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WINDHOVER INFORMATION INC. • windhover.com • Vol. 23, No. 6

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JUNE 2005

Medical Devices/M&A

Industrial Revolution:The New Medical Device Acquirers

They may not be medical technology experts,but industrial companies know what they like—

the fat margins and attractive fundamentalsof the medtech sector.

By Pete Lawyer and Rob Alford

This article is the first in a two-part series from The Boston Consulting Group (BCG) exploringthe financial rationale driving the steady trend of M&A activity in the medical technology sector—as well as the business implications that result. Here, the authors examine the phenomenon ofexternal players—industrial companies, conglomerates and others—acquiring companies andentering the medtech sector. In the follow-up article, they will analyze the role of acquisitive growthwithin the industry and its impact on large and small medtech companies alike. The series drawson the valuation techniques, used by BCG’s ValueScience Center, which combine proprietarydiscounted cash flow and relative valuation multiple models.

Companies that bend metals, extrude plastics and assemble electronic components may notknow much about medical technology, but they do know what they like: the fat margins androbust fundamentals offered by the medtech sector. And so, whether they’ve traditionally

played in high-tech or heavy industry, many of the companies churning out single-digit growthlargely by serving the aerospace, energy and manufacturing sectors now have their eye on tradingup. Flush with cash, they’re seeking to buy their way into a new and more promising market,acquiring medtech companies to bolster their growth and revenues.

Much like GE, 3M and Siemens before them, these outsiders recognize that medtech compa-nies deliver patent-protected revenue streams and that the demand for medical devices and otherequipment is likely only to soar as boomers age. These players also believe that the technical and

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business expertise that they bring to the table—combined with their rather deep pockets—willcompensate for their relative unfamiliarity with the particular demands of the life scienceproducts industry.

While playing in lower-margin businesses, many of the new entrants have finely honed theirbusiness processes—including product development, R&D and manufacturing—for maximum cost-efficiency and profits. As payers worldwide intensify pressure on price, such capabilities will no doubtprove critical in the medtech sector. Furthermore, other industrial newcomers have combinedoperational effectiveness with sophisticated quality control of components and materials. This one-two punch promises to knock out the greatest risks that threaten devices: ineffective products thatfail to clear regulatory hurdles and defective ones that result in major liability.

Indeed, some of the newcomers appear to be faring well in their endeavors. PerkinElmer Inc., forinstance, has transformed itself from a largely subscale and underperforming defense contractor (asEG&G in its former life) into a leading light in the medtech space. While the billion-dollar acquisitionsturn heads and grab headlines, in many ways the small medtech deals are transforming the landscapeby opening the door for new competitors seeking their first taste of the health care market.

In most cases, industrial acquirers have not immediately pursued companies producing com-plex medical devices. Instead, they have tested the waters by migrating first into medicalequipment or simple Class I or II devices that draw on some existing capability or skill set. Eventhough the operating margins for these initial lower-tech forays typically aren’t as high as thoseenjoyed by Class III device manufacturers, they still significantly outpace margins at the compa-nies’ existing businesses.

Still, such trailblazing practically guarantees a bumpy ride—particularly when the new path mustcut through a business as complex and as dependent on R&D as medical technology. Unlike thelarger medtech companies seeking “bolt-on” acquisitions, traditional industrials and conglomeratesmay lack first-hand experience and deep understanding of regulatory approval processes and re-quirements, medical marketing and hiring and retaining talent in the life sciences. For the unlucky or

the ill-prepared investor, these pitfalls can add up to certain failure—and a serious case of buyer’sremorse.

The Seduction

The lure of companies that design innovative medical technology is powerful. Their performanceis enviable across several dimensions. The sector boasts gross profit margins 30% higher than theS&P 400 on average—and the more advanced device makers have attained average gross marginsof 70% over the last five years. (See Exhibit 1.) Furthermore, over the past 10 years, the medicaldevice sector has created almost twice as much value for shareholders as did the S&P 400 on

Gro

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(1)Excludes financials

SOURCE: Compustat data, BCG analysis.

Gross Margin of Medtech and Pharma vs. S&P Midcap 400 (1992-2004)EXHIBIT 1

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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Devices

Diagnostics

Equipment

S&P Midcap 400(1)

S&P 500 Pharma

Medtech Average




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average. (See Exhibit 2.)Not only has the device sector significantly outpaced the highly successful biopharmaceutical

industry in value creation, it has also made its rapid ascent with far less volatility. Medtechcompanies were largely unaffected by the bubble that waylaid pharmaceutical and biotech playersearlier in this decade. Similarly, they have not seen their expectations for future profits diminish asthese other medical industries have.

The reasons for this buoyancy are myriad, but one important driver is that high-tech devices andequipment are not easily copied and rely significantly on the essential value added by skilledsurgeons (for implants and instruments) and technical operators (for imaging and other diagnosticequipment). Some knockoffs do exist, but their inroads in the United States, Japan and the EU havebeen slowed by physicians’ preferences for the tried and true—or, failing that, their fear of legalliability. Furthermore, in sharp contrast to the products of the pharmaceutical industry, there islittle clamoring for the latest medical technology in less-developed countries, which allows pricesto remain reasonably strong worldwide.

All of this is to say that the medtech sector is picking up speed—and interest. Over the past 10years, for example, the number of billion-dollar companies operating in the sector has grown byover 50% (from 23 to 37) and the number of billion-dollar device companies has doubled from 9 to18. (See Exhibit 3.)

The Shopping Spree

So who could resist such an alluring offer? Fewer and fewer companies, it appears, since BCGestimates that over the last three years industrial companies have invested $6 billion to acquiremedtech companies, accounting for 21 of 256 deals and 10% of the $65-billion total invested in thesector. (If the recent $25-billion J&J/Guidant deal is excluded, the $6 billion spent by industrialcompanies actually accounted for 15% of M&A deal value.) (See Exhibit 4.) No doubt, countless otherindustrials have considered entering or have actually funded organic efforts to develop the sector.

Tyco International Ltd., one of the leaders of this industrial revolution sparked a decade ago,assembled a mighty portfolio and achieved a great deal of success in the medtech area before beingfelled by other much-publicized troubles. Although the conglomerate faced a severe crisis of confi-dence in 2001-2002, the company has staged an impressive 250% comeback in its stock price since thedark days of 2002. The rebound has resulted because the cash flow and profitable growth of manyof Tyco’s underlying businesses have remained consistently sound. And the steadiest beat of all at theheart of this far-flung industrial giant resonates from Tyco Healthcare Group, a domain of propertiespicked up in the mid- to late-1990s that includes such luminaries as the former Kendall Co., US Surgical

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Cumulative TSR* of Medtech, Pharma and S&P Midcap 400 (1992-2004)EXHIBIT 2

*Total Shareholder Return; (1)Excludes financials, Note: BCG Medical Technology Sector Indexes

SOURCE: Compustat, BCG ValueSciences.

0

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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Devices

Equipment

Diagnostics

S&P 500 Pharma

S&P Midcap 400(1)




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and Mallinckrodt Medical. The $9-billion portfolio of Tyco Healthcare accounts for nearly one-quarter ofcorporate revenues, and it pumped out $2.1 billion in cash flow in 2004 with a 26% operating margin thatwas nearly double that of Tyco’s other business segments. Say what you will about Dennis Kozlowski—this is one bet that he got right.

More recently, Danaher Corp.—a leading provider of equipment and solutions, which serves abroad set of end-markets, including electronic test, precision motion control, environmental and productidentification in addition to mechanics’ hand tools—has quite publicly jumped at the chance to enter themedical device sector. The company responsible for equipping mechanics and weekend do-it-yourselferswith Sears Craftsman tools made its foray into medical technology only last year. During the first threemonths of 2004, it acquired three medical device companies and added medical technology as a wholenew platform to its already impressive and extensive list of divisions.

Danaher began the year with a $640-million acquisition of Radiometer AS, a Danish developer,manufacturer and distributor of systems for analyzing blood gas, electrolytes and metabolites.The company quickly signaled that it wasn’t merely dabbling in diagnostics when one month later itpurchased Gendex, a US manufacturer of dental imaging products, for more than $100 million.

Next, Danaher punctuated its message with an exclamation point when a mere four weeks later itannounced its acquisition of yet another medtech company: Kaltenbach & Voigt GMBH, akaKaVo. KaVo is a German designer, manufacturer and distributor of dental devices such as head-pieces and diagnostic and treatment systems. By combining Gendex and KaVo and building ontheir synergies, the company bought itself instant global reach in the dental device sector.

On the heels of Danaher’s recent acquisitions, the company logged record financial results for theyear, with 2004 sales of $5.3 billion, up more than 15% from $4.6 billion in 2002. Earnings were up aswell. Most importantly, Danaher investors appear to have given the strategic move two thumbs up. Withgrowth prospects bolstered by a hot new market, the company’s forward P/E ratio—a key indicator ofconfidence in future earnings—stands at 19x, a 15% premium over comparables. Another clear indica-tion of investor satisfaction is the short-interest ratio, with yearly averages down from 7.4 in 2004 to 5.2thus far in 2005, according to Bloomberg data. Shareholders are settling in for what they hope to be along and skyward joy ride.

Magnetic Attraction

Intermagnetics General Corp. engaged in a similar buying binge last year. It scooped up twomedtech companies and then divested cryogenic refrigeration company Polycold, the last vestigeof its instrumentation business, to help pay for the deals.

Intermagnetics develops, manufactures and markets superconducting materials and high-fieldmagnets that serve the energy and MRI markets, among others. The company formulated afocused strategy to strengthen its presence in the high-growth medtech sector. Integral to its planwas its nearly $150-million purchase in January 2004 of Invivo MDE, a patient monitoring and care

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1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

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$1

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Number of Major Medtech Players in the Past 10 YearsEXHIBIT 3

SOURCE: Compustat, BCG ValueSciences

DEVICE COMPANIES

OTHER MEDTECH




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device company, and its $100-million purchase in July 2004 of MRI Devices Corp., a manufacturerof radiofrequency coils for MRI imaging, particularly for cardiovascular, neurovascular and specialtypurposes. The companies augmented Intermagnetics’ existing Medical Advances unit, which de-signs and manufactures radiofrequency coils used primarily to image patients’ extremities.

In announcing the Polycold divestiture in January of this year, Intermagnetics CEO Glenn Epsteinexplained that since the company decided in 2002 to shift its focus to the “growing and increasinglyprofitable medical devices market,” Intermagnetics had “more than doubled … revenue and earningson an annualized basis.”

And the future is looking rosier still, according to the company. Contributions from the acquisi-tions, Epstein announced in July 2004, were projected to increase fiscal 2005 revenues to nearly $300million with an anticipated operating EPS of $1.55 to $1.65, an 80% increase over the prior year.

Of the acquisitions, Epstein said, “[W]e have created an enhanced and unique platform for growththrough internal initiatives and further acquisition opportunities.” He also noted an added benefit ofthe acquisitions: the diversification of Intermagnetics’ overall customer base. Thanks to the acquisi-tions and the resulting addition of new customers in the MRI market, he explained, the company’slargest customer, which had once accounted for 80% of annual revenue, now accounts for only 50%.

An Industrial Invasion?

Similar plays have recently been made at other industrial firms, including Teleflex, OSI and SmithsGroup. Teleflex Inc. held true to its word after announcing that it would be divesting non-strategicproduct lines and adding complementary ones in an effort to increase profitability and to staycompetitive. The company acquired Hudson Respiratory Care Inc. for $460 million in May 2004.It sold off the National Strand galvanized and stainless steel strand product line; Techsonic Industries,

a sonar device manufacturer; and its ownership in the Teleflex-NHK Automotive joint venture, amongother businesses. The acquisition of Hudson, a manufacturer of anesthesia and respiratory products,doubled Teleflex’s presence in the North American health care products market.

Founded some 60 years ago as an aerospace and automotive company, Teleflex first entered medicaltechnology about 20 years ago. The company has been focused on adding what the company calls“small attack units” in health care. (See “Teleflex: Hospital Supply’s Best Kept Secret,” IN VIVO, October2001.) They’ve amassed an entire battalion over the years. They started in urology and anesthesia byacquiring Rusch in 1989. Then they added surgical instruments through Pilling Surgical in 1991, closuredevices through Edward Weck in 1993, specialty orthopedic instruments through KMedic in 1999,

Other Medtech

Industrial4 5 10

62

8765

212

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66

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23

2002 2003 2004 2005YTD

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0.9 1.0

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5

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43.5(1)

5.1

50

41.3

2002 2003 2004 2005YTD

Dea

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($B

)

Industrials bought 21 of the256 companies acquired in

Medtech since 2002...

...representing $6Bof the $65B invested

in the sector

(1) Other Medtech includes the $25.3 billion proposed acquisition of Guidant by Johnson & Johnson.Note: Total value based on completed deals whose values were announced,

categorized by the acquisition announcement date. 2005 YTD as of May 15, 2005.

SOURCE: Windhover’s Strategic Intelligence Databases, BCG analysis

Industrial Segment of Medical Technology AcquisitionsEXHIBIT 4

Acquirers Represent Nearly 10% of the Value

50




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intermittent catheters through Medical Marketing Group in 2000 and cardiothoracic devices by acquir-ing substantially all of the assets of that segment of Genzyme Corp.’s business in July 2003.

OSI Systems Inc.—a diversified company operating in security systems, optoelectronic compo-nents and medical monitoring —acquired Spacelabs Medical Inc., a developer of patient monitoringdevices, for the bargain-basement price of $57 million—less than half of the $141 million Instrumen-tarium Corp. paid for it in mid-2002. Regulators required that GE divest the Spacelabs business as acondition of the conglomerate’s purchase of Instrumentarium.

OSI has been building its play in medical technology over the past several years, most recently, inMarch of this year, acquiring Blease Medical Holdings Ltd., a privately owned manufacturer ofanesthesia systems, vaporizers and ventilators. It had acquired Osteometer in 1998 and picked upmajority control of THT Medical a year later. These properties—an osteoporosis scanner businessand pulse oximetry franchise, respectively—gave OSI broader reach and branded presence in higher-growth and higher-margin medical markets.

Also in March of this year, Smiths Group PLC, a UK industrial engineering company whoseproducts include security detection for chemicals and explosives as well as aerospace and specialtyengineering equipment, purchased US medical device company Medex Inc., a manufacturer ofintravenous and safety catheters, for $925 million. Noting that the purchase placed the companyin the “big leagues” of safety and disposable anesthesia devices, Keith Butler-Wheelhouse, chiefexecutive of Smiths Group, said, “This purchase once again underlines our intent to pursue astrategy of profitable growth through the acquisition of high-growth businesses that complementor expand our product portfolio and through investment in research and development.”

The Medex deal builds on earlier Smiths Group acquisitions of medical device companies, includingDHD Healthcare, a US respiratory care device company purchased for $55 million in July 2004, andBivona Medical Technologies Inc., a US supplier ofsilicone tracheostomy tubes, purchased for $35.6 millionin November 2001. Of the company’s four divisions, itsmedical group reported the highest net margins for thefirst half of 2005—17% vs. 14%, 12% and 8% for the detec-tion, specialty engineering and aerospace businesses, re-spectively.

In Good Company

Today’s newcomers seek to join a who’s who of industri-als that have learned how to grow and profit from uniqueand valuable opportunities. Companies such as GeneralElectric Co., 3M and W.L. Gore weren’t born into medicaltechnology, but they have since parlayed core capabilitiesinto highly profitable device and equipment plays.

GE Healthcare Technologies Inc., for instance, ac-counted for about 10% of General Electric’s revenue in2004. With an overall revenue growth target of 10%, JackWelch’s successor, Jeff Immelt, faces the daunting task offinding some $15 billion in incremental revenues eachyear. For some perspective on just how herculean thetask, consider that a $15-billion company would fall squarelyin the middle of the Fortune 500 list of the largest industri-als in the United States. As Immelt articulated to a group ofstudents at a business leader forum at Marquette Univer-sity in March 2004, health care spending continues tocapture an increasing share of the nation’s gross domesticproduct, “an unstoppable trend.”

As former head of GE Medical Systems, Immelt is in-vesting with confidence and, so far, his picks are paying off. GE Healthcare Technologies produced $11billion in revenue from its imaging and monitoring devices in 2004. Another $3 billion was generated byGE Healthcare Bio-Sciences Inc., the former Amersham PLC. GE acquired the developer ofcontrast-imaging agents and genetic analysis systems for $9 billion in April 2004, in the hopes ofadvancing its molecular imaging and bioscience capabilities.

Other major players in this vein include 3M Company, the company renowned for sandpaper, ScotchTape and Post-It Notes, which launched a medical products business in 1961 that now represents itslargest business segment with 21% of company revenue. In the company’s first-quarter 2005 earningsreport, 3M CEO W. James McNerney, Jr. singled out the strong contribution of the health care portfolioand called for increasing reliance on the sector for growth and profitability.

Similarly, WL Gore & Associates Inc., the industrial materials manufacturer born in Bob Gore’sbasement in the 1950s and best known for Gore-Tex, entered the medical market in the 1970s with avascular graft. Today Gore’s medical division delivers various medical implants ranging from biodegrad-

Exploiting the OpportunityWhile Ignoring the Siren SongIn their eagerness to exploit opportunities in the

medtech sector, companies that operate beyond the palein medical technology can find themselves frustrated bythe lack of control that licensing arrangements afford andthe complications that joint ventures can create. Theseplayers can be quick to turn to acquisitions, expecting thatthey will be able to exploit core capabilities from their basebusinesses for higher growth and profit in medtech.

But avoiding a nasty case of buyer’s remorse demandsthat they test the waters before diving into medical tech-nology, evaluating each “opportunity” (as well as the op-tions of their competitors) by carefully considering:

• Is the buyer’s core capability/technology truly differ-entiated?

• Is the capability transferable to the device business?• Are the regulatory requirements well understood?• Does the company have the institutional fortitude

needed to see a product through approval?• Is there a credible plan to market and sell the product?• Will shareholders accept the business risk and poten-

tial liability?




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able hernia plugs to patches for heart and chest defects as well as MRI and ultrasound devices. In Aprilof this year, the company made its most recent medical acquisition—Tetrad Corp., a manufacturer ofspecialized probes and systems for ultrasound, laparoscopy and open surgery.

An Extreme Makeover

Clearly, as these expansion approaches demonstrate, playing in the medical device sector can indeedhelp the big get bigger. But for some of the industrial newcomers, the medtech sector offers more thanan opportunity to add another division or another market. It offers these players a way to refocus andrefashion entire businesses. One company that has taken the extreme-makeover approach isPerkinElmer, aka EG&G.

EG&G began its life serving the military industrial complex, designing timing and firing systems forthe government’s nuclear testing program in the 1940s. Over the years, the company grew fat—andultimately bloated—as a government contractor, providing services to NASA, the Departments ofEnergy, Defense and others. At one point, the company is rumored to have served as the primarycontractor in the now-fabled Area 51.

In 1998, when Greg Summe assumed the reins of EG&G, the company had more than 30 disparatebusiness units. Although many of these areas touched on the technology realm, most lacked growthprospects, the CEO explained to the Harvard Business Review and Wall Street Reporter magazine.Summe thus set the company on an aggressive course of divestiture and acquisition.

In 1999, when the company acquired the analytical instruments division of Perkin-Elmer from PECorp. (now Applera Corp.), there was an opportunity to position the company in a promising newmarket with an equally promising new identity as a high-tech player. After the acquisition and the namechange, the new PerkinElmer saw its instrument sales grow 280% to $200.5 million in the third quarterof 1999 (over third quarter 1998). To complete its reinvention, PerkinElmer then acquired NEN LifeScience Products, a reagent supplier to drug discovery markets, in 2000 and Packard BioScience, aliquid-handling and sample preparation company, in 2001. In total, all the acquired and existingcapabilities positioned PerkinElmer as a leader in drug discovery and genetic disease screening.

Flushing Cash Down the Toilet

Expanding into medical technology, however, doesn’t always work out as expected. Compa-nies and shareholders unaccustomed to the sector’s long product- development cycles, highlevels of investment and complex regulatory environment can quickly lose their way or lose theirappetite for their new adventure.

American Standard Companies Inc. serves as a particularly notable example—albeit one froma few years back. The company sought to expand beyond its product lines in air conditioners,anti-lock braking systems and well-known plumbing products. Its approach was to apply the lasertechnology it used in ceramics manufacturing to develop an easy-to-use benchtop optical ana-lyzer for in vitro diagnostics designed for use in physicians’ offices and small hospitals.

In the early 1990s, the company devoted itself to developing the technology, and, in 1997, giddyfrom some initial developmental success, it invested $212 million in the diagnostics division ofSorin Biomedica SPA—a price considered extraordinarily high at the time. With the investment,American Standard hoped to gain access to additional assays, a marketing organization and diagnos-tic industry expertise.

The move into diagnostics was part of the company’s strategy to increase its overall growthrate. Benson Stein, the VP and general auditor of the company, told Windhover in 1997 thatAmerican Standard was looking for opportunities in fields that were growing faster than itsmature core businesses. It also wanted to offset the cyclical nature of its businesses with acommercial line less subject to economic fluctuations.

“Although its expertise is not in health care,” Windhover noted at the time, “American Standardbelieves that its experience operating in highly competitive environments and in efficient applica-tion of low-cost, short cycle manufacturing can be applied beneficially to diagnostics.”

But consolidating its acquisition with its existing diagnostic resources resulted in dire conse-quences. Critical product-development staff ran for the exits, and the American Standard veter-ans who were left managing the division lacked diagnostics experience.

Product troubles with the benchtop analyzer and the failure of the legacy Sorin businesses togenerate sufficient cash to fund ongoing development raised questions about the diversificationstrategy. American Standard’s shareholders, who had recently supported the company’s deci-sion to rebuff a $4-billion takeover offer by Tyco, were focused on consistent quarterly earningsand dividend growth. They soured on the strategy after Medical Systems posted two years oflosses totaling $28 million.

By the end of 1999, forced to admit that it had erred, American Standard announced that itwould pursue the sale of the businesses—and took a $126 million loss. The company exited thebusiness completely after a year-long sales process, selling it back to a syndicate of Italianinvestors and Sorin management for substantially less than the original purchase price.




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A White Elephant in Cash Cow’s Clothing?

The tale of American Standard demonstrates how industrials or conglomerates seeking out medtechopportunities can saddle themselves with a “great deal” in the sector if they lack the capabilities to fullyexploit inherent opportunities or can’t afford to properly grow and develop the product pipeline. Whenconsidering an investment, problems can arise when industrials fail to:

• Adjust investors’ expectations for their new strategic direction—Investors in typical industrial firmslargely value companies’ consistent dividends and slow-but-steady earnings, cash flow and growth.Transitioning to a greater focus on medical technology requires that industrials recalibrate the expecta-tions of their investors, since delivering on long-term growth demands additional investment in theshort-term. Shifting mindsets in such a way will likely require targeting the sales message to a differentgroup of investors who have a higher tolerance for risk and longer-term investment horizons.

• Evaluate acquisitions based on criteria beyond their short-term earnings potential—Unlike a typicalindustrial firm, a prospective acquisition in medical technology cannot be valued based entirely on thecash flows projected for the next few years. Believing that expected future total shareholder returnwarrants current valuation, the market places a high premium on the long-term value of a medtechcompany’s technology—even if that value is not fully demonstrated. Therefore, companies in unrelatedindustries are simply not ready to move definitively into the sector unless they are willing to accept ayear or more of EPS dilution following an important medtech acquisition.

Once acquisitions have been made, problems arise in managing the new medtech businesseswhen:

• New entrants attempt to integrate businesses that have little overlap with core businesses andcapabilities. The highly entrepreneurial and scientific nature of device companies in particular meansthat they aren’t necessarily well-served by the same governance structure, metrics and policies thatwork well in manufacturing or industrial divisions. American Standard serves as an industry poster childfor this error. In contrast, GE has borrowed liberally from its highly structured and highly successfulplanning processes in running its health care division, but it has allowed the group to retain its autonomyrather than fully integrating it. A senior health care executive, for example, serves on GE’s executivecommittee. Teleflex, in a related strategy, has pursued a decentralized approach of largely disparatebrands with much success.

• Industrials aren’t prepared to invest the significant level of R&D spend required to fuel technologydevelopment. Most industrial companies consider spending anywhere from 2-3% in annual revenue onR&D a serious commitment of resources. A company that wants to enter the medtech sector must alterits expectations drastically. Breaking into a new market requires a product that is more than just a “metoo” offering, and heavy investment is often required to justify the clinical claims that will capture theattention in the marketplace. And market entry is just the first step. Maintaining leadership in the sectorrequires a sustained commitment to R&D: Medtech companies spend between three and five timesmore on R&D than S&P 400 companies do on average.

• Acquirers take an old-school approach to intellectual property. Device and other medtech companiescan’t afford to be squeamish about patenting aggressively and spending lavishly to defend thosepatents—or to attack the patent positions of others. But this mindset can seem foreign to companiesused to competing in traditional industries where intellectual property is less dynamic and less critical tosuccess and whose legal departments have long sought to avoid risk at all costs. Corporations need toassess the IP—both patents and know-how—at their newly or soon-to-be acquired medtech companiesif they can hope to exploit those opportunities. If they don’t possess the requisite skills to do so anddon’t know what they’re looking at, they’ll need to make another “acquisition”—bringing on a leader-ship team expert in the medtech sector.

• Players misunderstand the realities and critical nature of marketing and selling in medicaltechnology. Industrials might expect that the value of the best technology will be apparent and marketadoption therefore automatic, underestimating the need for demonstrated clinical evidence and anarmy of relationship-building and case-making sales reps. But even the most innovative devices won’tnecessarily get a warm welcome among surgeons, technicians and hospitals. These risk-averse playersare reluctant to add new equipment or procedures to their repertoire—or to replace proven ones. Andcustomers will often rebuff outright products that have a negative impact on their practice economics.Thus, not only must industrials invest in clinical investigation to demonstrate superior outcomes, butthey also need a firm grasp of the complex role that reimbursement plays in a product’s success.Further, they also must scale, deploy and compensate a sales force in a manner befitting an industry thatreaps average margins at least 30% higher than the S&P average.

Knowing what not to do is the first factor critical to success; understanding what steps to take is thesecond. A list of valuable questions that industrials and conglomerates should ask appears in thesidebar, “Exploiting the Opportunity While Ignoring the Siren Song.”




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When Outsiders Move In

With industrial and conglomerate players moving into the more attractive neighborhood of medicaltechnology, there are implications for the established medtech companies that already reside there—large as well as small. Now that medtech industry giants are no longer the only acquirers, smallercompanies gain more options and a larger audience for strategic partnerships. Outsiders willing to paycash for a presence in medical technology may well bid up the prices paid for acquisitions both byplayers within and beyond the industry.

Still, the giants likely aren’t in any serious danger of being forced out. In any fight for an acquisition,the Strykers, Boston Scientifics and Medtronics enjoy some clear advantages, including their estab-lished sales and marketing networks and their experience with protecting and defending intellectualproperty positions. But the brute force of their financial power is their most compelling attribute.

The equity markets have rewarded the leaders within the medtech industry with high valuations andP/E ratios—positioning their stock as extremely attractive currency for acquisitions. When they acceptshares instead of cash, acquired companies and their shareholders recognize the potential for substan-tial upside in the future. They are familiar with the industry’s historical TSR performance—nearlydouble that of the S&P 400 since 1990—and expect the trend to continue.

In recognition of these realities, most industrial firms that have recently entered the sector appeartherefore to be focusing on a targeted portion of the market (Smiths Group homing in on disposableanesthesia products, for example) rather than developing broad-based offerings. They also aren’t yetgoing after the highest-tech acquisitions, presumably because the technology and regulatory barriersare a bridge too far.

Nevertheless, the role of industrial giants is far from trivial. These major players are infusing vitalscale, cost-cutting efficiencies, business process excellence, and cash into the medtech sector. In theprocess, they are revolutionizing the business of medical technology and catapulting the industry intoits next, mature phase.

Examining the dynamics of intra-sector acquisition and its importance to growth and valuecreation—particularly in the high-performing and high-technology device area—is the focus of thesecond article of our series examining acquisition trends in the medical technology sector.

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and in vitro diagnostics industries.Ph: (203) 838-4401 • Fax: (203) 838-3214




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Medical Devices/M&A Industrial Revolution - bcg.com · INDUSTRIAL REVOLUTION: The New Medical Device Acquirers ©2005 WINDHOVER INFORMATION business expertise that they bring to …