A Critical Look At Nano-X Imaging – Disruptive Technology With Uncertain Credentials (NASDAQ:NNOX) – Digitalmunition

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Published on October 15th, 2020 📆 | 7479 Views ⚑


A Critical Look At Nano-X Imaging – Disruptive Technology With Uncertain Credentials (NASDAQ:NNOX)

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Introduction to Nano-X Imaging Ltd. and its sector

Since going public on August 20, 2020, Israeli company Nano-X Imaging Ltd. (NNOX) has drawn a lot of attention. The company claims to have developed a medical imaging device enabling a cost reduction by orders of magnitude. Given the overall market size of medical imaging, the amount of attention is hardly surprising. The company’s CEO is Ran Poliakine, former CEO of Powermat Technologies, a private company which successfully developed an inductive charging technology to develop wireless power solutions. So far, the stock price of Nano-X was a real roller-coaster ride. It quickly gained a lot of momentum and tripled its value after the IPO. Then short-sellers Citron Research and Muddy Waters published critical reports, claiming that the stock is in fact nothing but shallow air, and accused it of being “Theranos 2.0” (remember the miracle blood test that requires one droplet of blood?). However, these reports were not able to dampen the enthusiasm of investors too much, and the stock is still trading way above IPO price at the time of writing. I want to provide you with an in-depth look at what Nano-X Imaging is about. I will take a look at the technical details and the huge potential for the bull case, but also at the considerable risks associated with an investment at this stage of the business.

Source: Nano-X investor presentation – September 2020

Background information on the medical imaging sector

To understand what Nano-X Imaging is trying to disrupt, we have to first take a look at the medical imaging sector. Current state-of-the-art technology in medical imaging includes X-ray scanning and magnetic resonance tomography (MRT). Sophisticated X-ray devices are referred to as computed tomography (CT) scanners. What method is to be used (first) on a patient depends on the particular medical case. X-ray instruments are used frequently because scanning is fast (minutes) and provides decent results for a lot of applications, especially for imaging of bone structures and lungs. MRT instruments provide high quality images for soft tissues and internal organs. While MRT scanning is time-consuming and requires the patient to not move for as long as half an hour, it is considered less risky than using energetic X-rays. Overall, the technologies complement each other, though their possible applications certainly have overlaps.

When looking at prices, both CT and MRT instruments can get really expensive, depending on how sophisticated they are. To give you a very broad picture, prices range from five-digit dollar numbers for specific-purpose instruments to millions of dollars for very high-end instruments. Besides acquisition cost, maintenance of high-end devices can also come pricey and cost well above 100 thousand US dollars per year. Needless to say, these costs are passed on to patients and health insurance.

The Nano-X battering ram: The Nanox.ARC

Source: Nano-X website

What looks like a futuristic device from a Star-Trek spaceship is called the Nanox.ARC, and it is the reason Nano-X Imaging went public. This minimalistic device is supposed to enable high quality 3D-scanning of patients using X-rays. Conventional CT devices contain a large tube and are way more bulky, for a couple of reasons:

  • A large amount of electronics is required to generate and detect the X-rays
  • The X-ray source must be able to quickly circle around the patient to create proper 3D-images
  • Large cooling components are required as X-ray generation goes along with significant amounts of heat generation

In January, Nano-X Imaging submitted a 510(k) application to the US Food and Drug Administration (FDA) in order to obtain green light for deployment of the Nanox.ARC in the medical imaging sector. The FDA requested additional information and the review process is currently expected to last until early 2021.

As a first step, we submitted a 510(k) application for a single-source version of the Nanox.ARC to an accredited Review Organization under the U.S. Food and Drug Administration’s (the “FDA”) 510(k) Third Party Review Program (the “Third Party Review Program”) in January 2020. As part of the review process, in March 2020, we received an additional information request, referred to as a major deficiency letter, from the Review Organization which, among other things, required us to provide additional data and other information to complete the application and to address certain deficiencies highlighted by the reviewer, including the results of certain performance tests

Source: F-1/A filing – August 2020

Nano-X Imaging says that the size reduction of the Nanox.ARC is enabled by a novel, digital X-ray source that is remarkably cheap in production. This source is using the so-called field emission effect to produce an electron beam from an array of molybdenum nano-cones with negligible heat generation (scientific information that this is indeed possible can be found in literature, e.g. here or here). When this electron beam hits an anode, X-rays are emitted. The field emission effect is indeed real and is known for more than a hundred years. It refers to the emission of electrons by an electrostatic field. Many companies (e.g. Motorola Inc., Sony (SNE)) actually did a lot of research on field emission, since it can in theory be used for flat-panel displays.

A picture capturing early research on field emission at Motorola Inc. – Source

However, flat-panel display development was too expensive and complicated, other technologies won the race (especially liquid-crystal displays). In its F-1/A filing, Nano-X Imaging claims that a lot of knowledge about field emission was transferred from Sony to a company called FET Japan Inc., because Sony abandoned the project on field emission displays. FET Japan Inc. continued to work on the technology for non-display related applications, and this knowledge was transferred to the predecessor company of Nano-X as early as 2011. Since then, Nano-X (officially founded in 2018) was developing its novel X-ray source.

According to the investor presentation and F-1/A filing, this novel X-ray source is not only supposed to be cheap in production, but also enables superior fine-tuning of the characteristics of the X-ray beam (“multi-spectral separation imaging”), making the technology suitable for both soft and hard tissues at variable densities, simultaneously. And all of that while working with a gentle X-ray exposure dose. The Nanox.ARC seems suitable for all sorts of applications for which different CT or MRT instruments are currently needed. The F-1/A filing contains comparative images from a Nanox.ARC and a modern CT-scanner from Philips (PHG) displaying at least equal resolution (see below). It really sounds much like the egg-laying woolly milk sheep.

Sources: Nano-X investor presentation – September 2020 and F-1/A filing – August 2020

Market size, strategic outlines, and investor composition

Time to cover a more interesting topic. How does the business model look like, what are those plans to disrupt the medical imaging industry about?

Medical imaging devices are expensive. Nano-X wants to use its new technology to make imaging more accessible across the globe. According to WHO statistics, two-thirds of the global population has no access to medical imaging. According to Fortune Business Insights, the global medical imaging market size was around $33 billion in 2019 and is expected to reach around $43 billion by 2027, with a compounded annual growth rate of 5.1%. The medical imaging sector is currently dominated by large firms, like for example, General Electric (GE), Siemens (OTCPK:SIEGY), Philips or Toshiba (OTCPK:TOSBF). And remember, this market size originates solely from regions where medical imaging is accessible. It is easy to see the huge opportunity for Nano-X to grow rapidly, by:

  • Using its cheaper devices to enter the huge gap in the market represented by the population without access to medical imaging
  • Trying to steal market share from the established firms through competitive pricing.

Source: Nano-X Investor presentation – September 2020

Nano-X intends to use the proceeds from its initial public offering (roughly a total of 165 million US dollars) to manufacture an initial wave of Nanox.ARC units (about 15000 units are expected in the next 3-4 years), and to cover operating cash outflows like shipping, installation and deployment costs. Additionally, Nano-X needs to complete the development of its cloud platform called NanoX.CLOUD, which complements the NanoX.ARC as an end-to-end medical imaging service that provides image repository, diagnostic tools for radiologists, and connectivity to assistive artificial intelligence systems. The proceeds from IPO come on top of investments from firms like Fujifilm (OTCPK:FUJIF), SK Telecom (SKM), and Foxconn (OTC:FXCOF), which already raised a total amount of more than $100 million in crossover investments. These names seem to back the soundness of Nano-X Imaging: Foxconn is a large Taiwanese electronics manufacturer and produces devices like iPads and iPhones for Apple (AAPL), as well as gaming consoles for Sony and Microsoft (MSFT).

Nano-X Imaging business model

After receiving FDA clearance for its product in 2021, Nano-X is planning to start shipping its first wave of NanoX.ARC devices. It states that it has already entered distribution agreements in certain countries and received unit orders for thousands of devices from certain companies.

Source: Nano-X Investor presentation – September 2020

Its business model revolves not only around the superior pricing of the NanoX.ARC, but also around introducing a managed software-as-a-service (MSaaS) system through its Nanox.CLOUD, in order to enter the market with a cloud-based subscription model. From an investor’s perspective, the cloud-based subscription model should ring all bells and promises even more opportunity, since I tend to associate stable recurring revenues and attractive operating margins with it. Overall, Nano-X intends to commercialize its novel X-ray source by pursuing three simultaneous business models, as stated in its F-1/A filing:

  • Recurring revenues through subscription: Nano-X is intending to give away devices basically for free and receive a licensing fee for every scan that will be pursued, and also for the deployment of Nanox.CLOUD. From an investors perspective, this sounds especially attractive, as it retains customers.
  • Direct sales: It will be tough to get the subscription models working around the globe immediately, due to diverging regional regulations of the healthcare sector. That is why the Nanox.ARC will also be sold directly. This price is expected to be much lower than what you would pay for a conventional CT device and give Nano-X a competitive edge. Nano-X estimates the production costs for the Nanox.ARC to be around $10,000.
  • Licensing model: Apart from directly marketing its new devices, Nano-X intends to develop X-ray sources compatible with existing CT scanners from other companies, and help those companies immediately reduce their operating costs, while charging a licensing fee. This would seem like a smart move, since it discourages competitors to develop counter products and even makes them a potential source of recurring cash flows instead.

Source: Nano-X Investor presentation – September 2020

I immediately get urges to open my spreadsheets and start computing projected revenue growth through discounted cash flow models when I see these business prospects. If all of this is true, the term innovative disruption really fits the company. It could disrupt the medical imaging sector like Netflix (NASDAQ:NFLX) disrupted entertainment, like LEDs disrupted light bulbs. However, conducting an intrinsic valuation that is even moderately accurate is impossible right now, as the firm is just too young and there are a lot of inputs that are currently unknown. This includes regional regulatory hurdles in the medical sector, which quickly become incomprehensible when intending to start shipping into the whole globe, and a possible long-term response of competitors. Dominating companies in the imaging sector that can afford a multitude of capital expenditures won’t look at the invasive business strategy of Nano-X without countermeasures.

But it is safe to say that if the business model even remotely delivers what it promises, Nano-X can enter the imaging sector with the opportunity to grow into a massive business, giving the company a value far above the current share price. Just remember, the claim that a company is disruptive does not make it a home run, there are many steps to take along the way.

Risk and stock price assessment – authenticity of Nano-X Imaging Ltd.

After daydreaming about potential returns from investing into a disruptive, young and fast-growing company at an early stage, we have to remember the one rule of investing that is rather hard to bypass. High returns go along with high risk. High growth goes along with high risk. Everything about this company is screaming risk, and it is mandatory to discuss it. The last section already mentioned difficulties that go along with expanding into the whole globe. However, dealing with that is already the second step, and I think it can be delayed until we are certain about Nano-X being actually able to deliver what it promises at all. Since this brought up a lot of controversy among investors, I want to focus on this single but huge risk factor for now. All we know about the Nanox.ARC so far is written on paper, in the form of F-1/A filing, an investor presentation or website information.

ChartData by YCharts

Volatile stock price since IPO. The decline from all-time high in September marks the publication of the Citron Research report.

I bought a few shares shortly after the IPO, meant as a long-term holding. However, I sold rather quickly when the stock price doubled its IPO levels, wondering why investors were putting so much faith into the company with an operating Nanox.ARC yet to be approved.

We have little information about the contents of the 510(k) application, and we did not receive specific information on why the FDA responded with a major deficiency letter. The company’s statements on those matters are imprecise unfortunately, it is talking of “need of certain performance data” in the F-1/A filing. Right now, all we have is an option pricing model with too many unknown variables to assess the option value. For the conservative investor that wants to see real value for his investment, it is safe to say that the stock is fairly overpriced.

The short-seller reports bring some arguments to the table that actually require discussion. Citron Research published an article in the middle of September and sounds very unambiguous:

.. a stock promotion that is actually insulting to anyone who spends 10 minutes to read the prospectus.

First off, I bow to Citron for being able to obtain all the information it needs in ten minutes, since I require many hours to get a decent overview of the company and the underlying technological aspects of its product. Jokes aside, I think that Citron is bringing one valid, but also some poor arguments to the table. I want to provide you with my own assessment of Citron’s arguments and their accuracy. The following are some quotes from the Citron Research report.

There is not one scientific paper or submission that would back up any of these claims. As a matter of fact, we have not even seen proof of the product and have only seen a mockup drawing of what this machine is supposed to look like.

I partially agree to the first sentence. Nano-X itself did not submit any scientific papers which explain its technology. However, Nano-X is referring to technology that is plausible, possible and publicly accessible. It would be unwise of Nano-X to reveal the technical details of its only potential product before approval. I provided links to scientific papers which address ‘cold’ X-ray generation using field emission in the section about the Nanox.ARC. The statement that there is no visual proof of the product is not true anymore, since Nano-X released a video showcasing the Nanox.ARC scanning an artificial doll (Nanox.ARC prototype operated in Nano-X lab). However, the video was released after Citron’s report.

What you are about to read is accurate, and no we did not miss a 0. Since its founding in 2018, NNOX claims that it has disrupted the medical imaging market with a total R&D spend of $7.5 million. Compare this to GE Healthcare, a leading player in the medical imaging sector, who invested over 1$ billion in R&D just last year.

GE Healthcare (GE) is a huge company, and its R&D expenditures are divided into a multitude of research segments. It might be out of context to compare Nano-X to GE Research, because Nano-X was focused on one single tech device (the novel X-ray source) for multiple years. It did not start in 2018 either; according to its statements, the research asset existed for decades and originated from Sony. We hear from it now because it is getting close to a finished product.

NNOX’s entire company has just 21 employees with 15 in R&D. […] GE’s biomedical X-ray and CT imaging lab is supported by over 300K square feet of laboratory space with 1000+ staff scientists, engineers, and technicians

Those numbers can indeed be found on the website (Biomedical X-ray and CT Imaging Lab), but a quick navigation through the website reveals these numbers are not referring to the CT lab alone. Rather, they represent the compounded numbers for all R&D facilities owned by GE (see here and here – all facility websites present the same numbers). GE has plenty of R&D facilities with very different research topics. In fact, GE’s CT lab contains around 5 CT scanners and some peripherals. The CT lab is not populated by 1000+ scientists as Citron suggests. Both GE’s and NanoX’s X-ray labs are probably populated by an equally small number of trained, specialized scientists.

While investors have been gullible enough to buy the stock, the FDA had a different opinion. First it should be noted that NNOX did not even submit a novel product for approval but rather they submitted a 510(k) submission. […] By submitting a 510(k), you are saying you have nothing new and are seeking easy approval as you are just another product that has already been tested.

510(k) is a popular regulatory pathway to reach distribution permission. The Nanox.ARC indeed is nothing new from a scientific perspective in the sense that it uses X-ray radiation just like any other CT scanner. The major difference is that the X-rays are generated by a newly developed source, which does not change the underlying fundamental properties of X-rays, and the potential harm of the radiation. On the other hand, I am not quite sure why the process is taking over a year if Nano-X is at the stage the company claims to be. Usually, 510(k) approvals resolve faster than that.

NNOX’s commercial agreements may sound nice on the surface, but these appear to be no more than fake customers. […] Below is a photo of the office of Golden Vine international Company.

Source: Citron Research report

This is an argument that actually leaves me a little puzzled. Based on my own research, it seems like the picture that Citron took from Google Maps does not resemble the exact address of the supposed Golden Vine international company, but it is the closest you can get from Google Street View. Furthermore, it is in fact impossible to get adequate information about this supposed firm which reserved 500 Nanox.ARC devices. It is also impossible to get simple and precise information about the alleged CEO of Golden Vine international, Pepi Liao. The Short-Seller Muddy Waters Research provided a link to her LinkedIn account (Pepi Liao – Chairman of Asia – Emanual Business Club (International) | LinkedIn), and there is around zero information about Golden Vine. The Citron Research report also covers other customer agreements, and I have to admit, it makes a point:

The Gateway Group is listed as NNOX’s largest customer, yet nowhere on the company’s website do they mention operating in the medical device sector

Another major customer, LATAM Business Development Group, claims to be located in Brazil, yet only has three employees who are all located in Israel where NNOX is also coincidentally located.

One can only guess why Nano-X listed these customer relations in its F-1/A filing (see image below) and leaves hidden question marks like this. Did the company want to quickly present high reservation numbers for the Nanox.ARC in its F-1/A filing to support the prospect of its business plan? I conducted some more research on the rest of the listed commercial agreements. Some of them look equally weird. (APR 1998 S.L. is not involved in healthcare at all, neither is JSC Roel Group).

List of companies that submitted Nanox.ARC reservations. Source: F-1/A filing – August 2020

Its newest announcement, a customer agreement with SPI Medical, S.A.P.I. de C.V., does not look more trustworthy, all you can find is a very minimalistic website of the company.

I am disappointed because it seemed like my own research could make me happily ignore all the arguments from the Citron Research report. However, I had no choice but to agree with the report regarding one point, that most of the present customer relations appear to be odd. Right now, these hidden question marks are the reasons that keep me from repurchasing the stock. They do not make the product less believable, but I see no good reason why Nano-X would have to list untrustworthy or even fake customer relations. I assign a neutral rating to the stock, despite the great prospectus. The bull case is clearly visible, but there is some obscurity involved. Obscurity is nothing you want to see in a business that relies on promises to attract investors up until today.

Outlook – weighing risk against reward

Nano-X seems to have taken a step in the right direction, trying to win the trust of investors by announcing a public live demonstration of the Nanox.ARC device at the Radiology Society of North America (RSNA), led by CEO Ran Poliakine. The RSNA event is scheduled for November 29 – December 5 in Chicago. However, due to the Covid-19 pandemic, RSNA announced that the annual meeting will be completely virtual this year. It will be important to take a critical look on what is actually presented and how much proof it provides. Prudent investors should seize the opportunity and ask the CEO about customer relations, if there is a chance to do so at the virtual meeting. The stock price already jumped after the sole announcement of the live demonstration, which shows how impatient and overeager investors can be. I definitely recommend to wait for the presentation before making any judgement calls.

Right now, the adventurous investor could buy the stock for its momentum. I predict that a successful and transparent demonstration of the Nanox.ARC could quickly generate a large interest in the stock. But before proven otherwise, there is no certainty that Nano-X can deliver, and one should keep in mind that there is substantial risk of losing the investment.

For the conservative investor, I definitely recommend watching from the sidelines for a while. If the company can eliminate all question marks, provide ample evidence about the functionality of its Nanox.ARC, and start to execute its business operations, there will be enough time to jump in and profit from an effective market disruptor in the long run. This stock is a great example for the risks and uncertainties that come along with investing in a super-young tech company that promises a lot but hesitates to deliver. When evaluating such companies, it is hard to separate the wheat from the chaff. Due to its potential to disrupt the medical imaging sector, the stock will certainly remain on my watchlist until we get to know more.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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