Welcome to the New World

Welcome to the New World

This morning Insulet (NASDAQ:PODD) announced the pricing of convertible senior notes which according to a company issued press release; “Insulet estimates that the net proceeds from the notes offering will be approximately $169.3 million (or $194.7 million if the underwriter exercises its over-allotment option in full), after deducting the underwriter’s discounts and estimated offering expenses payable by Insulet (after giving effect to reimbursement from the underwriter for certain expenses).

Insulet intends to use approximately $120 million of the net proceeds from the notes offering to repurchase approximately $86 million principal amount of its outstanding 3.75% Convertible Senior Notes due 2016 pursuant to individually negotiated transactions. The amount paid to repurchase these notes includes approximately $1.6 million of accrued interest. The repurchases are expected to take place concurrently with the closing of the notes offering. Insulet intends to use the remainder of the net proceeds for general corporate purposes, which may include financing redemptions, repurchases and / or the settlement of conversions of Insulet’s existing 3.75% convertible senior notes due 2016.”

While this event would not normally be considered big news it does illustrate the new realities of the diabetes device world. Way back in the day the diabetes device business followed a rather predictable pattern. A company would come to market with a new product, take share away from the existing players in the market and then get bought by one of these players. A perfect example of this was Therasense, which ironically was the last conventional glucose monitoring company to follow this cycle. The company came to market with an innovative new product, took share away from the existing players and then was bought by Abbott (NYSE:ABT).

Many, including Diabetic Investor, believed that Insulet would follow this pattern as well. Truth be told this is also exactly what the original investors in the company believed as well. The company came to market with an innovative offering in the insulin pump market, the tubeless OmniPod insulin patch pump. While the launch of the OmniPod didn’t exactly go as planned the company eventually fixed some quality control issues and began gaining share. It seemed like it would only be a matter of time before someone came along and made an offer for the company. In fact many potential suitors did sniff around the company yet no offers came.

So what happened? Why wasn’t Insulet acquired? Several reasons actually. Yet the core issue wasn’t necessarily that there was something wrong with Insulet rather the dynamics of the market changed. In the old days with the market growing at double digit rates whatever internal issues a company had were generally overlooked. Simply put back in the day it really wasn’t necessary that a company be well run rather that it had a good idea. The fact is before Abbott bought Therasense the company did experience its fair share of problems. Yet Abbott basically overlooked these issues as they figured with their marketing muscle and disciplined management style this deal would catapult them to the top spot in BGM.

The diabetes device world is full of deals that looked just crazy at the time they were done. Yet with money basically falling from the sky they paid off in the end as margins were huge. This is no longer the case. The fact is the diabetes device world has become ultra-competitive. Combine this with the fact that margins are shrinking and it creates a much different M&A environment. Simply put a company won’t spend billions unless the deal will result in an immediate boost to profits.

Insulet basically got caught in the middle of all this and instead of being acquired has been forced to actually run the company. The same thing also happened to AgaMatrix, who at one time was the hottest commodity in the BGM space.

This is the reason Diabetic Investor believes that many of the newcomers to the diabetes device world will eventually fail. Many of these newcomers have excellent products. However, they are living in the past falsely believing that they will be bought by a larger player in the market just because they have a good idea. Those days are gone for good.

They fail to see a company like Johnson and Johnson (NYSE:JNJ) who acquired insulin pump maker Animas throwing in the towel. With all their marketing and financial muscle JNJ just couldn’t fix the issues the company had. Yes Animas is the number two player in the market, still the company never produced a profit for JNJ. JNJ should actually be commended for looking at the market as it is and not as they think it should be. They clearly see where this market is headed and better to get out now then throw even more money into a bad situation.

Diabetic Investor does not believe M&A in this space is dead. Rather we understand that deals done today will be done because a company has proven itself. That the company has demonstrated they are more than just a good idea. This is one reason it’s just a matter of time before Dexcom (NASDAQ:DXCM) will be acquired. While the company may have originally been built to be acquired the company adapted to the new realities of the market. Changes in management were made and it’s not an overstatement to say that Dexcom is one the best run companies in diabetes devices. Simply put Dexcom has proven themselves.

The mistake being made by many of the newcomers is falsely believing that building a better mouse trap is the road to riches. That potential suitors will be enamored with something that’s way cool. That the suitors will pay big bucks for what essentially is an unproven yet possibly promising technology.  Basically they are banking on the premise that wacky world of diabetes, where anything can and usually does happen, will remain wacky.

Well folks as wacky as this world may be these companies are also facing some very sobering facts. The market isn’t growing as it was, margins continue to shrink and money is not falling from the sky. The fact is many of the companies who would be the potential suitors of these newcomers are like a grown up who’s experienced one too many hangovers. Yes in their younger days they could party all night long and still make it to work in the morning. Yet as they have gotten older they realize this is no longer possible.

To Diabetic Investor it’s these newcomers who are partying way too much and will wake up with one hell of a hangover.