Standing eight count

Standing eight count

The best way to describe the situation Dexcom (NASDAQ: DXCM), who reported earnings this evening, finds themselves in is to think of a boxing match between two heavyweights who have fought before. Until recently Dexcom had the upper hand in these matches yet this last match their opponent, Abbott (NYSE: ABT) changed tactics. Rather than be the Abbott of old, Dexcom faced a new Abbott and rather than dominating the match got hit and bloodied a little. They were not knocked out, but they were stunned.

The reality is Abbott’s aggressive pricing posture with Libre is a problem for the company. The fact is Dexcom was caught with their guard down. They did not anticipate the label received by Libre when it was approved by the FDA nor did they anticipate just how aggressive Abbott would be with payors.

The company also has another problem coming as they know Medtronic (NYSE: MDT) is preparing to use their clout with payors. As much as no one wants it the price war has begun. Add in more competitors entering the CGM space and it’s easy to understand why the company is characterizing 2018 as a transition year.

They see the G6 coming sometime in the second half of the year, yet its arrival will likely not have a material impact until 2019. They see the first generation Verily product coming but know it will not arrive until 2020 at the earliest. They see a rising tide lifting all boats but also understand given the pricing environment they must sell more sensors to make the same amount of money. As we keep noting the CGM market is following the same path as the BGM market only at a much faster pace.

This is one reason we keep stating that if an investor has a two-year investment time horizon Dexcom shares are a bargain at current levels. Their time is not now, now being a time to recover from the blows they have taken. They must regroup, get back in the gym and come out stronger than before.

The company has several compelling advantages that play into their favor.

First the company is very good at manufacturing sensors on a massive scale. Second, they have plenty of money and while 2018 may not the best year from a revenue and margin standpoint there is no reason for panic. Third as these systems become mirror images of each other, and they will, partnerships become critical. Besides Verily, Dexcom has great partners which will help drive future growth. Even Tandem (NASDAQ: TNDM) which was on the brink of bankruptcy now has money and live a while longer. As we noted previously Dexcom could ill-afford another Animas situation.

To continue with our boxing analogue Dexcom has taken a blow and the referee has issued a standing 8 count. No one is throwing in the towel nor has anyone knocked them out either. This 15-round match is in the early rounds and by no means over. We see both fighters landing blows as this match proceeds. And while no one likes a draw that is a distinct possibility when this match is over.

Drifting away from boxing analogue think about the smartphone market. Apple is very happy and very profitable owning the premium segment of this market. Samsung isn’t exactly suffering, and Google is doing quite nicely with the Android operating system. There is an unusual amount of serendipity in the Valley these days. The old days when everyone fought against each other for dominance have thankfully disappeared into a peaceful coexistence with each company profiting by targeting different market segments.

This is exactly how we see the CGM market. Unlike other diabetes device markets the CGM segment is VASTLY underpenetrated, there is a huge untapped market. CGM is becoming the standard for glucose measurement. While we see commodization coming we also see market segmentation coming with it. Just as the smartphone market commoditized it also segmented with some consumers willing to dish out nearly $1,000 for premium phones, while others want something cheaper. Yet as we are seeing everyone in the Valley is fat with cash and for the moment very happy.

Dexcom and Abbott may be trading blows right now but don’t be surprised if they along with Medtronic find a peaceful coexist as Apple, Google and Samsung have found. Our gut tells that all these companies understand that if this becomes a race to the bottom no one wins even if they wear the belt. That being heavyweight champion will be meaningless.

It’s no good to win a fight if there’s no prize money to collect when the fight is over.