A Head Scratcher

Ok we know its Friday and the weekends beckons before us, but we are having a dickens of a time figuring out just what’s going on with our friends in beautiful San Diego, Tandem (NASDAQ: TNDM). At this point everyone knows what the company is doing that is clear. What isn’t clear is why investors are buying the stock or what story is Oppenheimer, the lead underwriter, telling.

Yesterday shares opened lower then rallied throughout the day closing up over 11%. This morning in pre-market activity shares are trading down between 20% to 30%. Who knows what will happens the rest of the day and quite frankly it really doesn’t matter. What matters is what happens next after the company bilks another few million from investors. What happens after Oppenheimer collects their fat fee and the creditors breathe a sigh of relief as they might just get paid.

Although this may seem counter intuitive one happy company is none other than Medtronic (NYSE: MDT). The fact is Medtronic has their hands full at the moment and could not handle the inflow of new patients if Tandem went under. If it happened they would deal with it but quite honestly, they are happy it isn’t happening just yet.

Dexcom (NASDAQ: DXCM) is also happy as they haven’t had much luck with their insulin pump partners. They likely realize that even with the extra money Tandem still has a very tough road ahead but at least that will give the company and Insulet (NASDAQ: PODD) time to get the sensor augmented OmniPod to the market.

Insulet too should be happy for no other reason than Medtronic won’t add a boatload of patients overnight. As we have noted we suspect some 80% of the Tandem patient base would move to the evil empire as they are used to being on a wired pump. This is the shortest distance between two points. Having Tandem around in a strange way helps Insulet as they can differentiate themselves from two not one competitor. Going head to head against the evil empire may seem like a plus but it also has its disadvantages too.

But these are the short-term implications. What about the longer term? What can be done so that Tandem can right the ship, get on solid financial footing and stay in this market? Or as we stated yesterday what’s the plan?

We’d say that step one would be to clean house, bring in a new management team that knows what they are doing. However, the company’s clueless Board of Directors seems content with current management and if they haven’t gotten rid of them already there is no reason to believe they will get rid of them now. Frankly its difficult to imagine the current team being bold enough to make major changes, changes that might give them a fighting chance.

Tandem does not have to worry just about Medtronic and Insulet. As we keep noting everyone wants to be an insulin pump company these days. Bigfoot is the furthest along in this quest, but Lilly (NYSE: LLY), CellNovo and yep Roche too wants to play in this sandbox. Yet with Medtronic controlling some 80% of the market this puts everyone else in the position of fighting over the remaining 20% of the market. The key to any insulin pump company experiencing real growth isn’t from this small portion of the market, no the key to real growth would be to do what has never been done, take share away from Medtronic.

The fact is the insulin pump market is not large enough nor is it growing fast enough so that any of these companies can grow organically. Based on the latest numbers available Tandem and Insulet have less than 200,000 total patients. While Medtronic no longer shares patient numbers most estimate they have three to four times as many patients. We estimate the pump market is growing in the low single digits therefore any real growth any serious growth would have to come from taking patients away from Medtronic.

One bright spot for Tandem and Insulet is lots of patients hate Medtronic. Unfortunately, Medtronic has what these companies covet most, prime formulary placement. Simply put while there is a great deal of displeasure with Medtronic however for many patients it comes down to money and quite simply its cheaper to go with Medtronic. This scenario is playing out right now with Animas patients many of whom aren’t all that thrilled they are being sent to the evil empire. Still when they get over the emotional aspect and start looking at the cost of switching to a pump other than Medtronic they begrudgingly accept their fate even though they don’t like it.

What Tandem needs to do most is throw out the standard insulin pump playbook and think way out of the box. The problem here is even with new money coming in they don’t have enough capital to do this. Even with the additional capital they still carry over $80 million in debt, their cost structure is still too high, and they still lose money on every system they sell. Some of this could be solved if the company did a much-needed restructuring but management seems unwilling to get out the knife and start cutting.

Folks the only way and yes, it is the only way Tandem beats Medtronic, heck any company beats Medtronic is to be cheaper than Medtronic. The reality that no one seems capable of accepting is that insulin pumps, even the way cool whiz bang new systems, are a commodity. That in the hands of a well-trained patient it really doesn’t matter which system they use. Sure, there are some minor differences between systems, but all pumps do basically the same thing the same way.

Medtronic besides owning the formulary uses their huge installed base to their advantage. This installed base is the goose that lays the golden eggs and allows the company to be very aggressive when it comes to contracting. This may be the evil empire, but it is not the stupid empire. The company sees each patient as annuity and will sacrifice some upfront money to get this annuity. Think about this would you rather have a one-time sale or the continual revenue stream from the sale of highly profitable pump supplies.

This in essence has been the problem with every Medtronic competitor as they concentrate on building a better toy not a cheaper toy.

To be honest we do want Tandem to survive for the long term as we don’t want to see their patients go through what Animas patients are going through. Even if current management collects fat bonuses they haven’t earned patients are more important. Our concern however is unless major changes are made all the company has done is delay the pain. And to be just as honest we can see a path forward IF and this is a huge IF the company throws out the standard insulin pump playbook and thought about things way out of the box.

Sadly, and we can this with conviction there is no way in hell this happens with the current management team. Rewarding this team is like rewarding a head coach who can’t win football games. Even the Cleveland Browns one of the worst organizations in the NFL knows this. But as we can see by their record, they have only won 4 games over the past three years and have not had a winning record since 2007. Over that time, they have changed head coaches six times which tells you the problem runs deeper which is what’s happening at Tandem. There is no question a new management team is needed but so too is new Board of Directors as they are equally culpable for the company’s problems

The bottom line is all the money in the world can’t fix stupidity or ineptitude.