The S2N Blog

  • IPO or Bust for Emerging Med Techs

    By: Amy
    Published: 18 Aug 2014
    IPO or Bust for Emerging Med Techs

    The recent receptivity of public equity markets to early stage biotech has encouraged more than a few emerging med tech companies to consider IPOs. The allure of the IPO, if successful, is obvious. More capital can potentially be raised on better terms from public investors than private ones to fund expensive commercialization efforts. More to the point, though, tired venture investors and management teams can achieve liquidity and returns sooner than waiting for an attractive M&A exit, which in med tech may require years of slogging it out on market for a multiple of sales deal.

    A glance at the five emerging med tech companies to go public in the last 6 months reveals reasonable success in raising money with their dazzling stories of large and growing market opportunities. Notably, all of the companies have a product on the US market, or within sniffing distance of it; contrast this with biotech where promising pipelines alone can drive successful IPOs and high market caps. Also notable is that fundraising expectations were a bit more bullish than the IPO market reality, with all five companies pricing below or at the low end of their target ranges.

    If tapping the public markets is something you are considering for that next round of capital, certainly the first step is determining whether public investors are likely to come to the table. Do you have, or are you close to, US revenues? Check. Is your product chasing large markets with big growth potential? Check. Are your VC investors tired and cranky? Check!

    An IPO, however, is not just about the day you get listed on the NASDAQ and pocket the cash. As a wise sage told me when I was pregnant with my first child, “Don’t worry about childbirth, worry about everything that comes after.” To gain some perspective on life as a public emerging medical device company, I spoke with Nassib Chamoun, former President, CEO and Founder of Aspect Medical Systems (ASPM), a brain monitoring company that went public in 2000, raising $52M in the IPO that funded the company to >$100M in sales, profitability and acquisition by Covidien in 2009.

    According to Nassib, being a public med tech company has certain advantages. “You are a somewhat more legitimate entity, especially when dealing with corporate partners,” says Nassib. Having that ticker next to your company name also raises your prestige with current and potential employees (I’m nominating T2 for the cutest ticker of 2014, by the way). Nassib also recalls fondly many of his interactions with sell-side and buy-side analysts. “They were like an outside Board – I often got more from them than they got from me.”

    The leadership of the IPO-ing emerging med tech company needs to prepare for some of new unique challenges, though, that come with being a publicly traded entity. Here are a few you can expect to encounter:

    1. The distraction factor: As we all know, being a CXO of a start-up med tech company equates to two full time jobs at a minimum. Add an IPO to the mix and you are now 300% employed. This burden repeats itself, albeit on a smaller scale, at least every quarter once you are public. Employee fixation on the company share price also adds to the distraction factor, especially when there are big swings (a common situation for emerging med techs – see point 4).

    2. The cost: According to a PWC survey, in addition to underwriting fees paid to the bank(s) taking you public, which can total as much as 5-7% of gross proceeds, companies spend an average of ~$1 million on IPO-related legal, accounting and other one-time costs, and ~$1.5M in annual recurring costs for extra staffing, legal, HR, technology and the like. These sums may not seem like much for larger companies, but for small med techs these additional expenses can have a real impact.

    3. The Full Monty every quarter: If you ever listen to a JNJ earnings call, you soon realize that you are learning absolutely nothing. Contrast that with the single product med tech company, where basically every aspect of your business, from your COGS to your installed base to your clinical trial progress, is discussed in intimate detail for the analysts plugging assumptions into their 1,000 line models so they can decide what box to put you in. You might as well send your competitors and every employee in your company your weekly management report. “One of our early competitors was also public and we knew everything about each other – it was a running joke,” said Nassib.

    4. The rollercoaster ride: Most public emerging med techs are thinly traded, which makes dramatic share price swings more likely. These swings may have little to do with your company’s results, though plenty of unanticipated things happen in early commercialization that can affect your share price. “The highs are higher and the low are lower,” recalls Nassib. “The volatility brought our organization closer together as we celebrated the successes and managed through the failures.” Small public companies are also more vulnerable to activist investors since it is easier to acquire a controlling share. “You can be forced to liquidate and give up significant future value for much smaller short-term gains,” warned Nassib.

    When I asked Nassib about Aspect’s decision to IPO, he emphasized that going public is rarely a choice. “With the amount of money and time required to develop and commercialize a novel medical device, you exhaust your angels, your VCs, your Mezzanine investors, and you still aren’t done. The exhausted investors, and employees, want some liquidity, and an IPO becomes your only option.” If it had been a choice, Aspect might have stayed a private company, though “going public is on the evolutionary path toward becoming a successful company – so live it up and enjoy the journey,” advised Nassib.

  • MDT + COV - Good or Bad for Medtech Innovation?

    By: Tim & Amy
    Published: 20 Jun 2014
    MDT + COV - Good or Bad for Medtech Innovation?

    Let’s be honest – the headlining acquisition of Covidien by Medtronic may go down as the most boring deal of 2014, unless of course you are an international tax accountant. The swirling buzzwords are inversion, offshore cash, G&A, and hospital contracts. Please wake me up when it’s over. Yet it may be the unintended consequences of this deal that are the real story, in particular the implications for med tech innovators. The real story won’t really be known for months or even years, despite Omar Ishrak’s reassuring pronouncements that the merger will “accelerate” investments in R&D.

    We at S2N decided an old-fashioned pro-con debate was in order. Question: Is the big fat marriage of MDT and COV good for Innovation? Tim took the Con position and Amy the Pro stance. Here’s blow by blow:

    Cash for innovation or cash for shareholders?

    Amy: You need a lot of cash to invest in disruptive innovation, and the combined “Medvidien” will be swimming in it. It’s a perfect match for gaining efficiencies in mature product categories to free up cash for real technological advances.

    Tim: This deal is a perfect example of how the big companies are throwing in the towel on innovation and focusing on the bottom line. The extra cash will all go back to shareholders, which is great for them but I’m not sure how that helps innovation.

    Temporary deal disruption or big investment hiatus?

    Tim: Good luck getting anything done with any division of MDT or COV for the next 3 years while management is completely focused on realizing those promised “synergies”. They will have a good, long run of earnings growth that will take pressure off top-line growth for a while.

    Amy: Really Tim, do you think they can afford to turn off the growth-oriented deal flow for that long? Sure, there might be a short-term disruption to early stage investments from the distraction of the merger, but pretty quickly they are going to have to put that cash to work to grow sales. Can’t cost cut your way to success forever!

    Spawning of new start-ups or lifestyles of the rich and famous?

    Amy: Think of all the med-tech superstars who will make big coin on the deal and then be released to the wild. Some of that money and expertise will start finding it’s way back into the emerging med-tech ecosystem.

    Tim: Wishful thinking, Amy. Med-tech veterans don’t have a rich history of aggressive angel funding. Mostly likely the deal will help the yacht and island markets more than med tech start-ups.

    One less acquirer in the pool or just fatter acquirers?

    Tim: The number of big-time med tech acquirers is pretty small as it is, and it just got one smaller. Negotiations with the new entity will be tougher, too, because there will be less deal competition.

    Amy: There is so little overlap in the business units of the two companies, except for endovascular, that it really doesn’t change the picture for most emerging med techs. The acquirer just got a bigger wallet.

    Helpful scale or focus elsewhere?

    Tim: After tax minimization, the other main drivers of this deal are negotiating power with hospitals and scale to sell in emerging markets. That’s where they see their growth coming from in the next couple of years. Innovation is on the back burner.

    Amy: Those more effective hospital and emerging markets sales channels will benefit innovative technologies, not just mature ones, and they will need more products to pull through those channels.

  • The Case for Early Deals in Med Tech

    By: Amy
    Published: 04 Jun 2014
    The Case for Early Deals in Med Tech

    To the consternation of many emerging med tech executives and their investors, the big medical device companies are much less active in the early stage deal space than their bio-pharma counterparts. Drug company leadership “gets” that future success depends on robust product pipelines infused with externally sourced innovation at every stage from Discovery clear to Phase III. Case and point: of Goldman Sachs’s 2014 list of “High Potential Drugs that could Transform the Industry”, Forbes noted that 75% of them no longer sit with the originated owner because of acquisitions or in-licensing deals. Contrast this with the med tech sector, where the hurdle to acquisition or meaningful strategic investment is not so much proof of concept but proof of market traction – a very high bar indeed.

    The time may be now for the big medical device companies to lift their heads out of their quarterly net earnings reports and start looking seriously at early stage investments in innovation. Here are three compelling reasons behind this logic:

    1. You can’t buy revenue forever

    For most of the large med tech companies, the solution to the growth dilemma has been minimally dilutive acquisitions of companies with existing, faster growing sales and better margins (or the near-term promise thereof once infrastructure “synergies” are realized) than their existing product portfolios. Makes a lot of sense – many of the technical and even market risks have already been reduced, and acquisition integration is something the big companies know how to do. The problem is that there and fewer and fewer “target” companies out there to buy, and competition for them is driving up multiples. A recent example is the December 2013 purchase of Mako Surgical by Stryker at a whopping price (for med tech) of 13X annual sales. The Wall Street Journal coverage of the deal noted that the price “…reflected the lengths that medical-device companies will go to jumpstart sales growth in the face of product commoditization and broad economic pressures…” Also given the cycle time from innovation to meaningful revenue in med tech, it is safe to assume many of the companies being acquired today were originally funded 10+ years ago. My guess is we will start hitting the nadir of available targets as a result of the tougher med tech financing climate that started back in 2008 with the financial crisis.

    2. Big companies can’t innovate (enough)

    With the sheer size of the large medical device companies (10 over $10B in sales in the US alone), and many existing product franchises losing ground under health care budget pressures, big med tech’s appetite for new products is voracious. The best new products are those that can contribute both to the top line with growing sales, and to profit margins with premium pricing; in other words, true innovations. Big med-tech is genetically risk-averse, bureaucratic and not the least bit scrappy, so internal R&D can’t deliver the goods. Pharma has come to terms with this fact and has outsourced most of their R&D, understanding that only about one-third of their innovation will be generated internally. Big med tech needs to follow suit both organizationally and financially, acknowledging that most “disruptive” medical technologies will be found out there in the emerging med tech community.

    3. The innovation ecosystem needs strategics to step up

    It is still quite challenging for emerging med tech companies to raise money, with the dollars tightest not so much at the earliest stages where a number of angels and grant-funding organizations have stepped in, but more at series B through D. A venture capitalist at a recent MassMEDIC financing conference talked about the new “valley of death” being in these later stages, when the cute little toddler technology becomes a hungry adolescent, requiring significant funding for clinical or market development depending on the regulatory path. While there has been some easing of the IPO market for med tech companies in early commercialization (see TRIV & EVAR), the public markets have not warmed to development stage medical device companies the way they have to their bigger risk, bigger reward biotech brethren. With the aging of the population and the demand for healthcare only increasing, the need for innovation is there but will go unanswered without sufficient risk capital to fund it – a lost opportunity for the large device firms.

    Some big med tech executives are coming around to the idea that they need to invest earlier and take more risk to maintain healthy businesses for the long haul. We have seen some movement in med tech toward structured deals between development stage companies and the industry giants – small steps toward the pharma model of deal making, risks and all. The CEO of Medtronic Omar Ishrak gets it, boldly stating in a recent earnings call “We would have done [the Ardian] acquisition over again, based on the data that we had at that time. You do clinical trials for a reason, and every so often, you are going to get negative results. And we don’t give up on strategic opportunities based on that.” Managing a pipeline requires both an acceptance that failure is possible, and the know-how to account for the risk in the deal terms (arguably MDT missed the boat there). Pharma has long had a more comprehensive understanding of the risks within their pipeline and how to manage them through licensing and co-development structures. Big med tech should take a page from the pharma playbook and aggressively fund external innovation, or be prepared to have the financial profile of utilities. Revenue is nice, but transformational growth is nicer.

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