Easing Pressures Should Boost Baxter's Prospects, Especially in 2025 and Beyond

Senior Equity Analyst

Julie Utterback

Although the 2015 Baxalta spinoff was successful, Baxter's financial results fell substantially in 2022-23 on external pressures, such as inflation and weak medical utilization trends. We see these external pressures easing. Also, we suspect Baxter's financial prospects will improve, especially in 2025 and beyond, as hospitals renegotiate their reimbursement deals with third-party payers, and as Baxter renegotiates significant contracts, a key group purchasing organization among them.

From a business strategy perspective, Baxter is currently focused on spinning off its kidney care division and improving the profit growth of its other businesses. In kidney care, Baxter's renal and acute care technology supports patients with failing kidneys. Baxter generates most of its kidney care revenue from at-home patients using its peritoneal dialysis, or PD, tools, but it also sells hemodialysis products to dialysis clinics and continuous renal replacement therapy and other organ support equipment to intensive care units. Concerns about long-term demand for dialysis, given the halting of a related obesity drug trial, have created uncertainty around the kidney care segment's expected spinoff by mid-2024. However, we suspect the intermediate-term outlook for dialysis demand has not changed much given potential benefits of those drugs on surviving renal patients. 

The balance of Baxter's business is focused on providing basic medical supplies and equipment to caregivers such as hospitals, which have been under pressure in recent years due to a mismatch in labor cost hikes and reimbursement rates with third-party payers that are in the process of being renegotiated. Through the 2021 Hillrom acquisition, Baxter provides beds, patient-monitoring devices, and other digital tools. These Hillrom tools, along with Baxter's own infusion pumps, have been negatively affected by inflationary pressures on input costs that have severely depressed margins, which remain a key area for Baxter to improve. Baxter also sells many injectable therapies, such as IV solutions, generic pharmaceuticals, and surgical tools to control bleeding.

Business Strategy & Outlook

Baxter has dug a narrow moat around providing dialysis tools and injectable therapies that have complex delivery systems. It claims top-tier positions in most of its product lines and typically competes with a concentrated group of peers. Overall, we think it would be difficult for new firms to enter these niches primarily because of the switching costs associated with some of its medical equipment and the intangible assets surrounding its proprietary technology and manufacturing processes. These factors form the basis of Baxter’s moat, and generally, we see a long runway for the company to generate economic profits with its existing technology and innovative pipeline of new products, especially in 2025 and beyond.

In its renal care segment, we believe Baxter benefits primarily from intangible assets associated with its proprietary technology, and switching costs related to placed equipment (meaning, the manufacturer or seller placed the equipment where the consumer will use it). Baxter is the second-largest provider of dialysis equipment and related consumables, behind only Fresenius Medical Care. While both organizations offer a broad spectrum of dialysis products, their strengths largely lie in separate technologies and geographic footprints. Through its peritoneal dialysis products, Baxter thrives in the home setting with a strong presence in emerging markets. Baxter dominates the PD medical product market while Fresenius leads the way in hemodialysis technology. Baxter’s proprietary medical technology in PD and its ability to continually innovate create a moat source related to intangible assets, and after the PD equipment is placed, Baxter structures payment for use of that equipment and related consumables as a monthly subscription with the consumables (tubing and solutions) delivered directly to each patient through Baxter’s own logistic network. In our opinion, if the treatments are working, patients have little incentive to switch because of inertia factors surrounding their own training around this self-administered treatment and the company’s business model, which creates a recurring revenue stream of consumables from placed equipment. Similar dynamics to the renal care business exist for Baxter’s acute therapy segment, which sells organ support tools to intensive care units of hospitals.

While a relatively small percentage of Baxter’s total sales (estimated in the midsingle digits as a percentage of sales), infusion pumps contribute to Baxter’s maintainable competitive advantages and recurring revenue outside of renal care. Infusion pumps are a medical technology that helps hospital staff, primarily nurses, automatically administer medical therapies and often lead to recurring consumable sales of administrative sets. Infusion pumps can be differentiated from a technology perspective from competitive pumps from the likes of Becton Dickinson and ICU Medical primarily in the United States. Infusion pumps have a relatively a long life (over seven years), which gives them a long period to enjoy recurring sales after the pumps are placed. Some pumps offer networking software that helps these devices become embedded further in the workflow of caregivers, too. During replacement cycles, hospitals often stick with familiar technology to ensure smooth therapy administration by their caregiver, as well. Overall, once an infusion pump is placed at a hospital, we believe that facility is unlikely to create a workflow disruption by switching to a new pump provider.

We believe Baxter's therapeutic offerings—IV solutions, nutritionals, and generic pharmaceuticals—contain elements of cost advantages and intangible assets as well, although we do not consider cost advantage as a moat source for Baxter overall. Baxter enjoys the top position in IV solutions in the U.S., stands in a leading position in parenteral nutrition, and excels in difficult to manufacture generic pharmaceuticals, such as anesthesia and aseptic premixes. Baxter typically faces limited competition in these target markets where top-tier competitors include Fresenius SE, B. Braun, and the former Hospira assets (now at ICU Medical and Pfizer). Overall, we see significant barriers to entry around these businesses, which keep most of the injectable markets that Baxter participates in concentrated from a competitive perspective. Specifically, key peer ICU Medical has estimated that it would take about $300 million and three years to build a manufacturing facility that would allow a new entrant to gain enough scale to compete effectively in the IV solutions business. We estimate that similarly large and time-consuming investments would be required in the nutritionals and generic pharmaceutical businesses. 

Beyond these up-front costs, the ongoing expertise associated with ensuring compliance due to stringent regulatory and group purchasing organization, or GPO, standards remain high. We see some intangible assets in them, too, related primarily to the difficult manufacturing processes, unique delivery systems that can provide mix benefits, and the reputational requirements to be considered a long-term supplier of hospitals in these niches. Even in generic pharmaceuticals, Baxter primarily participates in markets with complex manufacturing and administration requirements. In both its inhaled anesthetics and injectable therapy franchises, Baxter typically faces competition from only a few competitors primarily due to manufacturing complexity, which is much higher than in oral generics for example where competition and pricing pressure is more pervasive. Beyond the general manufacturing requirements, Baxter also excels in aseptic premix product manufacturing, which is required to keep some molecules stable and helps ensure safety through product administration. Offering ready-to-use injectables in the care setting can improve patient safety and reduce the time associated with administration tasks, which creates a valuable tool for nurses and doctors on the front lines of care and helps Baxter generate some mix benefits in these otherwise commodified markets. In its nutrition products, Baxter benefits from intangibles through its differentiated formulations and delivery systems. Adding to those intangible assets, we see some reputation-related advantages in these therapeutic offerings, particularly around the ability to be a reliable supplier of these essential therapies to hospitals in the GPO negotiating process.

In advanced surgery, we think the firm benefits primarily from intangible assets with its proprietary products to control bleeding and close wounds during surgical procedures. Baxter occupies the second position in this market behind Johnson & Johnson, and in advanced hemostats and sealants, its flagship Tisseel and Floseal products remain differentiated. Baxter continues to innovate in this area, too, with new launches aimed at significantly reducing valuable operating room time, including a reduced preparation time for Floseal and reduced suturing time through its Flow Coupler product. Ongoing innovation should add to the maintainability of this segment’s proprietary technology-related advantages. 

The 2021 Hillrom acquisition cut into Baxter's economic profitability due to the price paid and then due to a cut in profits because of hospital constraints on spending and inflationary pressures on input costs. While many of those pressures are easing, we think Hill Rom's proprietary offerings—including smart beds and patient monitoring devices—only have minor intangible assets surrounding them.

Narrow

Economic Moat

Baxter

Baxter International, Inc. engages in the provision of a portfolio of essential renal and hospital products, including acute and chronic dialysis, sterile IV solutions, infusion systems and devices, parenteral nutrition therapies, premixed and oncolytic injectable, bio surgery products and anesthetics, drug reconstitution systems and pharmacy automation, software, and services. It operates through the following segment: Americas, Europe, Middle East and Africa (EMEA), Asia-Pacific (APAC), and Hillrom. The Americas, EMEA, and APAC segments offer a portfolio of essential healthcare products. The Hillrom segment provides digital and connected care solutions and collaboration tools, including smart bed systems, patient monitoring and diagnostic technologies, respiratory health devices and advanced equipment for the surgical space. The company was founded by Davis Baxter in 1931 and is headquartered in Deerfield, IL.

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Baxter International, Inc. engages in the provision of a portfolio of essential healthcare products including acute and chronic dialysis therapies, sterile intravenous (IV) solutions, infusion systems and devices, parenteral nutrition therapies, inhaled anesthetics, generic injectable pharmaceuticals, surgical hemostat and sealant products, surgical equipment, smart bed systems, patient monitoring and diagnostic technologies, and respiratory health devices. It operates through the following segments: Americas, Europe, Middle East and Africa (EMEA), Asia-Pacific (APAC), and Hillrom. The Americas, EMEA, and APAC segments offer a portfolio of essential healthcare products. The Hillrom segment provides digital and connected care solutions and collaboration tools, including smart bed systems, patient monitoring and diagnostic technologies, respiratory health devices, and equipment for the surgical space. The company was founded by Davis Baxter in 1931 and is headquartered in Deerfield, IL.

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