Everyone wants in on this medical gizmo

This small-cap medical devices company has attracted the attention of two big American pharmaceutical giants, says Tom Bulford. And it’s not hard to see why.

Last week, I wrote about how most small medical businesses hope to ‘sell up’ to a bigger player. So it makes sense for them to do a bit of research and find areas where the big fish might be interested.

The company I want to talk to you about today, Sphere Medical (SPHR), has evidently done its homework. Two big American companies are in the hunt for its prize asset: The Proxima blood monitor. Last week, Sphere explained that, in return for an investment of £2m in 2010, Edwards Lifesciences currently has a right of first refusal over Proxima – and that expires on 17 November.

However under the terms of a new collaboration agreement with Ortho Clinical Diagnostics, Inc, a subsidiary of Johnson & Johnson, Sphere has “granted OCD a right of first offer over Proxima which will automatically switch to a right of first refusal over Proxima 4 if the Edwards Lifesciences right of first refusal has not been exercised by that time.”

Work that out if you can! But the bottom line is that Edwards (annual sales $1.9bn) and Johnson & Johnson, with massive annual revenues of a $67bn, are interested in Proxima. And both offer a shot at the big prize: the US market.

A product that ticks all the boxes

Proxima measures qualities of the blood such as its gases, electrolytes, glucose and drug levels with laboratory accuracy at the patient’s bedside. At the moment these tests take a lot of time, cost money and risk transmitting infections.

Proxima is attached to the patient’s arm. The blood comes out of the vein, passes through a micro-analyser and is then returned into the arm. The micro-analyser, which is Sphere’s key invention, is then able to instantly run blood tests and display the results on a bedside monitor. It could also have other useful applications.

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Proxima seems to tick all the boxes: it improves patient care and saves hospitals time and money. To get ahead in this industry, you need to fulfil an unmet need. And with 240 million blood gas and electrolyte tests carried out on patients each year in critical care, this is a large market.

Despite all this promise, the share price has slipped from 92.5p at the time of Sphere’s AIM debut in November 2011 to just 50p today.

This is disappointing. It comes from the massive £34m valuation the market slapped on Sphere 18 months ago. For all Proxima’s promise, it’s tough to commercialise new medical products. This is clearly true of drugs, but medical devices also have to go through the regulatory process too. They also have to demonstrate that they work in theory and in a hospital setting, and convince conservative doctors and administrators to change. Sphere admits that “the development of Proxima 3 has taken longer than previously anticipated”. Early-stage medical investors will know this phrase all too well.

Sphere shares are at a 20% discount

Thanks to Johnson & Johnson, Sphere now has plenty of cash. It should have the cash to take Proxima 3 through the European regulatory system by next year, launch the product in the UK, and develop the next generation Proxima 4 blood analyser.

Sphere is developing other products, like a device to monitor the level of intravenous anaesthetic in patients during heart bypass surgery. This device isn’t included in the deals with Edwards and Johnson & Johnson. But if it succeeds, Proxima seems likely to be one more product of British invention that ends up under American control. Not that the shareholders will be complaining!

Existing Sphere shareholders have the chance of subscribing at 40p and, given that this at a 20% discount to the current price of 50p, they would be foolish not to take up the offer.

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