by James Wagner
The field of medical technology is well known for the incredibly rapid pace of innovation. The pace of advancement
rivals that of the software industry. To see an example of the swiftness and magnitude of the change, one has to look no further than the changes in treating chronic Venous Insufficiency (CVI) that have occurred in the past ten years.
These advances have given rise to new procedures that allow clinicians to treat patients with less time, les trauma and less cost. The natural point of distribution for these technologies is through industry channels. However, given the rapid change and advancement, how can industry accurately and fairly place a value on
a given technology? There are the standard empirical methods used for placing value on more mature technologies or businesses, in other words, those calculative measures such as a multiple of sales, a premium on a stock price, a multiple of Earnings Before Interest, Taxes, Depreciation and amortization (“EBITDa”), but the real determination of value is the level of risk associated with the technology. Pre-revenue valuations are often
based on multiples of investment, comparable transactions, or perceived potential sales for the product. In other words, we can define “value” as the financial expression of risk. Risk, in turn, is the probability of success or failure in any of the myriad of parameters that have to be satisfied for a successful commercial endeavor.
The basic premise in setting a valuation for a company or a technology is that the more technologies become de-risked (e.g. clinical trials successfully completed, United States Food
and Drug administration (FDa) approval obtained, reim-bursement codes obtained, market tested and proved out), then the more industry is willing to pay. The converse is also true – the more investment/risk an acquirer has to take on, the less they would expect to pay, at least initially, until some of the questions are answered.
Valuation will shift along a continuum according to the allocation of risk – i.e., who bears the greater burden of
risk, the inventor/seller of the technology or the acquirer? For example, if this technology exists only as a drawing or concept and no prototype has been built, then the value will be less than if prototypes have been built, tested and patents have been issued. However, if the technology has been built, tested, patented, has FDa approval, a validated manufacturing process and is generating revenue, the technology will be valued far higher still. The reason is simply that the majority of the risk in the first case is on the acquirer (who is the one assigning the value) and in the latter example the risk has been minimized.
TYPES OF RISK
When determining how much risk a technology carries, one needs to identify the various types of risks that might
be encountered. For this discussion, we will focus on some of the more common and recognizable types of risk.
One obvious area of risk would be the market itself. Each market is subject to a myriad of influences and changes, including clinical data, reimbursement, competing techniques or the more nebulous “patient awareness” of a disease have immense impacts on market size and growth characteristics.
Each market has its own life cycle and an optimum entry point. If one enters too early, the dynamics such as ideal
patient and reimbursement may not have been defined. If one enters too late, price points maybe depressed and it will take much longer to make any investment profitable. The optimum entry point is while the market is growing so that the product can grow with the market. One can see from the chart below the revenue (circles) will grow commensurate with the market. However, there comes a point where the market matures, the technology becomes commoditized and revenue starts to decline.
Another consideration in valuing a technology, especially for multinational companies, is the viability of sales outside the United States. In many cases, one can sell outside the
U.S. before being allowed to sell in the U.S. This is often more complicated than it might appear. an acquiring company must weigh the effort and investment to gain earlier revenues against potential lower pricing and a sometimes more conservative approach to adoption.
Intellectual Property (IP)
Intellectual property is a highly visible area of potential risk. a patent is a right to exclude others from copying your
inventions without your permission. Some people mistake this right of exclusion for a right of monopolization; in fact, patent protection is a major driver of innovation. When someone can not duplicate an idea, they are forced to design around the protected product. That process of designing is innovation; it may yield only iterative results, but it may result in breakthrough discoveries. For those who feel patents, especially in medicine, are counter to the public interest, consider this: what would the incentive be for someone to invest their own time, effort and money to create something only to have someone else steal the idea? This is perhaps the strongest disincentive for innovation. Your idea is highly vulnerable to theft if there is not patent protection, which is why IP is such a major consideration is assigning valuation to a technology.
The process to obtain a patent is long and expensive. The cost to an inventor for the legal work to obtain a patent
typically ranges between $?0,000 to $50,000 and depending on the number of appeals, the cost could be far higher.1 Further, in almost all cases, the claims that the inventor initially asks for have to be narrowed before the patent is approved. One component of risk is the amount of time, money and effort the company will have to bear to file a patent. a second level of risk is that the protection asked for (i.e., the claims granted) may not be the ones the company initially valued.
Also part of the IP discussion is trade secrets and know how. These can’t be patented for a number of reasons, however they have been kept in close confidence by the seller of the technology. as a general rule, the lower the level of protection available, the lower the value that is assigned. Generally speaking, trade secrets carry a lesser value than an issued patent.
Regulatory agencies perform a vital function and on balance serve their purpose quite well. Regulatory approval, or lack thereof, is a critical component of valuation in medical technology since it offers such a high level of risk. There are countless companies and tech-nologies that offered outstanding potential, but were never successful commercially because they either couldn’t get regulatory approval or were approved for a less attractive
indication. Gaining regulatory approval is becoming more and more onerous every year. The california Healthcare Institute (cHI) compared 2010 FDa 510(k) clearances with the period from 200? to 2007 and found that clearances have slowed by 4?%2. In the same study, cHI found that the approval times for a premarket approval (PMa) have increased by 75 %?. The longer an approval takes, the greater the risk to the project. The challenging regulatory environment is not unique to the U.S. In countries such as china or Japan, the regulatory path
is on average considerably longer than the U.S. The benefit of early revenue must be carefully balanced against the cost and time required to realize that revenue.
The costs to support a regulatory submission are not inconsequential. a typical FDa 510(k) submission includes
bench testing of the device, an extensive Failure Modes and Effects analysis, labeling claims and instructions for use. combined with the FDa’s fee to review a submission, these items typically will cost about $45,000.4 Some estimates place the cost just to obtain a 510 k approval as high as $24 million.5 If clinical evidence to support the claims is required, the cost can increase considerably. The PMa process is much more complex, much riskier and therefore, much more expensive. In addition to many of the same elements used to support a 510(k), the PMa process requires large animal testing. The regulatory costs associated with a Pre-market approval (PMa) application for high-risk products run on average, about $75 million.?
With the increased focus on evidence-based medicine, the level of clinical data required to support a technology
increases each year. For this discussion, the clinical data we are referring to is necessary for commercialization and required for any regulatory submission. Product selection is based on relevant data to support a technology’s efficacy. as competition gets more heated, the requirement to distinguish a product gets greater. Funding the types of studies that will have a significant impact in the market can be an area of significant expense. For example, the cost of a typical prospective randomized controlled trial could be anywhere from $5 to $20 Million. On the other hand, a retrospective chart review of 50 patients will be considerably less, but will have commensurately less impact in the market.
Other risks that must be considered are the potential introduction of new products or procedures that impact the market for your technology. Reimbursement risk is an increasing issue, as it is now very difficult and can make
recovering development costs that much harder.
TYPE OF TECHNOLOGY
Another corollary of risk that is an important consideration in assigning valuations is the type of technology being
evaluated. Generally speaking, technology is categorized in one of three ways – iterative, significant or breakthrough. Iterative technology, as the name implies, is simply building off of existing platforms. an example of this would be end firing laser fibers transforming to side firing laser fibers. There are benefits but they are not ground breaking in na-ture. companies often use iterative technologies to refresh their portfolios, which is an important practice to extend the life cycle of a product line.
Significant technologies are those that reshape how cur-rent procedures are done. Thermal ablation of greater
saphenous vein was significant in that it transformed the treatment of cVI by being more effective than sclerotherapy and far more tolerable for patients than vein stripping. The advent of thermal ablation resulted in more patients electing to have treatment and essentially reshaped the market for varicose vein treatments.
Breakthrough technology transforms medicine and creates and enables treatments and procedures that didn’t exist before. Two excellent and reasonably recent examples are coils used to treat brain aneurysms and the Transcatheter aortic Valve Implants (TaVI). By successfully allowing physicians to endoluminally eliminate brain aneurysms via a small femoral artery stick with the same success rates as open aneurismal clipping, the sequella associated with surgical intervention were greatly reduced with no sacrifice in efficacy. In addition, since the patient recovery time is dramatically reduced as compared to treating cerebral aneurysms via craniotomy,
hospital stays are reduced, thus saving overall cost for the health care system. TaVI offers many of the same benefits to a much larger population. Not only has TaVI reduced the trauma and cost associated with open aortic valve replacement, it has also allowed treatment of patients too sick for traditional open heart surgery.
Once the areas of risk have been analyzed, the type of technology has been determined and the markets studied,
a financial value has to be placed on the technology.
The process to assign a financial value takes many things into consideration. First, since the main purpose of most companies is to increase shareholder value, an acquisition of technology will need to pay for itself and start returning a profit within a reasonable time. Most companies report their financial results with a three year horizon, and most acquisitions are valued on their ability to pay for themselves within a three year period.
A second reference point is found in comparative deals. Deals within the same space between similar companies or for similar technologies will be analyzed to help derive a benchmark price.
As one might expect, both the seller and buyer usually have a price in mind. Not surprisingly, the two prices are
almost always different. The buyer has to consider the price to pay for the technology, add whatever costs are associated with the successful commercialization and finally, project the market success.
At this point the buyer will likely start intensive modeling. This model will take a proposed price usually estimated
based on the seller’s number and an evaluation of comparable deals, add the expenses estimated to commercialize the technology, look at a sales forecast with assumed price points, risk adjust the model and determine how long it will take to recuperate the overall investment and turn a profit. Both parties will then negotiate a mutually agreeable price – or not.
All in all, the valuation of technology is based on a fair market price considering the costs the acquirer will bear to
fully commercialize the technology and the time until the venture is profitable.
James Wagner is the Director of Strategy & Portfolio Management. Wagner played a lead role in the acquisitions of both VNUS, Inc. and ev3. In addition, Wagner is responsible for the assessment of key new markets and technology and coordinates the Covidien Vascular Therapies business strategy. He is a licensed attorney and holds 4 medical device patents.
1 Covidien internal estimate
2 COMPETITIVENESS AND REGULATION: The FDA and the Future of America’s Biomedical Industry, California Healthcare Institute,
February 2011 p. 8
4 Covidien internal estimate
5 Wornsnop L(editor). The Journal of Medical Device Regulation. February 20011.8(1
7 Covidien internal estimate