|Lake Street Capital November 15, 2018|
Yesterday, we listened to a discussion between Tandem’s CEO, CFO and a research analyst at an event in Arizona. Tandem’s management discussed why some payors are beginning to pay more for what they are starting to recognize as the BEST automated insulin pump, the t:slim X2 – Basal IQ from Tandem. In diabetes, better health outcomes matter a lot. A better outcome means avoidance of significant short- and long-term health consequences of the disease. A better outcome means potentially using 15% - 20% less insulin, fewer doctor visits, less time in the ER or hospital. That saves real money for both the patient and the payor.
Better Health Outcomes – Experts agree there is a global health epidemic related to the millions of people worldwide with diabetes. About 10% of the more than 400M people estimated to have the disease are classified as type 1 or insulin dependent. If these people do not intensively manage their diabetes, all day, every day, they face significant and expensive short- and long-term health consequences. The key to effective management is improved “time in range,” and there is growing evidence that automated insulin delivery systems, such as Tandem’s t:slim X2 – Basal IQ pump integrated with Dexcom’s (DXCM) recently approved G6 continuous glucose monitor (CGM) can significantly improve a diabetic’s “time in range.” In the short-term, this can dramatically (anecdotally by 15% - 20%) reduce the amount (and cost) of insulin, it can help avoid hypo- and hyper-glycemia which can result in fewer trips to the ER, lower health costs and of course, potentially a superior quality of life
Good, Better, Best – During the discussion yesterday, TNDM’s management mentioned that payors appear increasingly willing to pay more for an insulin pump that can help a diabetic achieve better health at a lower cost. This is entirely consistent with the longer-term direction of reimbursement in healthcare. We expect this trend to increase over time and see Tandem as a potential significant beneficiary of this movement. The interesting questions are, why would payors reimburse Tandem at a level that suggests it offers the industry’s “BEST” pump when the Company has by far the lowest market share among the 3 major remaining players in this market? And, what might this mean for TNDM’s results going forward? And is this notion of “BEST” sustainable over time?
BEST – In simple terms, we believe there is growing evidence that t:slim X2 – Basal IQ integrated with Dexcom’s G6 CGM and carrying the current TypeZero algorithm for automated adjustments when low blood sugar is anticipated is the industry’s best pump. It is simple to use and is integrated with a CGM that does not require numerous daily finger stick calibrations. Perhaps most importantly, Tandem has its device updater which will potentially allow free, instant software downloads to next generation innovations in key functionality of the device. That is one of the game changers for TNDM and it is significant for everyone involved, most notably the patient.
Data To The Cloud – During the discussion yesterday, management highlighted another big difference between TNDM and its key competitor, Medtronic (MDT). That is, TNDM’s pump can wirelessly transmit real-time patient data to the cloud such that it is accessible by the patient, the caregiver (parent, spouse, etc), the physician and/or the payor. In a world where there are life and death consequences of this disease in minutes and significant long-term consequences to improved care management, the potential for immediate access to data is meaningful to all key constituents. MDT’s pump does not have a radio and thus the patient must download the data and take steps to make it accessible to the key constituents. We believe this is a significant point of difference for TNDM. To address this, once MDT adapts its system to compensate, it is likely the patient will need to buy a whole new pump. And payors may require a wait of up to 4 years or more before they will cover the cost of that pump.
Pipeline, Responsive FDA, Control IQ, t:Sport, Improved Algorithms – The conversation we listened to yesterday was relatively short, but a lot of useful information was conveyed. In particular, it is clear there has been a sea change at the FDA in recent years and the agency is highly engaged in accelerated responses to drive innovation in diabetes care. TNDM has demonstrated relentless innovation in product development and other aspects of their business. Thus, with Control IQ and t:sport in particular, it seems clear the pace of change will not abate any time soon. And keep in mind, TNDM is continuously working on improved algorithms for better glycemic control and it seems likely these can be delivered to in-warranty pumpers for free via software download. We don’t yet know how quickly all this can play out, and frankly we expect it to take years, not months or quarters due to the many significant impediments to rapid change that exist in healthcare.
Investor Pull And Tug – Clearly, investors view TNDM today from many perspectives. Those who bought it at a low price late last year or earlier in 2018 may be electing to take profits now in an effort to lock in gains. Others may view the stock as expensive and fully reflecting all the good news for the Company. We respect these perspectives and understand the logic behind them. On the other hand, we feel sure there are many deep pocketed investors who missed what we believe was the first big move in TNDM shares earlier this year. Thus, the recent correction can be viewed as both a logical and attractive situation for many. In the simplest sense, we believe there is a large, global diabetes epidemic now. At the same time, there is a revolution underway in the way diabetes can be managed. TNDM is operating at the heart of that revolution. We believe they have the best pump now, that it will get better, that patients and payors will benefit significantly from the current and future innovations. We see growing evidence that payors will reward TNDM with higher reimbursement for delivering better outcomes. TNDM’s share is small today and while it will take time, we expect their share to increase meaningfully over the coming years. We encourage investors to get involved now.
TNDM has just received FDA approval to market t:slim X2 Basal IQ, which competes directly with MDT 670G and integrates with the superior DXCM G6 CGM. The next product in Tandem’s line-up, t:slim X2 – In Control, likely heading for U.S. approval in mid-2019, will correct for both low glycemic levels and high ones. Combined with the other strong Tandem product features (small size, touchscreen controls, device updater), #1 rated customer service and integration with DXCM’s no finger stick calibration G6, we think it likely TNDM can become the industry leader over the next several years. These innovative products will keep diabetics “in range,” or driving down the center lane, in ways that will help them live like people with a fully functioning pancreas and minimize the significant and costly complications of this terrible disease. There is literally a revolution underway in diabetes management today and it is just getting started. At a minimum, we believe Tandem will play a central role in this rapidly evolving market and this offers investors an exceptional opportunity now.
The International Diabetes Federation estimates in 2017 approximately 425M people had diabetes worldwide, of which approximately 10%, or 42.5M, had type 1 and thus require daily insulin to manage their disease. There are significant and costly short- and long-term health consequences for poor management of this disease. Today, five product (non-drug) companies are leading the effort to improve care for diabetics world-wide. These five are Medtronic (MDT), Abbot (ABT), Dexcom (DXCM), Insulet (PODD) and Tandem (TNDM).
Medtronic is generally considered the industry leader today and MDT offers an integrated system called 670G, which combines a continuous glucose monitor (CGM), an automated insulin pump and an algorithm which translates data from the CGM to the insulin pump to drive automated correction of low glucose levels in the patient. This is something like a self-driving car which corrects when the vehicle drifts right (definitely important), but leaves the driver in control when the car drifts into the fast lane or the path of oncoming vehicles (something which needs to be addressed to optimize utility). DXCM and ABT both offer robust CGMs which have significant advantages over the MDT CGM in that they do not require frequent finger stick calibration as does MDT’s product. PODD offers a disposable insulin pump which is tubeless.
MDT and ABT are global, diversified medical product companies and diabetes is just one piece of their focus. DXCM and PODD are pure plays in diabetes care and each has unique attributes. TNDM is the smallest significant pure play diabetes company and we think its recently approved t:slim X2 – Basal IQ product integrated with Dexcom’s powerful G6 (also recently approved) offers a superior closed loop system to provide improved glycemic control to diabetics worldwide. This is likely to be very significant for TNDM, for diabetics and for investors, among others (payors, clinicians, competitors, etc.).
Tandem has experienced a remarkable turnaround in the past year and the stock has had a big move as a result. In the past 6 weeks, the stock has experienced its first significant pullback this year, with no significant negative news from the company. In fact, during this period the Company positively pre-released Q3 results and analyst’s generally increased their forecasts and price targets. Last week, TNDM reported Q3 results and again blew out the numbers. Predictably, the stock went down.
We believe the recent pullback offers growth investors an exceptional opportunity to get involved in TDNM now. TNDM has delivered >25% sequential revenue growth the past several quarters, blowing away expectations each time. 4Q is seasonally strong and both DXCM G6 and t:slim X2 Basal IQ are just now rolling out into the marketplace. TNDM is just launching in key international markets which are primed now because JNJ’s Animas pump was withdrawn from the market last year.
represents the most recent new market opportunity and we expect solid growth there beginning this quarter. TNDM has dramatically strengthened its balance sheet and its product pipeline is exceptional which suggests the forward outlook is as strong as its current outlook. In addition, we think it possible UnitedHealth Group may revisit its coverage policy for TNDM as the largest U.S. health insurer currently does not reimburse its covered diabetics for the industry’s best pump.
No one knows what results Tandem can generate in the next 4-6 quarters. No analyst has accurately anticipated Tandem’s recent performance, and it is unlikely this has changed now. We have suggested what might happen if Tandem can continue to grow revenue 25% sequentially as it did during the first half of 2018. If Tandem can deliver 25% sequential growth the next 4 quarters and if other recent metrics hold, we expect investors to drive TNDM shares to $60, which is our current price target. We note sequential growth in Q3 was actually 35.8%.
VALUATION $60 Price Target – Our 12-month price target on Tandem is $60, which is based on our expectation investors will place an EV of 11.5x on the run-rate revenue we think TNDM can achieve within one year (see our note of 8/20/18 for more details). The math works out to 11.5x $321M revenue, + $0 debt – $113M cash, divided by our estimate of roughly 60M shares outstanding in ~12 months.
We think a $60 PT is justified because:
· The combination of a patient-friendly insulin pump integrated with a continuous sensor has the potential to revolutionize care by helping people with diabetes reduce time spent “out of range” and thus, potentially reduce the costly and debilitating long-term complications of the disease.
· MDT is the industry leader with its own closed loop 670G pump. On Friday (8/17/2018), Tandem announced the launch of its t: slim X2 – Basal IQ, with a patented PLGS feature which could be upgradable for existing Tandem pump users to include additional innovations using a free, downloadable software program.
· Dexcom’s recent G6 approval from the U.S. FDA came with iCGM compatibility, making the pathway to future integrated product approvals clearer and potentially quicker. We think this can accelerate future product approvals for TNDM and drive faster revenue growth and improved margins over the next few years.
· Recent financings have given TNDM plenty of capital to reach cash breakeven, which is expected during the 2nd half of 2019.
TNDM has suggested the Company has a broad revenue target of $1B (no precise time frame). We believe such a goal is achievable given the size and significance of the diabetes market worldwide and TNDM’s exceptional positioning. This market is highly regulated (making entry of new competitive products difficult, time consuming and expensive). Recall, 3 significant competitors have exited this market in recent years, leaving a very limited number of true competitors now. Assuming TNDM gets to its revenue goal and investors continue to value diabetes stocks as they are today (see DXCM, PODD), we think it likely TNDM shares will trade well over our $60 PT.