Medtronic Reports
Medtronic Reports
Take a look at the last ten quarters for Medtronic’s (NYSE:MDT) diabetes unit and what do you see? What you don’t see is strong revenue growth. While Medtronic will stress how results look over a rolling 12 month period. The reality of the situation is that growth quarter over quarter is slowing and speaks volumes about the current state of the insulin pump market.
According to Medtronic who released results for their second quarter of fiscal year 2009 this morning, the diabetes franchise is being negatively impacted by two main factors, the poor economy and a negative pump replacement cycle. For years Diabetic Investor has been trying to get more detailed data from all the insulin pump companies, asking them to provide more detail on new pump patients and upgrades from existing patients. Diabetic Investor has long suspected that pump companies inflate results by basically double counting patients.
The reason for this request is the revenue generated by a patient new to pump therapy is dramatically different from an existing pump patient where the main revenue comes from the sale of pump supplies. With new pumps costing upwards of $7,000 just for the pump, a patient new to pump therapy generates a higher revenue stream, than an existing pump patient who spends approximately $2,000 per year on pump supplies.
Being the number one player in the insulin pump market Medtronic takes full advantage of their huge installed user base to generate the annuity from pump supply sales. However, should they begin to lose patients to the competition or fail to have existing patients upgrade to newer systems revenue growth goes from greater than 10% quarter over quarter to less than 5%. This is exactly what has happened to Medtronic.
Try as they might to talk up the sales of continuous glucose monitoring systems (CGMS), the reality is this business is far less profitable than insulin pumps. It’s also clear that while a company like Dexcom (NASDAQ:DXCM) is totally dependent on CGM sales, Medtronic is basically using CGM as a tool to sell more pumps. If existing patients fail to upgrade to these newer systems which integrate a pump and a CGM, the annual supply revenue remains flat. Besides the $2,000 in annual supply revenue generated by an existing patient, a patient who upgrades to an integrated system has the potential to generate an additional $3,500 per year based on the cost for replacement sensors. This is why Medtronic is heavily promoting integrated systems.
While it is true that sensor revenue is growing it is also true that sensors are being used well beyond their approved life cycle of three days. Instead of changing sensors every three days patients are extending sensor life to 7 or more days, this without adversely affecting the accuracy of readings. Bottom line, instead of buying 10 or more boxes of sensors each year the patient can get away with 5 or less boxes each year. What looked like a great way to generate additional revenue from a huge installed user base just hasn’t materialized.
The fact is Medtronic is feeling the heat from Animas, a unit of Johnson and Johnson (NYSE:JNJ), and Insulet (NASDAQ:PODD). Unlike Medtronic who uses CGM to increase pump sales, JNJ uses pumps to increase the sale of blood glucose monitoring test strips. As Diabetic Investor has pointed out several times, on average an insulin pump patient checks their glucose levels 8 or more times each day. It is also well known that test strips carry some of the highest margins in the industry. While Animas does have a deal with Dexcom to integrate the Seven System into the Animas insulin pump, their sales have not been adversely impacted by the lack of an integrated system.
The same is true for Insulet, who also has a deal with Dexcom. Insulet has proved there is a market for a wireless patch pump and is exactly expanding the market for insulin pumps. Although the company lacks the resources of their two main competitors they are the only player with a wireless pump and are taking full advantage of this fact.
For years Diabetic Investor didn’t think it was possible that Medtronic could ever lose their dominance in the insulin pump market. Holding nearly 75% of the market we believed the fight was for second place. Now that JNJ has righted the ship at Animas and Insulet has validated the wireless pump market, we’re not so sure. Like others we assumed that even if Medtronic’s competitors started taking away share they couldn’t compete when it came to the replacement or upgrade market. Simply put, while Animas and Insulet might gain the majority of new patient starts, Medtronic would retain their dominance by keeping existing customers.
The insulin pump is growing but by no means is it growing fast enough for either Animas or Insulet to overtake Medtronic by capturing the majority of patients new to pump therapy. In order to eat into Medtronic’s lead they had to get existing Medtronic patients to convert to their system instead of staying with Medtronic. Based on what we see and how the numbers are playing out this is beginning to happen.
It’s certainly not game over for Medtronic by any measure however should this trend continue some tough decisions will need to be made. JNJ has the resources to effectively compete while Insulet has the product to compete, should JNJ make a play for Insulet they could make a serious run at Medtronic for market dominance. Even without this combination it’s clear the market dynamics for insulin pumps are changing and not in Medtronic’s favor. The question is; are we seeing the beginning of the end or can Medtronic get back on track and remain dominate? Stay Tuned, this is getting very interesting.
