A Head Scratcher

A Head Scratcher

We have known for some time that Medtronic has been exploring multiple options for its struggling diabetes unit. Among the options being considered were a possible sale of the unit or combining the unit with another franchise and then spinning this combined entity off as separate publicly traded company. Our guess was a sale would involve private equity, the sticking point, excuse the expression would be how Medtronic valued the unit. The unit may be struggling but it is still the market leader in insulin pumps when it comes to installed user base and it does generate a healthy and profitable revenue stream.

Hence the reason this little item released Friday caught our attention;

“Medtronic plc (MDT) and Blackstone (BX) today announced that Medtronic intends to significantly increase research and development (R&D) funding in its Diabetes Group through an agreement to receive $337 million of funding from funds managed by Blackstone Life Sciences (“BXLS”) including co-investors, aimed at advancing new, innovative products especially designed to reduce the burden of diabetes management.”

The release goes onto state;

“Under the terms of the agreement, Medtronic will receive up to $337 million in funding over the next several years to fund four identified Diabetes R&D programs. For competitive reasons, Medtronic is not disclosing the specific development programs. Medtronic’s engineering, clinical, and regulatory teams will perform the development work to activate these programs. The funding received will be equal to the R&D expenses incurred. If successfully commercialized, Medtronic will pay royalties which are expected to be in the low- to mid-single digit range as a percentage of sales. Additional terms of the arrangement were not disclosed.”

With more $538 Billion under management the $337 million is a drop in the bucket for Blackstone yet we can’t help but wonder if they are using this small investment to take a deeper dive into the diabetes franchise for a possible acquisition at a later date. This is not an unusual strategy as it allows Blackstone an intimate look into the franchise.

As we have noted in the past in the hands of a new owner this once powerful franchise could be reengineered without any interference from the Medtronic mothership. It would allow the new owners to do something they should have done long ago, configure their systems to communicate with the Dexcom CGM. It’s long been known that the Medtronic CGM sensor is inferior to the Dexcom CGM sensor and its inaccurate unreliable performance has created a huge headache for Medtronic.

There is no question that one reason the Control IQ from Tandem is outperforming the 670G is it works with the Dexcom CGM Sensor. This is also the reason we are confident that when the Horizon system from Insulet arrives it too will deliver better results than the 670G. The fact is when it comes to hybrid closed loop insulin delivery systems two things matter the accuracy and reliability of the CGM sensor and the insulin dosing algorithm. The pump itself is of little importance as it’s basically a dumb piece of hardware that does what’s it told to do.

Looking at the data from the studies Medtronic has released for their 780G the improvements aren’t related to the pump rather the change to their insulin dosing algorithm and improvement in CGM performance. The CGM still is not on par with Dexcom but its performance has improved. As we noted the other day we don’t see the 780G stealing the spotlight from the Control IQ but at least Medtronic has taken sensor performance seriously.

The one area where Medtronic still maintains somewhat of an advantage over Tandem and Insulet is overseas. This has more to do with brand name recognition and established infrastructure then technology. And it should be noted that both Tandem and Insulet are both narrowing the gap overseas. The fact is here in the US all Medtronic has left is formulary position and even with that advantage they are struggling.

Still the unit has a huge installed user base which provides for a nice annual supply revenue stream and yes also pump upgrades. Tandem and Insulet have been chipping away at this base which is another reason Medtronic likely agreed to this investment as prior to it the company had instituted major cutbacks in R&D. It will be interesting to see if any of this money will be used to develop a Tyler something Medtronic was doing before the cutbacks came along. Not to be redundant but as we keep saying Tyler is the biggest threat to growth in insulin pump usage and properly positioned can be used as a bridge to insulin pump adoption.

The fact Medtronic themselves weren’t willing to invest $337 million of their own also speaks volumes here as quite honestly the amount is also a drop in the bucket for the company.

All in all our gut and many gray hairs tell us this is the first step towards Medtronic exciting diabetes entirely. The market is undergoing a dramatic transformation and likely will transition to a monthly fee revenue model in the not too distant future. The fact is the high upfront costs of beginning insulin pump therapy combined with the high annual cost for pump supplies which now include CGM sensors is limiting insulin pump adoption. Add in the fact that Tyler can produce insulin pump like outcomes at a fraction of the cost of an insulin pump is another reason this market will change.

The reality is Medtronic is not equipped to deal with these coming changes as it would mean a dramatic overhaul of a model that has been in existence for over 20 years. This overhaul isn’t just about money but a change in a corporate culture. As the old saying goes it’s not easy to turn a battleship on a dime.

New ownership unencumbered by the ways of the past can apply a much-needed restructuring that will allow the company to survive and prosper in this new environment. Without this change this once mighty franchise will continue to lose existing customers and have a difficult time getting new ones.

As Momma Kliff used to say change is never easy but without change stagnation then destruction comes in. This deal as we see it is the first of many steps towards change.