Medical Device Daily Washington Editor
WASHINGTON – It seems fairly likely that a number of med-tech companies watched with dismay as initial public offerings sagged over the past year or so, but these firms need not abandon any thoughts of an exit strategy, according to two analysts with Ernst & Young (New York).
The two team leaders – who spoke at the second annual med-tech conference hosted by the Advanced Medical Technology Association (AdvaMed; Washington) Monday – also indicated that while the rate of venture capital investment has slacked a bit from its torrid pace of earlier this year, the strong start at the beginning of the year may provide enough of a base that total VC investment may end up matching the record-setting clip of 2007.
Richard Ramko, U.S. medical technology leader at Ernst, said last year's "record-breaking venture capital was up to $3.7 billion." The size of the average investment also rose, from about $9 million in 2004 to about $14 million in 2007. "We've seen the average deal size go up" in recent years, Ramko said, but investors "want a clearer [regulatory] path" for their money. However, the trend on average VC investment seems to be reversing slightly this year, falling from $1.4 million to $1.3 million for the first half of the year.
Ramko showed a chart that depicted the effect of the greater interest on the part of VC money in products that are closer to showing a profit, hence putting more money into late-round companies and less into early-stage companies. He said "this trend has been going on for a while. The challenge is that if you do that for a number of years," the pipeline of new products will tend to run dry.
Ramko described 2007 as "the best IPO market since the mid-90s," but 2008 is shaping up as a tougher environment for going public. Ramko said the number of firms that have gone public has ebbed from 13 last year to three thus far this year, and he said he does not expect to see any more successful IPO offerings this year.
Ramko pointed out that the definition Ernst & Young used to define a med-tech company required that the company be headquartered in the U.S., and was limited to firms "that primarily design and manufacture medical technology equipment and supplies." Contract research organizations and contract manufacturers are not included.
According to Ramko's numbers, total financing for med-tech firms is off in 2008, partly because of the drop in IPOs, but also partly because of a stiff drop in convertible debt, which is defined as loans that can be converted into stock. Convertible debt last year ran toward $2 billion, but only to about a quarter of that sum in the first six months of this year.
Ramko said VC investors will stay involved in med-tech, but opined "it will be the latter part of 2009 ... before the public market opens up" for IPOs. As a result, "you'll see companies going public later in the life cycle." Private equity (PE) investors are also expected to stay active, giving device makers an exit strategy, but acquisitions or mergers that come in at a value above $1 billion will be tough to put together until the current debt mess settles.
The numbers offered by Ramko indicated no buy-outs of device makers by PE firms in 2005, but indicated a spike the following year to almost $13 billion. This number is slightly skewed, he said, by the purchase of Bausch & Lomb (Rochester, New York) by PE firm Warburg Pincus (New York) for almost $3.7 billion. PE purchases last year fell to roughly $10 billion, and the first half of 2008 seemed to keep pace.
According to Ernst's global biotechnology leader, Glen Giovannetti, who appeared with Ramko, PE investors are of the view that "med-tech lends itself to their model ... because they're buying cash flows." This does carry the condition that these investors are more geared toward "middle-market transactions" and less interested in start-ups and mature companies, such as the purchase of Chrysler (Auburn Hills, Michigan), which Cerebrus Capital Management (New York) bought last year.
The Ernst numbers included a breakdown of revenues for companies that are not part of a conglomerate such as Johnson & Johnson (New Brunswick, New Jersey). According to Ramko, independent device makers enjoyed a 6% boost in revenues in 2007 over the previous year despite a 3% decline in the number of firms occupying this territory.
Venture capital's impact on healthcare remains significant, Ramko noted, making up 33% of all healthcare investments. That number has held more or less the same level since 2003. However, VC has a more prominent place in the device and diagnostics industry, making up only 5% of all med-tech investment in 2001 but pushing to a high of 12% of all such investment last year. That ratio is expected to hold steady this year.
While the short-term outlook is mixed, the current situation is expected to have little impact on the longer market, which Ramko said bodes well because of the impact of an aging America on co-morbidities. However, he also cited greater access to healthcare in the developing world – much of which has its own baby boom to deal with – as another source of customers in the decades ahead.
When asked about any difference in healthcare spending depending on which candidate wins the presidential election in November, Ramko declined to attempt a forecast, but said that regardless of who wins, "clearly the pricing pressure" is something that will continue to increase.
He said "companies will have to continue to address that" in their attempts to obtain a national coverage decision from the Centers for Medicare & Medicaid Services. Any product that turns a procedure from an inpatient to outpatient procedure, or trims the amount of time a patient spends in the hospital, "will be very valuable."
Ramko said the take-home for those seeking reimbursement is that the offering "has to be better [than the competition] and it has to reduce cost."