It finally happened. After years of wooing investors and impressing shareholders with growth rates that shot into the stratosphere, revenues and overall expansion ratios in the medical technology industry fell back to earth in 2009 as unfavorable foreign exchange rates and crippling economic conditions eroded corporate profits.
Though the industry’s return to ground zero was not too calamitous for medical technology companies, its freefall from double-digit net earnings was not a total surprise. Financial analysts have long warned the industry that medical technology firms are not immune to the ebbs and flows of the economic tide. The right storm, they portended, could very easily destroy traditional long-term growth strategies.
And it did. The financial tempest born partly from the 2008 bankruptcy filing of iconic Wall Street investment firm Lehman Brothers not only sent profits plummeting (a rarity among medical technology companies) but also permanently altered the traditional business models that served the industry—and society—so well over the years. In the not-so-distant future, companies will have to find new ways to fuel long-term growth, claims a comprehensive report on the medical technology sector by global advisory services firm Ernst & Young.
“The convergence of several trends and sweeping reforms is placing tremendous strain on medtech’s long-standing business model and will ultimately force the industry to innovate the way it conducts business,” the report states in its opening paragraph.
“Many of the seemingly disparate trends now looming before the medtech industry—from comparative effectiveness research to the consolidation of hospital purchasing decisions and changes on the regulatory and reimbursement fronts—are symptomatic of a more fundamental shift: the emergence of a ‘health outcomes ecosystem,’ ” the report continues.
“This is a world in which firms will no longer be rewarded based on how many units of a product they sell, but rather on their ability to deliver health outcomes—i.e., improve patient health and access—while decreasing cost to the system.”
Put more simply, companies will have to revisit key elements of their business models—from capital funding and innovation to core competency and product development. Rethinking capital funding strategies may be one of the greatest challenges of the business model reinvention in light of the destruction inflicted on the funding landscape by the global financial crisis.
Though overall funding amounts survived the crisis relatively well (according to the Ernst & Young report, anyway), the distribution of venture capital has become more skewed. Complicating matters over the last two years has been the gradual shrinking of available funding across capital markets and the difficulty in raising money from limited partners. Plus, exits have become scarce and considerably more complex, which has led venture capital firms to carry their portfolio companies further and, consequently, spend less money on new investments.
As a result, venture capital fell for the second consecutive year in 2009, more than tripling its 2008 decline. Data in the Ernst & Young report show that venture financing in the United States and Europe plummeted 22 percent to $3.4 billion last year, with U.S. funding falling 24 percent to $2.7 billion and European financing slipping 6 percent to $701 million. By contrast, venture capital raised in both regions fell 7 percent in 2008 compared with the previous year.
Yet there is reason for optimism. Despite the significant drop in venture capital funding last year, the amount invested by American venture firms still surpassed the totals recorded by the medical technology sector between 2000 and 2005. And, in another sign that the darkest days may already have passed, venture capital investment in the sector for both the United States and Europe totaled $2.4 billion in the first half of 2010, a pace that, if continued, would enable both regions to surpass the totals they raised in 2009.
“There are some interesting dynamics at play in the venture capital market,” said John L. Babitt, Ernst & Young’s medtech leader for the Americas. “Financing rebounded in the second half of 2009 and dovetailed into 2010. There are still some challenges, though. There are fewer dollars being committed to venture capital funding, but we’ve seen very positive credit markets in the second half of 2010 and some pretty cheap and accessible credit terms. Venture capital continues to flow into the medical technology industry, but it has slowed down considerably. We expect to see more venture capital activity in the second half of 2010.”
That flurry of venture capital activity is likely to coincide with healthy levels of overall fundraising as the year winds down. Ernst & Young analysts claim total overall capital raised by American and European companies was up 104 percent during the first half of the year compared with the same period in 2009. They expect no less of a performance from the second half of 2010.
Last year, overall capital raised by U.S. and European medical technology companies totaled $13.2 billion, a 45 percent increase compared with the $9.2 billion firms in both regions collected in 2008, according to Ernst & Young’s Pulse of the Industry—Medical Technology Report 2010. Analysts attribute the surge to fundraising activity in the United States, where financing skyrocketed 88 percent to $11.4 billion (mostly due to debt financings). European companies contributed a paltry $1.6 billion to the collective fundraising pot, a 44 percent decrease compared with the $3.2 billion they added in 2008.
Source: Ernst & Young, Pulse of Industry Medical Technology Report 2010. |
Debt financing accounted for $7.2 billion, or 63 percent, of the total capital raised last year. Venture capital brought in 24 percent—down considerably from the 60 percent of total financing in 2008, but more in line with historic levels, the report stated. IPOs (initial public offerings) are still virtually non-existent, though analysts have noticed a rebound in the number of companies willing to test the IPO market in the United States. Such a rebound may have been triggered by last fall’s sale of 13.75 million shares of stock by AGA Medical Holdings Inc., a Plymouth, Minn.-based developer of devices that close structural heart defects and abnormal blood vessels. The company raised $199.4 million, well below the $275 million it previously had estimated. Weak demand forced AGA Medical to lower the expected price range for its IPO to between $15-$16 per share from $19-$21 per share, though the final per share price fell even further, to $14.50.
Perhaps inspired by the boldness (or bravery) of AGA Medical’s solo venture into the IPO market, Pasadena, Calif.-based GenMark Diagnostics Inc. followed suit in May, raising $26 million in an IPO that was underwritten by investment banks Piper Jaffray & Co. and Leerink Swann & Co. The molecular diagnostics company priced 4.6 million shares of stock at $6 a share, slightly below the $8-$10 per share range it initially had expected to receive.
Ernst & Young’s report suggests that the medical technology IPO market in the United States may be rebounding; as proof, it lists nine companies that have filed for initial public offerings. But one of those filings—from Carlsbad, Calif.-based molecular diagnostic firm AutoGenomics Inc.—is more than two years old (the IPO originally was filed in July 2008; executives seem in no rush to start selling shares) and another (filed by SurgiVision Inc. of Memphis, Tenn.) has been withdrawn since the report was drafted. In their defense, however, SurgiVision bigwigs never seemed confident about their decision to take the company public—over a four-week period in July and August, executives twice withdrew the firm’s IPO filing.
Of the nine companies that filed for IPOs, only Electromed Inc. of New Prague, Minn., made it to the finish line. The company, which manufactures a U.S. Food and Drug Administration-approved device to treat excess lung secretions, raised $5.5 million through the sale of 1.7 million shares. When it filed its IPO in May, the company had hoped to raise up to $13.8 million by selling shares priced between $4 and $6. But when the sale took place in mid-August, the company dropped its share asking price to $4, and from there the stock fell as low as $3.60 in its first day of trading before closing at $3.98.
IPO activity in Europe practically ground to a halt last year, causing volume to fall off a proverbial cliff. After attaining an average of at least 220 million euros worth of IPO volume annually between 2004 and 2007, the industry recorded only one initial public offering in 2009—that of Dignitana AB of Sweden. The 1.3 million euros ($1.9 million) the scalp cooling system manufacturer raised in the second quarter represents the lowest annual amount raised through an initial public offering since at least 2004 and follows a disappointing 2008 when only two IPOs raised a combined 13.4 million euros ($19.7 million).
While the report makes a strong case for renewed interest in the U.S. medical technology IPO market, Babitt believes that initial public offerings will continue to struggle for the foreseeable future. “They’re not coming back,” he told Medical Product Outsourcing. “It’s not just in the medical technology industry, but in all industries. The appetite is just not there among investors.”
Maybe not, but an appetite certainly exists among medical technology firms for debt offerings, according to Ernst & Young’s report. Of the $7.2 billion raised through debt financing last year, 93 percent went to just six companies: Boston Scientific Corp. ($2 billion), Medtronic Inc. ($1.25 billion), St. Jude Medical Inc. ($1.2 billion), Zimmer Holdings Corp. ($1 billion), Becton Dickinson and Company ($750 million) and Beckman Coulter Inc. ($500 million). The trend continued in the first half of 2010, when companies such as Medtronic ($3 billion), Life Technologies Inc. ($1.5 billion), Stryker Corp. ($1 billion) and Thermo Fisher Scientific Inc. ($750 million) took advantage of a U.S. credit market that is offering historically low interest rates for high-quality issuers.