For this quarterly update, we bring together a couple of strands of our medtech and device industry practice. First, as long-term observers, public market developments in 2022 were interesting and perhaps marked an inflection point for the short to medium term. Second, in October, we attended a medtech industry conference, where we were able to gather a rich set of perspectives. The implications for some of the larger companies in the space are probably clear-cut. The downstream reverberations to private, development stage companies may be less straightforward. Nevertheless, since development stage companies are typically constrained by currently available funds and continually contemplating the next funding round, these developments are of critical importance.
A tumultuous year in the public markets is coming to a close. By the end of the third quarter 2022, the S&P 500 was down nearly 25%, marking a near-bottom for the year. The broader medtech and devices industry largely followed suit. On the brighter side, established large, diversified companies, while lagging their own previous benchmarks, outperformed the broader market. As a group, some biotech and life sciences companies (see next section) also seemed to fare relatively well. A closer look reveals that within the group some of the larger companies with more diversified revenue bases and, perhaps more importantly, profitable operations performed much better than smaller companies promising higher growth but deferred profits.
Current profitability also appeared to differentiate better stock price performers among the medical device and healthcare technology companies. At the same time, negative sentiment was more apparent for wide swathes of these two groups compared to the broader industry. It is obvious in hindsight but over the course of 2022, as interest rates rose and remained high, markets seemed to prefer existing earnings and nearer-term cash flows over future (rosier) prospects.
The shift towards more caution also manifested in other measures of market sentiment and activity. Wholesale downward revisions of earnings (growth) estimates have not occurred so far (this may yet come to pass), so much of the price decline reflects compressing valuation multiples. The pace of M&A transactions, which had gone from strength to strength during 2020 and 2021 despite myriad disruptions and distractions, decelerated significantly in 2022. By our measure, total transactions volume in the industry through the first three quarters of 2022 was roughly equal to that of just the fourth quarter of 2021. The number of IPOs also slowed to a trickle.
No industry is an island but as we and others have pointed out, several long-term trends, demographic and otherwise, suggest a favorable overall outlook for the medtech and device space. Even against the seemingly dour recent market backdrop, a multitude of attendees at the medtech conference agreed on the relative merits of the industry compared to the broader economy and market. We work with a number of development stage medtech and device companies over the course of a typical year. From that perspective, we find the long-term trends interesting because of the structural emphasis on continual innovation that improve outcomes for patients and clinicians.
A defining feature of medtech innovation funding is that it occurs over multiple tranches as the technologies and companies achieve various developmental milestones. In this context, some observations for development stage companies:
An obvious first order effect of the recent public market developments over the past year is that development stage companies should expect generally lower valuations for funding rounds (at least) over the next couple of years.
Lackluster exit activity, via either M&A or IPO, delays and/or reduces deployable capital for venture capital funds, which will make them more cautious in considering investment decisions.
The sentiment shift towards more caution is shared by all investors, although the degrees will differ. Accordingly, in addition to valuation compression, some types of companies (for example, those at the pre-clinical stage) will find fundraising to be extremely difficult.
As a corollary, investors are likely to prize clean clinical data. Companies focused on demonstrating good clinical outcomes will be better prepared for future funding rounds.
Similarly, companies that can stretch their existing funds until they can achieve a good (clinical) milestone will be better rewarded in the next funding round.
Commercial traction after hurdling regulatory approval remains an important structural consideration, especially for the non-corporate investors.
Beyond the near-term market dynamics, a key conference takeaway for us was that the medtech funding eco-system is deep and diverse. We met and heard from traditional venture capital investors, corporate investors, and folks who operate in the continuum between them. The goals for the various investors differ to some degree, with some focused on financial attributes while others (like corporate VCs) include strategic considerations in the mix. Investors with broader goals and considerations are, to an extent, less sensitive to the prevailing market conditions and can afford to take a longer-term view. Even among these investors, financial terms and preferred deal structures vary considerably.
For development stage companies contemplating fundraising efforts, a deep and diverse investor eco-system can provide plenty of optionality. In keeping with a recurring theme of this update, a note of caution – evaluating a potential funding round requires both an examination of the financial terms and an understanding of the structural features and their longer-term implications.
Mercer Capital has broad experience in providing valuation services to medtech and device start-ups, larger public and private companies, and private equity and venture capital funds involved in the sector. Please contact us to discuss how we may be of help.
