sign with SE1 on the basis of purchase orders rather than on a long-term contractual basis. Hence, in order to strengthen its pipeline, SE1 is looking at the US West Coast to on-board more clients.

Nebulisers: Rising demand from growth in respiratory diseases

In the drug delivery space, SE1 has clients that engage in the production of nebulisers, a market that is set to witness growth in line with the rise in respiratory diseases (Figure 3) as the air quality continues to decline globally. SE1’s MEMS-based microfluidic devices make for better nebulisers for respiratory diseases, including chronic obstructive pulmonary disease (COPD),
asthma, tuberculosis and even lung cancer.

Production ramp-up in FY2020, as customers start volume production

As part of the 3-year supply agreement with NASDAQ-listed medical implant devices manufacturer Abiomed Inc., signed in November 2017, SE1 expects to ramp up the production of its sensors to support Abiomed in transitioning to the manufacturing phase. SE1’s sensor forms a component in Abiomed’s Impella offering, the world’s smallest heart pump, allowing for device implantation without imaging for faster and more accurate positioning. Based on American Heart Association’s prediction that by 2035, ~45.1% of the US population will have some form of cardiovascular disease (CVD), demand for Abiomed’s product offerings is expected to grow exponentially. Similarly, other clients are also entering into volume production phases with products that include SE1’s components, providing the company with scope for a massive production ramp-up of the MEMS business.

Substantial growth prospects longer term

In our view, the company’s latest developments in the LoC and OoC domains provide it with substantial revenue opportunities in the medium to longer run. We are particularity excited about the multitude of potential functionalities that these solutions open up in the healthcare domain, especially in the space of medical implants. The strong R&D backing available to SE1, as a result of its partnerships with prestigious institutes, such as Harvard University and MIT, offers it the ability to stay abreast with, and even ahead of the innovations in this fast-paced technology segment. We believe that these relationships are crucial for companies such as SE1, whose competitive advantage lies in the customisability of their solutions. SE1’s current OEM partnerships provide it with an opportunity to tap into the addressable markets of pharmaceutical giants, such as AstraZeneca, J&J, Roche and Takeda. On the back of these factors, we believe that the company’s MEMS business is very well positioned. We expect this unit to grow at a CAGR of 25.9% from FY2019 through FY2024, to reach US$12.1m in revenue .

SE1 on track to be EBITDA positive by FY2020

The company continues to fund its expansion through customer–partner engagements, wherein SE1 builds the product with its clients, such as with UWB and ClearBlade. Furthermore, as many of its clients are at the end of their designing stages, the company will be incurring lower R&D expenditure in relation to its chip development going forward, although we believe these may tick yup again in future R&D cycles for new software products. SE1 has also outsourced its manufacturing processes for the IOT Systems business. These factors are expected to keep the operating expenditure lower, driving an improvement in profitability. We expect the R&D expenditure as a % of sales to significantly drop in the near future, enabling the company to report a positive EBITDA from FY2020 onwards.

Valuation: Price range of 0.50-0.58 per share

DCF calculation suggests a substantially higher intrinsic value Given the relatively nascent stage of SE1’s operations, and its presence across niche segments, we believe that its long-term fundamental value is best highlighted through a DCF valuation.

Our DCF model uses a 9.6% WACC for SE1 (risk-free rate of 2.7%, beta of 1.25 and an equity risk premium of 5.5%). Applying this discount rate to our free cash flow projections through FY2028E and using a terminal growth rate of 2%, SE1 yields a value of A$0.50 per share.

Despite the microfluidics market being in its early stages, SE1 has still been able to on-board 5–6 clients. Moreover, SE1 enjoys customer stickiness as its sensors are used in the customer device design throughout the lifecycle of the product. The company overall has now over 50 customers, which almost doubled during the FY19.

Additionally, SE1’s move from being a components supplier to a systems supplier, and shift towards a recurring revenue model will substantially contribute to top-line growth in the next 3–5 years.

Conclusion: Fair value of A$0.50–0.58 per share

Our base case value of A$0.50 per share has been derived through the DCF calculation. Our bull case calculation results in a valuation of A$0.58 per share. Both the cases imply a substantial upside from the current share price.

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Pitt Street Research work is commissioned by the listed companies it covers, and Pitt Street Research has received or will receive payment for the preparation of such work. Please refer to the bottom of the research notes as published on Pitt Street Research’s web site for risks related to the companies being covered, as well our General Advice Warning, disclaimer and full disclosures. Also, please be aware that the investment opinion in this report is current as at the date of publication but that the circumstances of the company may change over time, which may in turn affect our investment opinion.

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