Will Funding Woes Doom The Next Generation Of Medtech Innovators?
By Doug Roe, Chief Editor
Industry and market disruption created by the Affordable Care Act could lead to unintended, long-term restrictions for medtech innovation.
By now, we all know the varied challenges created by the Affordable Care Act (ACA) — device tax introduction, reimbursement contraction, provider and payer consolidation, and pricing compression, just to name a few. But several years ago, the ACA’s potential impact was only speculation. We were looking into our educated crystal balls, but we didn’t have the data to see what trends would develop, or what those trends could lead to in the coming decade. Now, part of that picture is starting to take shape.
In March, Evaluate Ltd. released its annual report, Medtech 2015 in Review. The report contains global market analysis and insights related to the financial performance of the medical device and diagnostic industry. With two full years of information now available since the ACA’s passage, what can be gleaned? At first glance, 2015 had similar market drivers and followed very similar performance trends as 2014. But a closer look uncovers a disconcerting pattern affecting small companies and startups — the primary sources of new innovation, and the life blood of medtech.
Direct Investment Indicators
The last two years in medtech have been defined by mergers and acquisitions (M&A). Some of the largest deals in the industry’s history closed in 2015. “The overall total reached was $127 billion, despite (last year) seeing fewer deals close than any year since 2009. Excluding the Covidien deal, the average amount paid (per deal) was $804 million, the highest on record,” states the Evaluate Ltd. report.
The desired outcomes of M&A activity do not appear to have changed: develop a wider product portfolio, replace poor-performing products with new and/or more profitable ones, reduce tax exposures, and improve efficiencies in infrastructure and overhead. Deals were also driven by a growing interest in technology and software companies. Google and IBM kept busy by investing in medical technologies and forming alliances with medtech companies — or simply acquiring them.
Medtronic was highlighted in the report as an M&A strategic winner in 2015. Its nine deals made it the most active and the highest spender. The Covidien purchase will allow the new combined entity to offer products across an expansive scope. But just as impactful were some of Medtronic’s smaller deals: The company expanded its reach into the growing cardiology and neurology areas, and added several innovative technologies that it can leverage moving forward.
Venture capital (VC) investment displayed a comparable trend to M&A — fewer transactions, but much larger deals. Despite the quantity of deals being down approximately 30 percent, the amount of VC raised throughout the year remained level. These facets drove the average spend-per-investment up by 20 percent. The biggest losers in this shift have been the early-stage startups looking for funding in the early VC rounds.
One factor reducing the availability of VC in the early rounds is the growing reluctance of investors to shoulder the time burden of the investment before a product reaches regulatory approval. They are looking for companies whose product is already proven, and more. “Approval of a company’s technology is just the start. Potential buyers are seeking sales, reimbursement, and even profitability before pulling the trigger,” states Evaluate Ltd. The well-established companies, with approved products, also are receiving the larger sums, coming in the later VC rounds. Adaptive Biotechnologies, with its sequencing and diagnostic technology, was able to raise nearly $400 million through two late-round offerings.
Investment through initial public offerings (IPOs) mirrored the behaviors of other investment cash sources in 2015. IPOs were bigger, though fewer occurred than in previous years, and the companies receiving backing were closer to their product’s revenue-generating stage. The average IPO size was $84 million, which is greater than each of the previous two years, but the number of IPOs was down almost 35 percent. IPO investors, similar to their colleagues in VC, are looking for quicker returns on their money.
Stock Market Indicators
The top companies in medtech (large cap) experienced a disappointing market in 2015. The U.S. was slightly up and the European Union (EU) was predominantly flat. As opposed to top growth companies in 2014, which prospered through aggressive M&A, top growers in the past year were bolstered by new technologies and product approvals. Most growth occurred in therapeutics areas with new device innovation (e.g., the artificial pancreas), or those with large unmet needs (e.g., neurology and drug delivery). The trend in 2016 appears as if it will demonstrate a slight decline in market growth. This slide could persist as hospitals continue the consolidation process, creating fewer customers and budget/spending delays.
If there was a bright spot last year, it was the growth derived from new innovation and product approvals — a trend that needs to continue. “This focus on innovation bodes well for the industry. If larger companies are being rewarded for the approval of novel devices, they will hopefully be willing to invest in new technology, perhaps by acquiring smaller players with promising approaches,” states Evaluate Ltd.
Another area where medtech can seek solace is its market performance compared to biotech. Biotech saw severe declines in 2015. Part of this fall-off was due to how fast and how high that industry climbed, where medtech has experienced slow, steady increases — making the potential drop less precipitous. An additional positive could come from investors steering available funds away from bio and into the currently less-volatile medtech market. Such a shift would also reinforce the trend of investors seeking faster returns on investment (ROI), as biotech generally has longer development cycles before a product is ready for market.
Regulatory Indicators
The current financial environment did not impact new devices getting to market. In 2015, the FDA approved more devices than any other year in the last decade — a remarkable total of 52, which was a 55 percent increase over 2014. Still, don’t be fooled by this metric. Earning FDA approval may be getting easier which, in turn, could help smaller companies. But startups’ experience much more difficulty in acquiring the required equity and get to the filing stage. When you examine the data closer, larger companies like Roche and Medtronic dominated the majority of last year’s approvals.
Changing EU guidelines present another challenge to smaller companies. While the FDA is loosening some of its regulations and improving its process speeds, the EU is becoming more stringent. This is not to say the EU plans to hold device makers to a higher standard than the FDA, but more an observation based on changes being made to achieve global regulatory harmonization. Many smaller companies have traditionally pursued European CE mark approval first, as it has proven faster and the bar for approval lower than FDA approval in the U.S.
“Traditionally companies target CE mark first for their devices, taking the easier path to bring in revenue to keep them going while negotiating the lengthy and expensive U.S. regulatory system. A change to this well-established pattern could deprive young companies of a way to stay afloat,” states Evaluate Ltd.
Future Indicators
Today, as we review our ever-tightening profit-and-loss (P&L) statements and reposition our roles in the new healthcare ecosystem, we should not lose sight of tomorrow. Evaluate Ltd.’s report cannot help but sound ominous in stating that “Early-stage investment is being given to an increasingly smaller pool of companies, which could cause some serious problems in the future. Medtech needs a large cohort of startup companies to hedge against failure and to foster innovation. Depriving them of the funding now could eventually choke the industry.”
Finding new investments, and new ideas to fund innovation, is critical to the goal of addressing unmet medical needs, and potentially to the very future of medtech.