Can investors profit from medical devices M&A boom in 2013?

Can investors profit from medical devices M&A boom in 2013?

Posted on Dec 18, 2012

A recent Reuters article indicates medical devices M&A activity is poised to take-off in 2013. This after activity has fallen to a near low since 2009.  Is there a way that investors can benefit from such mooted M&A activity?

With all the pressures from payors, the 2.3% medical devices sales tax and healthcare reform, companies are looking for angles to optimize operations, and add new innovations to boost future revenues and profits.

The article suggests companies within the orthopedics/spine and cardiovascular space are most likely to benefit. That’s actually quite reasonable since large medical devices companies in these spaces are very profitable and cash-rich. They’re also hungry for new innovation, much of which will be sourced from outside. Also, in these sub-sectors innovations can be very much game changing (clinically and commercially) with opportunities to tap large markets. Private equity buyers will typically pay an EV/EBITDA multiple of 7-10x. This enables them to use considerable debt to leverage the transaction and still have sufficient cash-flow to pay down the new debt.

Strategic buyers are often willing to pay more. They may use less debt to facilitate the transaction (typical financing routes include using cash on balance sheet, share transactions and of course, debt). But a strategic buyer is also usually looking for some kind of business synergies. This could include leveraging a new innovation, getting their foot in the door of physician offices,  sales force, utilizing existing expertise in a given space, cost synergies and other rationales.

But even then, a strategic buyer will pay 5X to 10X to pre-revenue company with decent technology. Typically trategic buyer will pay 10-20x EV/EBITDA multiple.. For a buyer to pay over 20x EV/EBITDA, the acquisition has to work out fantastically well. Occasionally they do.

For some reason Orange County has seen some great companies and terrific exits. Companies have made multiple in the range of 5 to 20X. Orange County is hub for ophthalmology, spine, obesity, cardiovascular and diagnostic companies.

Keep in mind strategics and private equity investors are no fools. There is a very good reason why they (strategics) generally stay between a 5-10x  for a pre-revenue company and 10x to 20x EV/EBITDA multiple – because at this level, they have a very good chance of earning a positive return.