Diagnostics & Imaging Week Executive Editor
MINNEAPOLIS - The climate for investing in the medical technology sector is at least warm and perhaps hot. Borrowing from the chart indicating steak-doneness, let's go with "medium well."
But for those who lean toward the "half-empty" side of the half-full/half-empty argument, what dark clouds are lurking out there to cast a shadow over the present sunny view for the sector?
Well, some panelists addressing the question during last week's 4th annual Medtech Investing Conference here cited the "too much money" thing, while others point to a suddenly popular whipping boy, the matter of getting reimbursement for a new product.
Jeffrey Barnes, a general partner with Oxford Bioscience Partners (Boston), said during a session on "Med-tech Investing 2005: Trends in Investing in Medical Devices and Healthcare Technologies," that while the device sector is on a roll insofar as attracting investor dollars, some storm clouds in the distance offer down-the-road concerns.
The biggest, he said, is "fundamental liquidity."
The former med-tech market analyst-turned venture capitalist said there is a "staggering" amount of money invested by venture capitalists in the life sciences sector, posing at least the potential for a liquidity crisis down the road.
"The ability for us as investors to be able to [eventually] get out of as many deals as we get into is a concern," said Barnes. "It's not a near-term problem, but the issue for many VCs may be getting out," the oft-cited "exit strategy" that represents the end-game for such investors.
Robert More, general partner with Domain Associates (Princeton, New Jersey), said that if a liquidity crisis is looming, "VCs are mostly to blame."
He said that given the growing amount of money invested in the sector and the resultant burgeoning valuations of development-stage and near-commercialization companies, "you're going to see pressure on the exit."
But for him, the larger issue for VC investors is "finding a great CEO and management team." On a list of priorities that a venture capitalist might have in deciding whether or not to back a start-up company, he said that "IP [intellectual property] is pretty much a must; market size is important; and having the right management is very important."
That said, he commented wryly, "If someone can cure cancer, we can find someone to run that company."
William Harrington, MD, a partner with Three Arch Partners (Portola Valley, California), said the issue may not be so much that of there being too much money invested in the sector, but rather one of whose hands that money is in.
With some broad-based healthcare venture capital funds putting a larger proportion in devices than might have been true in the past, he acknowledged that those running such funds do have some concerns about valuations of some of the companies in which they might be invested getting bid up to unrealistic levels.
But Harrington, who has moderated panels dealing with the reimbursement issue at prior versions of this conference, identified that issue as the biggest storm cloud for investors. He noted that many companies nearing the commercialization stage the point at which venture capitalists usually are poised to cash in on their investments now are finding that their biggest roadblock is getting paid for their product.
Panel moderator Jim Tullis, founder and CEO of Tullis-Dickerson & Co. (Greenwich, Connecticut), nodded agreement. "Reimbursement is not as simple as you might think."
Setting the stage for the discussion of the device and diagnostics sector as an investment focus, Ralph Weinberger, a partner in the Technology Industry Group of PricewaterhouseCoopers (Minneapolis), cited the "consistent interest" that the sector has attracted.
He said that some $1.7 billion in VC dollars came into the sector in 2004, representing some 8% of all VC investment in the U.S. last year. That trend has continued thus far in 2005, Weinberger said, with some $445 million in VC investment in the device sector in the first quarter.
Because some VCs have cut back on their investment in other healthcare sectors such as biotechnology and pharmaceuticals, he said the percentage going to devices actually grew to closer to 10% in 1Q05.
In Minnesota, he said, the device sector attracted about $145 million in VC funding last year, some 45% of all venture capital dollars that came into the state.
When Tullis asked the panelists to address why the sector is so hot to investors, Barnes responded: "One of the reasons is that in some of the other sectors such as biotech and pharma, the [investment] models aren't working as well as they used to, so devices look relatively more attractive."
He added that the attractiveness is enhanced by the fact that the "liquidity horizon" for device firms is still fairly short, that the capital requirements for device firms "is still fairly small compared to other life sciences sectors," and that investment risk is lower than, say, in biotech.
Harrington, whose firm has had a "primarily devices focus" since its founding in 1993, said, "these are more predictable investments and less volatile," but added that they're also "less robust" in terms of returns.
Noting the "different dynamics" that apply to device investments than biotech or pharma, he said the greater predictability of device investments appeals to an investing community that is "increasingly risk-adverse."
More also hewed to the "predictability" mantra, but noted that now, device firms "not only have to prove [to VCs] that their device works but also that it's going to get reimbursed and that docs are going to use it."
Harrington sounded a cautionary note amid the general euphoria about financing sources particularly the re-opening of the initial public offering (IPO) window being more generally available to young companies that need the funding to continue their push to market.
"We've seen some companies exit [via IPOs] that I think are a little questionable as public companies. Some of these companies are going to disappoint."
He said that he is not convinced that the IPO market will remain a "warm and fuzzy" exit strategy but added: "M&A [mergers and acquisitions] should remain strong."
The Medtech Investing Conference is produced by International Business Forum (Massapequa, New York) in conjunction with Medical Alley/MNBIO (St. Louis Park, Minnesota), a Minnesota-centered association focused on healthcare products and services.