Originally Published MDDI February 2005

Making News in 2004

Erik Swain

J&J's Acquisition of Guidant Shakes Up Device Industry | IPO Market Returns with a Flourish | Taxus Raises Bar for Device Industry | Advanced Bionics Cashes In | Utah Medical Products Defies FDA |Cardinal-Alaris Deal Creates New Business Model | FDA Activities Concern Investors | Medical Imaging Advances by Leaps and Bounds | Defibrillators Ride Several Trends to Popularity | Wall Street Loves Orthopedics, Too

Each year, the medical device industry proves that it's a vital cog in the global economic engine, and 2004 was no exception. In fact, it was one of the most fruitful years for device-industry corporate activity in some time.

Emerging device firms found the initial public offering market a viable option for the first time in almost two years. The blockbuster-scale revenues of drug-eluting stents captivated Wall Street, as Boston Scientific's Taxus, introduced to the U.S. market in March, quickly became one of the best-selling devices ever. Developments in the cardiovascular, orthopedic, neurological, imaging, and safety-device segments excited analysts and enticed investors to return to the device industry after a few years of reticence or concentration elsewhere. And a number of significant mergers and acquisitions occurred, culminating in December with the largest deal in industry history: Johnson & Johnson's proposed takeover of Guidant.

What follows is a look at the people and companies behind these developments and other major industry news of the year. Their stories stand out as examples of the effort and ingenuity that make the device industry as crucial to a good economy as it is to good public health.

J&J's Acquisition of Guidant Shakes Up Device Industry

Johnson & Johnson's unprecedented proposal last December to acquire Guidant Corp. got industry talking. If it clears antitrust scrutiny—and that's a big if—industry could witness an enormous company make history. Combined with Guidant, J&J may present device makers with a competitor unparalleled in size and seemingly unbeatable in resources. The $25.4 billion deal would be the largest acquisition ever seen in the device arena, showing that the industry giants will stop at nothing to get bigger.

At the very least, the acquisition will strengthen J&J's position in the lucrative cardiovascular sector. Although most analysts have not indicated that this is the bellwether for industrywide conglomeration, it may alter the way mergers and acquisitions will be conducted for the next few years.

“Consolidation no longer is limited to just buying up the little guys,” says Thomas Gunderson, managing director and senior research analyst for Piper Jaffray (Minneapolis). “‘Bigger is better' is alive and well. The bigger they get, the bigger their appetite becomes. There's very little out there in medtech that isn't at some point acquirable.”

The deal, orchestrated by J&J CEO William Weldon and retiring Guidant CEO Ronald Dollens, made sense to the principals for a number of reasons. It makes J&J a player in the high-revenue cardiac rhythm management (CRM) market for the first time. It enables J&J to use Guidant's technology to strengthen its drug-eluting stent platform. And it resolves Guidant's inability to find a successor to Dollens, the only CEO it has had since being spun off from drug maker Eli Lilly & Co. in 1994. Dollens announced his retirement in May 2004.

It also represents a shift in emphasis toward devices for J&J, a conglomerate with a wide variety of products across the entire healthcare and personal care spectra. J&J has a number of key prescription drugs that will soon come off patent. A combined J&J/Guidant team might be able to create a second-generation drug-eluting stent to rival market leader Taxus from Boston Scientific Corp. (Natick, MA). Taxus overtook J&J's Cypher in market share primarily because of better deliverability. J&J will also bank on Guidant's pacemakers and defibrillators to help make up any revenue gap. Analysts expect revenue growth for implantable defibrillators, for example, to top 20% in 2005.

Government antitrust regulators will have to sign off on the deal before it becomes official. That review will scrutinize the firms' stents and related accessories such as catheters and balloons. What could emerge as a stumbling block is the firms' carotid artery stents. Guidant received the first FDA approval for such a product in 2004. J&J is expected to be the second to market, and no other competitors are believed to be anywhere near a product launch. The deal would place all carotid artery stents under the same corporate umbrella for the foreseeable future.

The acquisition could affect the device-industry job market. Those whose functions are duplicated might find themselves looking for work, and those who were looking for an excuse to move on may find it in the merger.

Some analysts have predicted that the next mega-acquisition will be Boston Scientific buying St. Jude Medical. The primary reason would be the same as the J&J/Guidant marriage: a top player in stents wanting to become a top player in CRM.
However, Gunderson does not believe the deal would start a trend of pharmaceutical companies buying device companies, as happened in the 1980s. “J&J is a very diverse company and always has been,” he says. “I don't think this means Pfizer or Bristol-Myers Squibb will get interested in devices again.”

IPO Market Returns with a Flourish

When Kinetic Concepts Inc. (KCI; San Antonio, TX), a manufacturer of specialty beds and wound-care devices, went public on February 24, 2004, investors could have been excused for ignoring the new stock. After all, the device industry had not produced a single initial public offering (IPO) since June 2002, and conventional wisdom on Wall Street was that the IPO market for devices was dead. Indeed, there hadn't been much enthusiasm for device IPOs since the late 1990s. The Street soured on them after a number of highly touted device stocks that came on the market in the mid-1990s went bust. As a result, analysts had come to believe that the only way for a young device company to mature, and for its owners and backers to cash out, was acquisition by an industry giant.

Those who passed on KCI last February are kicking themselves now. By late December 2004, its stock had produced a return of more than 150%. It had risen from its IPO price of $30 to more than $100 per share in just 10 months.

Whether encouraged by KCI's showing or responding to renewed investor interest in the device industry as a whole, other device companies jumped on the IPO bandwagon. In all, 15 filed IPOs between February and December of 2004, according to Thomson Financial Venture Economics.

Why did the medtech IPO market come back? There are several explanations. “It's not where you are at the time, but who's there with you,” says Thomas Gunderson, managing director and senior research analyst for Piper Jaffray (Minneapolis). Biotech and high-tech companies considering offering IPOs “just weren't mature enough. The device companies showed real revenues and growth prospects in the present or the very near future. Part of that may have been because the IPO window wasn't open to device companies in the last couple of years, so those that weren't bought had time to mature.”

Other IPO success stories so far include Syneron Medical Ltd. (Yokneam, Israel), with a return of more than 130% four months after its August 2004 IPO, and Fox Hollow Technologies Inc. (Redwood City, CA) and IntraLase Corp. (Irvine, CA), both up more than 75% since their October IPOs. Most of the other firms have shown minimal gains or losses in share price.

Is an IPO now a more likely or realistic path to significant return on investment than acquisition? No one on Wall Street is suggesting that. But it is once again an option for young entrepreneurial companies in the medical device industry.

Taxus Raises Bar for Device Industry

Drug-eluting stents, the device industry's only equivalent to blockbuster drugs, continued to generate extraordinary enthusiasm from the financial community in 2004. This was due in large part to Boston Scientific Corp.'s rollout of Taxus in March. The second drug-eluting stent to receive FDA approval, Taxus quickly gained market leadership and became the best-selling medical device of 2004. The jury remained out on whether Taxus was more clinically effective than its only U.S. rival, the Cypher, from Johnson & Johnson's Cordis Corp. But doctors seemed to prefer Taxus because of its better deliverability.

Taxus raised the bar for the device industry in several ways. First, its high level of success in the marketplace produced revenue numbers not previously seen in the device industry. That may lead some in the financial community to expect, reasonably or not, that the device industry will produce periodic blockbusters, as does the drug industry.

Second, Boston Scientific conducted one of the most comprehensive recalls ever seen in the device industry. The balloons on a handful of catheters deploying Taxus stents failed to deflate after the stents were released. The company documented fewer than 50 instances, and estimated the rate of the problem at 1 in 10,000 at most. It recalled almost 100,000 stents nonetheless. Remarkably, because of the firm's swiftness in addressing the problem and its ability to resupply immediately in most cases, Taxus had nearly regained its prior market share a month after the recall. Has Boston Scientific's massive recall set a precedent for the industry? If so, smaller firms may be squeezed. Many do not have the resources to conduct such a recall in the first place, much less to replace the recalled product so quickly.

“Boston Scientific was very proactive and took the proper approach,” says Greg Aurand, senior medical devices analyst for Zacks Independent Research (Chicago). “The same might not have been true for companies with smaller resources. In fact, liability issues are another reason why a small company might want to sell out

to a larger company. They could decide it might be better to let a company with more resources handle it.”

More players could enter the drug-eluting stent market in the near future. Medtronic, Abbott Vascular Devices (Redwood City, CA), and Conor Medsystems Inc. (Menlo Park, CA) all have drug-eluting stents in development. Whether the revenue pie will still be expanding when their products arrive on the U.S. market is open to question, however. Drug-eluting stent technology has been accepted so rapidly that some analysts believe it will soon become the standard of care. The effort to gain revenues will then become a market-share battle. But, with more competitors on the market, fewer will attain blockbuster-level sales.

Advanced Bionics Cashes In

Alfred E. Mann has a knack for discovering new medical technologies, basing companies on them, and selling those companies off for a tidy sum. He completed another such cycle recently when he sold Advanced Bionics Corp. (Valencia, CA) to Boston Scientific for $740 million. Milestones in the sale agreement could ultimately push the deal's value as high as $4 billion. Mann created Advanced Bionics in 1993 to market bionic devices to treat people with neurological disorders. Eventually, Advanced Bionics developed implantable devices to treat conditions from chronic pain to urinary incontinence through electrical stimulation.

Boston Scientific decided this cutting-edge approach was what it needed to get a foothold in neurology. The deal could foreshadow other industry giants taking a strong interest in the field, analysts say. In the conference call with analysts to discuss its acquisition of Guidant, Johnson & Johnson explicitly cited neurological devices as technologies it wants to acquire in the future. Likely targets, analysts say, are Advanced Neuromodulation Systems (Plano, TX) and Cyberonics Inc. (Houston).

Utah Medical Products Defies FDA

When a device company runs into compliance issues with FDA, the typical response is one of deference. Not so for Utah Medical Products (Midvale, UT) and its CEO Kevin Cornwell. They made news in 2004 by responding to FDA enforcement actions both in court and in the press. But this is not a mere case of sour grapes. If Utah Medical is successful in court, FDA's inspection practices for all device companies could change.

FDA cited Utah Medical for a number of GMP violations after inspections in 2001, 2002, and 2003. Eventually the agency placed a hold on the processing of export certificates for the company. Utah Medical then sued the agency in federal court to remove the hold. The company charged that the inspections that resulted in the hold were conducted improperly and that the action had led to lost foreign sales. In February 2004, FDA conducted a fourth inspection. Cornwell then blasted the agency publicly, accusing it of intending “to further tarnish [Utah Medical's] good reputation through a motivation that has nothing to do with the safety or effectiveness of our devices.”

In August 2004, FDA struck back. The agency filed a complaint against Utah Medical in federal court, seeking to stop it from manufacturing and distributing products until the GMP issues are resolved. It also issued a release noting that the company had a pattern of “significant deviations” from the quality system regulation (QSR) and vowing not to tolerate manufacturing practices that can put patients at risk. Utah Medical quickly filed a motion for dismissal, arguing that the QSR issues posed no public health risk.

Utah Medical would seem to stand no chance against a powerful government agency but for two things. One, Utah Medical's suit against FDA contains a statement from former FDA New England district director Ed McDonnell in which he claims that the inspectors did not follow proper policy and made material omissions and misrepresentations. Two, Utah Medical is being represented by McKenna, Long & Aldridge's Larry Pilot. As general counsel for the Medical Device Manufacturers Association and a practitioner of food and drug law for more than 30 years, Pilot understands FDA law and regulations as well as anyone. These may not be enough to overcome FDA's evidence against the company. But if Utah Medical does win, it could force FDA to rethink its inspection practices and give hope to other firms that think they have been wronged by the government.

Cardinal-Alaris Deal Creates New Business Model

Cardinal Health Inc. (Dublin, OH) is best known as one of the world's largest distributors of medical devices and drugs to hospitals and pharmacies. With its $2 billion acquisition of Alaris Medical Systems in July 2004, Cardinal became a device company itself. San Diego–based Alaris makes infusion pumps, patient monitoring systems, and other safety medical devices.

The deal will enable Cardinal to offer a suite of comprehensive medication safety solutions and to fold Alaris's automated systems into Cardinal's other offerings, which range across the entire spectrum of healthcare. For example, the devices that dispense drugs in the hospital, and the drugs themselves, are now under the same umbrella. If successful, the marriage could pique the interest of other distribution companies in device firms and create a wave of new synergies in product development, sales, marketing, and distribution.

At the Cleveland Clinic Medical Innovation Summit in October 2004, Cardinal Health founder and CEO Robert Walter gave a speech that essentially introduced Cardinal to the device industry and outlined its vision of integration. “Our motto is fostering innovation through integration, and we are seeking the highest level of integration,” Walter told the Cleveland Clinic audience. “At the core of that is the ability to use information. It is critical for us to bring our products and services to the site of care, and to have them be able to talk to one another and interact with custom systems. It is critical that we integrate them, whether they are Alaris pumps or Pyxis [a solid-dose-medication dispensing system], with hospital information technology systems. The next step is to have a PC in every patient room, integrated with Pyxis and Alaris, that provides access to all clinical information at bedside.”

Both the company and its business plan are things the industry will need to get familiar with in a hurry.

FDA Activities Concern Investors

The financial performance of device companies is the last thing on the mind of CDRH director Daniel Schultz. But how his center implements FDA policies, responds to political pressure, and acts to protect the public health could have a significant bearing on the economic well-being of the industry it regulates.

The rigorous FDA approval process is one reason why some investors shy away from the device industry. So perceptions of whether FDA is being tough on or lenient toward the device industry can affect Wall Street's enthusiasm for device companies. And Schultz, first as head of the Office of Device Evaluation and then starting as CDRH director in May 2004, is the figure shaping the perceptions of many analysts.

The events of the past year have produced mixed signals. On the positive side, CDRH has been moving aggressively to meet the performance goals outlined in the Medical Device User Fee and Modernization Act of 2002 (MDUFMA). In his public statements, Schultz has made it very clear that he wants CDRH to conduct faster reviews so beneficial technologies can get to the market more quickly.

The Office of Device Evaluation “has done and is doing an excellent job in making progress to meet the [MDUFMA] goals and figure out how best to use its resources,” he told MD&DI soon after taking office. “I am very [eager] to work with industry. That is a big part of what I did as a reviewer, as a division director, and as an office director. The question is, what is the most effective way to do it? We are working on that and figuring it out.”

But CDRH has sounded some notes of caution in the past year. In two cases, it took the very rare step of not approving a product despite an advisory panel approval recommendation and despite the technology already having been approved for another indication. One case involved Houston-based Cyberonics Inc.'s Vagus nerve stimulator, which was denied approval to treat depression, despite clearance to treat epilepsy. The other involved Inamed Corp. (Santa Barbara, CA). CDRH rejected the company's silicone implants for breast augmentation despite prior clearance to be used for breast reconstruction.

Schultz has also made it known that he expects high-risk devices to undergo postmarket studies, which in the past had been something required only of the drug industry. Recently, several devices have been approved on the condition that postmarket studies be conducted. The public health benefits are obvious, but the effect of the financial costs remains to be seen.

Adding to the uncertainty is FDA's coming under fire for approving Vioxx, a painkiller drug later shown to increase the risk of heart attack and stroke. It's possible that the fallout could benefit the device industry, in which product risks tend to be known early on and tend not to produce unforeseen side effects. But it's also possible that the political pressure sure to be exerted on FDA will result in more cautious and conditional device reviews. Indeed, in December 2004, CDRH came under criticism for failing to catch defects in a portable defibrillator made by Access Cardiosystems (Concord, MA). The company recalled the device in November.

What is certain is that FDA expects to see more data in applications concerning high-risk devices. And that means, ultimately, more work must be done to prepare a submission. “I remember when Bruce Burlington assumed leadership of CDRH in 1992 and began talking about the ‘drugification' of the device industry,” says Thomas Gunderson, managing director and senior research analyst for Piper Jaffray (Minneapolis). “Well, 12 years later, here we are. It's no longer a case of ‘put it in 50 people, and if it's reliably safe and might work, we'll approve it.' FDA is looking for much more clinical data.”

Medical Imaging Advances by Leaps and Bounds

Personalized medicine is the holy grail of healthcare. The medical device industry may have moved several steps toward it last year with a major development in the imaging sector.

In April 2004, General Electric Co. acquired Amersham plc and merged it with its medical systems division to create GE Healthcare (Waukesha, WI). The fusion of GE's imaging technologies with Amersham's imaging agents and diagnostics could create a new frontier in molecular imaging and personalized medicine. It will be up to Joseph Hogan, CEO of the GE Healthcare Technologies business, to translate those synergies into breakthroughs in medical imaging and information technology.

GE and its competitors have already been making great strides, says Thomas Gunderson, managing director and senior research analyst for Piper Jaffray (Minneapolis). “There has been a tremendous shift in imaging recently, particularly in cardiovascular,” he says.

“They are now using 64-slice CT scanners, which wasn't possible a year ago,” Gunderson adds. “If in 2009 you look back at what went on in 2004, this could be one thing that really had an effect. This could be good for all manufacturers of cath lab products.”

Defibrillators Ride Several Trends to Popularity

One trend driving growth in the device industry is the ability to give patients more control over their own healthcare. Philips Medical Systems (Andover, MA) is primed to take advantage of that trend after FDA approved over-the-counter sales of its HeartStart home defibrillator.

External defibrillators have shown strong growth in recent years, thanks especially to laws that require them to be as ubiquitous as fire extinguishers in some public places. As the devices saturate the public market, sales will slow. Philips can reverse that trend by creating a viable market for home use.

External defibrillators are but one reason why cardiac rhythm management (CRM) has become such a lucrative area. Technology for pacemakers and implantable cardiac defibrillators seems to improve with each year.

CRM trails only drug-eluting stents as the cardiovascular technology that most excites the investment community.

Wall Street Loves Orthopedics, Too

It used to be that if a device company wanted to really excite Wall Street, it had to be in the cardiovascular sector. Not any more. Recent advances in orthopedics have made it nearly as hot a segment.

One of the orthopedics firms leading the way is Zimmer Holdings Inc. (Warsaw, IN). CEO Ray Elliott and his management team have wowed analysts with the success of their minimally invasive technology platforms and their disciplined approach to growth and acquisition. “Minimally invasive surgery [MIS] is extremely important. Not only does it reduce the pain factor for the patients, it gets them back on their feet much faster,” says Greg Aurand, senior medical devices analyst for Zacks Independent Research (Chicago). “Zimmer is at the vanguard of MIS. But others will close the gap. The industry moves in cycles like that.”

Zimmer won acceptance for MIS by working hard to get buy-in from hospitals and payers as well as clinicians and patients. “Productivity is the ultimate goal, so we decided to take the program to the insurance companies and say ‘if you use our program, we can get your people back to work in two weeks instead of three months,'” says Elliott. “And our patients don't need to go to rehab centers or use high-cost narcotic painkillers.”

Growth in the orthopedics sector is also coming from better materials for artificial hips and knees. But 2004 saw the introduction of what may be the fastest-growing orthopedics product for the rest of the decade: the artificial spinal disk, promoted as a mobility-enhancing alternative to spinal fusion. J&J's Depuy Spine was the first to get FDA approval, and as many as three competitors could obtain market clearance within the next year. Excitement over this product class has been the driver behind several acquisitions, including Stryker Corp.'s purchase of SpineCore (Summit, NJ).

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