Medtech Forecast: The Experts Weigh In

Originally Published MDDI February 2004

Corporate Outlook



From drug-eluting stents to high-performing stocks, the medical device industry is in for a heart-pumping year.

Erik Swain and Sherrie Conroy

New Developments Stimulate Market

Analysts predict a strong year for medical devices, with exciting new developments to stimulate funding, growth, and revenues. Of particular note are products that cross over into areas traditionally dominated by pharmaceuticals.

“We are thinking a lot about solving medical problems that have been thought of as drug problems with devices,” Trevor Moody, a partner with Frazier Health Care Ventures said in a recent issue of Venture Capital Journal (VCJ). “We've made some investments related to that. The theme has been to look at the areas that drugs go after and look at the areas that haven't been served by drugs and solve those problems with devices,” he said.

Venture capitalists say they expect emerging medical technologies to drive more investment in the overall medical device market this year, according to VCJ. In addition to drug-eluting stents, other technologies should also attract venture capital this year. Such devices include implantables that act as sensors or release drugs. “We're going to see more real-time feedback loop activity,” Harry Rein, a general partner with Foundation Medical Partners, told VCJ. 

For smaller companies, the prospects for growth in neurostimulation markets are expected to continue because they are underpenetrated and large, Jan Wald, a vice president of A.G. Edwards & Sons, said in an interview with the Wall Street Transcript. “In the orthopedic space, the demographics just work out beautifully for these companies. We've seen high double-digit growth rates there as well,” he said. 

David Turkaly, a senior medical technology analyst with WR Hambrecht & Co. says that both large- and small-cap medical technology companies have outperformed the S&P 500 for the past three years. “This sector continues to be a very attractive area for investment.” He notes that consolidation in the medical sector is common even at lofty valuations, and its fundamentals are very strong. Leading companies have consistently posted high margins and high returns on equity.

“We expect these trends to continue and believe that selective stocks will continue to outperform the broad market over the next few years,” he says.

Strong Growth Predicted

Wall Street analysts generally believe that current valuations of companies in the medical device and supply industry reflect continued strong top-line performance. According to the Centers for Medicaid and Medicare Services (CMS), the strength of the $75 billion medical device industry is based on sound underlying financial fundamentals.

During 2003, the introduction of new technologies, such as drug-eluting stents and cardiac rhythm management devices, drove revenue growth. Similar growth is anticipated through the introduction of new products within the spinal and heart valve repair sectors. In its Health Care Industry Update, CMS notes that investors are most attracted to companies developing new technologies. Investor interest provides incentive for companies to produce innovative products or to seek them through acquisition. CMS says that merger and acquisition activity slowed in recent years as device companies focused on internal operations. However, analysts expect manufacturers may become increasingly acquisitive as they seek to fill thin product pipelines.

The gross margins of both hospital supply and medical device manufactures have remained consistent (see Figure 1), according to CMS. R&D spending for most medical device companies averaged 9–10% of revenues and remains in line with historical trends. According to CMS, median net income margins for device manufacturers improved substantially from 2001 through the third quarter of 2003.

Small medical device companies continue to experience limited access to capital. Venture capital investors have become more conservative. CMS notes, however, that venture capitalists are seeing preliminary signs of increased flow of investor funds.

Drug-Eluting Products Lead Market Future

The drug-eluting stent is the first medical device that is seen to have the revenue potential equal to a blockbuster drug. So it's not surprising that the technology is dominating the talk of financial analysts covering the medical device industry. In particular, the financial community seems to be awaiting with great anticipation the introduction of Boston Scientific Corp.'s (Natick, MA) Taxus drug-eluting stent, for which FDA approval could come as early as the first quarter of 2004.

The intense interest in the financial implications of drug-eluting stents was obvious at the Piper Jaffray Health Care Conference, held January 27 in New York City. Two of the best-attended presentations were from Boston Scientific and Johnson & Johnson (New Brunswick, NJ), whose Cypher product last year became the first FDA-approved drug-eluting stent.

“Boston Scientific is an extremely interesting story. They are on the threshold of something I have not seen in medical devices,” said Thomas J. Gunderson, a senior research analyst at Piper Jaffray (Minneapolis). “This is a company that has an established (sales) base of $3 billion but is still able to grow substantially from homegrown products,” helped in part by sales of Taxus in other parts of the world.

Other recent reports are equally enthusiastic about the outlook for drug-eluting stents and other combination products and the companies that make them. Front Line Strategic Consulting, Inc. (San Mateo, CA) projects that the worldwide drug-eluting stent market will triple from $2.1 billion in 2003 to $6.3 billion in 2008 because of an expanding patient population and applications for the technology that extend beyond coronary artery disease. Front Line's report projects the United States will account for 70% of the market because of favorable reimbursement rates. It expects J&J, Boston Scientific, and two firms with drug-eluting stents in development, Medtronic Inc. (Minneapolis) and Guidant Corp. (Minneapolis), to reap the benefits.

“We are very excited about this medical device segment,” said Rochelle Ellis, an analyst at Front Line's strategic market reports division. “For some patients, such as those with blockages in multiple vessels, drug-eluting stents offer a highly attractive alternative to bypass surgery.”

Likewise, Front Line projects the worldwide combination products market to jump from nearly $6 billion in 2004 to almost $10 billion in 2009, with drug-eluting stents accounting for 70% of the total. The firm believes the combination products industry will be helped by streamlined approval processes in the future. 

Larry Best, Boston Scientific's chief financial officer, told the Piper Jaffray audience that Taxus represents “the biggest opportunity in medical device history. There has never been a $5-7 billion opportunity for one product in the device sector. We think we can be number one. We have a better balloon, a better stent, a better polymer, and stunning results for our drug, Paclitaxel.”

Michael Dorner, worldwide chairman of J&J's medical devices and diagnostics business, said the U.S. launch of Cypher played a major role in boosting 2003 sales of the device business 18.5% over the previous year, to $14.9 billion. He said J&J fully expects competition with Boston Scientific and eventually others to be fierce, but it intends to “maximize our commercial opportunity.”

With all the anticipation, however, comes high expectations. While J&J reaped $470 million in U.S. sales of Cypher for the fourth quarter of 2003, some analysts were disappointed because they had projected sales closer to $600 million. A January 21, 2004 article by Dow Jones News Service quoted several analysts voicing concerns about Cypher's cost and deliverability, and the negative publicity it received over a few cases of thrombosis. Some pondered whether these issues might cause doctors to switch from Cypher to Taxus when it becomes available. If the device industry is not used to this kind of scrutiny and speculation from the financial community, it had better get familiar with it, for it comes hand-in-hand with billion-dollar sales projections.

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