Has the Nanosonics share price boomed because of it business model?

The Nanosonics Ltd (ASX: NAN) share price is trading near its 52-week high, closing today at $4.59.

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The Nanosonics Ltd (ASX: NAN) share price is trading near its 52-week high, closing at $4.59 on Tuesday afternoon.

The $1.36 billion market cap company's automated trophon EPR high-level disinfection device is a global solution for reducing cross-contamination between patients. Nanosonics recently released its trophon 2 machine, which it boasts is the most advanced ultrasound high-level disinfection solution in the world, offering: protection; flexibility; functionality; traceability; and integration for patients, staff and the environment.

Internationally we have seen and are seeing a trend towards stricter ultrasound probe reprocessing guidelines, which Nanosonics is looking to leverage.

The business model

Many people have heard of the razor and blade model, where a company will sell an initial product cheaply in order to lock in a customer to the repeat purchase of its consumable products. From fellow healthcare player Illumina, Inc. (NASDAQ: ILMN) to international food and drink giant Nestle SA (SWX: NESN), Nanosonics is employing the tried and tested business model. All of these companies benefit from selling an initial device at a near break-even margin, in order to reap the rewards of high margin consumables sales for the life of these devices. Because the consumables required for the installed device are bespoke to that device, this provides a steady stream of recurring revenue which can see a company's profitability soar.

These devices (also known as an installed base) need replacing over time, which can cause lumpiness in a company's results. Because selling a customer a device means locking them into your high margin consumables, it is well worth investing in research & development and sales & marketing costs. This is demonstrated by Nanosonics investment in its latest device, the trophon 2, and the recent expansion of its distribution agreement with GE Healthcare. The agreement now covers Denmark, Finland, Spain, and Portugal.

The impact on the financial

At 31 December 2018, this led to a 20% year-on-year increase in the company's globally installed base to 19,310 units. Revenue for the first half was up 36% on the prior corresponding period to $40.7 million. This is where the power of the business model comes to light. The sale of consumables and services rose 59%, leading to a massive 195% increase in profit before tax on the prior corresponding period.

Nanosonics is a high-quality company trading on an extremely lofty valuation of 238x earnings. The market understands that as more countries legislate for higher safety standards, Nanosonics stands to benefit from its sound technology and growing installed device base. Despite the promise, it may be prudent to buy into the company by dollar cost averaging in over time.

Proutlb95 has no position in any of the stocks mentioned and expresses his own opinions. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Nanosonics Limited. The Motley Fool Australia has recommended Nanosonics Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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