AAOS Preview: New Funding Models Key; Regenerative Tech Will Reshape Orthopedic Landscape
By Christopher Delporte, Editorial Director
Prior to the kickoff of this year’s installment of the American Academy of Orthopaedic Surgeons (AAOS) annual meeting
at the expansive McCormick Place convention center in Chicago, Ill., Orthopedic Design & Technology
caught up with Christopher Velis, president and CEO of MedCap Advisors
(pictured left). The Cambridge, Mass.-based firm provides merger advisory services, strategic consulting and valuation services to medical technology companies. MedCap also collaborates with major universities by investing in and founding new medical technology companies through its fund, GreyMatter Health Ventures
Velis has spent more than 20 years as an investment banker, consultant and venture investor in medical technology. He shared some of his industry insight with ODT
prior to the AAOS meeting. Velis holds very strong opinions about the current state of investment in orthopedic technology, what’s needed to spur continued funding for new product development, and how, if government isn’t careful, the United States could lose its spot as a market leader in medical device innovation.
The following are excerpts from our conversation.
Orthopedic Design & Technology: Depending upon whom you ask, you get very different pictures of the future of the orthopedic device market. For some, it’s a story of doom and gloom, while other sectors still paint a rosy picture of the marketplace. How would you rate the current state of innovation in the orthopedic sector?
There are some specific reasons for the differences of opinion. If you step back from asking people at particular companies and look at the whole industry, what you have is a fragmented situation. Some companies have access to funding and partnerships, and some companies have found themselves really contained because of the state of the capital markets, particularly the state of the venture capital community, which is not flush with cash. So, as a result, many of companies that would have been “layups” for venture capital five years ago are finding themselves very constrained, and that’s a problem because it certainly hinders innovation. It also hurts valuation. And, to me, that’s clearly not a positive trend. That said, when there is a lack of capital, other sources step in to fill the void. Traditional venture financings are getting back-filled by angel investor who are emerging en masse and providing lots of capital for developing technology. Wealthy families are stepping in to make investments, and sovereign funds from around the globe also are stepping in and making investments.
More importantly, stragtegics [larger orthopedic companies] are looking at deals a little bit differently than they were a few years ago. They are increasingly willing to make investments or strike partnerships that align the interests of newer technologies with their need for a developing pipeline. This is a really important factor, and it is motivated by their mutual interest. A little company needs funding, needs partners. Big companies have distribution channels, but most of them aren’t particularly good at developing new technology, especially companies in orthopedics. They’re much better at sales, distribution and marketing. And so those partnerships are starting to make a lot of sense. It’s not surprising that you’re getting doom and gloom from some and enthusiasm from others. Many companies are operating in the old paradigm of how to get funded. And as long as they’re operating in that old paradigm, you’re going to see gloom and doom. So, if you’re able to step out of the old venture paradigm and look for new sources of capital and new structures, you’ll see exciting possibilities. We’re in a transition period. I don’t see the traditional venture capital markets for orthopedics coming back any time soon.
ODT: What kind of companies will be most successful in this new reality? What are the biggest opportunities?
They fall into a couple of categories. The first one is companies that can validate the market by generating some sales on their own prior to trying to develop an exit are always looked upon favorably. Because their concept is proven, they have their regulatory approvals and nobody has stepped out to try and copy them. So that becomes a bit of a no-brainer. The second category is technology that’s disruptive, that has really destroyed—or has the potential to destroy—existing markets. And those are more risky because they’re not validated by the market. But they are much more exciting. They have a lot of potential. We’re interested in both categories, but the disruptive ones are what you really have to pay attention to, and there will be companies that emerge and will threaten existing markets. They are not about just another device for sales people to have in their bags. That kind of technology tends to grow exponentially. Here’s an example from another market: stents. Regular stents had re-shaped the cardiovascular market. Drug-coated stents come along and the traditional stent market was nearly destroyed. Disc implants had the possibility of doing the same thing. Motion preservation could have been entirely destroyed the fusion market. That’s why you had you had such a rush to pay big money for Synthes, for example. Synthes paid good money for ProDisc [artificial disc]. The Charité [artificial disc] was acquired by Johnson & Johnson for big money. It didn’t pan out because reimbursement didn’t pan out, but it was a real threat.
There are real threats that exist in the market today.
The number one category is biologics. Regenerative medicine is a real threat to metal implants, and we’re seeing it become integrated into practice on a daily basis. We’re seeing more approvals happen. We’re seeing the FDA (U.S. Food and Drug Administration) get clarity on how these products are going to be treated. And the nice thing for those developing [the technology], many of them are not drugs, so the regulatory approval process is potentially a reasonable and cost-effective one. So, autologous and transplant tissues, allograft tissues and new forms of allograft and autologous tissues like stem cells, peptide protein extracts, all could seize or stop degenerative orthopedic disease and potentially delay the need for implants. And, in some cases, there is technology that might even threaten the need for implants. I have no doubt that this will happen in the long term, that we’ll see increasingly fewer metal and PEEK (polyetheretherketone) implants going into the human body. We’re going to be better able to regenerate the tissues. And you’ll hear from many of the big strategics that think in terms of linear growth—converting one surgeon at a time. But if you go out in the marketplace and talk to the surgeons, talk to the companies that are succeeding in selling to them, look at the adoption rates and see that patients are willing to pay for some of these out of pocket, you get a better understanding of just how disruptive some of these technologies can become.
ODT: Where are the biggest challenges to innovation?
Innovation is hurt by the reality of our healthcare system. There are a number of issues we’re dealing with. We have a shortage of capital, which we talked about; a device tax in a market where we’re trying to decrease the cost of implants, raises cost rather arbitrarily; and an FDA that is often difficult to navigate because it is too protective the status quo—though very protective of patients, of course—but much more protective of the status quo than other regulatory body worldwide. And, often with new technologies, [the FDA is] unclear about the approval process, which leaves a struggle between innovators and the federal government.
That said, we’re way too centered on what’s happening in the United States. There are place in the in world where these technologies are much more easily studied. Europe is a very good example. Under the CE mark, Europe puts much more power in the hands of physicians to decide what we’re going to try and what we’re going to get feedback on. It’s very likely that we’re going to see new technologies validated, tested and approved in other parts of the world and that data being collected more rigorously and used with the FDA to try and get approval in the United States. Once the data is collected—and this is very much a data game—it’s very much a cascading situation where the markets are eventually going to have to open up to these technologies.
ODT: How will this market continue to evolve?
First you have to look at the continuum of care. It starts with aspirin and anti-inflammatories. Then you work into a whole slew of drugs and pharmaceuticals. And that universe is going to grow for the treatment of orthopedic pain. Then you get into things that are a lot more interventional such as platelet-rich plasma. Though there is some controversial evidence, there are applications where platelet-rich plasma has very positive data and is being used. There are other applications where it is questionable. But it can be injected or used in a surgical environment. Move one step further and you look at companies like Parcell Laboratories
that have proprietary stem cell technologies that are designed to be used in spine surgery and appear to have very favorable outcomes and you see interesting products coming onboard. BMP (bone morphogenetic proteins, which are intended to stimulate bone growth but have come under pressure due to accusations of off-label use and marketing practices), although threatened, has been a huge market for companies like Medtronic. It’s a billion-dollar market, but decreasing. It will continue to be under pressure by lots of other technologies with fewer or different sets of side effects or those that are maybe less expensive, but it set the direction for regenerative medicine. You also can’t deny that companies such as Musculoskeletal Transplant Foundation
(MTF) and Allosource
are leading the way with human tissue transplant. While we’re now transplanting bone and demineralized bone matrix and small pieces of cartilage, I have no doubt that the transplants are going to go down to the cellular and molecular level. These are organizations that are set up to do the research. MTF’s mission is to do research around regenerative medicine using human tissues. They’re probably a half-billion-dollar organization. And they’re partnering with companies like ConMed, Johnson & Johnson/Synthes and Orthofix, which makes them a very powerful contender in the direction that orthopedic medicine is going—same thing with Allosource.
ODT: Physicians often can be a stubborn lot, slow to change. How would you rate orthopedic physician acceptance and adoption of non-traditional technologies?
They can be stubborn and slow to change, but there are thought leaders in very sub-segment of orthopedics. But when you start talking about those more regenerative, earlier interventions, I’m seeing a lot of enthusiasm around it. I don’t think everyone is going to adopt quickly. There will be a lot who wait and see. But 10-20 percent of the market is going to see an opportunity to intervene sooner to get better outcomes to delay major surgeries. And there are 10-20 percent of patients that can pay out of pocket if these procedures aren’t reimbursed. So you’re going to see a lot more of them happening.
ODT: What are your expectations for predominant themes for this year’s AAOS annual meeting?
There’s a bunch of thing I expect to hear—some louder than others. We’re going to continue to hear frustration over taxes—on two fronts. On one front it’s about capital gains taxes. For any investment, [capital gains taxes] make it less attractive to put money into early stage companies. The second is the medical device tax. The combination of the two is doing medical technology in the untied states absolutely no favors, and they’re helping us to lose our competitive advantage to Europe. The second is the biologics theme. You’re going to hear frustration about how the FDA is frequently unclear about the approval process for various biologics, and you’re going to hear that there is a vast number of biologics in the review pipeline trying to seek clarity and seek clear paths to market. And I think we’re going to see that everywhere.
ODT: How do companies need to retool their thinking about doing business in the orthopedic market? Is there a message that’s being missed by national lawmakers?
You add taxes, an uncertain regulatory process and both capital gains and medical device taxes, and you’ve got a major problem brewing with desire to invest in medical technology. That’s something that the federal government and that our senators and representatives in Washington [D.C.] should pay very close attention to because it puts us in a situation to losing our edge in medical technology to other parts of the world. It doesn’t mean, however, there aren’t paths [to market] here. The winners are going to be companies that absolve themselves from the paradigm of only getting venture capital. It is a very unlikely path unless you’ve had some very major exits in the path. A guy like Fred Moll—who founded Intuitive Surgical, is on the board of Mako Surgical and is a guru in robotic surgery—he’ll get funding in this environment and go onto the next big project. It’s not like that for everyone else, and it’s important for entrepreneurs to start thinking about alternate sources of funding, to think about angel funding, looking at outside U.S. funds, and mostly partnerships and aligning with major strategics. Those are the ways to weave yourself through a very difficult path.
Investors are going to have so start thinking very globally. There’s going to be price pressure on anything used in healthcare. Demographics are going to outweigh that. You look at an aging United States, growing China, and most of all a huge population surge in India, and there’s absolutely no question that the number of patients on the planet is going to double and triple. There will be a huge need for medical technology and device, but a need for inexpensive and efficacious technology. So we need to stop thinking about high-profit, 90-percent margin implants. We need to start thinking about three things: Does it save the hospital money? Does it prevent suffering? Does it save lives? If entrepreneurs are thinking about those three things with a global perspective and thinking innovatively about sources of capital and partnerships with large companies with distribution networks, they’ll succeed. Short of that, it’s a really hard path.
[The medical device tax] should be repealed; it shouldn’t have been implemented in the first place. When I look at it, [the United States has] the best scientific minds in the world. Our firm is located smack in the middle of Harvard University (in Cambridge, Mass.), with MIT and Boston University close by, and Mass[achusetts] General Hospital on the other side of the [Charles] river. We have some of the best minds in the world right here in the Boston area. And that goes for many other parts of the United States—the best scientific minds and best resources. But we’re not demanding that the FDA be really clear about what it takes to get approval around innovative classes of products. Increasing capital gains tax on medical device investment when our goal is to drop the cost of healthcare makes no sense to me. This kind of investment should be privileged, not taxed at a higher rate if you’re going to risk your capital in this technology. And If you’re going to lower the cost of healthcare, why are you going to tax the devices used to treat patients? That makes no sense. It will raise costs. It’s going to defer investment into what is one of our national treasures—our knowledge around medical science and healthcare.