There has been a recent uptick in news stories about medical device company mergers, not to mention product liability lawsuits filed against medical device companies. To learn about how these two trends could impact medical device credit ratings, we reached out to an analyst at S&P.

Brian Buntz

Last year went down as the biggest year for M&A activity on record, and this year is looking similar thus far.  

Another trend--albeit an unrelated one--is a growing amount of medical device firms being accused of fraud. While the most recent case resulted in the acquittal of Vascular Solutions' CEO Howard Root, some medical device companies have faced stiff penalties. For instance, last year NuVasive was ordered to pay $13.5 million to settle false claims allegations. In 2014, the DOJ handed out more than $100 million in fines to medical device companies.

To learn more about how M&A and litigation are affecting device companies financially, we reached out to David A. Kaplan (pictured), CFA director of the healthcare group at Standard & Poor's (S&P), which has just published a report titled "Factors Leading to Default for Medical Device Companies," which we have summarized on Qmed.
 

Qmed: What are your thoughts about the rapid uptick in M&A in medtech? How risky might this be for companies that are making aggressive acquisitions?

Kaplan: There are often operational challenged or hiccups when integrating acquisitions. Sometimes that can lead to a material deterioration such as with Cooper's acquisition of Sauflon... a recent example where integration challenges ultimate contributed to a rating downgrade.

Still, most companies have the capacity to handle an acquisition even if there are hiccups. It's primarily when multiple acquisitions are being integrated simultaneous that we see risk growing exponentially.
 

Qmed: There has been an uptick in medical device fraud litigation in recent years. How big of a risk do you think fraud is currently as a cause of medical device company defaults?

Kaplan: Many of the defaults we are aware of affected distributors, who bill Medicare for the product they deliver to Medicare enrollees.

Medicare has been using third parties to audit distributors of medical products and has been clawing back overpayments, so it's hard to say whether it's the fraud or the enforcement that has increased.

Overall the default rate seems low for the sector, so I don't think it is widespread--especially among the large companies that we rate.

The research I've seen indicates Medicare fraud may be very substantial though I think it's likely relatively smaller operations--smaller than the ones we rate.

In our analysis, we fully rely on accountants/auditors to sign off on the accuracy of the financials, and we don't consider that risk of fraud until there is a distinct reason for suspicion or where there are known issues, such as allegations of fraud, accounting misstatements, or delayed filings. As an example, we withdrew our ratings on Hanger Inc. in October 2015 after financial statements were extensively delayed.
 

Qmed: Does this suggest that shifts in Medicare reimbursement (such as bundling payments) under the Affordable Care Act might also cause more defaults?

Kaplan:The industry has gone through a lot of consolidation, and that reduces the number of competitors, increases market share for the remaining companies, which makes each company more essential to the industry. It also often increases product diversification. A large diverse company with a strong market share can potentially be harmed by bundled payments or other industry changes but is unlikely to be pushed to the point of default, especially if they manage their debt levels conservatively.

We are studying the impact of CMS's bundled payments on hips and knees (in which the hospital is paid for and is responsible for covering the rehabilitation costs over the 90 days following the procedure).

We see two main areas of potential concern. First, bundled payments may lead to more pricing pressure for device makers (particularly orthopedic companies such as Stryker and Zimmer-Biomet) as hospitals (especially those with above-average costs) look for various ways to improve their profitability. Second, hospitals will be incentivized to do comparative research such ... which of the knees/hips lead to quick/less expensive rehab. This could create winners and losers among the device companies whereas, in the past, no-one had enough of an incentive to study this closely. From a credit perspective--given asymmetric returns to debt holders--the downside risk is always more of a focus than the potential upside.

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