Tandem Diabetes: Bullish As Innovations Capitalize On A Booming Sector – Seeking Alpha

Investment Thesis

With no known treatment, diabetes remains one of the last frontiers in preventative medicine. The insulin pumps manufactured by Tandem Diabetes Care, Inc. (TNDM) aid in its control. With pump shipments improving nearly three times over the last-twelve-month (LTM) period, Tandem has witnessed a more than two-fold increase in its LTM revenue.

Against this backdrop, the company estimates of nearly doubling the revenue and achieving its first-ever positive EBITDA in 2019 seem realistic. The innovative product pipeline even rivaling the market leader Medtronic plc (MDT) should accelerate the revenue growth in the long term. The strong cash flows with zero long-term debt could drive expansion and innovations further.

My conservative assumptions over five years of forecast indicate a top-line expansion of more than five times and based on price to sales ratio of 10.0x and 12.4x, a capital gain of 194-264% in five years. Meanwhile, the path for the commercialization of future medical innovations that could unsettle Tandem's business model remains lengthy and unpredictable. As a result, the annual compounded gain of 29-36% over the forecast period makes the stock a compelling buying opportunity at least in the near term.

Source: The Company Website

Only controllable, but no known permanent cure yet, Diabetes Mellitus (DM) is a chronic illness requiring life-long treatment. The human body needs the hormone, insulin for its cells to utilize its energy source, sugar. In DM, either the body doesn't produce enough insulin (Type 1 DM), or the cells can't use it properly due to insulin resistance (Type 2 DM).

According to the International Diabetes Federation (IDF), 425 million adults worldwide were living with DM in 2017 with 10% of the cases due to Type 1 DM (DM1); the number is forecast to reach 629 million by 2045. The Centers for Disease Control and Prevention (CDC) estimated there were 23 million diabetics in the US as of 2017 with DM1 making up 5-10% of the patient population.

Insulin, the main treatment for DM1, is administered through either Multiple Daily Injection (MDI) therapy or the Continuous Subcutaneous Insulin Infusion (CSII). CSII needs costly and durable insulin pumps or tubeless and disposable patch insulin pumps. The insulin pump industry in the US consolidated into the three main competitors when Roche Diabetes Care of Roche Holding AG (OTCQX:RHHBY) and Johnson & Johnson (JNJ) exited their US pump businesses in 2016 and 2017. The industry leader, Medtronic along with Tandem cater to the durable insulin pump market with their products t:slim X2 and Minimed, respectively. Insulet Corporation (PODD) manufactures the patch pump, Omnipod. As changes in lifestyle result in a higher prevalence of DM, the pump market is fast expanding driven by rising disposable income among consumers.

Source: Yahoo Finance

In addition to durable insulin pumps, Tandem manufactures disposable products that are used together with pumps: cartridges and infusion sets for storing and delivering insulin. The domestic business makes up more than three-quarters of its top-line while international operations, launched in the third quarter of 2018 (2018 Q3) account for the rest.

Tandem's latest product, t:slim X2 with Basal-IQ, launched in 2018 Q3 is the only device fully integrated with the G6 continuous glucose monitoring (CGM) system from DexCom, Inc. (DXCM). The Basal-IQ technology minimizes the risk of hypoglycemic events through its first-generation Automated Insulin Delivery (AID) algorithm.

The cutting-edge technology with user-friendly product design has propelled Tandem's revenue growth recently. In 2018, the top-line expanded 71% year-over-year (YoY), backed by a 77% YoY increase in pump shipments. With LTM revenue more than doubling from the previous period, I believe the sales momentum should continue buoyed by the company's attractive pipeline of products.

Source: koyfin.com

In 2019 February, the United States Food and Drug Administration (FDA) classified t:slim X2 in a device category named ACE pumps (Alternative Controller Enabled infusion pumps). According to the management, the new classification will broaden and fast-track the future commercialization of the product. The company plans to launch its second-generation AID system, t:slim X2 with Control-IQ technology in 2019 Q4 subject to FDA approval. In direct competition with the hybrid closed-loop functionality in Minimed 670G, the new pump system minimizes not only hyperglycemic but also hypoglycemic events and delivers the automated correction boluses. The revenue growth could further sustain in the long term with the launch of t:sport, currently planned for a launch next year. With a short infusion set and 50% smaller than t:slim X2, the device is expected to enhance user mobility.

My sales forecast for Tandem spans five years and considers only the DM1 population in the US and overseas, assuming its growth equals the relevant population growth rates at 0.6% and 1.0%, respectively. The company estimates the size of the current US pump market as 550,000 units, where DM1 users make up 80%. It forecasts the pump usage among US diabetics to improve from the current 30-50% within the next 3-5 years. Tandem's international expansion targets 3 million DM1 patients in overseas markets. Assuming 150,000 pump users in its near-term target markets, it believes the international usage to range from 10-20%.

Being conservative, I believe the pump usage in the US and overseas should improve up to 50% and 15% over the next five years. The US LTM pump shipments have more than doubled over the preceding period, and quarterly shipments increased more than eight times within a year internationally. Driven by new users and customer switching, I expect Tandem's US market share to range from 10-15% over the next five years from 10% in the LTM period (estimated based on US insulin pump usage data provided by the company). I further assume the international market share to increase up to 17-22% from 12% in the LTM period.

The company targets $350-365 million in revenue for 2019, at its midpoint nearly a two-fold increase from the previous year. Assuming a constant unit revenue and sales composition from the first half of the year, I forecast Tandem to cross $1 billion in revenue in five years, more than five-fold increase from 2018.

Sources: The Author; Data from Company Filings and Author Estimates

With the sales growth accelerating, negative LTM EBITDA gradually declining and loss margins narrowing, Tandem's plans to achieve its first-ever positive adjusted EBITDA margin in 2019 seems convincing. The higher pump shipments could result in economies of scale in manufacturing to lower the cost base and keep operating margins above 25% in the long term. Meanwhile, the strong cash position and negative net debt strengthen the financial position supporting the future R&D expenditure and overseas expansion.

Source: koyfin.com

Tandem and Insulet share mostly a similar revenue mix and trade at 10.0x and 12.4x of their 2019 per share sales estimates, respectively. Application of the same price to sales range over the forecast period implies a share price of $177-219 in five years with a capital gain of 194-264% at a 29-36% compound annual growth rate (CAGR). With the stock trading at more than 10% of discount to its value in 2016 July, the solid capital gain indicates a buying opportunity to profit from an undervalued stock in a booming sector.

Given the brisk pace of medical innovations, the investor, however, should keep an eye on the risks to the Tandem's business model as the company's top-line is fully dependent on diabetes care. In contrast, for Medtronic and Insulet, non-diabetes treatments make up 92% and 12% of their top-line, respectively. In the long term, I expect Tandem will wean itself off its reliance on diabetes treatments as the rising revenue and cash flow further reinforce its R&D capabilities.

Though Tandem plans to introduce the closed-loop technology in the next quarter, Medtronic with its Minimed 670G already has the first-mover advantage in the technology. Unlike Minimed 670G, however, t:slim X2 with Basal-IQ is remotely updateable, lightweight, factory-calibrated, Bluetooth-enabled, and sports a touchscreen. Smaller and sleek in design t:slim X2 with its novelty and enhanced end-user convenience will position Tandem at a competitive advantage in my opinion.

Source: The Company Website

Unlike patch insulin pumps, the durable insulin pumps are costly, and the third-party reimbursements are crucial for improving market share. In mid-2016, the largest private insurer in the US, UnitedHealth Group Incorporated (UHC), picked Medtronic as its preferred insulin pump supplier for adult diabetics, and last February, the policy was extended to cover the patients aged seven and above. However, with Tandem bringing more innovations and user convenience to its products, I believe the customer and healthcare provider preference will prevail over the cost concerns.

Once commercialized, the preventative drugs and vaccines currently under development against DM1 could one day upend Tandem's business model completely. Last June, when Provention Bio, Inc. (PRVB) announced that its Teplizumab had shown to delay the onset of DM1 in individuals at-risk for developing the illness in a phase 2 trial, Tandem's stock fell more than 6%. However, with the phase 3 trial of teplizumab expected to complete only in 2022, the lengthy and unpredictable regulatory process for the drug's commercialization will cushion Tandem's revenue stream in the near term.

In the last twelve months, Tandem's insulin pump shipments have increased nearly three times, and revenue has more than doubled from the preceding period. As a result, the plans to double the revenue and achieve the first-ever positive adjusted EBITDA in 2019 seems realistic. Driven by an innovative pipeline, the growth momentum should continue. Even the conservative estimates over a five-year period project a more than five-fold increase in revenue while a price to sales ratio of 10.0-12.4x implies a capital gain of 194-264%. Despite a remote possibility of disruption to Tandem's business model from successful medical innovations, the capital gain of 29-36% CAGR over the period indicates a compelling buying opportunity

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Tandem Diabetes: Bullish As Innovations Capitalize On A Booming Sector - Seeking Alpha