Pulse of the industry
EY medical technology report 2016
Year in review
During the 12 months that ended 30 June 2016, the medical technology industry boasted a strong M&A environment but a slight decline in revenue and a pronounced dip in profits. Pure‑play medtechs fared better than conglomerates during 2015, growing the top line by more than 2%. Both groups were buffeted by currency headwinds.
The year featured a solid performance in venture capital financing. However, the public capital markets’ appetite for initial and follow-on public offerings seemingly disappeared as the year progressed and a generally weaker financing climate emerged.
Medtech market capitalization outpaced both the broader markets and other health care sectors. These mixed metrics indicate that medtech is in transition, adapting to fundamental shifts in reimbursement, consumer empowerment, digital enablement and the competitive landscape.
Although capital allocation strategies suggest management teams are focused on short-term priorities, there are also intriguing signs that the sector is investing in long-term innovation. Early-stage medtech investing reached new heights, spurred by strategic investors and a growing interest in developing tools necessary for biopharmaceutical innovation, including genetic sequencing services for diagnosis and precision medicine.
The year also saw the emergence of several partnerships between medtech and infotech companies, as Johnson & Johnson teamed up with Alphabet Inc.’s subsidiary Verily Life Sciences to create Verb Surgical, and Medtronic tapped into the computing power of IBM’s Watson to improve diabetes treatments.
In 2015, the US and EU medical technology industries continued to outperform the broader markets despite a marked decline in mergers and acquisitions and initial public offerings. But following three years of low-single-digit growth in key metrics such as revenue and net income, the medtech sector has dipped into the red.
Amid continued pricing and reimbursement pressure, total revenue for the sector fell by 1.2% and net income dropped significantly (-15.5%) compared with 2% growth in each metric during 2014. That revenue contraction is the sector’s first since 2011, and was driven by currency headwinds of approximately 2%–3% on a net global basis and underperforming conglomerates.
Pure-play medtechs actually saw revenue increase 2.3% in 2015 — a far-from-stellar performance that was weaker than 2014’s 5% revenue growth. As pure-play medtech growth slows for the third consecutive year, the industry appears to be in transition. To reignite performance, medtechs will need to embrace more modern capital allocation strategies, including continued investment via partnerships and M&A.
Although the 2015 M&A and IPO markets weren’t as strong as 2014, nearly US$32 billion in acquisitions by medtech pure-plays and more than 30 debut public offerings kept investors interested, as deal activity remained solid and newly public companies contributed more than 1% to the sector’s market cap gains.
The medtech sector’s market capitalization rose by 12.7% in 2015, with 23 companies posting market cap gains of more than US$1 billion, compared with only six companies that declined by at least US$1 billion. This overall growth is less impressive than 2014’s 21% growth and 2013’s 31%.
Further analysis shows that therapeutic device companies, the largest subgroup of pure-play medtechs, posted the largest gain in this metric, increasing 19% over the calendar year. In fact, all of medtech’s pure-play subsectors remained above water, with even the imaging companies managing to eke out a gain of less than 1% on the year.
The sector’s other financial performance metrics held relatively steady during 2015. R&D spend grew at just over 6%, roughly the same increase as the past two years. That growth was once again aided by newly public medtechs, whose contribution to R&D spending accounted for more than US$400 million.
SG&A expenses grew 2.9%, less than the 5% growth seen in 2014, as general corporate expenses were trimmed following the prior year’s spate of large acquisitions.
At only US$20.4 billion, total US and European medtech financing during the 12 months ending 30 June 2016 fell to the lowest level since 2010–11. The year-on-year 60% drop stands in sharp contrast to the US$51 billion raised in 2014–15. That record total, however, was inflated by nearly US$42 billion in debt financing raised mostly to pay for a small handful of megadeals.
In contrast, the 2015–16 period featured a dearth of large debt deals and an abrupt narrowing of the window for medtech IPOs. Follow-on funding has recently become scarce as well, with only US$500 million of the year’s respectable US$2.5 billion total flowing in the first half of 2016
A lack of early stage venture funding marred the sunny financing picture of 2014-15. In 2015-16, early stage venture funding rebounded, providing a reason for optimism even as the public markets grew more skeptical of medtech's growth opportunities.
During the year, medtech venture financing grew by more than 10% to nearly US$5.6 billion. That venture total remains a worryingly minor slice of both health care venture capital and venture capital overall, as other corners of the health care universe have typically offered investors better returns. But it’s the greatest amount medtech has raised since at least 2004.
The absence of medtechs in the debt financing market did not signal a weak M&A environment; the industry continued to enjoy a healthy takeover scene during the 2015–16 period. Less expensive bolt-on deals were the model du jour as medtechs continued to execute on their business model transformations.
Mergers and acquisitions
Highlighted by a single megadeal — Abbott’s US$30.7 billion acquisition of St. Jude Medical — the year that ended 30 June 2016 featured a pronounced uptick over the prior year in merger and acquisition activity and deal value. In aggregate, medtech M&A reached nearly US$80 billion.
Changing business models, particularly the need to pursue efficiencies of scale and the ability to offer comprehensive patient solutions in an increasingly price-sensitive marketplace, have helped drive the dealmaking agenda.
A changing regulatory landscape, particularly in Europe, may also contribute to the ongoing health of the M&A market. Companies grappling with compliance issues sparked by new regulations may opt to exit certain markets and double down in others.
Importantly, 2015–16 featured the third consecutive uptick in the total value of non-megadeals. Deals valued at less than US$10 billion reached an aggregate total of US$46.5 billion, eclipsing the previous high set in 2011–12 and establishing a new record for the sector.
The total number of M&A deals with announced terms also reached a record high, with 2015–16’s 213 deals nearly 37% above the prior year’s 156. Average deal values for non-megadeals held relatively steady, dropping to US$220 million from the prior year’s US$230 million.
The continued rise in the value of non-megadeal M&A is intriguing. Those deals involved a wider array of acquirers, signaling the emergence of a new set of mid-tier consolidators that may ratchet up competition for new technologies.
A weaker capital markets environment also may be implicated in the boost, as the supply of innovation capital retreated to a level not seen since 2012.
Driven by a still-strong environment for bolt-on deals, total M&A in 2015–16 grew 27% over the prior period, even as deals valued at or above US$1 billion fell from 14 in 2014–15 to 11 in 2015–16. The overwhelming majority of the M&A in medtech was generated in the US, as the sector’s leading geography accounted for an astounding 91% of all deals (by seller location).
Growth by acquisition is still the medtech’s go-to strategy, one that shows no sign of changing in the near term.