Southern California's medical technology companies reeled in the second-highest clump of venture capital dollars in the last year, but it's still way behind the north end of the state.
Southern California raised 13 percent of the total venture capital dollars from June 2011 through last month, according to a not-yet-released Ernst & Young 2012 state of the medical technology industry report.
“Northern California has three times the amount of funding as Southern California,” said Dan Kleeburg, partner at Ernst & Young LLP, who leads the San Diego life sciences practice and calls Sequenom Inc. (Nasdaq: SQNM) and Isis Pharmaceuticals (Nasdaq: ISIS) clients.
Northern California's medical technology companies absorbed $1.2 billion of investments, compared to the $447 million that headed to Southern California.
Kleeburg previewed some of the report's highlights during the Biocom DeviceFest conference at the Westin South Coast Plaza in Orange County on Tuesday.
San Diego-based Biocom, the largest regional life science association in the world, holds the annual conference to unite players in medical device and diagnostic space to discuss U.S. Food and Drug Administration compliance, finance, intellectual property and commercial launch planning.
Medical technology (medtech) companies primarily design and manufacture medical technology equipment and supplies and range from venture-backed, pre-revenue startups to mature global conglomerates.
“Economically, it's a healthy industry,” said Kleeburg, who assists clients with public stock offerings and debt registration.
He helped Isis spin-off Regulus Therapeutics file its initial public offering on Aug. 17.
Southern California's medtech scene boasts a mixed financial performance, he notes. From 2010 to 2011, revenues for Southern California's medtech companies jumped 9 percent to $14.2 billion. Net income was down 9 percent to $940 million. Financing was down 21 percent (adjusted).
Some notable performers were San Diego's Illumina Inc. (Nasdaq: ILMN) and ResMed Corp. (NYSE: RMD), which earned double-digit growth. In 2012, there have been eight deals north of $1 billion.
"There's a lot of activity out there," he said.
Headlining that clump are Hologic Inc.'s (Nasdaq: HOLX) $3.9 billion acquisition of San Diego-based Gen-Probe, and Apax Partners' $6.3 billion deal to buy Kinetic Concepts Inc.
There is an attempt to remove some of the risk from the deals getting done, he notes.
“So in early-stage deals, we are seeing less up front and seeing more milestone and earn-out-type structures in those deals,” he said. “Larger medtech is trying to derisk the acquisitions through those strategies.”
Between 2008 and 2010, the percentage of U.S. and European M&As with milestone provisions tripled, from 5 percent to 15 percent.
A changing customer environment — marked by a spike in hospital consolidation and physicians becoming hospital employees — are all putting pressure on the growth of medtech companies.
In 2006, there were 57 hospital consolidations, 77 in 2010, and in 2011, 86 hospital M&As were announced.
The percentage of U.S. private practice physicians is decreasing. In 2005, 33 percent of physicians were independent; in 2009, 30 percent; and that number is expected to shrink to 24 percent in 2013.
“Putting power in the hands of fewer makes it more difficult for medtech,” he said. "There's significant consolidation in terms of who the buyers are."
The funding environment is "a story of the rich getting richer,” he said.
Funding is being funneled into the big commercial leaders, defined as companies with north of $1 billion in revenue.
"Since 2006, the funding has increasingly been going toward these commercial leaders," he said.
In 2012, about 71 percent of the capital went to those giant companies. That means smaller startups and emerging firms are only getting a small piece of the funding pie.
That means investors are putting their money into safer segments instead of diversifying their portfolios with earlier-stage investments.
“Innovation capital has flatlined since the financial crisis,” he said. "We are seeing less and less investments go to the A rounds."
Funding was mostly concentrated in a handful of mature companies that took advantage of historically low interest rates to raise debt — funds that were typically used to restructure balance sheets, finance acquisitions or fund general operations.
The sales model is also changing; even tenured biotechs that have been selling products for a while are finding it's tough to get new ones introduced.
“Part of it is identifying who the customer is and what data they need to be able to sell that product internally in a hospital environment,” he said.
Patients are becoming an integral part of the sales cycle.
“The level of education among patients who are tech savvy has grown significantly,” he said.
There are currently 9,000 health care apps available to the smartphone user, for example, and that number is expected to grow to 13,000 in the next 18 months.
“A lot of patients are well-educated and asking questions. They are interested in aligning their health care with data and outcomes,” he said.
Innovation starts at the bedside, working with doctors to create new products and technology.
“You need to figure out what information is coming out on the back end and how patients and doctors are utilizing that. Finding a way to capture the value of that data from a business perspective,” he said.
He's seen clients, including a glucose monitoring company, acquire data mining companies to figure out how to best package the data.