Tim Boreham is one of Australia’s best-known small cap analysts and business journalists.

Company chieftains love to wax lyrical about a “transformational year” in their glossy material, if only for want of something more positive and concrete to say.

But in the case of our home grown but globalized healthcare outfit Resmed, there’s more than a kernel of truth about the 2018 year being, well, transformational.

While the San Diego-based Resmed has always been a keen acquirer, in the last nine months it has shelled out more than $US1.1 billion ($1.5bn) for three businesses in the US that stray beyond the company’s previous remit of tackling sleep and respiratory disorders.

The acquired operations are all in the broader game of digital health: that is, gathering and analyzing patient data to improve the standard and efficacy of clinical support. They also broaden Resmed’s presence in chronic obstructive pulmonary disease (COPD), which is an ever-expanding market as the wheezing populace ages.

While an extension of Resmed’s increasing emphasis on cloud-based monitoring of its sleep devices, the purchases also diversify the nature of company at a time when cheaper and more convenient alternatives are emerging to Resmed’s continuous positive air pressure (CPAP) masks and pumps.

“The acquisitions are driven by our strategy to be the world leader in digital health for sleep apnea and COPD and out-of-home software,” CEO Mick Farrell says.

CPAPs deliver pressurized air through a nasal mask to prevent obstruction of the upper airway – and thus snoring — during sleep.

Many users find them uncomfortable and compliance rates in the past have been low, but that doesn’t stop the company from selling in 120 countries with coverage of six million cloud-connected devices.

While Resmed is no spring chicken it’s still only lightly penetrating the global market: according to Mr Farrell, 836 million people “suffocate” with sleep apnea every night, globally.

Despite the perception that snoring is largely the claim of fat middle aged men, 40 per cent of patients are women.

Resmed turns Pacman

With Resmed gobbling up so many targets, the investor relations department’s M&A announcement template is fast wearing out.
In December Resmed unveiled the purchase of Propeller Health, a Wisconsin based asthma and pulmonary health specialist, for $US225m.

Propeller markets sensors that attach to an asthma inhaler or COPD drug delivery devices and pairs with a mobile app to track medication usage (rather like what the ASX-listed Adherium (ASX:ADR) has unsuccessfully tried to do).

In mid November last year Resmed completed the $US750m purchase of the Minnesota based Matrix Care, “a leader in software solutions for more than 15,000 providers across skilled nursing, life plan communities, senior living [retirement homes]and private duty [home based care].”

Matrix Care provides to 13,000 facilities run by 2500 home and hospital operators.

Early in the September quarter closed the $US126m acquisition of Healthcarefirst, which provides services to home health and hospice agencies.

A new joint venture with Verily combines Resmed’s expertise in sleep apnea with Verily’s advanced health data analytics, to study the financial and health aspects of undiagnosed untreated sleep apnea.

Resmed’s big-ticket splurge started with the $US800m purchase of software-as-a-service business Brightree in April 2016.
In early 2016 Resmed entered the COPD market with its first-own branded portable oxygen compressor unit, the Mobi (two years previously Resmed acquired the Texas-based Inova Labs and sold Inova’s Activox range of compressors).

Despite the digital penetration Resmed hasn’t exactly been ignoring its core products, having unleashed several iterations of the existing masks that are more comfortable to use.

Financials and performance

Investors last week accorded Resmed’s December quarter (and first half) results the all-round raspberry, sending the shares down 12 per cent on the day (from $16.45 to $14.47) and then a subsequent 9 per cent over the ensuing week.

Using Resmed’s internally deployed non-official accounting measure, earnings were steady at $US144.5m, while revenue increased 8 per cent to $US651m.

As usual, there were a variety of gripes including slow non-US device sales – up 3 per cent on a constant currency basis – with sales in France and Japan especially sluggish because the company is no longer enjoying the revenue benefit of earlier device upgrades.

Some commentators bemoaned the cessation of share buy backs, which should not be surprising given the acquisition spree.

Resmed last year bought back 200,000 shares, at a cost of $US22.8m.

But in essence it looks like earnings simply fell a tad shy of expectations.

Overall mask sales grew 10 per cent and device sales crept up 3 per cent. With the exception of France and Japan, the company reports “excellent” growth in masks and devices in the Asia Pacific and western Europe.

Despite last week’s slump Resmed shares have performed OK given the general global market meltdown of late 2018, with the ASX-listed shares (Chess depository interests) gaining 17 per cent over the last 12 months.

Resmed’s home domicile is the New York Stock Exchange.

Sleepers awake: the small cap alternatives

While Resmed taps a seemingly capacious market for its wares, many clinicians and patients are waking up to the cheaper alternatives available for sleep apnea sufferers at the lower end of the severity scale. For investors scared off by Resmed’s $18bn valuation there are cheaper ASX-listed alternatives.

Oventus (ASX:OVN) has been selling its anti-snoring mouthguard called O2 Vent – a mouthguard with a duckbill for breathing through – since it was approved in the US in July 2017.

Oventus describes its O2Vent technology as a “second nose” based on mandibular advancement, which simply means pushing the lower jaw (the mandible) forward to allow more air to the back of the throat when nose-breathing.

Like Resmed, Oventus has been developing iterations of its core product. These include a nylon rather than titanium version, O2Vent Optima, which is “lighter and more aesthetically pleasing”.

O2Vent/Exvent is an additional valve that enhances positive end-expiratory pressure (PEEP). In late stage development, O2Vent Connect is a CPAP system which connects with an air pump, allowing for its use without a full-face mask.

Also in the lab is O2Vent Onepap, a PEEP valve for patients who stubbornly breathe through their nose despite mounting obstacles. The air pressure created ensures a transition to mouth-breathing as the patient snoozes.

Then there’s the more established Somnomed (ASX:SOM), which markets its Somnodent device (mouthguard) to 445,000 patients across 28 countries.

In a “disrupted” period, Somnomed posted a 15 per cent revenue increase to $28.8m, but an EBITDA loss of $5.65m. The ‘culprit’ was the company’s chain of US sleep centres, Renew Sleep Solutions (RSS) which lost $7m.

The good news for investors is that Somnomed has decided to put RSS to sleep for good.

In November Somnomed announced the departure of its CEO for three years and a bit, Derek Smith. Stepping up to the helm is chief numbers man Neil Verdal-Austin.

Somnomed describes Somnodent as the “gold standard oral sleep appliance” and we guess 455,000 patients globally can’t be wrong.

The market values Oventus at $31m while Somnomed commands a chunkier $105m valuation.

Meanwhile, the $27m market cap Rhinomed (ASX:RNO) sells its Mute range of plastic nasal dilators for snoring and sleep apnea.

Excuse the overly technical language, but Mutes are clip-like plastic appendages one bungs on one’s snoz to expand the nostrils and let in more air.

Dr Boreham’s diagnosis

Despite the acquisitive splurge into non sleep apnea activity, Resmed remains focused on the “globally underpenetrated” sleep and respiratory markets.

While management hasn’t ruled out further purchases, we get the impression that company will focus on its existing assets, in terms of increasing operating leverage and interoperability between the businesses.

The quarterly results show the growing importance of the digital side of the business, with software-as-a-service revenues gaining 63 per cent to $63.2m (just under 10 per cent of turnover, compared with 6 per cent a year earlier).

“We are now moving to the point where software-as-a-service has become a big enough segment to talk about,” Mr Farrell says.

Resmed cites a global market of 936m people with mild to severe sleep apnea, fewer than 20 per cent of whom have been diagnosed and treated.

That’s a glittering prize not just for Resmed, but for the mouthguard minnows.

There should be room for all, but in each case management’s challenge is not to fall asleep at the wheel.

A version of this column first appeared in Biotech Daily

Disclosure: Dr Boreham is not a qualified medical practitioner and does not possess a doctorate of any sort. He may occasionally day dream but has never been accused of falling asleep on the zzzzzzz …

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