Medical Device Daily Contributing Writer
SAN JOSE, California — The 17th annual Medical Device Conference sponsored by the influential law firm of Wilson Sonsini Goodrich & Rosati (WSGR; Palo Alto, California) was held here late last week at its usual venue, the downtown Fairmont Hotel.
As always, the meeting drew strong attendance from a variety of groups, including venture capitalists (VCs), medical device entrepreneurs, patent attorneys, accounting firms and other service providers to the medical device industry.
The timing of the meeting was propitious, as the turmoil in the capital markets and the economy over the past nine months has had an enormous impact on the venture capital community in general and on in investments in the medical device industry in particular.
The future prospects of the VC world were recently negatively portrayed by the recent headline "Venture Capital Bubble Set to Burst." The storyline, derived from a report titled "Right-Sizing the U.S. Venture Capital Industry," that was written by the Ewing Marion Kauffman Foundation (Kansas City, Missouri) was several-fold.
First, contrary to popular belief, the venture capital industry is not a necessary condition in driving high-growth entrepreneurship.
Second, the VC industry needs to shrink, that is, it is over funded and its assets need to shrink to buoy overall returns.
Third, as a result of too much money to invest, the venture industry's current returns have been unsatisfactory, both in a relative and absolute sense. For example, the venture industry lagged the Russell 2000 Index, which measures the performance of the small-cap segment of the U.S. equity universe by 10% over the 10-year timeframe from 1998 through 2008. This underperformance occurred despite the fact that those 10 years include the dot-com period, which materially inflated the overall venture industry performance.
According to Paul Kedrowsky, a senior fellow at the Kauffman Foundation and the author of the study, "the venture business should shrink ... possibly by as much as 50%. It's inevitable ... whether it realizes it or not, whether it wants to or not, the venture industry has to change."
More negative news on the future of venture investments in the U.S. was disclosed in a recent survey by the National Venture Capital Association (NCVA; Arlington, Virginia), which disclosed that only 17% of venture capitalists expect to increase their domestic investments in the next three years, while more than half are investing in companies outside the U.S.
"The U.S. is no longer the only area in the world for venture capital activity," said Mark Hoesen, director of the NVCA, which co-authored the report with Deloitte Touch Tohmatsu (New York).
During the first WSGR session of the day, titled "The Private Financing Conundrum," VCs from four prominent firms discussed the current malaise in VC investing in medical devices. Mike Kaplan, a partner with Three Arch Ventures (Portola Valley, California), said that VC investments in the medical device space in 1Q09 was about $600 million, down about 50% from 1Q08.
Kaplan identified several "structural issues" that are impacting VC investments in the medical device space. These included the obvious challenges like the FDA, which he noted is getting "more and more difficult to work with," reimbursement issues ("never more important than now") and newer issues like marketing restrictions to physicians, healthcare reform, cost effectiveness demands and conflict of interests developments with physicians and the consolidation of potential acquirers (e.g., Guidant's acquisition by Boston Scientific)
Despite these myriad concerns, Kaplan stated that "sentiment in the venture community has definitely bottomed and that now is a wonderful time to invest."
He added that "we may look back on 2009 as a vintage year for investing because the rate of return could be so good."
Kaplan's comments were echoed by Jan Garfinkle, founder and managing director of Arboretum Ventures (Ann Arbor, Michigan), who generally agreed that this is an attractive time to invest but noted that this was especially true for early stage med-tech opportunities.
John Maroney, a general partner with Delphi Ventures (Menlo Park, California) agreed with Garfinkle, noting that "valuations are not much different than in the past in early stage deals but have changed significantly for later stage investments." Later on in the discussions, he added that there have been some "ugly terms" in some later stage deals, particularly for those that have missed their milestones or have nearly exhausted their cash.
Although the headlines and events have been far from favorable in recent months, there appears to be reason for optimism on the horizon. In a session titled "Unlocking the Public Market," two investment bankers from Piper Jaffray (Minneapolis) gave an excellent presentation called "Perspectives on the Return of the IPO Market."
Richard Gustafson and Neil Riley reviewed the extraordinarily poor performance of the equity markets in the last four months of 2008 and through the first two months of 2009. For example, the Russell 2000 index dropped 37% for the full year.
Another measure of the very challenging nature market in the past year was demonstrated by the Chicago Board Options Exchange Volatility Index (VIX). The VIX, which is considered by many to be the world's premier barometer of investor sentiment and market volatility, peaked in October/November at about ten times its norm, with the broad market experiencing 18 days of 5% or more advance or decline.
According to Riley, "this volatility has not happened in the last 50 years of market history and illustrates the stresses that the markets have been under."
Their presentation ended on a much more upbeat note, as a series of slides showed that the market recovery since March has created an environment where select financings are being completely rapidly and successfully.
Two particularly strong offerings were analyzed, Hansen Medical (Mountain View, California) and Dexcom (San Diego), each of which had excellent "follow-on" financings this year. In both cases, Riley pointed out that the final amount raised was larger than the original filing and that both companies' stocks have appreciated impressively since the deals were completed.
The two bankers compared the current period to 2003, which was a period when a first half market rally fueled a very robust financing environment in the second half. During the first half of 2003, there were very few deals sold but they provided investors with a handsome rate of return.
Similarly, there have been a dearth of financings so far this year but investors have fared very well. Will this set the stage for a flood of second half financings?
According to Gustafson, "It certainly feels like we are in a recovery phase ... I think and hope that med-tech IPOs will be increasing later this year."