Why this will be a tough sell

Why this will be a tough sell

When news broke last week that Bayer has once again put their diabetes device unit up for sale, it prompted many to speculate just who would buy the unit and for how much. While those issues are interesting perhaps better questions to ask would be what will the buyer get and can the new owners adapt to how the blood glucose monitoring (BGM) market operates.

As it stands today Bayer is the number four branded player in BGM, well behind market leader LifeScan, a unit of Johnson and Johnson (NYSE:JNJ). Also ahead of Bayer is Abbott (NYSE:ABT), another company who would like nothing better than to sell their diabetes device unit and Roche who is about to spin off their diabetes device unit into a separate privately held company. Some of the more notable others players are Nipro Diagnostics who entered this market by acquiring Home Diagnostics, Arkray, AgaMatrix, Nova Biomedical and Bionime.

At one time many speculated that GE, yes the company that brings good things to light, was getting set to enter this market and as we have noted on many occasions Sanofi (NYSE:SNY) tired but failed to enter the market with their ill-fated way cool now way dead iBGStar.

Today as we move closer to interconnected diabetes management there are several newcomers to this space; among them TelCare, iHealth and Livongo just to name a few. It is also well known that tech giants Apple, Samsung, Facebook and Google have at one time or another had an interest in glucose monitoring.

The point here is whoever buys Bayer will find this space very crowded. But that’s just part of the story as not only is this a very crowded market it’s also a commodity market where price trumps performance.  As we have noted frequently competitive bidding did not push this market into disarray it merely pushed it over the edge. Payors, both private and government, are now in complete control over what they will pay for a box of 50 test strips. That at under $11 per box of 50 test strips the once obscene margins made in this market are gone for good. Yes there is money to be made in BGM but to make it a company needs massive scale something Bayer lacks. Worse it would cost the new owners a small fortune to accumulate the scale they need to compete effectively.

BGM is not like other industries where a roll-up strategy might work as Bayer test strips don’t work with Abbott, Roche or LifeScan systems. A private equity firm could not say buy Bayer, Abbott and Roche and then save millions as there are no operational synergies between platforms. Yes they might save some back office and sales costs but not the massive savings needed to justify the rumored $2 billion price Bayer wants for their unit alone.

Bayer also lacks a product portfolio that will thrive in the future when IDM becomes the norm and outcomes based reimbursement takes hold. Quite frankly newcomers such as TelCare, iHealth and Livongo are better positioned for this change than the old guard. Not only are their products ready but so too are their business models as they know the key to the future isn’t in the collection of data but in turning that data into actionable patient information which ultimately drives better patient outcomes.

Right now companies like TelCare, iHealth and Livongo live in a world where selling systems are more important than selling a product. With the BGM market transforming once again it’s systems that matter not products. Bayer lives in a world where the collection of data is all that matters, while these newcomers live in a world where it’s the use of the data that matters.

So let’s just pause for a moment and reflect on where we’re at, an over-crowded commodity market with Bayer selling a unit which is ill-positioned to adapt to the changes that are taking place within the market. A unit which lacks the massive scale to maintain reasonable margins, a unit that plays in a market that is barley growing and some would argue actually contracting. So please explain to us again why this unit is worth $2 billion. Why any firm, public or private, would want to invest billions in this market.

Listen we know that the diabetes device sector is overly wacky and that there have been some truly nutty deals made in this space, but honestly we can’t think of one that would be any wackier than Bayer selling this unit for anywhere close to $2 billion. Remember this is not the first time they have pursued a sale and quite frankly there aren’t too many companies like Sanofi who would seriously consider spending billions to perhaps make millions. (Actually Sanofi is about the only company we’re aware of that likes to throw good money after bad deals something they proved once again when they partnered with MannKind (NASDAQ:MNKD).)

These rumors that there are multiple private equity firms interested in this unit may be true, however these firms didn’t get where they are today without performing solid comprehensive due diligence. Or put more bluntly they didn’t make billions by being stupid. The fact is a private equity firm of any stature who might buy this unit would only do so at a far lower cost than $2 billion, a billion maybe but anything more than waste is quite frankly a waste of money.

Should this sale actually occur, and frankly we’re not sure this second go around will end up any different than first, it will mark the end of an era. Those new to BGM may not realize this but it was Bayer who forever changed BGM when they started giving away meters for free. Back in the day this razor/razor blade business model was revolutionary a concept that was quickly copied and became the de-facto BGM business model. Yet like so many in this market they failed to adapt to changes in the marketplace, aggressive competitors and was once thought to be on its last breath. The unit was briefly resurrected under the solid leadership of Sandra Peterson, who ironically is now heading up JNJ’s diabetes units.  Once Ms. Peterson left the unit once again fell on hard times and is now for sale, yet again.

Having covered this market for the past 20 years Diabetic Investor just can’t fathom why anyone would want to spend so much when they will get so little. Frankly these private equity firms, the one’s rumored to be interested in Bayer’s unit, would be better off buying one of the newcomers to the space. Even if the sale price falls well below $2 billion whoever buys the unit would have to invest millions more and even with that investment there is no guarantee they will ever see a decent return. The newcomers may not have the brand recognition of a Bayer but in today’s market brand recognition really does not matter and certainly isn’t worth $2 billion.

As it stands today Diabetic Investor isn’t overly optimistic that any sale will take place and Bayer will have to dramatically lower the asking price if they really want to see a deal get done.  At the moment Bayer is dancing the limbo let’s see just how low they will go.