The recently imposed 2.3% tax on medical device makers’ revenue is likely to increase merger- and-acquisition activity in the sector and put a number of Orange County-based companies on the radar of potential buyers this year.
Deals in the healthcare industry are nothing new in OC, where 24 companies ranging from device makers to nursing home operators were bought or sold last year, according to data from the Newport Beach office of B. Riley & Co., a Los Angeles-based investment bank.
The device tax looks set to prompt deals up and down the roster of local companies, which range from startups to long-established players.
“You’re going to see opportunities for bigger [strategic buyers who see that] some of these midsized to larger companies also are having difficulty with their ability to fund trials because they now have a new tax burden,” said Greg Presson, a managing director in B. Riley’s Newport Beach office.
Earlier-stage companies also could become merger-and-acquisition targets if venture capital investors become reluctant to cover the costs of the device tax, according to Bruce Feuchter, a partner with Newport Beach-based Stradling Yocca Carlson & Rauth.
“Someone has to finance that tax,” Feuchter said. “The seller is going to have to finance [it] because the buyer, the hospitals, say, ‘We’re not paying,’ and Medicare says, ‘We’re not paying.’ ”
A mix of expense cuts to offset the tax and a “need to deliver revenue growth … will encourage companies to look outside for potential acquisitions to drive profitable growth,” William Link, a managing director of Menlo Park-based Versant Ventures who works from its Newport Beach office, said in an email.
Medical device companies that “are doing pretty well, gone commercial, not yet gotten profitable—there’s a likelihood that they’ll have to sell earlier” because of the tax, Fuechter added.
Potential Targets
Among the OC-based companies already drawing notice as potential targets are:
• Edwards Lifesciences Corp., the Irvine-based cardiac device maker with a recent market value of $10.1 billion and annual sales of $1.9 billion.
Chicago-based Morningstar Research recently tabbed Edwards, which is known for its less-invasive heart valves, as one of its top deal picks within the healthcare sector. Morningstar said it “would not be surprised if a larger competitor, such as Johnson & Johnson were to approach Edwards. In particular, J&J management has already indicated the firm is interested in structural heart products.”
Edwards declined to comment.
• Laguna Hills-based eye device maker Glaukos Corp., which received Food and Drug Administration approval for its iStent glaucoma treatment last year and has raised more than $100 million in venture capital funding.
• Tustin-based Uptake Medical Inc., a maker of devices to treat emphysema. The company has confirmed that it’s been in ongoing talks with several potential buyers.
• WaveTec Vision Systems Inc., an Aliso Viejo-based company that has raised some $70 million in its history. WaveTec’s devices are used in cataract surgeries.
The device revenue tax went into effect Jan. 1 as part of federal healthcare reform. It has already accounted for some $600 million in payments to the U.S. treasury, Presson said. It is ultimately expected to raise $30 billion over a 10-year period.
It’s applicable to almost any company that has revenue of $5 million or more, regardless of whether it is profitable. Some devices are exempt from the tax, including corrective eyewear.
The levy on devices “actually loosens the environment for deals” because higher costs for startup and emerging device companies have “in turn put more power in the hands of industry behemoths, making them even more appealing as partners or acquirers of intriguing technology at earlier stages,” Morningstar said in its report.
Predictions
Presson and Feuchter predicted that device taxes will also affect companies from an operational standpoint.
“It’s our view that the most significant burden is going to fall on the backs of startups and emerging medical device companies,” Presson said.
Venture capitalists, which provide much of the funding for such companies, will have to absorb the tax and related costs “for longer periods of time,” he said.
“It will now cause their financial backers to look at these companies and decide which ones in their view, with this new [tax] burden, have the most likelihood for success. Those that may be on the margin are not funded … innovation is limitless, funding is not.”
Presson said there will be a point where some companies will have to cut jobs or limit their research-and-development spending because they won’t be able to pass tax-related costs along to insurers, patients and hospitals—something that advocacy groups representing the latter have hammered device makers on in recent days.
The Washington-based Healthcare Supply Chain Association last week launched a website that it claimed would “help raise awareness of efforts by some manufacturers to shift costs of the tax directly to hospitals, healthcare providers, patients and taxpayers.”
The association noted that hospitals have pledged to pay $155 billion over a 10-year period toward healthcare reform.
“It’s sort of now having to parse your dollars—a portion of this tax will not be able to be passed on,” Presson said. “The realities are that you really can’t [pass it on] because the market is so competitive.”
