Yesterday Moody’s issued the following rational for their debt rating for the now independent LifeScan;
“Moody’s Investors Service (“Moody’s) assigned a B2 Corporate Family Rating and B2-PD Probability of Default Rating to LifeScan Global Corporation (“LifeScan”). Moody’s also assigned a Ba2 rating to the company’s $125 million secured revolving credit facility, a B1 rating to its $1.4 billion secured term loan B and a Caa1 rating to its $350 million junior ranking secured term loan. The rating outlook is stable.
Proceeds from the new credit facilities and $473 million of equity contributed by Platinum Equity, LLC will be used to acquire LifeScan from Johnson & Johnson (“J&J”) in a transaction valued at approximately $2.1 billion.
LifeScan’s B2 Corporate Family Rating reflects its ongoing declines in revenue due to structural declines in volume and pricing for blood glucose monitoring strips (“BGM”). Moody’s expects that LifeScan’s revenues will continue to decline in the mid-single-digit percentage range for at least the next two-to-three years. Moody’s expects that continuous glucose monitoring systems — a category where LifeScan has no presence — will gain share over time. The company’s ratings also reflect execution risk around the ‘carve out’ of the company from J&J. LifeScan’s ratings reflect its moderate leverage, as Moody’s expects that debt/EBITDA will remain below four times. The company also benefits from its very good liquidity, reflecting strong free cash flow. LifeScan also benefits from its leading market position in BGM products and its global presence with a majority of revenue generated outside North America.”
Before we go into a deeper commentary here it’s nice to see that Moody’s at least has a solid grasp of the glucose monitoring market. Something quite frankly most analysts/investors do not have evidenced by the continued flow of money into conventional BGM companies. Listen when a company like Intuity Medical can continue to raise money you know there is something seriously wrong these people.
Now onto what LifeScan now an independent company will do next. As the Moody’s analysis correctly notes and what we have stated previously this business as bad as it is continues to throw off lots of free cash. While part of the mothership Johnson and Johnson (NYSE: JNJ) gutted LifeScan turning the franchise into a lean organization giving it the ability to make money while the market collapsed. This lean organizational structure combined with the strong free cash flow opens many possibilities.
As Moody’s notes and as we have stated many times CGM is becoming the standard for glucose measurement and LifeScan does not have a CGM. Yet as we have been reporting should the company decided to acquire a CGM there are plenty to chose from. With a market cap of almost $8 billion we doubt they go after Dexcom (NASDAQ: DXCM) who likely will be gobbled up at some point by a company that has tons of cash and is making the deep dive into diabetes. And we can think of one or two who are doing just that, but we digress.
Should LifeScan venture down the CGM path look for them to acquire a company that has a good sensor that can be manufactured at a very low cost. While there are more charlatans than real companies in the CGM wannabe space there are one or two who could be real and would be worth a look. This would likely pit LifeScan against Abbott’s (NYSE: ABT) FreeStyle Libre more than Dexcom’s new G6. A battle which would be interesting because LifeScan has something Abbott doesn’t have, 25 million built in patients already using a conventional LifeScan system.
This is one we reason why we never understood why a company like Google did not make a play for LifeScan. Besides having boatloads of cash, the company is partnered with Dexcom and the two of them are working the coolest new toy in CGM the slap it on turn it on no calibration needed 14-day sensor. A product which will cost the equivalent of three test strips per day. Think of how many sensors they could have sold had they owned the 25 million patients LifeScan has. Let’s say that of the 25 million only 10 million are in developed markets and let’s also say they only converted 25% of these patients to CGM.
That’s 2.5 million patient’s folks who let’s say on average use 6 sensors a year which means they would have sold 15 million sensors per year. That my friends is what’s called scale and scale drives efficiencies which drives … wait for it … profits.
Looking at how highly leveraged the LifeScan purchase was one has to wonder why Medtronic (NYSE: MDT) did not pull the trigger. As we have noted Medtronic is entering the stand alone CGM market albeit with an inferior product. Yet inferior or not they too could have converted patients from BGM to CGM. Plus, Medtronic could have converted these same patients some of them anyway to insulin pump therapy which is their core profit center. Heck we even think they could have sold the I-port in the less develop nations another area where LifeScan has lots of patients.
What boggles the mind is that no one in diabetes or anyone making the deep dive understood that the real value of LifeScan wasn’t sales EBITA or even its free cash flow. The real value of LifeScan is 25 MILLION PATIENTS. Patients are the most valued asset in diabetes and they are very expensive to acquire.
Think about this just for a moment and ask yourself why Google, Apple and Amazon are making the deep dive into diabetes. Are they in this to sell sensors, insulin pumps, Tyler’s or apps? Or are they in this to expand their existing platforms? Existing platforms which they can use to sell their customers with diabetes other stuff. Think of what it would mean to Amazon for example if they had the ability to sell or at minimum distribute drugs to patients with diabetes. Amazon would happily take their small fee per transaction when that small fee is multiplied by MILLIONS of transactions. Scale huge scale is a beautiful thing.
Heck we see no reason why LifeScan could not approach Amazon with the idea of becoming their glucose monitoring partner. They could start with conventional systems while they search for a CGM provider. As we have stated many times think what it would mean to Dexcom or Abbott if they had Amazon as a partner. Think of the doors this opens.
What’s even crazier here is that none of these companies realized how desperate JNJ was to sell LifeScan. Everyone knew that JNJ screwed the pooch with Animas and wanted out of diabetes devices in the worst way. Any of the cash rich techies could have easily done the deal. So too could have Medtronic just based on how leveraged the deal is and folks Medtronic also has gobs of cash. No, the problem is what it always is these people can’t see the forest for the trees. What is it we keep saying about that simple peanut butter and jelly sandwich.
And one thing before we move on for the record we do not like even like peanut butter and jelly sandwiches. Now a simple American cheese sandwich that’s ok which just so happens is another sandwich these companies would screw up. Heck with an American cheese sandwich you only need bread and American cheese and if you want to get fancy you can grille this sandwich too something you can’t do with a peanut butter and jelly sandwich but again we digress.
The fact of the matter is Platinum did not acquire a BGM company they bought 25 MILLION PATIENTS AND ABOUT $500 MILLION PER YEAR IN FREE CASH FLOW. The question is what they will do with the assets they own and the money they generate. We’re going to stop asking why someone else did not also see what Platinum saw. Why these companies who were already in or making the deep dive in did not see the real value here.
We’re going to make another prediction here and now so take notice. Having been around this wacky world a few years we already know what’s going to happen. Platinum will go about their business and in year or two, maybe three will sell LifeScan to one of these companies for three or four times what they bought it for. Heck even they flipped it for twice what they paid for it that’s’ not a bad return on investment considering how leveraged the deal is.
And you know what it won’t bother any of the companies that eventually buys LifeScan from Platinum that they bought an asset for $4 billion they could have owned for $2 billion. Listen when you have gobs of money and your core businesses continue to add to that huge cash pile who cares. Yes, when they acquire an asset for twice what someone else paid they will say what a bargain it is, and everyone will do the happy dance. This my friends has happened many times, which is just another reason why we call this the wacky world of diabetes.