International investment banking firm Capstone Partners has been tracking mergers and acquisitions (M&A) activity in the medtech outsourcing industry for several years now and reports a notable increase in the number of recent transactions. Several noteworthy transactions have been completed or announced so far this year, and the volume of transactions is rising. From January 2013 to May 2013, Capstone noted nine completed M&A transactions in the sector. During the same period in 2014, at least 20 transactions were completed.
In a recent Capstone poll of corporations and private equity firms with holdings or interest in the medical device outsourcing industry, buyers noted that acquisitions are an increasingly important part of their strategic plans. Many respondents suggested that before 2013 they were more concerned with internal initiatives, but now that the industry is experiencing better growth they are again looking to make acquisitions that make sense.
This uptick in activity presents an opportunity for owners of private medtech outsourcing businesses who may be looking for the chance to sell or recapitalize their company at an attractive value, but it also offers benefits for medical device OEMs.
Positive Outlook Drives M&As
The recent surge in M&A activity reflects the outsourcing industry’s positive outlook and attractive growth prospects. By all accounts, the medical device outsourcing industry is poised for solid growth, as it continues to benefit from both increased worldwide demand for medical devices as well as the continued shift in manufacturing and support services toward contract providers.
Many years ago, the medical device industry maintained a rather low level of outsourcing due to OEMs’ concerns regarding quality, delivery delays, and regulatory compliance. However, market dynamics have driven OEMs to increasingly rely on outsource providers. Healthcare reform and the excise tax on medical device sales, increased regulatory requirements and costs, higher manufacturing tolerances and the increasing complexity of medical devices, and reduced hospital budgets are all squeezing medical device OEMs. The resulting product innovation and pricing pressures require medical device OEMs to emphasize efficiency and improved outcomes in all phases of their businesses. In many cases, their processes can be improved by outsourcing some or all of their functions, and outsourcing can help lower costs, increase agility, accelerate time-to-market, and boost their returns on investment—all critical factors for success in today’s environment. Additionally, the freed up capital has allowed OEMs to focus on critical research and development as well as sales and marketing activities. As OEMs have adopted the use of contract manufacturers, they have found them to be reliable and of high quality; as a result, the acceptance of outsourcing has grown.
In addition to the increased use of outsourcing, contract manufacturers stand to benefit from a positive outlook for the medical device industry. While recent market demand was impacted by the recession in the United States and abroad, the outlook calls for improved economic conditions and employment, as well as the implementation of the Affordable Care Act, all of which should help revive demand for elective procedures. In the long-term, medical device firms expect growth opportunities to be driven by aging populations around the world who are demanding a higher quality of life.
Now that outsourcing is displaying healthier growth, including an improvement in the operating performance of both the acquiring firms and their targets, strategic players and private equity groups are eager to make complementary acquisitions in the industry.
Macro M&A Trends
In addition to the above-mentioned industry-specific factors, the M&A market in general is healthy, and these favorable conditions are supporting activity in the medical device outsourcing industry. Generally speaking, strategic players have strong balance sheets and a desire to supplement their organic growth through acquisitions. Many are also supported by rising stock prices. Meanwhile, private equity firms still have large amounts of capital to deploy (estimated at $500 billion) and are enjoying a healthy fundraising environment. For all buyer types, the debt markets remain favorable, providing available capital, low interest rates, and reasonable lending conditions.
As a result of these favorable conditions, processes are yielding multiple bidders and transaction values are healthy. The bottom line is that the current environment has all the attributes that private companies look for in a favorable M&A market, which is contributing to elevated levels of activity and valuations.
M&A activity in medtech outsourcing is also being driven in large part by the demands of medtech OEMs, who stand to benefit from the industry’s consolidation. In fact, contract manufacturers and service providers are feeling pressure to implement new and differentiated capabilities in an effort to deepen their relationships with OEMs and offer a more compelling value proposition.
Many of the most successful outsource providers have positioned themselves not just as traditional suppliers, but as true partners to their OEM customers. These OEMs continue to require a broader range of capabilities and efficiencies as they demand one-stop solutions from their outsourced partners.
As a result, consolidation in the outsourcing industry continues, often with larger players acquiring smaller niche companies that add specific competencies to their portfolio of services. In such cases, the buyer’s goal is to develop into a significant, integrated outsource provider that can deliver not only high quality manufacturing, parts, or complete devices, but a turnkey solution that often combines engineering, product development and prototyping, regulatory and quality assurance, sourcing, packaging, distribution, and supply chain management. As companies become multidisciplined providers, they not only secure more business within existing accounts, but the increased scale also favorably positions them to add new relationships with large OEMs.
Smaller contract providers are feeling the effects of these dominating players, and many are looking to sell to a larger entity rather than be left behind. Going forward, companies with a full offering of services are expected to be best positioned to offer the cost savings, simpler supply-chain processes, and time-to-market advantages that OEMs demand.
What Buyers Want
M&A activity is healthy across medical device outsourcing segments, and we are witnessing transactions in most specialties, including EMS, precision machining, stamping, plastic injection molding, and extrusions. Capstone has also noted a number of transactions involving service providers, including those related to product design, product launch and marketing, regulatory affairs, product quality and safety, and supply chain management.
In general, strategic buyers are targeting prospects that provide specific capabilities or services that complement their core offerings. On the other hand, private-equity buyers looking for a platform holding in the segment are generally interested in the category as a whole and will consider targets within a range of specialties, as these private equity buyers cast a wider net than their corporate buyer counterparts. The industry still remains highly fragmented, making it an attractive sector for private equity.
Valuation is in large part influenced by the needs of and fit with a specific bidder. That said, there are certain attributes of medical device outsourcing companies that buyers will generally pay a premium for, or apply a discount against, relative to the pricing norms for the industry. Interestingly enough, many of these attributes align with criteria OEMs consider when choosing outsourcing partners (Figure 1).
|Figure 1. Many of the characteristics that strategic suitors and private equity groups currently use to evaluate and price acquisition candidates in the medical device outsourcing space (shown above) align with criteria medical device OEMs consider in choosing their outsourcing partners.|
Consolidation Will Continue
Several active buyers have noted that the availability of quality companies for sale in the industry is a bit scarce, a trend seen across the M&A landscape. Capstone attributes this to a lack of confidence among CEOs who, since the recession, have been repeatedly hit with negative economic and political developments that have kept them on the sidelines. This waiting time is coming to an end. With excellent M&A market fundamentals in place, growing demand from buyers, and (finally) more visibility into the future for business owners, we appear to be in a “seller’s market.” As a result, expect deal supply to improve in the coming year, resulting in an increase in industry transactions.
With outstanding M&A market conditions in place, strong demand for quality companies from buyers, and rising confidence among CEOs, Capstone anticipates that M&A activity in the medical outsourcing industry is poised for continued growth in the next 12–18 months. In all, expect buyers and investors to continue to be attracted to the favorable demographic factors of the medical space and the consolidation and scale opportunities inherent in the highly fragmented medical device outsourcing industry. As the medical device industry grows and market factors support increased use of contract manufacturers, Capstone believes that M&A activity in the space will benefit in terms of both heightened buyer interest and more attractive business valuations. Medical device OEMs will continue to benefit from the trend toward consolidation as outsourcing providers become one-stop-shops offering a variety of services ranging from engineering, product development and prototyping, and regulatory and quality assurance to sourcing, packaging, distribution, and supply chain management.
Eric Williams is managing director and head of the health and medical practice at Capstone Partners, an investment banking firm dedicated to serving the corporate finance needs of middle market business owners, investors, and creditors. Reach him at [email protected] or 215-854-4065.