The health care industry is receiving more than its fair share of attention these days. With the implementation of the Affordable Care Act well under way and the U.S. government supporting an expanded health care system, strategic buyers and private equity firms alike are clamoring to invest in the health care sector. In fact, according to a survey conducted by KPMG LLP, 60 percent of M&A professionals working in the health care sector indicated they would do more deals in 2013 than they did in 2012. The medical device subsector, which includes a broad range of instruments and products used to diagnose, prevent or treat disease, has become a main driver of M&A transactions within the health care space. Deals involving medical devices, such as pacemakers, surgical blades and catheters, had the greatest gains in deal value within the health care industry during 2012. In the fourth quarter alone, 16 medical device M&A deals closed, representing a total value of $3.4 billion, according to PricewaterhouseCoopers.

Medical device companies have become popular with private equity investors and strategic acquirers for a number of reasons. According to ReportLinker, the value of the global medical device industry is expected to reach $228 billion by 2015, up from $164 billion in 2010, marking annual growth of nearly 7 percent. This is no surprise when considering that life expectancy has risen by nearly 20 years over the past 50 years, increasing the need for medical devices. Additionally, worldwide demographics are increasingly shifting toward older populations. Between 2000 and 2050, developed regions will see their over-60 age group grow to 34 percent of the total population, up from less than 20 percent. The aging population, coupled with lifestyle-related diseases, ensures increasing market demand for the medical device industry. Strategic acquirers are making the biggest push in the space, purchasing a wide variety of medical device companies. Flush with cash, it's a smart move for strategic acquirers to buy medical device companies rather than rely on organic growth alone, which can be slow. Strategic buyers need to stay current as the health care industry evolves under the new government initiatives, and they are finding deal flow from the venture community.

This makes sense, considering venture capital is heavily invested in the space. U.S.-based medical device companies raised a total of $2.44 billion from venture capitalists in 2012. Additionally, venture disbursements to U.S. medical device companies climbed by 32 percent in the fourth quarter of 2012, to $581 million from $440 million. This is set against a backdrop of overall venture capital investment (for all sectors) falling by 3 percent in the fourth quarter, according to the PricewaterhouseCooper's quarterly MoneyTree report.

Strategic acquirers such as Abbott Laboratories (NYSE: ABT), Boston Scientific Corp. (NYSE: BSX), Covidien (NYSE: COV), Johnson & Johnson (NYSE: JNJ), Medtronic Inc. (NYSE: MDT), Stryker Corp. (NYSE: SYK) and St. Jude Medical Inc. (NYSE: STJ) have bought or invested in early-stage, venture-backed medical device companies recently.

For example, in 2012 alone, Covidien bought or invested in five venture-backed medical device companies. Its most recent acquisition, in January 2013, was CV Ingenuity, a drug-eluting balloon technology company. CV Ingenuity had raised approximately $35 million from venture capital firms such as BioStar Ventures, Life Sciences Angels, New Enterprise Associates, Synergy Ventures and Western Technology Investment. Covidien, which won Mergers & Acquisitions' M&A Mid-Market Award for Strategic Buyer of the Year, spent $1.14 billion on fast-growing acquisition targets in 2012.

"Our investment in companies with products in the development stage allows us to enter new, fast-growing categories much faster than if we used internal development resources," said Amy Wendell, Covidien's senior vice president of strategy and business development, in a February interview with M&A. The company is also committed to organic growth, doubling its spending on research and development over the last five years, she added.

Johnson & Johnson is also showing a strong appetite for acquiring medical device companies. At that beginning of the year, Johnson & Johnson put out a report touting its medical device and diagnostics unit saying that products in this division accounted for 41 percent of its total sales in 2012. In January 2012, the company invested in venture-backed Clarimedix, a manufacturer of therapeutic medical devices, with Highland Country Venture.

Additionally, Medtronic has been acquisitive in the space. In September 2012, the company bought Mainstay Medical, a developer of a neurostimulation device to treat back pain. Investors in the company include Capricorn Venture Partners, Fountain Healthcare Partners and Sofinnova Partners.

In April, Medtronic took a stake in a venture-backed company called mc10, a developer of high-performance electronics that can be implanted in the human body. Venture capital investors in the company include Braemar Energy Ventures, North Bridge Venture Partners and Osage University.

The strategic acquirers' strategy is tried and true. Larger firms aren't known for being able to innovate quickly, so buying early-stage companies that have had some venture capital backing is a viable strategy. "In general, medical devices and products are a vibrant area, and there are a good number of smaller transactions done by strategics after some venture capital has been put to work," says Nick Konstantinou, a managing director in the health care practice of Lincoln International, which in April advised Incline Equity Partners on its sale of Orthotic Holdings Inc. (OHI) to Frazier Healthcare.

Strategic buyers aren't the only acquirers showing interest. Private equity firms are interested because they understand the same macro dynamics that intrigue the strategic acquirers and they are shying away from investments tied to reimbursement rates, leading many firms to look more closely at the medical device sector.

"A lot of firms that would normally invest in health care services are starting to look for investments in other places because of the unstable reimbursement rates," says Joseph Ibrahim, a principal on the healthcare team with Riverside Company, which has a number of investments in the subsector. "That, coupled with an aging population, makes investment in medical devices all the more attractive."

Private equity firms are placing their bets on lower-tech, more mature medical device companies. "Typically, private equity buyers are interested once the product and business model have been established and the company has achieved some scale," says Konstantinou.

RoundTable Healthcare Partners has successfully bought and owned a number of lower-tech medical device companies. For example, in April, RoundTable's portfolio company Argon Medical Devices Inc. acquired the Interventional Products Business from Angiotech Pharmaceuticals. Argon manufactures single-use radiology products, such as drainage catheters. The division of Angiotech that RoundTable bought manufactures disposable and reusable biopsy products for the diagnosis of cancer, drainage catheter products and vascular interventional devices.

"The deal is complimentary on all points," says Craig Collister, a senior partner with RoundTable Healthcare Partners. "Access to hospitals and the doctors is becoming increasingly challenging."

"Having a broader offering is advantageous. One sales team can go into meetings with a comprehensive offering, which makes it easier to get in the door," Collister said.

The Argon/Angiotech deal is a classic example of how many private equity firms like investing in the medical device subsector, taking complimentary companies and putting them together to create scale even if the companies aren't exactly the same.

"Financial buyers tend to be more open-minded in terms of forming a thesis around a new product area or go-to market strategy, while strategic buyers often face constraints with regard to what fits well with their existing products and business strategy," says Konstantinou. "They have to 'stick to their knitting,' or investors and analysts may question what they are doing. Private equity firms have fewer constraints; they can combine service or products in ways to grow a business and address an emerging market opportunity. In some instances, middle market private equity firms are looking for investment situations where they can put together more than one asset and apply operational and market expertise."

These themes held true during Incline's four-year ownership of OHI as well. Incline had made the investment in the manufacturer of custom orthotic devices because the firm recognized a growing need for these products--a result of an increasing aging population and the fact that people are standing on their feet longer, causing more foot, ankle, calf and knee strain. During its ownership period, Incline made two add-on acquisitions-of an ankle brace device technology company in 2008 and an orthotics company in 2011- and grew the company's sales force. OHI was generating high returns when Incline sold the company in April, according to Konstantinou.

While there was strong interest from both strategic acquirers and private equity firms in OHI during the sales process, Frazier Healthcare came out ahead.

"When it came time to exit the investment, there was interest in the business from a variety of buyers," says Konstantinou. "Frazier's expertise and knowledge in health care, and the orthotics sector in particular, made it the best new investor to continue to drive the growth of the company."

The less-technical medical devices, which aren't the devices that come to mind immediately, can be innovative and also make for great investments for both private equity and strategic acquirers. "The key is to find products that are either lowering the cost of delivering care or helping to improve patient outcomes," say Collister. "Medical supplies and medical devices don't have to be high-tech to represent attractive investment opportunities."

RoundTable owned Aspen Surgical, a surgical blade company that made a small innovation. Initially, RoundTable initially liked the investment because the surgical blade is a low-cost item, very important to procedures and not tied to directly to government reimbursement. "When you have a device that is subject to reimbursement, there are challenges because reimbursement rates are changing all the time," says Collister, who adds that the surgical blade is always needed, regardless of what surgical procedure is taking place.

During RoundTable's ownership, Aspen added a sheath over its blade-a minor innovation that yielded big results. "Hospitals treat nurses and doctors for cutting themselves all the time, the sheath stops the cuts and saves the hospital thousands in unnecessary costs," says Collister.

RoundTable sold Michigan-based Aspen Surgical to medical device company Hill-Rom (NYSE: HRC) for $400 million in July 2012. At the time of sale, Aspen had annual revenue of approximately $120 million.

What's more, Riverside's Ibrahim says that its portfolio company Precision Wire Components, which makes custom wire components, could be a great purchase for many larger strategic buyers. "Several of the largest global leaders in medical device manufacturing could utilize Precision Wire's specialized process in the devices they assemble and distribute," says Ibrahim. "These types of companies are attractive to the big strategic buyers because they offer a unique value-add to the devices they already own. They are solving a specific problem."

There's no question that strategic acquirers are ready and willing to buy from both private equity firms and venture capitalists. The same strategic buyers that have bought companies from venture capital firms have also bought companies from private equity firms. Last year, Covidien, Medtronic, Johnson & Johnson and Boston Scientific each completed acquisitions of private-equity-backed companies, meaning private equity firms will mostly likely be in a good position when it's time to exit their investments.

"Private equity has the opportunity to help moderately sized companies grow and deliver better outcomes," says Collister. "No one is saying they want to pay more and have worse outcomes. Big companies aren't good at innovating like the smaller players can. The smaller companies can drive change, but they often need a sophisticated investor to help them achieve their objectives."

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