MedTech M&A and Manufacturing Predictions for 2018

2017 was a year of unprecedented global change, and the impacts were certainly felt in medtech and healthcare. Some of the biggest changes occurred in the United States: Businessman/reality television star Donald Trump took office and the Republican Party controlled the White House, U.S. Senate, and House of Representatives for only the second time since 1929. The GOP promised to dismantle the Patient Protection and Affordable Care Act (a.k.a., Obamacare) and then fumbled the execution of it, a new U.S. Food and Drug Administration chief assumed control of the agency, lawmakers (led by President Trump) attacked Big Pharma, catastrophic hurricanes raked the Caribbean, and Congress passed a tax plan that will affect the medical device and other industries for years to come.

Despite so many changes and uncertainty in 2017, mergers and acquisition (M&A) activity remained robust. Throughout the year, the industry saw numerous deals involving private equity, OEMs, foreign investors, and other strategic buyers who continued to use M&A as a tactic to grow their medtech platforms and holdings.

Impact on 2018
We certainly are bound to see more changes this year, many that we can’t predict. But, all signs show that medtech M&A activity will remain strong in 2018. Many of the core factors that powered last year’s pairings remain: decent financing terms and leverage, liquidity and cash on balance sheets, OEM consolidation (BD-Bard, on the heels of BD-CareFusion, Medtronic-Covidien, etc.). These factors will continue to drive contract manufacturer consolidation as well as an environment with multiple buyers (private equity, OEMs, and other strategics). In addition to M&A, 2017 proved to be a strong year for publicly traded medical technology stocks, with most medtech-weighted funds or ETFs growing 30 percent or more and outperforming both the S&P and broader market indices.

As advantageous as they are for healthy M&A activity, however, these factors can be challenging for companies and could negatively impact the market. While valuations remain at or near record highs for the best pure-play medical device assets (companies focusing primarily on medical), these assessments may be reaching their peak, potentially portending a weak second half of 2018. The availability of prime assets with robust balance sheets and earnings, as well as seasoned management teams and strong pipelines, are being reduced on account of past M&A activity. Case in point: many companies (OEMs) and financial buyers have seriously been contemplating smaller-sized deals due to actionability and a lack of larger pure-play assets. This trend is likely to continue in 2018.

Active buyers will once again look to actionability this year when considering M&A deals. The most active of these customers have had more focused and larger deal teams looking for both acquisitions and partners, and have built relationships to keep abreast of the market’s pulse. The most successful medtech private equity owners are typically experienced in the sector and understand the nature of the business, the players, and the market landscape.

Cross-border deals were strong in 2017 and will continue to grow this year as global OEMs increasingly lean on their Tier 1 suppliers for support and help in managing their downstream providers. Many multinationals (i.e. Molex Inc., TE Connectivity, Nordson Corporation, among others) and some of our clients are also very active, looking to grow their medical device divisions, market share, and/or capabilities. European and Asian buyers continue to depend on the North American market to acquire assets that give them a geographic footprint and access to U.S. customers. To a lesser extent, there are U.S. buyers looking to gain a foothold in the European Union or Asia and looking for synergistic assets in these markets. Establishing a presence in China or Asia has become a priority of late as multinational firms with global clients seek to supply and access fast-growing regions with large, aging populations. 

U.S. Tax Plan Fallout
The new tax plan (The Tax Cuts and Jobs Act) repeals an itemized deduction for healthcare expenses, thereby preventing families with high healthcare expenditures from subtracting these outlays from their taxes. The change could cause some people to refrain from seeking costly remedies or procedures, though it is still too early to determine the plan’s impact on the general populace.

Another potential complication of the tax plan is section 4303, which imposes a 20 percent excise tax on goods manufactured overseas by subsidiaries of U.S. companies. This new charge could have a damaging effect on the medtech industry because companies that purchase items from foreign subsidiaries would now have to pay an additional levy. That could be devastating to countries like Puerto Rico (considered a foreign land under U.S. tax code), where pharmaceuticals and medical devices are responsible for 30 percent of the island’s gross domestic product in 2016. According to businesspuertorico.com, the U.S. territory is home to more than 70 medical device manufacturing plants that produce everything from surgical and medical instruments to ophthalmic goods, dental/orthodontic equipment and supplies, and orthopedic implants.

Conversely, the reduction in corporate taxes proposed by the plan should lead to increased R&D, more jobs, and the creation of high-priced, cutting-edge medical products. It will be interesting to see exactly how the tax plan will play out in medtech over the years. If some of the Obamacare claims are true—that having more insured patients is good for both patients and the industry—it’s possible that fewer people opting for coverage and procedures could hamper future healthcare consumption in the United States. Only time will tell.

Will the Medical Device Tax Be Resolved?
Lawmakers seemed to forget about the medical device tax last year, or at the very least, they did their best to ignore it. The 2.3 percent levy had been on a temporary hiatus since the beginning of 2016 but is now technically back on the books (as of Jan. 1). Just five days before Christmas, AdvaMed CEO Scott Whitaker warned of the tax’s looming reinstatement and appealed to President Donald Trump for administrative relief. “Unfortunately, while Congress worked with you to advance this major legislative undertaking, they have failed to address a punitive tax that singles out the American medical technology industry, threatening jobs in the U.S. and future innovations for patients, and washing away the benefits of tax reform for our companies,” Whitaker wrote in a letter to Trump. “It is vital that you work with Congress to ensure they do not take a step backward and allow this devastating tax to be reinstituted on the industry. Retroactive action by Congress next year cannot fully undo the impact of allowing this tax to be triggered on January 1. Short of legislative action, I would strongly encourage you to direct the Treasury and IRS to provide whatever administrative relief you can…”

There is legislation in the U.S. House of Representatives to defer the medical device tax again. A bill introduced by U.S. Rep. Jackie Walorski (R-Ind.) and former Rep. Erik Paulsen (R-Minn.) would suspend the device tax for another five years but industry leaders are concerned the legislation could potentially be put off indefinitely. The Joint Committee on Taxation has stated that repealing the medical device tax would cost the U.S. Treasury about $20 billion over a decade. Before it was temporarily shelved in 2016, the Internal Revenue Service collected between $1 billion and $2 billion per year from 2013 through 2015. Such a windfall could make it difficult for the GOP to argue for another postponement, especially with mid-term elections coming up this year.

The Only Constant in 2018
If 2017 taught the medtech industry anything, it is this: Change and surprise will be the only constant this year. Overall, the global business climate and macro market drivers, especially for healthcare, will remain robust. Micro-technology, artificial intelligence, robotics, telemedicine, wearables, and implantables (among others) will all continue to change business as usual and shift many paradigms in the healthcare marketplace. M&A, continued consolidation, and the blurring of some traditional lines (OEM/distributor/contract manufacturer) worldwide will present opportunities for some and challenges for others. Stay tuned. 

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As president and founder of Bonifacio Consulting Services, Mark Bonifacio works with medical device OEMs and contract manufacturers to help them grow organically and through mergers and acquisitions. Mark leverages his education, decades of global manufacturing experience and extensive international network to provide unique value. In his early career, Mark worked for several major medical device OEMs, then co-founded APEC, a medical device contract manufacturer. Mark built APEC from the ground up, and sold it to Freudenberg Medical in 2007. He established Bonifacio Consulting Services soon after. Today, Mark assists organizations in business growth, strategy and tactical execution, M&A, joint ventures, and licensing. He also advises on cost-reduction initiatives, operational, and organizational improvements. Notable clients include TE Connectivity, MedPlast, Wendel, Onex, Medtronic and Millipore, among others. With a B.S. in plastics engineering from the University of Lowell (now UMASS-Lowell), Mark brings deep engineering and operational expertise along with an entrepreneurial drive. Mark is well known in medical device manufacturing and is a regular speaker and contributor for industry events and publications.