The S2N Blog

  • 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.

  • Emerging Med Tech Margins - Don't Think Price, Think COGS


    By: Tim
    Published: 08 Apr 2014
    Emerging Med Tech Margins - Don't Think Price, Think COGS

    Fact: the prices of medical devices, whether innovative or commodity, are under significant pressure from all corners and in all parts of the globe, and will continue to be for the foreseeable future. Fact: whether seeking to please public shareholders or angel investors, medical device companies need their products to carry healthy profit margins (or at least the promise of them) at market ASPs. So if pricing is tight and margins aren’t to be sacrificed, the spotlight turns to costs. In this health care climate, low COGS are replacing premium pricing as the key to profitability. The large, established medical device companies rely on their vast manufacturing teams to pull dollars (or Yuan) out of production costs to maintain gross margins that range from 32% (HSP) to 58% (COV) on the low- to mid-tech end, and 67% (BSX) to 75% (MDT) for the high rollers.

    For emerging med tech companies developing “innovative products to address significant unmet medical needs” (quoting every investor deck we’ve ever seen), the aspirational gross margins demanded by investors generally hover around 75-80%. In reality, decent margins aren’t usually achieved until ~$50 million in revenue and 3-5 years on market, and profitability can be an important milestone for strategics keen on non-dilutive acquisitions. All of these forces are moving COGS up that management priority list even in the earliest stages of development.

    To get the inside scoop on how emerging med tech companies can get a handle on COGS as they design their first products, we talked to Rev1 Engineering, an outsourced medical device product development house that specializes in working with development stage medical technologies. The Rev 1 folks gave us three tips for managing product costs both at initial launch and scaled production.

    1. COGS are not just about material cost

    Speed and efficiency in manufacturing can equate to significant margin dollars gained. Design for Manufacturability (DFM) is the best approach for minimizing costs over the life of the product. The goal of DFM is to achieve higher manufacturing yields and greater throughput via process development. Once a design is locked in, regulatory hurdles can limit flexibility and make product changes very expensive and time consuming, so teams should really consider delaying design freeze until all processes and COGS are vetted. If you don’t invest the time and effort up front, then you can pretty much plan on absorbing high manufacturing costs until the next sensible opportunity for regulatory re-filing.

    2. Shelf life is critical

    Many devices are launched with short shelf lives that get extended over time as the testing data rolls in. With hospitals tightly controlling inventories and many first devices sales happening outside the home country, a customer- and shipping-friendly shelf life is ever more important. Begin shelf life extension efforts as early as possible to facilitate early commercial sales. Also be sure to keep an eye on, and minimize where possible, disposal, retrieval, swap-out and freight costs. These are all non-value-added, expensive activities that can really impact margins in an unanticipated way.

    3. Select suppliers carefully

    Get an early start on developing supplier strategies to optimize capacity, production capabilities, and pricing leverage with suppliers. Often the quick-turn prototype supplier of development materials is not able to compete at volume and will bring risk to the commercial ramp if transitions to scale suppliers aren’t made in a timely manner. Avoid development delays by using quick-turn component suppliers for prototypes (or even print them yourself with a 3D printer), and in parallel qualifying prospective suppliers of key materials for commercial scale manufacturing way ahead of the anticipated sales ramp.

    The ultimate goal, and balancing act, is to have functional product asap for testing, piloting and fundraising, while preparing for longer-term commercial success. “Management teams need to make smart trade-offs between speed to prototype and future profitability at scale,” says Rev 1. “You have to spend some money to save money, and sometimes the right call is to pace development to implement the right production and sourcing strategies for the long haul.”

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