How this could work

How this could work

The days of conventional finger stick glucose monitors may be coming to an end but that does not mean they will just disappear and never be heard from again. There is no question in anyone’s mind that continuous glucose monitoring is the future but the future is not here just yet. It’s also no secret that Johnson and Johnson (NYSE: JNJ) and Roche the two largest BGM companies want to sell their respective franchises. It’s also obvious that Abbott (NYSE: ABT) is placing their glucose monitoring future on the FreeStyle Libre.

Still conventional BGM does have a future and in the right hands could be a nice cash cow. Just by way of example look at LifeScan. Although JNJ does not breakout the numbers for LifeScan and Animas separately it’s fair to say that LifeScan accounts for 90% of their diabetes device revenue. The same is true for Roche. It’s also true that LifeScan and Roche have millions of customers. One more commonality between LifeScan and Roche is both have rightsized their units to reflect current market pricing dynamics. Simply put anyone who acquires either unit or both would not have much heavy lifting to do.

It would also be foolish to ignore that the LifeScan and Accu-Check brands still carry value. Conventional meters may be a commodity but patients, physicians and CDE’s know these brands.

One more positive and this cannot be understated, LifeScan and Roche have established relationships with payers. Unlike the new kids on the block, the ones with way cool whiz bang cloud enabled conventional meters, LifeScan and Roche systems are on almost every formulary.

So, allow us to outline a couple of scenarios where this just might work.

In the past many, including Diabetic Investor, have discounted the possibility of a roll-up strategy. The main reason being LifeScan test strips are not compatible with Accu-Chek meters. In a traditional roll-up, the acquiring company would convert patients into the most profitable system. That cannot be done here. However, it would work if say someone bought both franchises and eliminated duplicate back office/sales functions.

Perhaps the best way to think about this is look at consumer product giant P&G, a company which manages multiple brands under one roof. Besides their flagship detergent Tide, P&G also has Gain and Era. Each brand comes with a different price point and reputation. There is no reason that this same strategy cannot be applied to BGM. Let’s face facts meters are not medical devices anymore they are consumer products just like Tide and Gain.

The fact is the LifeScan and Accu-Chek franchises even in today’s market throw off millions in free cash. We estimate that LifeScan alone generates almost $300 million per year in free cash for JNJ. Yes, this number is decreasing organically by about 10% per year, but even so that’s lots of cash.

The key to making this roll-up strategy work is valuation. Ask any successful private equity firm what’s the most important factor is when it comes to making money and they’ll state it’s not over-paying for the asset. In this case they are not buying these assets so they can revamp these units and resell them at higher price then they bought them for, they are buying free cash flow.

Another possible scenario is using the huge installed user bases that these franchises have as a launching pad. Or put more simply in fell swoop a company like Google, for example, has massive scale. Massive scale that comes with the infrastructure to run the franchise attached. As everyone knows Google is partnered with Dexcom (NASDAQ: DXCM) for the slap it on turn it on disposable low cost CGM sensor. What better way to launch this product than to already own 20 million patients that currently use a conventional meter. While not every patient will convert to CGM many will. Even the ones who do not convert will still generate some nice cash.

To us we see the future of diabetes management coming down to battle over platforms, which diabetes management platform is used by the patient. These platforms as we keep stating will include everything the patient needs to manage their diabetes with the patient’s smartphone becoming the hub. This is not a battle between toys or even drugs, no this battle is between iOS and Android.

Think for a moment what it would mean to either Apple or Google to add 20 million users to their platform. Now it’s true that many of the 20 million are already using one of these platforms but given their respective market shares, with Android being the more popular platform, these tech giants could convert patients to their platform. Listen just as Lilly (NYSE: LLY) and Novo Nordisk (NYSE: NVO) have a healthy rivalry, Apple and Google are fierce competitors.

What gets lost here is that many view this battle between Apple and Google through the prism of diabetes alone. That diabetes management will be their lone source of revenue. This is not the case as we keep stating these companies don’t need to be in diabetes to make money, they want to be in diabetes so they can make even more money. Money that will be made not just from managing patients and selling them way cool toys but more money to be made from selling these patients all the other stuff they already own.

The Achilles Heel for Apple and Google is finding new growth platforms. This is another reason they are making the deep dive not just into diabetes but health care. Yes, Apple makes a ton of money selling new iPhones but they know the market is becoming saturated and they will need new ways to make money. The same goes for Google and their Android operating system.

The fact is while conventional BGM is on its last legs the race is far from over. These franchises do have value. As always this will come down to do who is willing to recognize this value. Let’s be honest Google, Apple and private equity has the bucks to make this happen. Now let’s see which of these players has the foresight and vision to recognize this value.