While stocks in medical devices, like pharmaceuticals, have underperformed the S&P 500 due to pricing and growth concerns in 2006, the merger and acquisition market remains robust, with many smaller companies now choosing to look for acquirers rather than pursuing the traditional route of the initial public offering as an exit strategy.

Such were the conclusions of Luke Sarsfield, a vice president of investment banking at Goldman, Sachs & Co. (New York), presented during a Tuesday audioconference on med-tech investing, sponsored by AHC Media, publishers of Medical Device Daily.

The market has also seen some “share swings” as a result of technological innovations, with the most recent evidence of that being in the concerns surrounding drug-eluting stents compared to bare-metal stents.

Sarsfield and co-panelist Larry Haimovitch, president of Haimovitch Medical Technology Consultants (Mill Valley, California), were in agreement that management capability – particularly in the view of venture capitalists – is a key element for investor confidence. The panel was moderated by Jim Stommen, national editor of MDD.

According to Haimovitch, just as “location, location, location” is the mantra for success in real estate, in med-tech investing and for company success, the mantra is “management, management, management.”

But why the reticence among med-tech investors?

Sarsfield’s answer: “Concerns about what the top-line growth looks like” is a factor that has weighed on med-tech stocks. Pricing, he said, has also had an impact.

“I think investors have grown more concerned about the pricing environment and the potential for increases not being as robust as we’ve enjoyed here historically,” Sarsfield told listeners. “And I think there has certainly been good reason for folks to draw those conclusions.”

Investor shyness has led to “significant multiple compression” in stock prices, he said, compared to five years ago, even though companies have “actually done well from an operating performance perspective.”

Perhaps because of solid performance, “executive confidence” is high, Sarsfield said, and there is a strong M&A market now, both from a broader healthcare perspective and specifically in the medical device space.

To illustrate, he said that there have been a number of “relatively sizable transactions,” such as the $33 billion leveraged buyout (LBO) of HCA (Nashville, Tennessee), which occurred in July and was the largest LBO of its kind at the time, he said (Medical Device Daily, July 25, 2006).

An example in the device space is Biomet’s (Warsaw, Indiana) announcement agreeing to its acquisition by a group of private investors for $10.9 billion (MDD, Dec. 20, 2006).

“We think this is definitely emblematic of confidence in the executive suite to be focused on the growth and future trajectory of the business,” Sarsfield said.

The downside in this robust M&A environment — depending on which company you’re talking to, most likely — is that investment bankers have seen “hostile activity seep back into the healthcare space,” he said. He cited the acquisition by Boston Scientific (Natick, Massachusetts) of Guidant as the perfect example of that scenario, with Johnson & Johnson (J&J; New Brunswick, New Jersey) jumping into the fray but being outbid by Boston Scientific (MDD, Jan 26, 2006). The Boston Sci/Guidant deal was valued at $27.2 billion.

“We think as assets become increasingly strategic and there is a scarcity or perceived scarcity of high-quality, mid-market assets, you’ll see some of the large cap acquirers move aggressively when they think it’s appropriate to secure these growth platforms,” Sarsfield said.

There is room for hope, especially in the smaller companies, where much of the innovative R&D is taking place, the two panelists agreed. However, Haimovitch pointed out that smaller company products have to be better than those of their larger competitors.

Also required are the key elements of solid executives with good leadership and communication skills, and a business story that attracts adequate funding, which Haimovitch called “the fuel in the tank.”

It should come as no surprise that investors are also looking hard at the executive abilities of companies where they choose to place their bets. As Haimovitch said: “management is a key element of due diligence.”

The old “war horse” sectors have slowed a bit in the last three years, in part because of their basic structure, the panelists said. The top five players control greater than 90% of market share in cardiovascular, and the top six players control greater than 80% of the market share in orthopedics.

The panelists said that some of the promising areas for smaller companies — and robust growth for those companies — relates to our aging populations.

Sleep apnea — just one of the increasing problems of aging — showed growth of 114.2%, according to Sarsfield. And other sub-sectors are growing rapidly — such as dental products (97.8%) and ophthalmics (82.5%)

Lasik is also very promising, Haimovitch said, with Lasik treatment now being performed on about 1.5 million eyes a year at $2,000 per eye, about 98% from private pay.

The aesthetics sector, due to its reliance on private payors, is also a highly promising area, panelists agreed.

Haimovitch added that the area of stroke treatment is another sure growth opportunity. Stroke is “very poorly treated” in the U.S., he said, with 85% of strokes occurring in the U.S. characterized as ischemic.

Last but not least, a significant trend that will be driving future growth — and consequently future investment — will be this much-bandied-about term “convergence” of technologies in the medical device industry.

“I know it’s clearly on the minds of many of the big healthcare conglomerates,” Sarsfield said, noting a growing realization that “in the future, many of the therapeutic treatments are going to require a combination potentially of a specialized diagnostic, blended with a potentially device-based delivery system, to get site-specific delivery of a biologic compound.”

Sarsfield said it is “very obvious” that device companies need to lead the charge on this front, since they are “uniquely situated . . . to provide access virtually anywhere within the body.”

A CD recording of the audioconference reported on here, “The Climate For Investing In Med-Tech — What You Need To Know,” is available from AHC Media for $299. Please call customer service toll-free at (800) 688-2421 or, outside the U.S. and Canada, (404) 262-5476.