JNJ’s next move

JNJ’s next move

Yesterday during Medtronic’s (NYSE:MDT) Investor Day they finally gave analyst a look at their much awaited patch pump that will compete with OmniPod made by Insulet (NASDAQ:PODD). The company also indicated that sales of continuous glucose monitoring systems (CGM) will play a bigger role in the future. Additionally they indicated that are working on a CGM system to be used in the hospital.

Now that we know were Medtronic is headed it will be interesting to see what Johnson and Johnson (NYSE:JNJ) will do. The company already owns LifeScan, the leader in conventional blood glucose monitoring, and Animas, the number two player in the insulin pump market. Seeing as Medtronic has made it clear that they see closed loop insulin delivery as the future, it would seem that to remain competitive JNJ needs to add some pieces to their diabetes puzzle.

The company already has an agreement with Dexcom (NASDAQ:DXCM) that would allow the Dexcom CGM system communicate with Animas insulin pumps. When completed this effectively puts Animas on par with Medtronic technology wise. The fact is once a pump and cgm communicate it’s not a major leap to get to the next step which is a semi-closed loop and eventually closed loop system.

The gap in JNJ’s portfolio appears to be having a wireless insulin pump. Prior to being acquired by JNJ, Animas had a patch pump under development but it really never made it beyond the concept stage. The company has also publicly acknowledged that a patch pump does fit into their future plans. But so far we seen or heard nothing that would lead anyone to believe that company is anywhere close to having a patch pump. Given JNJ’s history of acquiring technology rather than building their own, it would seem that Insulet would be a perfect fit and fill a gaping hole in JNJ diabetes device portfolio.

This deal seems even better when you consider that Dexcom also has an agreement with Insulet.

Looking at Insulet’s current market cap, just north of $201 million, JNJ could easily afford Insulet without breaking a sweat. It’s also well known that Insulet is having some financial issues as evidence by the deal they signed with Deerfield Management. Desperate for additional capital the company agreed to pay Deerfield interest on money they haven’t even borrowed yet. Deerfield correctly assessed the situation and made a deal that would make even a Mafia Don proud.

As much as this deal appears to make sense and everyone runs out to buy shares Insulet there are some hurdles Insulet must overcome. First and foremost is lowering cost of goods. The company has already done a fine job of validating that there is a need for wireless pump technology. With over 10,000 patients using the OmniPod system there is no doubt that wireless pumping is here to stay. The company also has a pricing model that fits right in with the current and future economic realities of the insulin pump market. The company also has a new pod under development which will offer stiff competition to the new Medtronic patch pump.

What Insulet hasn’t done is find a way to make a profit on each pod they sell.  Even if the company is successful at reducing COGS to their stated goal of $15 per pod this cost is still too high. The reality is COGS must drop below $10 per pod for a patch pump to be commercially viable. However, Diabetic Investor doesn’t believe Insulet needs to get COGS all the way down to $10 per pod to make this deal happen. Given the state of the market, competitive landscape and JNJ’s goal of being number one or a very close number two in every market they play in all the company needs to do is to make progress on the COGS front. If JNJ sees it’s possible to get COGS anywhere near $10 per pod they will swoop in and buy Insulet as they realize with their marketing and manufacturing expertise they will be able to get COGS were they need to be.

The real issue here is one of timing, which unfortunately is not on Insulet’s side. According to Medtronic their patch pump will be launched about a year from now and even with some delay’s it’s likely the product will be ready before the end of 2010. That gives Insulet a narrow window of opportunity to convince JNJ that if they don’t move now it will be too late as Medtronic will have the advantage due to their huge market presence and brand name awareness.

The fact is when it comes to insulin pump sales it’s a battle between Medtronic and one other pump. It’s also true with a patch pump Medtronic will have the most complete line of pump options giving them a major leg up on the competition. If Animas is to effectively compete and have any chance at eating into Medtronic’s market dominance they must have a product on par or better than what Medtronic has. This means not just having a pump/cgm combination but a wireless pump option as well.

While it possible JNJ could develop their own patch pump or buy someone other than Insulet, this scenario ignores Insulet installed user base. Currently the OmniPod Personal Diabetes Manager (PDM) contains a FreeStyle blood glucose monitor from Abbott (NYSE:ABT). As Diabetic Investor has pointed out on several occasions insulin pump patients monitoring their glucose levels more frequently than any other patient, testing on average eight times each day. It’s also well known that the BGM market is becoming increasing competitive and market share means everything. This is the reason LifeScan has an exclusive agreement with Medtronic here in the US for the UltraLink monitor that communicates with Medtronic’s insulin pumps. Bayer has this same agreement with Medtronic outside the United States.

Although JNJ may not be able to get Insulet’s COGS down immediately the saving grace just might come from installing a LifeScan monitor into OmniPod’s PDM. With 10,000 or so PDM’s in the market that an additional 30,000,000 test strips sold. Even better for JNJ, that’s 30 million test strips Abbott won’t be selling. Although margins on test strips are declining they haven’t fallen so far where 30 million plus additional test strips sold is taken for granted. While this won’t pay for the deal by itself it does soften the blow and allows the company time to boost sales and lower COGS.

Armed with Insulet and having an Animas/Dexcom combo product JNJ using their considerable marketing muscle would give Medtronic a serious run for their money.  The fact is without these elements JNJ will be relegated to always being an also ran to Medtronic.

This deal is far from perfect and the timing may not be exactly to JNJ’s liking but with Medtronic ready to move the cost of waiting is even worse. As Abraham Lincoln once said; “We have all heard the story of the animal standing between two stacks of hay and starving to death.”