Originally published February 1996
Thomas J. Gunderson and Thomas P. Schnettler
Although the growth of a medical device company often depends on its ability to develop new and innovative products, a company's success is frequently determined by its strategies for handling the fluctuating regulatory and reimbursement environments. Such strategies also affect how the investment community allocates its funds. Careful study of some of the recent approaches of several manufacturers reveals how these strategies worked.
LENGTHY DEVELOPMENT CYCLES
Recent years have witnessed an increase in the length of the premarket approval (PMA) process for medical devices. More and better clinical data than in the past are often needed to satisfy FDA's requirements. Longer trials require more resources, not only to cover clinical costs, but often to sus- tain the company while the trials are being conducted.
Many manufacturers have overcome this obstacle with alternative strategies. In order to generate the revenue necessary to fund extensive clinical research in the United States, many development-stage companies such as Spine-Tech, Inc. (Minneapolis), Conceptus, Inc. (San Carlos, CA), and Urologix, Inc. (Minneapolis), have begun marketing their products in Europe. Marketing in Europe before the United States has also provided these companies with opportunities to implement product design improvements. Such improvements enable the company to produce a better product with which to enter U.S. trials, thereby reducing the risk of costly and time-consuming restarts of clinical research.
Vivus, Inc. (Menlo Park, CA), is pursuing FDA approval through a new drug application route. The company is minimizing clinical trial expenses by combining both regulatory and reimbursement concerns into a unified program.
Successful companies like these are surviving the long FDA review cycle by looking to markets outside the United States to produce capital, and by planning clinical trials with both FDA and payers in mind.
EDGING OUT THE COMPETITION
Longer development times tend to raise obstacles to competition. For example, Steris Corp. (Mentor, OH) has enjoyed a virtual monopoly since receiving FDA approval to market its low-temperature sterilizer in 1988. Two competitors with higher-priced products did not get approval until 1993 and 1995, respectively, whereas a third withdrew its submission because of FDA questions about its data. Meanwhile, Steris's investors have profited, as earnings have grown at a compound annual rate of more than 70% and the company's stock price has soared from $3.50 to $34.00 in less than four years, adjusted for a 2-for-1 split in 1995.
Exogen, Inc. (West Caldwell, NJ), received regulatory approval of its first bone-healing product late in 1994. Having collected ample data from its randomized, placebo-controlled clinical studies, the company is now well on its way to having physicians and payers accept its product as the current standard of care. Any new competitor may find it difficult to conduct a randomized trial with Exogen's product already approved and in use.
In short, companies that can accomplish quick, successful clinical trials and market their products first will reap the benefits of reduced competition.
The increased resources necessary for new product development and the uncertainties of regulatory and reimbursement approval have resulted in increased interest in corporate partnerships between smaller entrepreneurial enterprises and larger, established medical companies. Partnering with big companies can lower the risk for development-stage medical companies. Conversely, larger companies can accelerate their growth by joining with smaller innovative companies that are developing new products. In such strategic alliances, the overall investment risk is reduced for both parties.
For example, Spine-Tech has united with Ethicon Endo-Surgery, Inc. (Cincinnati), to jointly develop minimally invasive surgical techniques for spine fusion, and to train surgeons in their use. The Sofamor Danek Group, Inc. (Memphis, TN), and Genetics Institute (Cambridge, MA) have agreed to develop bone-growth factors for use in spine surgery. And Mentor Corp. (Santa Barbara, CA) has a technology and licensing agreement with Sonique Surgical Systems (Escondido, CA) to develop an ultrasonic liposuction product. Such strategic alliances enable companies to offset part of the increased costs and risks of new product development while fostering close ties for the future.
FDA AND THE MEDIA
Over the past year, FDA's emphasis on enforcement has become widely apparent--more so for some companies than for others. Mentor Corp. and Sofamor Danek have both been under FDA scrutiny over issues relating to the safety of their devices. But media coverage and plaintiff litigation have had an even more significant effect on the two companies' businesses.
For breast-implant manufacturers such as Mentor, FDA requested more supporting safety data and eventually required that all silicone-gel implants be part of an ongoing postmarket trial. But the main reasons that the silicone-gel implant market in the United States dropped from roughly 160,000 units in 1991 to 80,000 units in 1994 were the highly publicized news coverage of medical problems attributed to leaks in silicone-gel breast implants and the related multibillion-dollar class action settlement. Mentor agreed to a relatively minimal $24-million settlement and has since gained from the pullback of its competitors, but its stockholders suffered initially as the breast- implant controversy battered all participants.
Questions surrounding the use of Sofamor Danek's pedicle screw had existed for two years without adversely affecting the company. But when the ABC news magazine 20/20 aired a segment unfavorable to pedicle screws, market demand fell 5 to 10%. Plaintiffs' lawyers gathered forces to try to receive class certification from the federal court. In the meantime, Sofamor's stock price fell from the mid-$30s before the show aired to $11 per share at its 1994 low.
These two examples show how adverse media coverage can greatly affect the success of a company. FDA actions can influence public and media perception of companies and their products. For the reasons above, successful companies are working to maintain good relationships with FDA while avoiding adverse media coverage.
Traditionally, investors have evaluated medical device manufacturers by characteristics that reveal each company's position in the marketplace. These include the type of proprietary product, size of the market opportunity, gross margin potential, revenue stream, and strength of the management team. Companies must continue to articulate these characteristics, but they must also emphasize to investors the following, less obvious traits:
* A clearly defined regulatory pathway with definite completion dates for clinical trials.
* Clinical data demonstrating efficacy and cost-effectiveness.
* Wherever possible, a reimbursement scheme for approved products.
* A demonstrated ability to secure regulatory approval ahead of competitors.
* Strategic corporate partnerships designed to add future value by bringing products more quickly to market, accelerating the ramp-up rate for sales outside the United States, and demonstrating market acceptance for new products.
* An FDA-compliant operation.
Accentuating such information can be useful in proving a company's worthiness to investors.
Recent statistics suggest that the investment community is eager to back medical device manufacturers. In 1995, 23 medical device companies had raised more than $1 billion in the public equity markets by the middle of September. In just the first half of the year, venture capitalists invested more than $300 million in 50 medical device and equipment companies. And, over the past 5 years, a set of 10 leading medical device stocks have nearly quadrupled in value, substantially outperforming broader market indices. For companies that can easily adapt to a changing regulatory environment and clearly communicate their strategies for success, a receptive audience of investors awaits.
Thomas J. Gunderson is a vice president and senior research analyst and Thomas P. Schnettler is a managing director and senior investment banker at Piper Jaffray, Inc. (Minneapolis), an investment firm.