Christopher Delporte, Group Editor03.31.09
Despite a financial market slowdown, a few of the larger medical device firms seem to find the timing right to make a few select, market position-enhancing purchases.
In January and February, Medtronic spent $1.25 billion on the purchase of three firms. Abbott Laboratories snatched Advanced Medical Optics (now called Abbott Medical Optics) for $1.4 billion. St. Jude Medical made a few purchases in the $250 million range at the end of December last year. At the beginning of December, Johnson & Johnson (J&J) bought Mentor Corp. for $1.1 billion.
So much for a market slump you say? Much like individuals who have decided to gobble up the devalued stock of relatively stable companies to take advantage of low share prices in hopes of long- or medium-term gains, medical device companies are ready to make a deal for the right technology.
“Small to midsize firms are in a challenging position. I recently met with the head of one of the largest companies I follow that said it is a ‘target-rich environment,’” said Rick Wise, a research analyst who covers the medical device industry for Leerink Swann & Company, a healthcare-focused investment banking firm. “That’s probably a fair, honest and realistic summary of what it’s like out there. Now’s the right time to buy, if you’ve got cash on hand.”
In a recent interview, Wise told me that growth, which has always been a top priority for medical device companies, has been harder to come by in the last several years.
“That growth challenge has been caused by the fact that—and it happens to be a positive thing—companies have gotten very large. J&J, Abbott, Medtronic, Covidien—these are big companies with tens of billions in revenue, and it’s hard to grow at the same rate as you get larger,” Wise said.
“The second thing is that the dramatic growth over the last 15 years has been from breakthrough areas in interventional cardiology products like balloons and stents, or CRM [cardiac rhythm management] products like ICDs [implantable cardioverter defibrillators]. These products created multi-billion-dollar markets. On the device side, it’s not clear where the next multi-billion-dollar markets are coming from. And to top it off, existing markets have had challenges—about performance in ICDs and stents— and challenges in marketing practices—most recently in the reconstructive hip and knee market. Overall, there’s not a lot of dramatic large-scale innovation right now.”
He noted that a more difficult reimbursement and clinical environment at the moment makes it tougher for large, diverse companies to support substantial investments in sales, legal and clinical infrastructures on a global basis.
“One way to help leverage investments is to identify and invest in early and medium-stage companies that offer markets and breakthrough products or help companies expand geographically,” he said. “And that’s what we’re seeing the big guys do.”
Wise explained that most large companies in the medical device industry have modest levels of debt and are “significant cash generators,” which enables them to do deals that can be financed out of cash and short-term borrowing pretty easily.
“Now, if a company wants to buy something that costs more than $2 billion, that might be a little different,” he said. “The deals we’ve seen so far have largely been financed out of cash. It’s the classic picture of the large fish eating the smaller fish.”
Having covered the medical device industry for 20 years, Wise predicts the trend will continue, calling the sector “continuously acquisitive.” The rate at which purchases will happen and when they’ll take place are the harder predictions.
“There’s always a lively debate about who J&J or Abbott, for example, will buy next,” Wise said. “And there’s been a great deal of discussion over the last five years about whether one of the large diversified companies would buy one of the large standalone cardiology or orthopedic companies. But growth has slowed in those areas, and those expectations seem to have receded a little. Growth and return on invested capital are what people are looking for—not just acquisition for acquisition’s sake.”
Clearly, however, it’s still a difficult time for companies that were hoping to use an initial public offering to finance growth. For the private-equity investors and venture capital-backed startup firms, Wise described the current market conditions as “Darwinian.” And just being a small company with an innovative product isn’t immediately enough to get you an offer from a large firm—though a few of Medtronic’s recent purchases were venture-backed.
“It has to make sense. It has to be the right fit. Why would companies buy the smaller firms that have a hard time financing themselves, suggesting that they’re the least compelling investments?” Wise said. “And every CEO at a midsize to large company has to consider that if they do a deal whether their stock will go up. If you’re buying an early stage [company], it’s not going to be sales- and margin-enhancing on day one.”