Full article reprinted from "The Gray Sheet" - February 23, 2009
The U.S. medical technology industry's access to private venture capital remained relatively strong in 2008, while its ability to raise funds through debt and public stock offerings took a beating from the global financial crisis, according to a recent 1report by consulting firm Ernst & Young.
"The one area of investment that remained somewhat resilient for much of the year is venture capital," the report states. However, funds raised by medtech firms through other means, including convertible debt, follow-on and initial public offerings, were down sharply from the prior year.
The medtech industry raised $2.8 billion in venture capital (VC) for all of 2008, down 18% from 2007, according to the report. By comparison, overall U.S. financing for medtech sank 59% to $4.6 billion from 2007, reflecting a "collapse in debt financing" and weak public markets.
Entitled "Resistant In Any Recession? U.S. Medtech Financial Update and Outlook," the January Ernst & Young report follows up on a mid-year analysis released last September (2"The Gray Sheet" Sept. 29, 2008, p. 3).
When considering the 2008 total for medtech financings, "it is important to note that both 2006 and 2007 were record years for financing, and the 2008 total still surpasses the average amounts raised from 2000-2005," the report notes. Ernst & Young defines medtech as medical devices, diagnostics, drug-delivery equipment and analytical/life science tools.
Capital Markets Dry Up In Fourth Quarter
Most of the decline in total medtech financing for 2008 came in the fourth quarter, when only $380 million was raised. Almost all of those funds came from venture capital.
The report attributes the relative resilience of VC funding for medtech in 2008 to two factors: "First, since the traditional exit for medtech venture investments has predominantly come through acquisitions, and since strategic buyers continue to pursue emerging medtech companies, the dearth of IPO exits has less of an impact on medtech investments than on investments in industries such as biotechnology. Second, medtech's shorter (and less expensive) innovation cycles have historically led to quicker exits than in biotech, giving VCs a greater degree of comfort in the current market."
Several topics covered in the report were revisited during a Feb. 12 AdvaMed conference on the impact of the financial crisis on medtech firms, which was led by execs from Ernst & Young.
"Private equity really likes the characteristics of medical technology," commented Ernst & Young's John Babitt, senior manager, transaction advisory services-life sciences industry sector resident. "There's usually manufacturing involved, there's scalability that can be accomplished with additional capital, [and] most of the time these companies run an attractive profit margin."
Even in the current environment, private equity investors may look to take minority positions in profitable public firms, Babitt suggested. They may also be attracted to smaller "all equity" deals that do not include debt components, and "tuck-in" acquisition opportunities, he said.
Another recent venture capital report cited an aggregate 15% year-over-year decline in U.S. venture capital funding in 2008 for the life sciences sector (including medical devices and biotech) to $8 billion. However, life sciences "accounted for 28% of all venture capital invested and retained its position as the number one investment sector for 2008" vis-a-vis all other industries, concluded the MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association, based on data from Thomson Reuters.
IPO Market Closed For "Foreseeable Future"
Despite the relative resilience of venture capital in 2008 compared with other medtech funding sources, it was still a "tumultuous year for capital formation in the U.S. medtech industry," the Ernst & Young report states.
With the global financial crisis taking a toll on public markets, only three medtech firms were able to complete IPOs in 2008 - all in the first quarter. They include CardioNet, Mako Surgical and Lifeline Scientific. By comparison, there were 13 medtech IPOs in 2007.
While the three medtech IPOs raised a total of $115 million in 2008, the 13 in 2007 raised $1.1 billion. For follow-on public stock offerings among medtech firms, "funding was 53% lower in 2008 than the $1.5 billion raised in 2007," the report states.
The outlook is not likely to improve anytime soon. "The public markets are expected to remain closed for the foreseeable future, with most analysts not expecting additional IPOs until the end of 2009 or later," Ernst & Young states.
With respect to debt offerings, the medtech sector raised over $1 billion in the first half of 2008 but received "a paltry $16 million in the second half, after the credit crisis started to deepen."
"As the global recession continues to deepen, these are potentially worrying trends, particularly for smaller companies," the report states.
M&A Activity Declines With Capital Markets
Medtech deal-making activity also was curtailed by limited access to capital in the latter half of 2008.
While the first half of 2008 saw $19 billion worth of merger and acquisition deals in the U.S. medtech industry - roughly at pace with activity in the first half of 2007 - the second half of 2008 generated only $5 billion in M&A activity.
As a result, M&A activity for all of 2008 fell 49% to $24.9 billion. "In addition, there has been a decline in the number of deals - from 87 in 2007 to 63 in 2008 - and a decline in average deal size," the report notes.
The decline in deal values in 2008 "may stem in part from the heated deal activity of the last couple of years and the natural cyclicality of large-scale public M&As," the report states. Furthermore, the drop in the number of deals in the second half of 2008 may have resulted in part from lower stock market valuations.
"As the market caps of smaller companies have declined, some prospective buyers may be waiting for asset prices to fall even further before initiating acquisitions."
At the same time, "this would suggest that deal flow should pick up in 2009 - albeit at substantially lower valuations."
Medtech stocks are often seen as a safe haven in tough economic times, but they too were hard hit in 2008 - with some exceptions. Generally speaking, after staying "fairly steady through the first three quarters" of the year, medtech stocks "followed the overall market in a sharply downward direction" in the fourth quarter, the report notes.
As of Dec. 31, the medtech sector's market capitalization had fallen 36% for the year - "essentially performing no better than aggregate market indices such as the Dow Jones Industrial Average (down 34%), the S&P 500 (down 39%) and the Nasdaq composite (down 41%)."
Year Ahead Brings "Significant Challenges"
The year ahead "will bring more challenges for numerous medtech companies," the report predicts. Among these are projected declines in admissions among many hospitals and healthcare providers, which could limit medical equipment purchases.
Providers have also seen "significant declines in elective and cosmetic surgeries," in particular. "For instance, patients have been delaying orthopedic procedures such as knee and hip replacements and disk-related back surgeries, as well as cosmetic procedures such as augmentations, bariatric and Lasik procedures - often some of a provider's most profitable procedures."
Going forward, medtech firms may "need to defend their supplier relationships as hospitals move to consolidate vendors and seek volume or other discounts," the report advises.
"While most medical technologies are considered fairly recession-resistant, firms should anticipate significant challenges in a global recession that is still deepening and likely to be prolonged," Ernst & Young concludes.
- Jon Dobson
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