BBI Executive Editor

MINNEAPOLIS, Minnesota "Convergence converts" populated the audience last month during the 3rd annual Medtech Investing Conference at the Millennium Hotel here. After hearing a wide-ranging discussion by a panel probing "The Convergence of Technologies and Applications Shaping Medical Devices Today," many attendees bought into the belief that med-tech's future will involve a variety of combination materials. Saying "we're seeing a realization that there are going to be many biologic solutions" to health problems, Jay Schmetler, managing director of Rivervest Venture Partners (St. Louis, Missouri), noted that large med-tech companies "are seeing this both as an opportunity and a threat." As a result, he said those companies are "trying to get smarter about biotechnology," looking at partnerships and making investments in biotech firms. While there will be "a lot of missteps along the way," Schmetler said that we nonetheless "will see more and more of these combination products."

As in the two prior years, the Medtech Investing Conference was produced by International Business Forum (Massapequa, New York) in conjunction with Medical Alley (St. Louis Park, Minnesota), a Minnesota- and Upper Midwest-focused trade association for the healthcare industry.

Panel moderator Michael Sweeney, general partner with InterWest Partners (Menlo Park, California), cited the convergence of information technology (IT) into the overall healthcare picture, with a particular focus on how IT works with medical products to improve both the speed and the quality of care. Using the example of technology developed while he served as chief executive officer of Ventritex (Sunnyvale, California), which was later acquired by St. Jude Medical (St. Paul, Minnesota), he said that firm's early implantable defibrillator technology generated "what we thought was a massive amount of data." Now, just a few short years later, that "massive amount" appears "a ridiculously small amount" compared to what is being generated today thanks to the rapid advancements made in data capture and transmission.

The question today and for the future, Sweeney said, is "what are we doing with this data?"

Scott Jenkins, PhD, worldwide segment executive for pervasive healthcare in IBM Life Sciences' Healthcare & Life Sciences division, had a ready answer. "In order to get personalized medicine," he said, "we have to capture and pump information to all the people who need to see it." The three main points of that capture/pump equation, Jenkins said, are the point of origin of the data, knowing where to put the data and understanding how it works within the healthcare "ecosystem." Offering a parallel to real estate's "location, location, location" mantra, he said "data, data, data [is] the key to personalized medicine." And, he added, "Your companies make a device [based} on that."

Chris Coburn, executive director of CCF Innovations, the technology licensing and commercialization arm of the Cleveland Clinic Foundation (Cleveland, Ohio), said the convergence of technologies has generated "great excitement from the clinical end." Saying that "for centuries, diagnosis and treatment have been snapshot-based," he posed the rhetorical question, "What happens when the entire thing is real-time?"

The answer, according to Coburn, is that "Longstanding areas of clinical domain are blurring." He said that clinicians largely are "energized" by the pace of such developments, even though many questions remain, such as whether the future job of a cardiologist "is going to be more data-driven, with less human interactivity."

Also energized as a panelist was Blair Childs, executive vice president of strategic planning and implementation for the Advanced Medical Technology Association (AdvaMed; Washington), who said, "The future for innovation [in healthcare] really is astounding." Noting, for instance, that "the whole IT area has barely been touched," Childs declared: "We're at the best point we've ever been in terms of how we're accommodating new medical innovations" within the regulatory and reimbursement hierarchy. "I feel this will differentiate us from the rest of the world."

Childs cited several elements of the Medicare reform act that were championed by AdvaMed, including new DRGs (diagnosis-related groups) for "add-on" new technologies. "Now device companies can get adequate reimbursement up-front," he said, characterizing that step as "a big change for CMS [the Center for Medicare & Medicaid Services]." He added, "We also now have an Office of New Technology at CMS that it is meant to be an advocate" for such technology, which among other things will help med-tech firms "get payment for breakthrough technologies used in clinical trials." Other provisions in the Medicare reform bill strengthen the local reimbursement decision process.

On the regulatory side, Childs noted that provisions in the Medical Device User Fees and Modernization Act put in place user fees for med-tech product approval submissions, intended to provide added funding to help build up FDA product review staffing, and an Office of Combination Products, whose focus is to help speed approvals of drug/ device or device/biologics products. "All of this means the future is very bright for medical technology," he said.

Keeping an eye out for the exit

When they hear pitches from entrepreneurs nursing their start-up companies along or chief executive officers heading up development-stage firms, the various questions investors ask really boil down to one: "What's in it for me?" And those making investments or setting up alliances in such companies on behalf of corporate behemoths ask similar questions with a slightly different twist: "How will tying ourselves into this company help our product mix?" Separate panel discussions at the Medtech Investing Conference addressed both areas of interest. With the initial public offering (IPO) market for med-tech companies just starting to shake itself out of a slumber that saw the better part of two years pass without a single company being able to use that exit route, merger and acquisition (M&A) is the exit route of choice for companies and investors seeking to cash in on their dollars and efforts.

David McDonald, managing director of RBC Capital Markets (Minneapolis), who chaired the "Dealmakers Share Exit Opportunities" panel, said that the "buyer" side of the equation primarily involves larger medical technology companies that are "mostly strategic buyers" seeking to broaden existing product lines or establish new platforms. "Boston Scientific [Natick, Massachusetts] is extremely active, and Abbott Laboratories [Abbott Park, Illinois] has picked up its activity" in the M&A arena, he said. Among other big players, McDonald said Medtronic (Minneapolis, Minnesota), the largest pure-play device company, "has backed off a little bit," while "GE Medical [now GE Healthcare; Waukesha, Wisconsin] has been very active in the imaging space." He said the number of companies that have done more than one deal over the past five years totals in excess of 40, an interesting note on the breadth of M&A dealing in the device sector.

Francisco Salva, a director with CIBC Capital Partners (San Francisco, California), said his firm "has spent a lot of time in the spine area" over the past year or more, but added, "we're a bit apprehensive these days because the big players have made their bets" in that space. Salva said that other device sectors where activity is ramping up are ophthalmology (especially with firms focusing on solutions to such problems as presbyopia, or nearsightedness, which affects a huge share of an aging population) and abdominal aortic aneurysm repair, particularly directed toward percutaneous approaches. And, while this conference was focused on the technology side of medicine, he noted that the biopharma space "has been really hot" in terms of dealmaking.

He said more and more strategic buyers "are taking the Boston Scientific approach of buying big equity slices in companies, with an option to buy" the companies at a future time.

Panelist Shelly Wall, a vice president at Morgan Stanley Venture Partners (New York), said that since the start of the year, the trend in the M&A space has been away from late-stage companies to those in earlier stages of product development. Citing "a pretty dry market" for dealmaking over the past couple of years," she said its resurrection is the result of greater numbers of larger companies "broadening their [product] portfolios with multiple acquisitions." Wall added that "companies are becoming more cautious" in their M&A activities. She urged entrepreneurs to "look up from what they're working on in developing their products to see how the market might value their companies."

Bruce Machmeier, partner with the Oppenheimer Wolff & Donnelly (Minneapolis, Minnesota) law firm, said there's "a very active market . . . [it is] a fruitful source of companies for sale." He said entrepreneurs eyeing a merger or sale as an exit route for themselves and/or their investors "need to run the business well." Saying they need to "run the company from the beginning as though you're going to sell it," Machmeier urged entrepreneurs or CEOs of those seeking an M&A exit "to clean up any messes over intellectual property or stock ownership many buyers just don't want to have to deal with those things."

As for what buyers are looking for in companies they might look at as potential acquisitions, McDonald cited 1) growth, 2) profitability and 3) visibility. "In the device sector," he said, "companies that have a razor/razor blade business model get the most attention." In other words, those firms whose products have a built-in, ongoing stream of disposable sales are favored over those whose products are a capital equipment expense to healthcare providers.

As for what sellers should look for in a buyer, Salva cited the hope that the seller's management team would be a good fit with the buyer's organization, unless the seller is simply looking to exit the business completely, in which case management fit may not be as important as the overall cultural fit.

For the corporate viewpoint, another panel addressed "Corporate Strategy: Managing Investments, Acquisitions, Alliances and Partnering." Jagjit Gill, director of new market development for Boston Scientific, noted that his firm "consummated 16 investments or acquisitions in 2003." With the interventional cardiology space Boston Sci's largest area of activity becoming "more crowded," he said that in considering new deals or alliances, "we need to look closely at how we can impact what we do there." While the impressive commercial success his company has enjoyed in the first two months of U.S. sales of the Taxus drug-coated stent is resulting in revenues that can help feed other areas of activity, Gill wryly noted that it also has resulted in "the bar being set very high" insofar as new areas of business are concerned. In looking at companies in which to invest or to acquire, "we need to determine if the juice is worth the squeeze," he said.

Omar Amirana, MD, vice president of technology and business development at St. Jude Medical's (St. Paul, Minnesota) Daig Division, said his focus is on "opportunities for bundling [products] or areas we aren't presently in." As for what his firm is looking for in terms of an alliance or an acquisition, Amirana offered a succinct definition: "Devices that make procedures better, faster and safer."

Sami Hamade, vice president of business development for Guidant's (Indianapolis, Indiana) Compass unit (Menlo Park, California), which is focused on investing in other businesses and technologies, noted that there's a distinction to be made between "arm's length, traditional VC-type deals and staged-acquisition takeouts" of companies. Hamade said Guidant's investment philosophy isn't necessarily directed toward gaining control of companies in which it invests. "We realize there's nothing better than innovation . . . and we're willing to relinquish some of the control issues."

Gill said that for Boston Sci, "it goes back to what we know best endovascular, percutaneous approaches. For our customers, we want to identify what the next clinical void is that they want to get involved in." And, he cautioned, "if it isn't something we can add value to, we aren't interested."

Unmet needs, large markets are 'must haves'

When they review companies in which they might invest, venture capitalists have some pretty specific ideas about what they're looking for or in some cases, what they most definitely don't want to see. Panelists addressing the question during the conference noted that the plus side of the ledger at least two "musts." The technology envisioned by the entrepreneur seeking financing has to address a significant unmet clinical need and also must present a large market opportunity.

Running virtually neck-to-neck with those two are the reimbursement outlook for the product that may result from the collaboration between investor and entrepreneur, and the eventual outcome for the venture capitalist from his or her investment. Panelist Buzz Benson, managing director of Piper Jaffray Ventures (Minneapolis), put the latter two in question form: "Are these technologies payers are willing to pay for?" and "Where are the exit opportunities?" In general, he said, his firm looks at milestones and financing stages, regulatory timeframes ("This can be a nightmare," Benson said), reimbursement and intellectual property.

As a cautionary note for both investors and entrepreneurs, he warned that one of the realities of investing in device companies is that "you're going to have [an added] financing round you hadn't expected." Such a round is "very frustrating," Benson said, "but it's amazing how things go bump in the night."

Ross Jaffe, managing director with Versant Ventures (Menlo Park, California), added: "we call it the 'hiccup round.' Point-to-point thinking doesn't work in this environment you have to think it all the way through." Citing his firm's goal of getting a return of "10 times our investment," Jaffe said that makes it imperative that companies in which it invests "go after larger market opportunities." And the way to zero-in on such opportunities, he added, is to "look for [companies with] solutions to important clinical problems."

Trevor Moody, partner with Frazier Healthcare Ventures (Seattle, Washington), said, "we try to be really open-minded about opportunities, but there are areas that are a tougher hill to climb" than others. He cited clinical diagnostics as an example of an area where the combination of unmet needs and large market opportunity is more difficult to bring into alignment, while acknowledging that Frazier has had some success in investing in that sector. Moody and other panelists noted a decided preference for financing companies involved in sectors populated by clinicians who are enthusiastic early adopters of new technology cardiovascular, for instance.

For Alison de Bord, a principal with Alta Partners (San Francisco, California), what her firm's investment will do in terms of bringing a company along is vitally important. "We spend a lot of time looking at where our dollars will take a company in terms of clinical progress. [We try] to model the future."

Panel moderator David Stassen, general partner with St. Paul Venture Capital (Eden Prairie, Minnesota), put a more specific number on market opportunity and unmet need. "If you can't see at least $1,000 per procedure out of your technology," he said, "it's going to be difficult to grow your company."

As for reimbursement, Moody said it is "as important an area to companies as regulatory; giving it enough attention is critical." de Bord, whose firm does more late-stage investing than others represented on the panel, added: "One of the big issues with late-stage investing is that companies just have not focused enough on effort and importance on reimbursement." Noting that "there is an ability to mine payer databases [on reimbursement policies] ahead of time," Benson said, "it's very important to do this."

One piece of advice from Stassen on the reimbursement question is for companies to avoid markets where CMS approval is necessary. In the plastic surgery sector, he said, "a Visa card is your reimbursement."

Asked to identify emerging opportunities in which their firms might invest, the panelists had large areas of agreement. Moody, for instance, cited disease states that have been largely subject to drug management, but now are seeing devices not only gaining a foothold but also being poised to capture the lion's share of the market congestive heart failure being a significant example.

For Benson's firm, pulmonology/respiratory is an area of interest. "We have made two deals there," he said. Benson added that "women's health has come back that area has a very large appeal to a large population." And diagnostics can be a successful area for investment, he said, "if you can match a diagnostic technology with a specific therapy." One very large area of interest, Benson said, is diabetes, where a VC investment might be buoyed by the fact that there is "a lot of government interest" in that disease state. "We're also very interested in drug/device combinations," he said. "Where you have opportunities for convergence, there is interest."

Noting the tendency to jump on the bandwagon of so-called "hot" markets (he used obesity as a current example), Jaffe warned: "When too many [med-tech] companies go after a new market, it's hard for many of them to grow." He cautioned that investing "is not just about hot, sexy markets we need to keep looking at [developments in] established markets."

Responding to a question from the audience about the vision market, Jaffee said, "Ophthalmology is a phenomenal space," with opportunities driven by an aging population and their need for vision improvement, along with dealing with such severe vision problems as acute macular degeneration and diabetic retinopathy.

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