Report on Medical Device Industry — Mass Medic Conference

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Where is the MedTech industry going? A brief report from the MassMedic conference held Friday, November 1 at UMass Boston, follows:

The top ten segments for device development over the next 5 years will not change; the leaders are in vitro diagnostics, cardio, diagnostic imaging, ortho.

R&D is predicted to grow at an annual rate of 3.9%, remaining on average at about 6% of sales; but the top twenty companies will spend at a higher rate.

M&A deals are way off during the first half of 2013; the vast majority of medical device deals still happen in the US.

Similarly, medtech financing is constricted, with a smaller number of smaller deals. There were eight medtech  IPOs world-wide, 6 in the US, in 2013 to date, dwarfed by the number of biotech deals. Leading states for financings: California, followed by Massachusetts (but following pretty far behind).

Seventeen emerging companies pitched to the assembled hoard of investors, entrepreneurs and service providers, at all stages of development. Fields included: regeneration of damaged body parts; software for patient monitoring; imaging, cancer treatment, various diagnostic technologies, orthopedics.

Compared to last year, presenters have learned their lessons: all came prepared to discuss reimbursement and time-lines. Less whining about FDA delays. Reimbursement codes and pricing models to appeal to doctors and to fit into insurance regimes were discussed prominently, along with (of course) focus on patient outcomes.

Wachtell Lipton Firm Takes Some Lumps

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Without question one of the premier lawfirms in the United States, Wachtell Lipton long has represented, and spoken for, “larger corporate interests.”  Today’s news brings us two factoids suggesting that it is not always easy being Wachtell.

First, the Shareholder Rights Project at Harvard Law School (SRP) announced that its efforts  have led to a decrease in classified (staggered) boards among the S&P 500 to less than 10% (considering the Project’s negotiating 99 contracts with companies which have agreed to bring management proposals to declassify).  The SRP then endorses the virtue of declassification as increasing board responsiveness, and cross-links to its prior article entitled “Why Wachtell Lipton was Wrong about the SRP.”  Classified boards used to be favored as a fundamental corporate protector; many of us were taught that you classified your board to make sure management was not sandbagged by those error-prone shareholders.     Wachtell long has been understood (at least in my mind) to favor protections of corporate status quo through board controls (staggered boards, poison pills, etc.) as fundamental to sound management.  How times have changed.

And speaking of poison pills, CVR Energy has just sued the Wachtell firm (and two partners) for malpractice.  Seems that last year Wachtell allegedly advised CVR in the face of Carl Icahn’s takeover bid, and at one point Wachtell allegedly advised accepting an agreement to set aside the CVR pill.  Then Icahn successfully took control.  Now in charge of CVR, Icahn claims that Wachtell hid from the board an agreement that doubled the fees of CVR’s advisers (Deutsche Bank and Goldman Sachs) if Icahn were successful.  So Icahn wins, walks in and find that “his” new company has a $36 Million obligation that (he claims) was hidden from the board of CVR.  It is a strange suit as the malpractice allegedly occurred prior to the time Icahn owned CVR and also facilitated Icahn’s success,  but, of course, it is a corporate debt and he inherits it (the bankers have sued CVR for their fees, claiming they were earned in connection with the May 2012 stock sale to Icahn).

Most of us lawyers recognize Wachtell as a legal powerhouse and a leader in corporate thought and practice.  It seems that not everyone agrees with that perception, however….

FCPA Again

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Today’s email basket contains an SEC announcement of its settlement of Foreign Corrupt Practices Act charges against medical equipment seller Stryker Corporation, involving world-wide corrupt payments to foreign government individuals in an effort to garner business contracts. 

The tab?  About $13.2M in fines including interest of more than $2M!  And some of the matters complained of date back to 2003; the SEC has a long memory.

I have written before about intense SEC and DOJ interest in bribes of offshore government employees to gain business, noting it is a slippery slope.  Many overseas companies are indeed government-owned one way or another, and “grease payments” to individuals affiliated with these companies constitute government bribes.  This is particularly sensitive in, and less obvious in, the life science area where overseas hospitals, for example, are often government institutions.

That said, it is hard to imagine a more uninspired set of alleged facts.  In one Strkyer episode, a payment allegedly was laundered through an offshore lawfirm, booked as a legal fee although no services were provided, and the law firm just forwarded the money.  In another case, a $200,000 donation allegedly was made to a public university in Greece to fund a lab for a public hospital doctor.

My favorite: Stryker allegedly sent a director of a public Polish hospital on a paid business trip– with spouse –including 6 days in New York City, two Boradway shows and five days in that vertibable hub of life science deals:  Aruba.

Stryker’s profits on these deals were about $7.5M.  The net: negative almost $6M, and on top of that all those legal fees….

Women for style (and profit)

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Women have a drive for style and uniqueness, expressed in clothing, jewelry and home goods.  (Men, not so much.)  How do you build a $1,000,000,000 business around this concept? 

The answer is by operating the category leader in internet home goods sales, says Wayfair CEO Naraj Shah, speaking to the ACG-Boston  Breakfast Meeting this morning. 

Targeting the women of  middle market households with incomes of $60,000 to $250,000 per year, and driving flow to its website by aggressive television advertising, Wayfair has an annual order run rate of $1,000,000,000.  Shah expects online orders for home goods to grow to 22% of all sales by 2019. 

Why do people shop on line?  You can do it any time, delivery is automatic and you have a broader selection.  If you are interested in wide selections of styles, shopping on the internet is much more convenient than going to dozens of stores.  Wayfair offers over 7,000,000 items for the home market; examples: 8,000 table lamps, 4,000 bar stools. 

Having so many different items reflects the diversity of the home goods market.  Take for example a comparison of the United States sales of paper goods such as towels, and of lighting.  Each is a $7,000,000,000 annual market.  Paper has about 50 SKUs.  Lighting has about  500,000 SKUs.  Only on-line marketing can capture this product diversity. 

To which factors does Shah attribute the growth of his company?  First, he picked a very large market so  he could continue to compound growth.  Second, he took no outside capital until he had $500,000,000 of sales, allowing him to focus on customer needs rather than on financial targets driven by investor requirements.  Third, he focused first on efficacy of his technology so as to make the online shopping experience simple (“we are a technology company that happens to focus on home goods”). 

Certain elements of the business are intuitively evident: Wayfair does not carry much inventory, using a network of vender fulfillment companies covering 12,000 brands.  One thing that seems counter-intuitive but relates to customer satisfaction: Wayfair takes charge of the entire delivery process, picking up the product, consolidating it and shipping to the customer themselves from various warehouse locations. 

Is there room for growth?  Not only is the market large, but also as of now only about 1% of visitors to the website actually place an order.  Even a modest increase in the sales rate could drive great expansion. 

Finally, what about the high end of the market place?  Wayfair at present has not significantly addressed this market.  But looking at the demographics, the middle market alone is certainly big enough to accommodate growth in  the current business model for a long time.

Board Role in Cyber Security

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 Yesterday’s post outlined  some major issues in cyber security.  From a governance standpoint, in the face of heightened cyber risk, what are the obligations of a board of directors? 

  • Make sure that management develops a “breach plan” that identifies the level of cyber risk you are willing to undertake, and that outlines your legal, contractual and regulatory obligations if a breach occurs.  Identify your legal and public relations team. Determine insurance coverage.  Do you have a plan as to what to say to your customers? 
  • Do not automatically turn over cyber security to your CIO; they are generally not prepared.  If you are large enough, consider establishing a new position of CISO (“Chief Information Security Officer”). 
  • Identify your key protectable elements of information, the “crown jewels, ” and focus on protecting those;  it is not possible to protect everything (there are too many devices plugged into the internet and too many unknown portals into your company). 
  • Apply a goodly portion of your IT budget to both defense against hacks and, perhaps more importantly, immediately discovering hacks so they can be contained. 

Setting up such a system requires a deep dive by the board, initially, in order to establish preparedness.  For ongoing monitoring, consider establishing a risk management committee chaired by in-house counsel, reporting through the CEO to the board.  Arrange for quarterly reports, and deal with cyber security risks as part of enterprise-wide risk management.

Cyber (In)security

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 “There are only two kinds of companies in the United States: those who have been hacked and know it, and those who have been hacked and do not know it.”

Thus spake Richard Clarke, consultant to US presidents, at an October 10 joint breakfast meeting of the Greater Boston Chamber of Commerce and NACD New England.

Also on the panel: Art Coviello, EVP at EMC; Chris Goggans (billed as “one of the world’s most famous hackers” and now vice president of a security consulting firm); moderator Jeff Brown, Chief Information Security Officer for Raytheon.  A subsequent blog will address appropriate director response; below are highpoints of the panel: 

  • Any company’s system can be hacked.  Hacking should be viewed as a risk management issue; what are the “crown jewels” of information that must be protected, and how can you protect that information? 
  • IT systems are dynamic and changing, with  proliferation of devices accessing the internet and your company.  Thus no preventative program is fool-proof. 
  • Every company should have a “warning system” that monitors information systems continually, to find the hack early and thus reduce the “dwell time” during which the hacker is sitting in your system. 
  • Certain foreign governments (China and Russia were mentioned) hack US companies and turn over trade secrets to their own domestic companies. 
  • While at least one major company does not “go to the cloud,” because the cloud broadens the “attack surface” over which an intrusion can occur, smaller companies may be well served in the cloud because they may thus benefit from cloud-based security services they could not otherwise afford. 
  • If you suffer a “material hack,” the SEC requires disclosure by public companies.  Forty-eight states require notice to customers if their personal information is compromised.  Contractual arrangements may require cyber network protection, mediation and indemnification from counterparties. 
  • Publicity  for a company that has been hacked can be devastating; you need a plan not only to limit or shorten hacks, but also to deal with the press, the general public and your important constituencies such as customers. 

Private Equity Update

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 The common wisdom is that private equity funds will purchase a “platform” company, and then seek to build on that platform with “rollups” until a certain enhanced size is reached.  Then, the company can be sold or can go public, enjoying a greater value multiple. 

Not so fast, said a panel of senior private equity professionals at Duane Morris’ October 2 private equity forum held in Boston. 

Participants included Marty Mannion, Managing Director of Summit; Jay Jester, Managing Director of Audax; Tom Wippman, Senior Outside Legal Advisor to Sterling Partners; and Phil Mazzini, former President of H&R Block’s retail business who built that business through “hundreds of acquisitions.” 

The game has changed, agreed the panel, since the old days when the idea was simply to do acquisitions, grow bigger and then assume an enhanced value.  A more sophisticated investment environment requires more than mere conglomeration leading to size, but rather enhancement of the businesses. 

Key points:

  • * It is important to start with a solid platform company with strong, acquisition minded management.  The HR factor, and adequate integration of add-ons, has become central; “in the day,” integration was never looked at, only size. 
  • * Carefully pick an industry in which you propose to do a rollup; is it possible?  You might ask, is anyone in the industry already doing a consolidation?  Although some may think, “no one is doing it so what a great opportunity,” the panel agreed that it is a negative sign when people who know the industry best are not attempting consolidation. 
  • * Finally, the PEs acknowledge that they are unlikely to be able to compete with a strategic buyer.  The strategic simply knows more, knows where cost savings are most likely to occur, and is thus likely to out-bid the private equity fund. 

Changes in Med Device IP

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Protecting the IP of med devices is undergoing rapid change, requiring manufacturers to revisit their IP programs: changes in US and European regulation, convergence of technologies, attacks by patent trolls.

 Some of these changes were outlined at last Friday’s MassMedic conference in Waltham, MA, with presentations by counsel from here and the EU.  Highlights:

            *Last year’s America Invents Act created a more robust method of challenging a patent by a proceeding within the Patent and Trademark Office; the hope was to limit expensive and drawn-out suits in US District Courts.  Unfortunately now many challenges are mounted in BOTH venues, and it is not clear that defendants will be able to “stay” or delay the Court proceedings while the PTO determines patent validity.

            *Convergence of medical technology with other technologies (notably in mobile medicine) has complicated the identification of an alleged infringer.

            *Riding the trend of introducing med devices in Europe before the US to take advantage of what is perceived to be a more manageable regulatory path, the EU is considering a “unitary” patent which, once granted, would cover most EU countries (alas, not all).  (Presently, a grant of European patent must then be “registered” in each country individually.)

            *So-called patent “trolls,” non-operating entities which sue manufacturers seeking royalties for infringement, are turning more to med device companies. Not all such entities are predatory; plaintiffs may include universities, research facilities, emerging companies with innovative technology whose rights are ignored by large manufacturers.  (The methods used to assert claims, the popular courts in which to bring suit, and some strategies to resist were discussed by my partner Tony Fitzpatrick; let me know if you would like to see his power-points on this volatile topic.)

Death of Noncomps?

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Popular and trade press reports indicate that Governor Patrick is supporting legislation that will ban noncompetition agreements under Massachusetts law.  The theory is that noncomps deter mobility, that mobility is good as it fosters competition in the tech sector, and Massachusetts wants to remain a tech hotbed.  (Noncomps have been verboten in California, in most instances, for a long time.)

The issue arises as Massachusetts considers adopting a beefed-up trade secret protection law.  As traditional noncomps often were premised on preventing abuse of trade secrets, the ban on noncomps in light of increased trade secret protection by statute is a logical extension.  Presumably noncomps would still survive if incident to the sale of a business or if the employer is paying the former employee not to work.

This change is long-overdue.  Enforcing noncomps in Mass courts has become difficult and unpredictable, as well as expensive.  Noncomps here go back literally to horse and buggy days, when dairies tried to prevent drivers from going to the competition with knowledge of the milk route and how many bottles of sweet cream Mrs. Murphy liked to take on Thursdays.  But one result will be that employers will have to review their methods of protecting intellectual property; it is better to prevent leaks at the source than to rely on a strenghtened statute after the fact.