It wasn’t so long ago when diabetes was 1 of the hot sectors of med-tech, in which many companies felt they had to have a presence, no matter what the cost. And although it’s true that the incidence of diabetes continues to increase at worrisome rates in many countries, the diabetes market is no longer a "build it (or buy it), and the growth will come" type of proposition. It may not be quite true that diabetes has become a "winner takes all" sort of market, but it’s definitely a market where data, pricing and marketing muscle make a big difference.
Reimbursement makes life more challenging in monitoring
It’s been accepted fact for more than a decade that those who have diabetes and test their blood glucose more often have better long-term outcomes. Unfortunately, the cost of testing is starting to add up for healthcare payers and it’s having a direct impact on the major testing companies.
Abbott (NYSE:ABT) led the way in the first quarter, if you can call virtually no growth on an operational basis "leading." The larger businesses at Johnson & Johnson (NYSE:JNJ) and Roche (PINK:RHHBY) had a much harder time of it – JNJ reported a 10% operational decline in diabetes care revenue this quarter, while Roche logged a 5% decline. Bayer also noted a slight decline in its diabetes diagnostics sales for the quarter. (As Medtronic (NYSE:MDT) reports off the normal calendar cycle, their results are not yet available.)
Across the board, the companies said basically the same things about the state of the market. Reimbursement cuts in Europe are pushing down prices and/or utilization, while increased price competition in the U.S. is likewise harming sales. While companies with fresher offerings can still hope to gain some incremental share in the market, it’s becoming increasingly difficult to build any real moat in the business.
The real exception to this is at the small independent player DexCom Inc. (NSDQ:DXCM). Against this relatively dismal backdrop of revenue shrinkage, DexCom reported product revenue growth of almost 50% for the March quarter. Certainly DexCom is helped by starting from a low base (less than $30 million in quarterly product revenue), but DexCom does benefit from being positioned at the higher, premium end of the market where customers are willing and able to pay out of pocket for the benefits of continuous monitoring.
Treatment likewise a mixed bag
One of the challenges in assessing the diabetes market is that the large players like J&J, Abbott, Roche and Medtronic give very little detail about the composition of their business on a quarter-to-quarter (or even year-to-year) basis. To that end, while insulin pump penetration continues to increase, it seems reasonable to assume that this segment of the diabetes market has seen more than its share of challenges as well.
Data on the value of insulin pumps is not the problem, nor is the problem the performance characteristics of the offerings from Medtronic and J&J. Instead, the issue is once again money. Relative to the diabetes market as a whole, more pump-users are covered under private insurance programs and bearing the brunt of more adverse reimbursement conditions (including higher out-of-pocket requirements).
As in the case of monitoring, there is a growth exception. Like DexCom, Insulet (NSDQ:PODD) is 1 of the strongest revenue growth stories in med-tech right now, as 4th-quarter revenue rose 23% and management guided for 2013 growth ranging from the mid-teens to the low 20%s (with core OmniPod insulin pump growth likely in the 20%’s).
It’s also well worth noting that Becton Dickinson & Co. (NYSE:BDX) is 1 of the stronger growth stories on the device side of diabetes. Becton Dickinson recently reported nearly 7% revenue growth from its diabetes care business, which has shown itself to be at least somewhat insulated from the reimbursement challenges hitting the sector right now.
The FDA, reimbursement make the drug side no picnic either
While the device side of diabetes is certainly important, a little perspective is also in order. Novo Nordisk (NYSE:NVO) generates more revenue from its sales of insulin and diabetes medications in 1 quarter than the device side of the business combined. When you factor in the insulin and drug businesses of Eli Lilly (NYSE:LLY), Sanofi (NYSE:SNY), Merck (NYSE:MRK), Bristol-Myers (NYSE:BMY) and AstraZeneca (NYSE:AZN), it’s no secret where the truly big money lies.
While it’s a lucrative market, it too is not immune to the pressures of the market today. Reimbursement is emerging as a bigger and bigger threat, while the FDA’s tighter standards and more rigorous safety testing demands have held up new products from the likes of Novo Nordisk and Bristol-Myers/AstraZeneca. Even those with approved products are finding that the going can get tough – witness Bristol-Myers/AstraZeneca’s struggles to grow its GLP-1 business (headlined by the once-weekly Bydureon) against Novo Nordisk.
The bottom line
In a growth-starved market like healthcare, it’s hardly surprising that the best growth stories (Insulet, DexCom, Novo Nordisk) are also some of the most expensive stocks in the space. While that is not a problem so long as the growth rates stay strong, Edwards Lifesciences (NYSE:EW) highlights the risks attendant to buying expensive stocks if/when the growth rates start to underwhelm.
What is it going to take to get the market going again? Breakthrough products, as opposed to incremental improvements, would certainly help – if JNJ or Medtronic can crack the code on a closed loop system/artificial pancreas or if a drug company can develop a safe drug that significantly reduces HbA1c, the healthcare systems will find the money to pay for them. On the other hand, as investors have seen so clearly in cardiac rhythm management, orthopedics and stents, it’s getting harder and harder to drive impressive growth with only stepwise improvements in the products on offer.
Stephen Simpson CFA is a former sell-side and buy-side analyst who focuses most of his professional attention on financial and investment writing. In addition to a decade of work as an analyst, Mr. Simpson has worked as a wet-bench biomedical researcher and a consultant in the med-tech industry, as well as writing on a freelance basis for over 10 years. He can be reached via email at email@example.com.