M&A among medical device firms will spur further CMO consolidation

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By: Sakthi Prasad --

26 June, 2014

M&A among medical device firms will spur further CMO consolidation
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In collaboration with Chanderkanth Gautham

Mega deals continue to flow in the healthcare industry in general and medical devices sector in particular. Medtronic, whose popular products include pacemakers and defibrillators, recently agreed to buy the No. 8 player Covidien for about $43 billion. Initially, a combined Medtronic-Covidien will be at least on par with current market leader Johnson & Johnson in terms of revenue.

The Medtronic-Covidien deal is not an one-off event; instead the M&A gavel continues to pound in the devices space. For example, J&J bought Synthes for $21.3 billion.  Some of the other prominent deals in the medical devices sector include Zimmer-Biomet and Baxter-Gambro.

All these deals were based on rationales ranging from tax savings to negotiating with hospitals that are becoming prudent in device purchases.

Also, the deal flow in the medical devices sector is happening on the backdrop of cost pressures faced by the healthcare systems of U.S. and Europe - both economically mature regions where hospitals are getting paid less to deliver healthcare services. Meanwhile, U.S. hospitals are also buying each other to manage their businesses in the changed scenario.

Given this continuing flux in the medical sector, it becomes imperative for medical device companies, also known as Original Equipment Manufacturers (OEMs), to sport a wide product portfolio so as to compete better in the marketplace.

More than 50 percent of Medtronic's therapeutic focus is getting complimented through the Covidien deal, while the other 50 percent gets newly added to Medtronic's portfolio.

Hence the deal is beneficial from product portfolio point of view besides the associated tax benefits that would be derived out of domiciling the combined entity in Ireland.

The only hitch for now is that the combined entity doesn't have full-fledged synergy in cardiac space. Medtronic, however, has said that it will continue to comb for potential acquisitions and it won't come as a surprise if forthcoming deals goes on to address synergies in the cardiac space.

M&A among medical device firms will spur further CMO consolidation

Medical devices companies (i.e., OEMs) such as Johnson and Johnson, Medtronic and Boston Scientific partner with Contract Manufacturing Organizations (CMOs) such as Accellent, Great Batch and many others to manufacture devices used to treat ailments in therapeutic areas such as cardio, vascular, neuromodulation and so on.

CMOs depend on OEMs for their survival. The question now is what happens to the CMOs given that OEMs are going on a deal spree?

Thus far, CMOs have been focusing on their niche expertise. For example, they manufacture either only orthopedic implants or surgical devices.

However, this single therapeutic focus on part of CMOs may not hold water for long. Since OEMs are going on a deal spree, it will become necessary for even CMOs to acquire each other in order to stay relevant in the shifting circumstances.

And perhaps one could argue that CMOs were alerted to this trend in advance as is evident from deals such as Accellent buying Lake Region Medical and Nordion combining its operations with Sterigenics.

While OEMs are expanding their therapeutic focus, there are likely chances of CMOs boarding the same wagon for becoming one stop shop for OEMs. Below are some of the prominent deals that followed the previous mega merger of OEMs (excluding Medtronic-Covidien).

Medtronic-Covidien

Medical device CMOs will further scale up their capabilities in the coming days covering bigger gamut of therapeutic areas through mergers and acquisitions.
Thus far about 30% of top CMO players were involved in either M&A or expansion plans in emerging and developed markets and this trend is expected to continue.

Hence, the deal flow in OEMs and CMOs are going in tandem with each other, which is only expected to bring in benefits for all the players involved.

Below chart shows the therapeutic strengths of top 11 CMOs , which account for almost 60 percent market share, and the potential for future deals that would complement each other's strength areas.

CMOs

Note: Some of the companies which don't operate in major therapeutic areas such as Cardiac & Vascular, Surgical and Orthopedics have been excluded from the above table.