Summary

• Dexcom is a leading manufacturer of real-time Continuous Glucose Monitors (rtCGM) in the United States and many parts of the world and provides customers with significant benefits and cost-savings.
• The company has a track record of industry-leading growth and returns to shareholders; it has a deep connection with its “Warrior” community/consumers that would be hard to replicate in many industries.
• People with Diabetes were tested on several fronts during COVID-19 as it is one of the leading co-morbidities. These ultra-exigent circumstances resulted in accelerated approval and use of Dexcom’s product, and the results were overwhelmingly successful.
• The company’s three-pronged growth strategy and R&D and partnerships continually put it at the leading edge of secular trends affecting health care and leave it insulated from many competitive fights as a data provider whose product reduces costs in a very inefficient system.
• Elevated results match the company’s lofty valuation over time. Management has expanded in areas where it didn’t have an advantage, and we believe it will drive growth above consensus.

COVID-19 was a devastating pandemic that was scary for all of us. It was even more frightening for those suffering from chronic conditions that significantly increase the prevalence of adverse outcomes when the virus is caught. For those with Diabetes, there were many additional complications from just the issue of co-morbidity. Lockdowns complicated provision of care from healthcare professionals and access to food and loved ones who previously assisted with care may have also been inhibited. Thus, this firm and its customer base were in many ways at the Epicenter of multiple healthcare crises afflicting the United States at the same time. The pandemic stressed an already ramshackle US healthcare framework that has always been tough-going for those with chronic conditions.

For those Diabetics who did catch COVID-19, the simultaneous provision of their care associated with Diabetes also put healthcare workers at enhanced risk of exposure. On many counts, just as radar and high-octane fuel helped the British Royal Airforce hold back a seemingly insurmountable Axis tide,  Dexcom’s customer-oriented and data-driven technology helped make outcomes significantly better for millions of patients than they would have otherwise been. Clinical data now shows that Diabetics had a much greater total Time In Range (TIR) using Dexcom’s CGM and ancillary products, leading to lower costs for hospitals and insurers and higher quality of life for patients.

Source: Company Reports

Indeed, the technological advantage radar provides is not a hyperbolic metaphor when comparing the advantages Dexcom’s G6 and next-generation G7 rtCGMs provide. They dramatically improve the current standard of care, lead to cost savings for insurers and providers, and significantly increase patient comfort and outcomes. Sometimes you want to buy a stock because the company simply makes a better mouse-trap, has an unshakeable bond with its customers, and knows how to execute. This describes Dexcom well.  

Source: Company Website

There’s no polite way of saying it. The American Health Care system is a hot mess and has been for decades. Most countries spend about 10% of GDP on Health Care, but we spend 20%. Rising costs, rampant fraud, waste, and gravity-defying, perverse economic incentives are necessarily navigated obstacles when investing in this challenging but steady sector. These obstacles are luckily significantly mitigated by the heroes on the frontlines of Health Care’s provision and the tireless innovators who navigate a perplexing labyrinth of red-tape for approval that scares away the undedicated and dooms the unprepared to failure.

Health Care can make airlines look like the epitome of red-blooded, regulation-free capitalism.  Despite the many inefficiencies and shortcomings of our system, it is still one of only three GICS-1 sectors where companies from the United States are dominant. Diabetes and its 24/7/365 management requirements are an expensive and cumbersome side of an expensive and cumbersome system. The prevalence of Diabetes has been increasing significantly.

Yet, the current standard of care is exceedingly lacking in outcomes, patient comfort, and convenience and results in considerably higher costs to the healthcare system. Diabetes costs the US economy around $90 billion annually in lost productivity alone. In a system where its estimated 25% of spending is a complete waste and cost-incentives are constantly undermining the patient quality of care, a product that simultaneously improves outcomes and reduces costs to the overall system is in a particular sweet spot that insurance companies, the gate-keeper to the consumers in this sector, are highly incentivized to encourage.

Source: Company Reports

Why Is The Product So Great For Target Consumers?

Diabetes is one of the most costly and prevalent chronic diseases in the United States. Its prevalence is also rising in many places worldwide as burgeoning new middle-class consumption patterns begin to look more and more like their Western forebears.  As you can see from the previous figures, the costs of personal care for Diabetes are significantly increasing and will nearly double their 2017 levels by 2030.

Currently, about 10.5% of the US population has Diabetes. Dexcom is particularly popular amongst those with Type I Diabetes; these folks need insulin daily to survive because their bodies no longer can produce it. Type II Diabetes is less severe and involves the body’s inefficient or ineffective use of insulin and its regulation. The company has implemented impressive strategies to break into these markets by doubling their sales team and giving out large amounts of samples to physicians they view as essential to efforts. More visible actions like their SuperBowl Ad featuring Nick Jonas, a brand ambassador, have also positively impacted brand and product awareness.

Source: Company Reports

The addressable market is more than seven times bigger for Type II patients than the company’s current core user base. In addition to expanding into more customers with Type II Diabetes (where the use of Dexcom’s product can even result in remission), the company has aggressive plans to expand into the rest of the world. It is maximizing its growth strategy by increasing its means and capacity for production and having a divergent product strategy in markets based on the development of their respective reimbursement frameworks. Of course, in their core market of the United States, which is also the largest market for medical devices, demand is set to continue growing due to the inexorable rise of Diabetes witnessed over the last decade.

Dexcom’s most visible hook or sale might be that you don’t have to “prick” your finger like in the current standard of care, which is BGM and involves taking 4-11 often painful and inconvenient samples a day. This is in comparison to a device that is installed once and lasts for up to two weeks. However, the benefits go far beyond the comfort the device provides to the consumer, although those who have experience with managing this complex chronic disease will know that this benefit is a significant morale booster and, for certain folks like those with dexterous hobbies, can significantly alter their quality of life for the better. Dexcom is similar to Epicenter companies in that it has a vital connection and provides an indispensable service to its consumers. We can scarcely imagine a more sticky product, and consumers who start using Dexcom’s product rarely switch back to the alternative. The early developments concerning expanding into Type II markets have been auspicious.

Source: Company Reports

Dexcom’s Management Has a Track Record of Delivering To Shareholders

The medical device business can be a tough one, and without experience, relationships, and a proven track record, risks for product development can be very high. Gaining and keeping the consumer’s trust in the face of stiff competition and continuing to innovate is a lot more complicated than walking and chewing gum.

Management’s strides during the COVID-19 pandemic have been impressive but weren’t exactly a turnaround because many of the events of the pandemic accelerated initiatives already underway at the company, for example, FDA emergency authorization for inpatient use of its CGMs. The results were very positive. Kevin Sayer, the company’s CEO and President has been at the company a while and has pulled off several impressive feats. We always love to see a CEO who is also a Certified Public Accountant, even if the credential is non-active. His performance has been stellar compared to his peers, and we see no reason why that will change.

Source: SeekingAlpha.com

Over the years, the company’s share price appreciation reflects a strong product, strong management, and these two things converging with strong secular tailwinds. Regulatory realities make the digitization of the Health Care sector slow going, but Dexcom is a leader in this area for several reasons. COVID-19 has only compounded the reasons for their ascent in this large market.

The company has partnerships with some of the most prominent players aiming to modernize healthcare that show people real-world examples of why the new data-driven paradigm is superior. This company is generating reams, and reams of actionable data from its patients also should result in a virtuous cycle of declining customer acquisition costs over time in conjunction with its already considerable efforts to increase advertising. It has partnered with Alphabet Healthcare skunkworks Verily and the illustrious Teledoc. It is a significant beneficiary of the shift to telemedicine in general.

Source: Product Website

Also, it has partnered with United Health Care to develop the CLARITY software, which provides clinics with web-based portals for analyzing data and making data-driven treatment decisions. These two partnerships show the forward-thinking of management that is part of the solution in a healthcare system burgeoning at the seams in the wake of COVID-19. Companies that aren’t part of the solution (drive up costs, even if they increase the quality of care) will likely suffer a much more dismal fate than if the pandemic had never happened. This strengthens Dexcom’s relative position and probably adds barriers to potential competition as well. A solution proven to be a win-win-win in our Nation’s complicated healthcare triumvirate is sure to gain additional upside momentum.

The company’s track record makes us a little apprehensive about the complicated multi-pronged growth strategy it is in mid-stream of executing, so far with colors flying. It is changing how it gains access to markets using a blitzkrieg-Esque sales strategy centered on altering channels to be more reliant on Pharmacies and doctors. The dramatic success of the FDA emergency authorization for using the company’s product likely will open additional revenue streams that developed organically out of the crisis. The company also has credible efforts with prodigious implications for growth in international markets.

Source: Company Reports

Trial By COVID

Diabetes is the seventh leading cause of death in the United States and seriously increases the risk of adverse outcomes contract COVID-19. Thus, several regulatory relaxations were granted due to the elevated risks that facilitated a dramatic and rapid rise in telehealth that will likely outlast the pandemic. The rise of telehealth significantly increased the use of the product. It encourages a much more effective remote interaction, giving the provider a rich, nuanced story of data that makes their job much more accessible and improves outcomes significantly. This helped many folks more successfully manage their treatment during lockdowns and prevented many possible adverse outcomes that could have happened without the company’s industry-leading product and software enriched by partnerships, as mentioned earlier.

Clinics and telehealth providers are significantly able to improve their efficacy when their patients use Dexcom’s product. This partially illustrates what we mentioned earlier. When a product falls in the sweet spot of win-win-win in the US healthcare system, it gets to the front of the line because everyone realizes it’s in their interest for it to succeed!  Insurers want to save money, customers want better, more comfortable care, and clinics and providers wish to have more data to make better decisions, mainly since they are in a post-COVID proving ground. Whether or not their COVID-driven prominence sticks around largely depends on whether the rest of the sector can digitize and modernize. Companies like Dexcom, who are on the right side of that process, have friends in high places, kindred spirits if you will, that help advance forward-thinking devices that act in a symbiotic fashion with multiple parts of a vast and complicated healthcare apparatus.

Currently, the FDA does not allow the use of CGMs in a hospital setting. Here is a clear-cut example of red-tape inhibiting patient care in our system, and COVID-19 helped cut through it. Older models that weren’t developed by as capable a company as Dexcom suffered from poor accuracy, calibration issues, and interference from common medicines like acetaminophen and sensor drag have all been overcome by Dexcom. On April 1, 2020, at the height of the pandemic, the FDA granted emergency authorization. Thus, the third area where COVID-19 accelerated the adoption of the company’s product in a way that wouldn’t have been possible otherwise was in hospital use.

For this reason, the FDA approved the product for emergency use, and the results were very successful and promising.  As a member of company management commented at a recent investor conference, it’s always better to go in front of the FDA with a lot of data. Dexcom, by nature of their product, customers and partnerships, is never lacking in this department.

Risks And Where We Could Be Wrong

Healthcare is a sector known for stability, and while this is true for Dexcom on a longer-term basis, as we’ve shown, the company is very volatile around earnings. So, if you are a person who can’t handle price swings, this may not be your stock. As you can see from the figure below, a moderate price movement in the wake of earnings recently has been the exception rather than the rule. Out of eight of the pictured post-earnings market actions below, five of them resulted in moves of 10% in either direction. As you can see, significant upside moves were more common and greater than the downside ones.

Source: Thinkorswim

In addition to this, the medical device industry and Health Care Sector are generally challenging areas fraught with immense risks. This is undoubtedly true for Dexcom. Despite many of the advantages we have cited earlier, the FDA ultimately is a body with a final say on product approval. Its timelines can be arduous, lengthy, and often very out of sync with what investors would like. We’d say that this factor is significantly mitigated by the recent all-hands-on-deck efforts in the sector responding to COVID-19 and Dexcom’s productive and model-citizen-like contributions in the area. This should engender some goodwill, but most importantly, the company has real-world data proving that its product is better than the current standard of care. Even for a fickle regulatory agency, a company armed with this type of information is formidable and likely possesses advantages over competitors who don’t have it.

Source: Company Reports

Another risk in medical device markets, particularly since many use semi-conductors is supply-chain bottle-necks and disruptions to the often advance manufacturing processes required. Sometimes, the complicated timing of capital allocation for R&D, which is very high in this sector juggled with problems in FDA approval or other unforeseen issues, can cause disaster. We think the seasoned track record of growth makes this risk less acute for this company. We also believe recent capital expenditures by management aimed at doubling manufacturing capacity while also reducing costs is a significant power move that shows this company is ready for another decade like it has just had.

There is price risk here because the company does enjoy a significant premium compared to competitors. This suggests that stumbles or severe setbacks to its multi-pronged strategy for growth could result in substantial price declines, similar to the ones sometimes seen in the wake of earnings reports. One of the most significant risks, of course, is that the G7 model fails in clinical trials, but given this is a next-generation product with many proven aspects, we see this as pretty remote.