The global medtech industry struggles to sustain growth, putting future innovation at risk

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The FINANCIAL — Despite a record number of IPOs and a robust mergers and acquisitions (M&A) market, the global medtech industry continues to face tepid growth and a dwindling pool of investors for early-stage companies, raising important questions about the long-term sustainability of the sector. These and other findings were released on October 6 in Pulse of the industry, the 2015 edition of EY’s annual medical technology industry report.

Glen Giovannetti, EY’s Global Life Sciences Leader, says:

“Over the last 12 months, the disparity between the ‘haves’ and the ‘have-nots’ in the medtech sector has grown increasingly stark. Even in this buoyant fundraising and deal-making environment, there remains a persistent gap in the type of early-stage venture capital funding required to support an innovative medtech ecosystem. This lack of funding is partially attributed to an increasingly uncertain reimbursement climate, exacerbated by the repetitive nature of medtech innovation, and the resulting pressure for companies to find new ways to demonstrate the value of their products.”

Storm clouds emerge

Over the 12-month period that ended 30 June 2015, the industry saw a climate that was far from uniform and presented many challenges: 

Revenue and net income remain flat: Revenue for public medtech companies in the US and Europe totaled US$341.8b in 2014, a modest 2% increase from the prior year. Net income rose 4% to US$16.9b.

Venture funding falls: Total venture funding from July 2014 to June 2015 totaled US$4.7b, a drop of approximately 2.4% year-on-year. For the fifth year in a row, medtech’s share of US venture dollars declined, reaching a decade-long low in 2014 of only 5.9%.

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Early-stage funding eroding: During the 12 months to 30 June 2015, only 29% of venture investment went to companies raising their seed, first or second rounds, as opposed to 37% in the prior 12-month period. Investment in early-stage companies also dropped in absolute terms, to less than US$1.3b from nearly US$1.6b in the prior period.

Innovation capital drops: Despite a positive climate for IPOs, innovation capital, the money raised by companies with less than US$500m in annual revenue, fell by nearly 12% to US$13b in the 12 months to 30 June 2015. Innovation capital’s share of total funding in the sector dropped to a record low of less than 26%. This was partly due to a spike in debt financing of US$40.8b, which represented more than 80% of the total financing dollars raised in 2014-15.

Reasons for optimism

Despite these difficult finance obstacles, the industry also delivered several strong, and, sometimes record-breaking, performances, highlighting the opportunities that exist for innovative companies in the sector. 

Smaller medtechs deliver strong performance: US-based medtechs with less than US$500m  in annual revenues outperformed the broader medtech industry in 2014-15, delivering revenue and net income growth of 6% and 16%, respectively.

Steady and healthy M&A market: While the most recent 12-month period saw fewer total M&A deals than any of the previous four-year periods, average deal size for non-megadeals (deals worth less than US$10b) reached a four-year high. Notably, from July 2014 to June 2015, the medtech industry announced 16 deals worth at least US$1b. 

New financing high driven by debt and IPOs: Medtechs raised nearly US$50b between July 2014 and June 2015, the second largest total in the industry’s history and nearly double the amount raised in the prior period. Although debt financing made up the overwhelming majority of the financing raised during the period, the surge of 43 newly public companies contributed US$2.3b, a 57% year-on-year increase. 

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R&D investment rises while cash returned to shareholders decreases: Investment in R&D rose 6% in 2014 to US$14.3b, the fifth consecutive yearly increase. During the same period, companies returned less cash to shareholders via dividend and share buybacks. In 2014, medtech companies returned US$15.6b of their net cash generated through their operations to shareholders, a 15% decrease compared to 2013.

Jeffrey Greene, EY’s Global Life Sciences Transactions Advisory Services Leader, says: “At a time when the industry is continuing to experience rapid consolidation, a changing customer base, and a rise in shareholder activism, companies at all stages need to implement effective capital allocation strategies to create and demonstrate value. The increase in R&D spending, coupled with the reduction in dividends and share buybacks, as found in this year’s Pulse of the industry suggests industry members are rebalancing their capital priorities in response to the critical need for long-term investment in innovation.”

 

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