Vantage point – More consolidation in medtech, but no early-stage joy

Analysis

Thanks to biopharma’s more onerous clinical trial requirements it takes a vastly larger amount of venture capital to get a biotech concern to the revenue-generating stage than it does a medtech company. But, if a biotech is aiming for a trade sale, it does not need to. Big pharma will buy biotechs pre-revenue, but this is not true of medtech, says Gareth Down, head of European healthcare at the investment bank William Blair.

“The pharma-life science space is driven by formulaic gates: clinical trial outcomes. Once you get to those gates, there is a well-established mathematical rule to determine the success of something that has just concluded phase IIa versus phase IIb,” Mr Down tells EP Vantage. “We find that the large buyers of medtech businesses focus on revenue because they don’t have that same gating system.”

For medtech buyers commercial success is the only solid indicator that a company is worth acquiring. And this is a crucial factor in explaining venture funders’ reluctance to invest in medtech start-ups compared with biotechs. VCs know that medtechs will suck in more and more cash before standing an equal chance of an exit. Unlike biotech start-ups they will need to negotiate FDA or at least European approval, hire a sales force and essentially build a business.

A biotech, by contrast, can be a small lab group completing clinical trials, which is an appealing asset in itself, Mr Down says – it does not need to be a business per se.

Gareth Down head of European healthcare William Blair

Continuing scale-building

But even once medtech companies have reached the revenue-generating stage there is no great appetite for acquisition, Mr Down says.

For large, multi-billion-dollar players to take an interest, a private medtech business needs to reach significant scale. The exception is if they have a completely game-changing, cutting-edge technology protected by first-rate IP – and businesses like that are hard to come by, he says.

It is only when a medtech company has built itself up that buyers consider reaching for their wallets. Mass consolidation has changed the face of the medtech industry over the past couple of years, but the drive to build scale is still very much present.

“There’s still a trend for consolidation, even in the mid-market, and there will continue to be a flight to scale in medtech,” Mr Down says. He highlights the dental and orthopaedics sectors as areas that could see more amalgamation among mid-size and larger groups.

Of the orthopaedics sector, he says: “Five years ago there may have been 10 sizeable billion [dollar]-plus market cap players, today there are eight, and I expect in five years this will reduce further.”

This chimes with what other industry watchers expect.

“There’s probably a deal or two on the orthopaedic side,” John Babitt, Ernst & Young's medical technology leader for the Americas, tells EP Vantage. “We’ve seen a couple of them now, and I’m pretty convinced there are about two too many competitors in orthopaedics.”

Since credit is readily available and cheap, Mr Babitt says, companies will continue to see an appeal in bulking up. Pressure on pricing has not let up, and mergers among hospital chains and nursing homes mean medtech companies have fewer customers.

Mr Babitt also expects to see increasing shareholder activism in the medtech space, pointing to Baxter as a company that has felt pressure from its investors. This is likely to spur M&A activity as well as divestitures of underperforming units as medtech groups attempt to placate their more vocal shareholders.

Taking a breath

This is all very well for companies that have managed to survive long enough to see sales. But what about the early groups struggling to reach this point? Mr Babitt says the climate in venture funding for start-ups is extremely dour. “The troubling consideration is the decline in venture capital, in particular a decline in early-stage VC funding,” he says.

When EP Vantage analysed VC trends a similar decrease was found (Medtech venture financing crisis worsens, July 15, 2015).

EY’s yearly report on the medtech sector, Pulse of the Industry, was published last month and found that during the 12 months to June 2015 only 29% of medtech venture investment went to companies raising their seed, first or second rounds. In the prior 12-month period this figure was 37%.

The areas best placed to attract venture funding are, Mr Babitt says, digital health – “there seems to be quite a bit of appetite and frothiness to those companies” – and services and solutions. Medtronic and Philips are two groups that have made moves towards hospital services, though this is arguably not strictly medtech.

There is more of an interest in investing ahead of IPO, Mr Babitt says. But companies tend to look at floating as a marketing tool to get them greater exposure and financial flexibility – most likely a step on the way to an acquisition, which remains in many cases the primary goal.

The jury is out on whether the IPO window is beginning to shut, he says, but this need not threaten everyone. “When things get tough the good companies can probably still get out. The marginal companies won’t – they’ll look to sell.”

William Blair’s Mr Down says that this is already happening. He agrees that 2015 has been a strong year, but draws attention to the recent “wobble” on Nasdaq, saying that “a breath is being taken”.

The quality bar to get onto Nasdaq has increased over the past year, he says. If a company is to attract IPO backers it has to be “on target and on message” – active in a hot area such as digital health or diabetes.

While the markets will hopefully remain receptive, it is getting medtech companies to the point at which they can generate sales, attract a buyer or go public that remains the difficulty.

To contact the writer of this story email Elizabeth Cairns in London at elizabethc@epvantage.com or follow @LizEPVantage on Twitter

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