Medical device firms are plagued by uncertainty as healthcare reform plays out in Washington, D.C.
Any preview of business activity anticipated in a forthcoming period of time is framed in uncertainty, but that is particularly so when it comes to medical technology and 2010. So much so that UNCERTAINTY needs to be used in all caps. The uncertainty is fueled by the as-yet-unclear status of healthcare reform in America, which, as this was written, remained firmly in the “unfinished business” column on Capitol Hill.
Heading up the medtech industry’s laundry list of concerns over where Congress is going on healthcare is a proposed $20 billion to $40 billion tax on the industry—an 800-pound gorilla if anyone in the field has ever seen one.
In a sector that depends on a flow of innovations perhaps unmatched in American industry, those responsible for promoting those efforts say such a tax could be the death knell for some companies—especially the smaller firms that generate a disproportionate share of new ideas—that already are struggling with making their business models work.
In the mid-October markup of its version of a healthcare reform bill, the Senate Finance Committee included a proposed $40 billion tax to be levied on device companies over a 10-year period beginning in 2010, as a means of generating revenues to help pay for various provisions of healthcare reform. The House version, rolled out in the latter part of that month, modifies the proposal to a $15 billion to $20 billion total figure, with a 2013 startup date.
The proposed tax has the leaders of U.S. medtech companies, and of associations serving that segment of the overall economy, crying “foul”—and doing so with as much unified vigor as has been evidenced on any issue in the sector’s history.
Mark Leahey, president and CEO of the Washington, D.C.-based Medical Device Manufacturers Association (MDMA), said the proposed tax “would have a devastating impact on innovation and patient care and our industry moving forward.” He told Medical Product Outsourcing, “If you go out and levy these taxes on companies, regardless of whether they’re generating any profits, that’s just going to be the death knell for innovation in our industry.”
In addition, he said, “I am not aware of any tax or any industry in which the federal government levies a tax on the total revenues of a company.”
Leahey cited the push for improving patient care via reform of the American healthcare system. “When we’re trying to promote the adoption and utilization of effective technology, it seems inconsistent with the overarching goals of improving care,” he said. “The majority of companies in this industry are small businesses, and we have heard from many companies who say their tax exposure under this provision would exceed the profits they generate for a year.”
Leahey said of MDMA’s small-to-mid-sized company membership: “We are the pipeline for innovation in the medical device industry. The large companies are very good about improving products and getting distribution through their distribution channels, but the real innovation still comes from small, innovative companies, and this tax would be devastating to them.”
He said MDMA maintains “our steadfast opposition to any tax amount. Practically speaking, once you have this mechanism into the industry, whether it’s a $15 billion, $20 billion or $5 billion, once you have that lever in place, this is going to get ratcheted up over time.”
The leaders of the nation’s largest medical products industry trade group, the Advanced Medical Technology Association (AdvaMed), spoke out against the proposed device tax as well. AdvaMed Chairman Mike Mussallem, who is CEO of Irvine, Calif.-based Edwards Lifesciences, told the media following the unveiling of the Senate version of the bill that “we don’t believe that taxing our industry is a great vehicle” for covering some of healthcare reform’s costs. He added in an AdvaMed statement that the organization is “deeply concerned about the impact of the tax on patients, medical device sector jobs and the national economy.”
AdvaMed President and CEO Steve Ubl said of the device-tax plan: “We continue to believe that it’s bad policy” and is “bad for innovation.” He added that the planned tax “is a really devastating proposal for a large share of our membership.”
Tom Sommer, president of Boston, Mass.-based MassMEDIC, a regional med-tech industry organization, termed the plan “an extremely destructive proposal. We at MassMEDIC continue to oppose the tax outright, and we support any legislative efforts to achieve that goal.”
Sommer told MPO the proposed tax is “destructive on several fronts. Not only is it going to decrease profits of medical device companies, but it also is likely going to result in reduction of research and development and manufacturing operations in this country. I view this as being a very counterproductive initiative and one that we’re hoping will be defeated as Congress continues its consideration of healthcare reform. We’re very interested in getting some finality here, and hopefully we’ll see that healthcare reform as it passes does not include that device tax.”
Don Gerhardt, president and CEO of another regional group, Minnesota’s LifeScience Alley, warned of the impact on smaller firms’ finances. “The smalls and mids develop the largest number of new jobs,” he said, but the imposition of a device tax “may mean that they will have to trim or shut down R&D to meet their bottom lines. If you’re running a medtech company and have lower revenues and higher costs with a device tax, it may become a question of where you move your manufacturing. But where are you going to move your R&D?”
Taking a larger view, he said, “The two net export industries in the U.S. are aircraft and medtech, and here the pols are pushing medtech out.” The question, Gerhardt said, is, “What are we doing to ourselves?”
Rick Wise, medtech analyst for Boston, Mass.-based Leerink Swann, said, “It’s not like the clouds are going to disappear from the horizon fully in 2010, and it seems almost certain that the medical device industry broadly will be asked to pay some form of extra tax to help fund healthcare reform.”
Financing Hits a Wall
The 2009 story for medtech has been highlighted, particularly for small- and mid-sized firms, by the brick wall that has effectively sealed off access to financing.
Larry Haimovitch, president of Mill Valley, Calif.-based Haimovitch Medical Technology Consultants, who in particular follows the comings and goings of startup and early-stage firms in the sector, said 2009 “has been marked by the incredible meltdown of financial markets and how badly medtech has performed, especially small medtech. There has been a huge flight to security and away from early stage. The upshot is that the financial markets are not real good.”
Haimovitch said that because there is no initial public offering (IPO) market, thus closing off that traditional path to exit for venture capitalists, “VCs are keeping their powder dry, focusing on funding existing portfolio companies.”
He said the perception is that the economy is having a huge impact on healthcare, with “huge declines” even in non-discretionary procedures, with people just not coming in to get needed medical work done.
Haimovitch cited the example of a cardiac surgeon friend who said his business was off sharply, beginning in the fourth quarter of 2008. “People are just not coming in,” the surgeon said. “There has been a surprisingly deep decline in procedures that I never would have imagined.”
MassMEDIC’s Sommer said tightened access to financing has had a major impact on the medical technology sector. “It is a very tough environment out there for early-stage firms and venture capital investments. Investments in medical device startups have decreased significantly in the past year. Since the first quarter of 2008, we have seen a decrease in investment in medical devices. That’s pretty much across the board in all industry sectors, but it is tough out there for medical device startups.”
He added, “The real critical piece as far as we are concerned is that only about 12 percent of the financings are headed to that startup, or seed level, and that’s the danger sign that we see looking at financing trends.”
Discussing the changing VC model, he said, “We’re seeing so-called startup companies that now are in the 10- to 12-year range. We also have seen the other end, where companies that have been in that startup category for a significant period of time are not getting that last round of investment for a variety of reasons, and we’re seeing a larger number of older startups disappear.”
Covington Associates Managing Partner Ben Dunn told MPO that in looking at VC funding, he figured the number of deals year to date was down by about 40 percent and the amount invested was down by about a third. “So I think we’ve seen a real pullback on the VC side, which really started in Q408, really in response to the economic downturn. Things now look like they have stabilized a little bit, but I think we’re going to see reduced funding going forward.” Covington Associates is a Boston-based investment banking firm for which healthcare is a key sector.
Dunn believes that one of the results of the changing investment landscape is the reduction of VC firms. “I also think that the VC model for medtech companies as a consequence will change a little bit as well. What I mean by that is that they are going to fund more capital-efficient medtech startups. Rather than looking at a business that needs $50 million, they will look at a business that needs $10 million to $15 million.”
That bodes well for outsourcing as a sector, Dunn said. “You’ll see startups using much more outsourcing. They should be using more outsourcing than they already are for a number of services.”
Noting that with the IPO window having been slammed shut, exits are now via mergers and acquisitions by larger players, he said, “Strategic acquirers in this economy are looking more for safer acquisitions, really filling a certain need—nice tuck-ins, another product they can give their salespeople, or a technology they can easily move into existing divisions. Those tend to be smaller deals and smaller companies.”
Dunn added that the financial fallout is not all bad. “You look at the traditional mindset of the industry, which was, hey, all of these people are going to get sick, so it’s constantly going to be growing. I do think that from an investment standpoint, there was some overfunding of medtech in the early part of this decade.”
He added, “You had too many companies—too many spinal companies, too many orthopedic companies. Ultimately there is only space for two or three [companies] per segment, because if you are going to sell out and you look at the market, how many big guys are there? There isn’t room for 12 different spine companies. There was a little over-exuberance, and now we’re faced with people taking a harder look at these sectors and realizing that there are a lot of different forces affecting device companies, and it’s not a sure-thing slam dunk.”
MDMA’s Leahey said, “If you’re a new company looking for funding, you’re in a difficult place, because a lot of the VCs who have invested in the industry follow the analogy of, you feed the kids you have first before you have new kids. They are trying to preserve their cash so that if some of their existing portfolio companies hit a bump in the road, which with some of the delays at FDA is becoming increasingly likely, that they have the resources to get those companies to the finish line.”
While noting that a lot of venture funds are holding on and allocating resources among their portfolio companies rather than looking to expand their portfolios, he said he also thinks there are some that are revisiting the traditional venture model. “All of a sudden the whole model for limited partners in terms of returns is flipped upside down, and I think that’s the whole question. If something isn’t done to allow these new technologies to move through the whole process more efficiently, while still assuring safety and efficacy, that, coupled with the lack of access to capital, could be very devastating to innovation as well.”
Gerhardt said both angel and venture financing “have turned way down.” Liz Rammer, executive vice president of LifeScience Alley, noted that a session on creative financing was planned for the group’s annual meeting, and observed, “That will be one full meeting room.
Leerink Swann’s Wise said of 2009, “It’s difficult to generalize about medtech because we have this combination of huge mega-companies like Johnson & Johnson and Abbott and Baxter, down to very specialized but large companies like Stryker and Zimmer, and down to tiny, pre-profitable but interesting technology companies like Insulet, for example.”
He said the overall outlook for medtech firms “depends in part on full resolution of the healthcare reform issue, so Washington is out of the mix. The second point is that ortho stocks should have a good 2010 in the context of an aging developed world population that shows no signs of getting thinner, or exercising less, both of which drive ortho. But we have seen procedures stabilize this year, pricing not getting any worse in Q3 than we saw in the first quarter, so we have seen a stabilizing environment. As unemployment rates go down, as the pain in your hip or knee worsens over time, ortho should continue to attract investors and I think be one of the better performers.”
Richard Ramko, U.S. medical technology leader for New York, N.Y.-based consulting firm Ernst & Young, told Medical Product Outsourcing that medtech “held up rather well in 1H09, but it obviously has been a challenging year—a year of haves and have-nots. It has been a very tough year if you needed to raise capital.” Now based in Palo Alto, Calif., in the heart of the teeming San Francisco Bay Area medtech scene, he added that financing “has declined significantly—some would say dried up. Clearly, VCs are still investing, but the crystal ball has gotten a lot cloudier, and I don’t think that is going to change anytime soon.”
Healthcare Reform Clouds Outlook
In addition to the concerns over the fate of the device-tax proposal, the larger question of what form healthcare reform will take when it finally is signed into law certainly clouds the medical products industry’s outlook for 2010.
Wise said that 2010 should be “a better year” for medical device firms, especially the large-cap companies, because some form of healthcare reform will then be in place. “Uncertainty is greater than actual negative news, which can be defined, analyzed, discounted. [So] if the uncertainty of healthcare reform can be resolved, it seems to me that investors will once again be free to look at the fundamentals of these excellent companies who have strong balance sheets, global franchises, solid top- and even faster bottom-line growth because of leverage, mix, etc.”
Covington Associates’ Dunn said, “My sense is there still is going to be uncertainty, even when the bill is signed. The bill is so lengthy, so arcane and confusing, that it is going to take a while for people to figure out how it will specifically impactdevice companies, because medtech companies are one step removed. That said, it will be a relief for people to say, OK, at least this thing is out there and we at least know what it is. But in terms of seeing the full effect, it’s going to take a couple of years.”
Most importantly, he said, “You’re going to need to see how it’s going to affect individual sectors. What’s it going to do to imaging? What’s it going to do to peripheral vascular? How are individual devices going to be affected by the legislation?”
Dunn added, “Those are all things that will take some time to play out. But at least if we have the bill out there, there will be something there for people to sink their teeth into and begin to think about.”
Ernst & Young’s Ramko said companies are going to have to improve outcomes and cut costs. “Companies will have to be careful,” he told MPO. “With healthcare reform, more persons will be covered, but we’ll see growing pricing pressures across healthcare.” He cited cardiovascular, orthopedics and women’s health as particular medtech sectors that may do well in 2010.
Looking ahead to 2010, MDMA’s Leahey said, “There are some significant technologies in the pipeline,” citing some of the technologies that medtech companies are developing in regard to obesity, hypertension and cancer. “I think it’s very exciting about moving the needle from the patient care perspective. But certainly there is a lot of uncertainty about how this healthcare reform bill will impact the industry.”
The challenge, he said, “will be making sure there’s a regulatory and legislative environment that promotes innovation.” Leahey added: “Similar to the oath that doctors take to first do no harm, we should have a similar refrain in our world. In looking at any policy, it shouldn’t harm either the patient or innovation, and often times those are one and the same. There’s a lot that the industry needs to focus on next year to make sure there’s an environment for companies to develop these innovative products that improve the quality of care for millions of Americans on a daily basis.”
LifeScience Alley’s Gerhardt told MPO, “With healthcare reform, there will be much uproar, but it is going to take a while to sort out. He added, however, that “It is unconscionable that we are not dealing with tort reform while doing healthcare reform.”
Sommer said that the final form—if any—that a device tax takes will be crucial to medical product firms next year. “The cost of the tax is going to be passed on to end users, so it really defeats the purpose of lowering healthcare costs because, ultimately, doctors and hospitals and patients are going to pay the cost of this tax.”
The outcome of the continuing battle over the device tax “really is the big question for 2010,” he said. “A lot of medtech companies have been able to weather this recession,” but the crystal ball turns decidedly cloudy if companies have to deal with paying such an excise tax.
FDA Changes Mean More Uncertainty
Changes already being made or those envisioned at the FDA are another big area of concern for the industry.
Leahey, for example, said that one of the areas that he thinks would especially benefit patients, the FDA and the industry is making the FDA panel process more predictable and transparent. “There is an opportunity for the FDA and industry to work together to make sure that panel process operates more effectively and efficiently. We also are looking forward to 2010 to the review of the 510(k) process, because this process is critical to allowing companies to innovate and improve technologies to benefit the patient. We want to make sure there’s a robust 510(k) system in the future in order to promote patient care and innovation."
Wise, a longtime watcher of the med-tech sector as an industry analyst, said, “It seems inescapably clear that the FDA is going to be a more complicated and challenging force for industry to reckon with, even in the very intense period of the past couple of years. There’s a new head of the device division, there’s obviously a new head of the FDA, the political pressures from Congress are intense, and the management of the FDA is going back to basics, and safety is clearly their No. 1 mission.”
He added that the agency is “looking at every aspect of ensuring greater safety, and updating regulations to fit that, so it seems almost a certainty that the 510(k) system will change moving forward, instead of essentially being an honor system, is going to involve much greater scrutiny.”
Wise said that for more complicated products “whether they are actually PMAs or there is going to be some sort of new middle category, such new products, are going to take longer to get through the FDA and to market than they have.”
LifeScience Alley’s Gerhardt said revisions to the 510(k) program “are a substantial threat to the growth of small companies,” effectively threatening the introduction of new technologies. He said he is concerned about what kind of approach FDA is going to take as it reshapes itself and how new technology will be introduced and how long approval will take.
Dunn said, “There’s a fair amount of uncertainty right now between changes at the FDA and also healthcare reform. I wouldn’t call it a perfect storm, but you’ve had this economic downturn, you’ve had the tough capital and financing markets, and now you throw in all these regulatory issues. The industry is faced with an awful lot of factors right now that it hasn’t traditionally been faced with, and I think that is leading to a great deal of uncertainty into the future.”
Jim Stommen retired recently after 15 years as executive editor of Medical Device Daily, prior to which he was editor of newspapers in several U.S. communities.
Device Tax Would Imperil Growth, Companies Say
Michael Fillauer, president of Fillauer Inc., a Chattanooga, Tenn.-based maker of orthotic and prosthetic products, told the Chattanooga Times-Free Press that such a tax would “stifle innovation. Healthcare and medical devices in particular are a growing segment of the economy. Why do you target [a] successful part of the economy?”
Howard Root, CEO of Maple Grove, Minn.-based Vascular Solutions, said that in the short term the tax would forcehis company to trim R&D spending, while in the longterm, it could force the abandonment of a plan to expandits Minnesota plant and to outsource some manufacturing overseas.
From the big-company side, Mark Vachon, president of GE Healthcare Americas, told the hometown Milwaukee Journal Sentinel that “a tax of this size would clearly have a dramatic impact on innovation and a dramatic impact on jobs.” He estimated that GE Healthcare would have to pay an additional $200 million a year in taxes under the proposal.
Boston Scientific CEO Ray Elliott said during an October earnings report conference call that the proposed tax “would raise costs and lead to significant job losses” at the Natick, Mass.-based company. [It] makes absolutely no sense.”
In an open letter published in the Syracuse Post-Standard, Julie Shimer, president and CEO of Skaneateles Falls, N.Y.-based Welch Allyn, said the tax would “impede innovation and ultimately deny [patient] access to life-saving medical devices.” She added that “this proposal threatens to devastate the very industry that could save billions of dollars in the health care system...We believe that health and tax policies should be used to change unhealthy behavior rather than suppress innovation and improvements to patient care.”