|Shares Out. (in M):||8,600||P/E||33||0|
|Market Cap (in $M):||230||P/FCF||0||0|
|Net Debt (in $M):||-46||EBIT||8||0|
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Intricon is medical device company that manufactures ultra-low power digital signal processing (DSP) and ULP wireless technology for the hearing aid and medical services segments. The main thesis highlights are:
· Medical (body worn segment): Intricon is the main manufacturer of components (sole supplier of transmitter, sensor assembly, serter, and charger) for Medtronic’s 670G closed loop CGM, with a close relationship since 2003 and dual commitments for capex expansion. From our conversations with a former director, our understanding is that the relationship is extremely collegial, forward looking for 3 generations, and extremely likely to become contractual
· Hearing aid disrupter: Intricon was historically a manufacturer of hearing aids for the big 6 oligopoly (~90% market share), but the recent passage of OTC Hearing Aid Act of 2017 levels the platform for new disruptive distribution channels. The mark up of hearing aids at retail is ~50x ($50 to manufacturer vs $2,400 ASP). Intricon is trying to build the next “Warby Parker” of hearing aids and is currently in investment mode (losing money), but has an addressable market of ~$3 billion (Revenues are $7 million today)
· Screens poorly: You are buying this at $220 million market cap, or $175 million enterprise value. The P/E (ex-cash) on the body worn segment (largely Medtronic diabetes) right now is <20x. It is growing 25% this year and estimated to grow mid-teens going forward, in line with Medtronic’s own projections for growth of its 670G and later generations (vs. Dexcom’s guide of 20+%). Medtronic has 70% share of the legacy insulin pump market (roughly 800,000 users, of which only ~150,000 are currently on 670G) with the intent to convert all users to 670G and later generations over the next few years. With 30% incremental margins, if Intricon grows 15% top line for 3 years to 2021, this segment can achieve ~$25 million in net income (<7x this segment on 2021 earnings, assuming no cash build)
o We can get creative with the hearing aid business, but we see it as pure upside. If the business actually takes off (final rules on regulation is due within next 12-24 months), it seems that there’s a decent amount of room to run from $8 million run rate to something much more significant if the TAM is in the billions. If for example, the business grows from $8 million to $20 million in the next few years, and is worth 4-5x revenue given the growth backdrop, the segment itself could be worth 50% of the current EV.
The company generates roughly 2/3 of its medical device segment, and 1/3 from hearing aids (in the financial statements, this is broken out as body worn devices – which includes medical devices and hearing related devices, and Hearing Health – their direct-to-consumer segment):
· There are 1.4 million type 1 diabetes patients in the U.S. (29 million total) – as the immune system attacks insulin producing cells, type 1 patients are required to take insulin for the rest of their lives (not preventable w/ exercise and diet)
· Prior to CGM technology, finger sticks and glucose meters were used to determine blood glucose levels. However, finger sticks are only able to tell you a snapshot of your current glucose level (a number at one point of time and the patient has no idea if it’s going up or down or how fast or slow). Therefore, patients had to test themselves at numerous points of the day in order to maintain a healthy glucose range (between 80-140 mg/dl). Ultimately, finger sticks fail to tell the whole story necessary to manage blood glucose levels within a healthy range
o Too High Glucose: Cardiovascular disease, blindness, kidney failure and nerve degeneration
o Too Low Glucose: Diminished cognitive ability, loss of consciousness, potential death
· Dexcom was at the forefront of the introduction of continuous glucose monitoring (CGM), which includes an applicator, a sensor/transmitter, and a display device (now with iCGM can be viewed on iphone, etc)
o a sensor (placed under the skin to continuously measure glucose levels in interstitial fluid) This piece is generally worn 10-12 days and represents the key stream of recurring revenue for the company
o a transmitter that automatically captures and sends out blood glucose data via Bluetooth every couple minutes (this is generally expected to last around 12 months)
o a transmitter that automatically captures and sends out blood glucose data via Bluetooth every couple minutes
· Why is CGM inevitable?
o Continuous monitoring means patients can manage their disease without constant proactive monitoring
o Overnight monitoring reduces danger of severe nocturnal glycemic events (“dead in bed” scenarios) and eliminates the need for proactive overnight management
o No more finger sticks
o Closed loop systems are now auto-pilot: the system will predict when to suspend and administer insulin – will continuously dose insulin up or down every 5 minutes/24 hours a day
o Companies are so confident it will work/reduce healthcare costs that Medtronic launched a guarantee: “With this Guarantee, Medtronic will provide flat-fee reimbursements up to $25,000 per pump over 4 years for qualifying diabetes-related inpatient hospitalization and emergency room admissions for eligible in-network patients in the United States….This new program demonstrates the strong confidence we have in our ability to deliver improved clinical outcomes with our MiniMed670G system and our commitment to value-based healthcare that not only improves outcomes but drives down the enormous burden of diabetes-related healthcare costs”
§ Medtronic during diabetes conference: “When we looked at patients who are on pump, our pump therapy versus those patients that were on multiple daily injections, what we saw was a 27% reduction in preventable hospitalization. So, those patients that were on pump therapy had 27% fewer preventable hospitalizations than matched MDI patients”
o One meta-analysis of six CGM cost saving studies indicated that a US commercial health plan with 10mm lives could save $9-$13mm with CGM by averting hospitalizations for severe hypoglycemia ($950 - $1,350 per patient)
· Market Size:
o Penetration in the US for CGM is around 15-20% among type 1 (Morgan Stanley predicts a user base of around 300k in the US currently); likely to increase to peak penetration of 50-75%
o Type 2 could become addressable as costs come down (market is 10-20x larger than type 1)
o Solid reimbursement and payer support should continue to facilitate the ramp of the product category
o OUS opportunity – 24 million if assuming 5% of 470 million diabetic population. Abbott has mentioned a total of 40 million type 1 diabetics out there, which implies a lot bigger OUS market
· Players: Dexcom (leader), Medtronic, Abbott
o Dexcom is the leader and Abbott and Medtronic are known to have inferior products, but that doesn’t mean they can’t grow/compete. Medtronic disclosed 150,000 670G smartguard users in the latest quarter, up from 135,000, 97,000, and 70,000 previous 3 quarters:
o Dexcom is predicted to have around 300k users; 83% of revenues are from the US, so maybe around 250k
o Libre is a little different / lower cost – it is a sensor that comes with a handheld reader so that you can just scan the sensor in lieu of a fingerstick. The normal control/injection of insulin is done manually. However, it has 1.3 million patients and is adding 300k a quarter; targets both type 1 (2/3) and type 2 (1/3).
§ As of Q3’ – 200,000 users in the US; 800,000 users OUS
§ $1 billion dollar business
In the medical device segment, Intricon has grown from $37.6 million revenues in 2016 to $67.7 million Q3’18 LTM largely due to Medtronic. Intricon is the sole supplier to Medtronic’s MiniMed transmitter products, which is Medtronic’s continuous glucose monitoring (GCM) product, along with the sensor assembly, charger (the transmitter is detachable from the sensor and requires charging), serter (for applying the transmitter), and transmitter connect. Essentially, they are the supplier of everything but the pump/infusion device and the actual sensor. The transmitters are ~50% of revenues from Medtronic, sensors 35%, and ancillaries 15%:
Intricon is riding the massive secular growth of intelligent diabetes management:
· MiniMed 670G (newest version of Medtronic’s closed loop insulin management system) has significantly higher attach rates than legacy pumps of 35%:
o While never fully disclosed, Medtronic stated in June/18 at the diabetes conference that they expect attach rates to go from 35% to 65%; but that’s because there are medicare limitations, etc.: “I think as people move to the 670G, the attachment rate goes up dramatically. But in terms of our overall pool of patients, it averages out to 65%”
o On top of that: “The Medicare reimbursement will come with a non-adjunctive claim, and as I mentionedwe're going for the non-adjunctive PMA this year so. Yeah” -> that is another 15-20% of the population (so up to 85%)
· Guardian Connect is a standalone CGM that does not require a pump attachment; this market growing much faster than connected pumps, and Medtronic is new to this market (Libre was only one in this market)
o Medtronic believes the market is $1.3 billion or so in 2019 growing at mid 20% range. They only entered the markets last year
· Medtronic has 770,000 patients on insulin pumps (out of 1.1 million); while competition is high with Dexcom, we believe even marginal market share loses will result in much higher revenues to Intricon given the generational shift in products:
Recent datapoints suggest growth should continue, though may be pushed back depending on international approvals:
· 1/7/19: “We already have 150,000 patients who are using this product [670G closed loop], are happy with it and we're just beginning to launch it outside the U.S., getting good success in Europe and in other regions”
· “Yeah. So as we've talked about, diabetes is facing a very known headwind in the back half of this year given the significant strength that they had with the 670 launch last year at this time. So we're expecting diabetes to perform well, but not in the double-digit area in the back half. Because of regulatory approvals outside the United States, we're working with regulators to get approvals as fast as possible. We don't control that though. We're working with our suppliers in diabetes to install new equipment”
The relationship with Medtronic is strong – Intricon helped develop the original CGM back in 2003, is investing in capacity for future demand, is designed into all current CGM platforms, and the sole supplier of Medtronic’s transmitter. Given Intricon’s expertise in low power small form factors combined with the expansion of capacity for future volumes, Intricon is likely to be already designed into the next couple generations of sensors. Our conversations give us confidence that Intricon has decent IP and know-how around miniaturization of these products, and that it would be very difficult (though not impossible) for Medtronic to find alternative suppliers. We believe Intricon is a real value-added supplier (not many customers would help fund capex otherwise) and not simply an outsourced EMS.
Based on our conversations, we believe Intricon gets roughly $100 per transmitter and $2 per sensor. That mean’s annual revenue per user of 670G comes to roughly ($100/2) $50 + (2*365/10) $73 + $17 (ancillary), or roughly $140. If Medtronic converts the majority of its 750-800k users to 670G over next 3-5 years, that means 670G itself will do $105-$120 million in revenue. Then, on top of that there is the growth story of Guardian Connect (similar profile of transmitter + sensors), which could add 10s of millions if Medtronic captures some market share from Libre (who is doing over $1 billion). There is also legacy components of Medtronic/cross selling that already exists in the numbers (revenues were steady at $30 million before 670G growth exploded in 2017)
For sanity check, Dexcom is doing around $1 billion of revenues this year. On year end 300,000 users, that comes out to around $3,300 dollars per customer. A GS report states: “MDT: Historical sales based on the assumption that CGM is roughly 25% of Diabetes segment sales and intermittent company commentary.” Diabetes is around $2.1 billion of sales, so around ~$550 million in sales are CGM (we also know they have 150,000 670G)
Medtronic sales for Intricon is around $57 million, so they are ~10% COGS for Medtronic’s CGM portion of the business. Dexcom has around 35% cost of sales, which include their own manufacturing (which is largely the sensor), as they outsource everything else: “Currently, those single sources are OnCore Manufacturing Services, which manufactures and supplies circuit boards for our receiver and transmitter; ON Semiconductor Corp, which produces the application specific integrated circuits used in our transmitters; DSM PTG, Inc., which manufactures certain polymers used to synthesize our polymeric membranes for our sensors; and The Tech Group, which produces injection molded components.”
If Medtronic is similar and has 35% cost of sales for its CGM components, this implies Intricon’s cost portion is around 30% of the cost of goods sold (10/35). This doesn’t seem too outlandish as they are the supplier of almost all the components with exception of the actual sensors.
Risks: obviously, there is significant customer risk here, but we believe Medtronic is unlikely to rock the boat given the current inflection point of systems like 670G (and the move to artificial pancreas) and any disruption in the markets currently would lead to Dexcom continuing to bridge the gap on product quality. The “capture” of the customer is also much more important upfront now given the razor/razorblade model that comes with the transmitter/sensor. In fact, all our research indicates that the relationship between Intricon and Medtronic is getting more intertwined.
Over time (esp. with the hiring of Doug Pletcher), the company is likely to expand its marketing efforts to win business from other big medtech players. Business is hard to win in this sector, just as it is hard to lose business. Furthermore, we understand Medtronic operates like silos and that the expansion of the business in diabetes is translating to inquiry and opportunity with segments like cardio and neuro. While this is still “Medtronic,” we understand that divisions operate almost as separate clients. Hence, over time, as capacity expands and Intricon brings in more revenues from ex-Medtronic diabetes, we think the customer concentration risk becomes less of a concern and the multiple is allowed to run.
This segment is an optionality. LTM revenues were just over $7 million with losses exceeding $2 million. Intricon believes the hearing aid market is underserved and ripe for disruption. Why? the average markup for hearing aids in the US is 50x (it costs $50 to manufacturer, but has a $2,400 ASP) – a result of a consolidated market and requirement to see a hearing specialist for eligibility.
Intricon believes it can bring the price down to $400, and that it can address 13.4 million of the 37.5 million Americans with hearing loss ($3 billion market). We don’t have to dig into the numbers given the imprecision of it all, but the key catalyst to this portion of the story is that the passage of the OTC Hearing Aid Bill in late 2017, which allows individuals to buy hearing aids online/at pharmacies without a hearing specialist (the hearing aid will be self-calibrated). This creates the opportunity for channel disruption (particularly as incumbent big 6 is unlikely to cannibalize their own highly profitable in-store sale to sell online at 1/6 the price). Intricon categorizes this as a Warby Parker/Smile Direct Club moment.
While the business is currently off to a slow start, our conversations from a previous employee indicate that the management team has been extremely forward looking when it comes to this opportunity and is very motivated to make this the next leg of the growth story. Again, you don’t need this to work given the VC-esque stage of the business, but it is a nice lotto ticket that could be worth something significant.
Singing of contracts with Medtronic
Q4 Results, clarity on Medtronic 670G ramp for 2019
Movements with Hearing Aid Act
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