Medical Device Link.

Ten medtech companies went public in 2000. Here's how they're faring, and what their performance means for future debuts.

It wasn't so long ago that highly successful initial public offerings (IPOs) headlined most news programs and fed the get-rich-quick dreams of entrepreneurs everywhere. In 1996, 46 medical technology companies went public. Times change, however, and as companies failed to deliver the spectacular—but perhaps unrealistic—gains demanded by investors, the number of IPOs declined. In 1999, no medtech IPOs occurred.

In 2000, the medtech IPO market rose from the ashes, with 10 companies selling shares to the public for the first time—and providing interesting insights into what may or may not affect a company's attractiveness to potential investors (see Table I).

A Quarter-by-Quarter Scorecard

During the first quarter of 2000, exceptional investor exuberance created an IPO market that raised more capital than any other quarter in the history of the new-issue market—despite broader market volatility. Strong demand for technology and healthcare offerings opened the window for 126 IPOs that raised a combined $20.4 billion in capital.

Because of the exceptional momentum of the first quarter, many companies saw their initial filing ranges revised upward, but still found their shares selling at prices well above even the adjusted levels. On average, companies witnessed a 38% increase in their share price between filing and offering.

In the healthcare sector, biotechnology offerings dominated the IPO market both in the number of deals proffered and in the amount of capital raised. All told, in 2000, 67 biotechnology IPOs raised nearly $6.8 billion. Despite the receptive market, only one medtech IPO, Aspect Medical Systems Inc. (Newton, MA), priced during this quarter.

Coming off the stellar performance of the first quarter, the second quarter proved more challenging as concerns about rising interest rates and broader market volatility softened the IPO market. In April, 60 deals were officially withdrawn or postponed, the highest monthly total ever. Consequently, investors not only became more cautious, but they also focused more on valuation than was the case in earlier offerings.

Despite the downturn, biotech remained strong in the second quarter. Three medtech companies—Oratec Interventions Inc. (Menlo Park, CA), Sonic Innovations Inc. (Salt Lake City), and Intuitive Surgical Inc. (Mountain View, CA)—took advantage of this momentum to make their debuts in the public markets.

Early in the third quarter, the hot, albeit narrowly focused, IPO market finally began to expand beyond telecom infrastructure and communications companies. Underwriters took advantage of favorable market conditions and bombarded the market with a record 129 IPOs, raising a combined $20.8 billion. In turn, the large number of offerings allowed investors greater selectivity in choosing deals, resulting in renewed emphasis on growth and proven business models.

From July through September, healthcare IPOs weathered increased pricing pressure yet led the IPO markets in terms of activity and after-market performance. It was during this period that most of the year's medtech IPOs came on the market. Vascular Solutions Inc. (Minneapolis), Rita Medical Systems Inc. (Mountain View, CA), Regeneration Technologies Inc. (Alachua, FL), American Medical Systems Inc. (AMS; Minnetonka, MN), Curon Medical Inc. (Sunnyvale, CA), and Wilson Greatbatch Technologies Inc. (Clarence, NY) all completed their initial offerings by the end of September.

After a strong showing during the first nine months of the year, medtech IPOs lost their sizzle in the fourth quarter. The proverbial "four horsemen of the offering-market apocalypse"—fear, uncertainty, disappointing earnings announcements, and deteriorating market conditions—combined to quell interest in potential IPOs. Uncertainty surrounding the presidential election, high-profile earnings disappointments by numerous technology blue chips, fears of a hard landing by the economy, and a black-and-blue broader market all coalesced to scare away would-be investors. Given such conditions, no medtech IPOs were completed. The new-issue market, which opened the year with much celebration and frenetic activity, rang out 2000 very quietly.

Class of 2000 Upstarts

While last year's crop of IPOs represented the rebirth of the medical technology capital markets, it also was distinct in that the class of 2000 was much more regimented than in years past, with each company falling into one of three groups: upstarts, trailing-revenue stories, and reverse-leveraged buyouts. The overall performance of each group proved disparate, with significant deviations occurring even within each subclass.

The EndoWrist instruments by Intuitive Surgical allow surgeons to operate through 1-cm ports.

The first group of IPOs consisted of upstart companies, or firms that currently generate little or no earnings but are expected to sharply increase revenues in coming years. To date, the four companies in this group—Intuitive Surgical, Vascular Solutions, Rita Medical Systems, and Curon Medical—have run the gamut in performance.

Intuitive Surgical designs and manufactures the daVinci surgical system, which "seamlessly" translates natural hand movements made by the surgeon at a console into corresponding micromovements by instruments inserted into the patient through small incisions. Through this technology, surgeons achieve a level of minimally invasive fine-tissue control previously available only through direct manual manipulation, reports the company.

Intuitive Surgical went public on June 12, and raised $45 million by offering 5 million shares at $9 each. Intuitive did not experience the huge, one-day jump in price witnessed by some other offerings during the same period; instead, it closed at $9.03 after its first day of trading. While Intuitive's shares dropped as low as $7.88 in late June, the stock recovered, closing at $15 per share, up 66.7%, at its 30-day mark. Intuitive closed December 29 at $8.50 per share, just below its offering price.

A significant factor stabilizing Intuitive's stock price is the strong reviews the daVinci system is receiving from surgeons. While widespread cross-procedural platforms are still largely in development, cardiovascular sources say that the daVinci system results in quicker patient recovery and dramatically less-invasive procedures. Such news is music to investors' ears.

Despite the alluring opportunities for developing the daVinci system for additional specialties, the company faces some dark clouds on the horizon. Computer Motion (Santa Barbara, CA) recently filed a lawsuit against Intuitive, citing patent infringement. While any settlement is months—and most likely years—away, the case casts a shadow over Intuitive's immediate future.

Vascular Solutions manufactures, markets, and sells the Vascular Solutions Duett sealing device, which is a combination balloon-catheter delivery system and biological coagulant that is used to rapidly seal catheter puncture wounds. The device is marketed to interventional cardiologists and radiologists for use after angioplasty, angiography, and stenting procedures.

Vascular Solutions went public on July 20, raising $42 million by selling 3.5 million shares at $12 each. From there, the company never looked back. It closed at $16.50 on its first day of trading, and by the end of its first 30 days, shares were up 33.9% to $16.06. Its stellar initial performance was clouded by a weaker-than-expected earnings report late in the year that caused investors to slam the stock to its close of $7.38 on December 29.

The Duett sealing device by Vascular Solutions is designed to rapidly seal the femoral artery puncture site.

Two key factors should drive Vascular Solutions' growth. First, it has demonstrated strong customer retention: 85% of client laboratories have placed additional orders for the Duett system. Second, as of October, Vascular Solutions had barely penetrated the catheter lab market, which should account for massive market growth in coming quarters. These two factors, combined with the Duett system's strong average selling price and management's emphasis on supervising overall expenses, create a strong foundation for the company's future prospects.

Rita Medical Systems develops, manufactures, and markets a system of disposable needle electrodes and radio-frequency generators that use radio-frequency energy to heat solid benign and cancerous tumors to the point of ablation, or cell death. While this system was initially created to treat liver cancer, Rita is looking to expand the product's use into treating other liver ailments, such as unresectable liver lesions, as well as other forms of cancer, such as bone, breast, and lung cancers.

Rita debuted on July 27, just one week after Vascular Solutions, and raised $43.2 million on the sale of 3.6 million shares at $12 each. While Rita ended its first day of trading up $1.81 to $13.81, it lost steam as the month progressed, closing out its first 30 days at $11, down 8.3%. While Rita spent much of the year hovering at or near its offer price, late fall did not treat the company well, and as of December 29, shares were trading at $8.50.

The recent sell-off of Rita shares presents something of a paradox. On November 28, the company released clinical data that showed successful use of the Rita system to treat malignant breast tumors. Furthermore, several research analysts have expressed support for the company, reiterating their "buy" ratings and asserting that current valuations present tremendous buying opportunities. Despite the seemingly good news, the stock continues to trade some 30% below its IPO price.

The Model 1500 RF generator by Rita Medical Systems is designed for use in percutaneous, laparoscopic, or open procedures.

Curon Medical develops, manufactures, and markets the Stretta system (primarily a mix of radio-frequency generators and single-use disposable devices) for the treatment of gastrointestinal disorders, specifically gastroesophageal reflux disease (GERD). A second product, the Secca system for the treatment of fecal incontinence, is currently in development.

Curon priced its IPO on September 22 at $11 per share, raising $55 million in gross proceeds. The stock has been relatively stable since its IPO, with closing prices ranging from $10.06 to $14.13. Curon's stock reached $12.38, 12.5% above its offer price, 30 days after its IPO, yet took a nosedive starting in early December. The stock finished the year at $4.02.

The company is currently trying to break into a market with well-entrenched competitors, but its Stretta procedure is less invasive than surgery and provides favorable economics for patients, providers, and payers. Further, clinical results lead analysts to believe that there will not be a prolonged adoption period for the Stretta procedure because it has proven quite effective at treating GERD. In the near term, the company plans to continue ramping up its customer base and building its sales, marketing, and distribution infrastructures, which also should bode well for future earnings.

Trailing-Revenue Companies

Companies with at least $30 million in trailing revenue (i.e., revenues posted within the past 12 months) made up the second group of IPOs. While the revenues of this group—comprised of Aspect Medical, Oratec Interventions, Sonic Innovations, and Regeneration Technologies—are not expected to shoot to the moon with the same momentum as those of the upstarts, they are expected to post relatively high revenue growth in coming quarters. Interestingly, these IPOs have fared the worst through the market downturn, losing, on average, 39% from their offering price.

Aspect Medical develops, manufactures, and markets anesthesia-monitoring devices that enable the operator to assess and adjust a patient's level of consciousness during surgery. The company developed its current line of monitoring equipment based on its patented core technology, the FDA-approved Bispectral Index (BIS Index). The BIS Index directly measures the effects of anesthesia on the brain, and allows greater control over patient consciousness during procedures.

Aspect Medical went public on January 27, making it the first medical technology company to debut in 2000. The company raised $52.5 million, offering 3.5 million shares at $15 each. The offering was an immediate success, with shares closing at $28.25 after the first day of trading. Within a month, shares had shot to $43.13, representing a 30-day return of 187.5%. However, this momentum could not be sustained, and shares settled back near their offering price by midspring. As of December 29, shares were trading just shy of $9.

The Stretta system by Curon Medical is designed for the treatment of gastroesophageal reflux disease (GERD).

Aspect's stock softened for several reasons. Sales of the BIS systems have not increased in line with projections, primarily because of unforeseen competition in the sector and the reluctance of hospitals to invest heavily in new, noncritical equipment. In addition, while the initial adoption of BIS systems by hospitals across the country fueled early growth, second-stage adoption has not met with the same exuberance. Many potential buyers have adopted a wait-and-see mentality, choosing to wait until Aspect's competitors have introduced new products before making a purchase decision.

Oratec Interventions develops and markets minimally invasive devices that use controlled thermal energy to treat spine and joint disorders. It currently markets two devices, the SpineCath IntraDiscal Electro-Thermal Therapy system (IDET) for low-back pain and the ElectroThermal Arthroscopy system for joint disorders, that incorporate this technology to modify, cut, or remove damaged tissue.

Oratec went public to a receptive market on April 4, and earned $56 million by offering 4 million shares at $14 each. From there, Oratec experienced a performance trajectory similar to that of Aspect's. By the end of the first day, shares were trading at $25.63, and within a month, they had reached $36.75, representing a 30-day return of 162.5%. Following in Aspect's footsteps, however, Oratec also witnessed its share price deflate significantly, to a year-end price of $5.13.

While the arthroscopy division remains strong, the chief culprit for Oratec's troubles lies with providers' inability to get reimbursed for IDET therapy, which has understandably spooked Wall Street. Despite this setback, the spine business still holds promise, the IDET procedure continues to gain popularity, and steps have been taken by Oratec's management to secure reimbursement for the IDET procedure.

The SpineCath IntraDiscal ElectroThermal Therapy system by Oratec Interventions offers treatment for degenerative disc disease.

Sonic Innovations designs, manufactures, and markets advanced digital hearing aids and hearing components. Sonic has developed and patented a digital signal-processing (DSP) technology which is embedded into a miniature single-chip platform. The company sells two lines of hearing aids, the Conforma and the older Natura, both of which incorporate Sonic's proprietary technology.

Sonic went public on May 1 and generated $50.4 million on the sale of 3.6 million shares at $14 per share. While Sonic closed the first day at $21.13, it did not experience the same initially astronomical growth as those companies that went public earlier in the year. At the end of 30 days, the company was trading at $16.56, up just 18.3%. Furthermore, like those that went before, Sonic's share price eventually settled below its offering price. The stock was trading at $6.69 as of December 29.

Problems for Sonic stem from difficulties with one major OEM customer that had signed contracts to purchase Sonic's DSP chip hybrids in both the last quarter of 2000 and in 2001. Questions have arisen about the customer's orders and its willingness to pay. As of October 25, the OEM owed Sonic more than $8 million on previous orders. As a result, Sonic has removed all of the OEM's contract revenues from its 2001 operating plan, leaving any future payments as an upside surprise. Further, given the variable nature of OEM revenues, Sonic has refocused its business strategy to concentrate on its branded business, since audiologists have had strong success with these products. This change may well shore up the company's sagging share price.

Regeneration Technologies is a leader in the use of natural tissue and innovative technologies to repair and promote the healing of bone and other human tissues. The company processes a wide range of musculoskeletal allograft tissue, or tissue recovered from deceased human donors, for biologic safety and implant mechanical characteristics. Surgeons then use these tissues in procedures to mend a variety of bone and tissue defects, including spinal vertebrae repair, musculoskeletal reconstruction, fracture repair, repairs to the jaw and related tissues, and treatments for urinary incontinence and heart valve disorders.

Regeneration Technologies went public on August 9 in a very busy offering market. The IPO brought in gross proceeds of $79.8 million at an offering price of $14 per share. The stock has moved little since its offering, dropping 12% to $12.31 30 days after its debut, and closing at $14.25 on December 29.

The Natura digital hearing device by Sonic Innovations.

Despite the current sluggishness of Regeneration Technologies's stock, the company's third-quarter results show revenue and earnings growth of 63% and 128%, respectively, over the same quarter a year ago. Both figures were slightly above analysts' expectations. The company also plans to drive gross margins higher by altering its product mix and reducing tissue-processing costs. In coming years, Regeneration Technologies plans to build on product innovation and take advantage of its significant distribution agreements with market leaders in spine care and urology, as well as a diverse product portfolio targeting unmet industry needs.

Reverse-Leveraged Buyouts

The final group of IPOs in 2000 consisted of reverse-leveraged buyouts. Relative old-timers, AMS and Wilson Greatbatch Technologies were both founded in the early 1970s, and both have a stable revenue base exceeding $85 million. These two IPOs were the most successful of 2000's offerings, gaining an average 35% over their offering price.

AMS supplies medical devices to physicians specializing in the treatment of urological disorders. AMS markets a broad line of proprietary products that focus on incontinence, erectile dysfunction, and prostate disease. The company benefits from its long-standing reputation for quality, excellent relationships with leading urologists, and leading market positions for artificial urinary sphincters, penile prostheses, and urethral stents.

On August 10, AMS priced 6.25 million shares at $11 each, making it one of 28 IPOs that debuted the week of August 7. Despite only 5% growth in its first 30 days, the stock eventually jumped 77% from its offering price, closing at a high of $19.50 on October 25. Overall, AMS has been spared from the carnage experienced by many other medtech IPOs as well as the broader markets, trading at $15.88 on December 29.

Top-line revenue growth for AMS is expected to accelerate from 4% in 1999 to 16% in 2002, due primarily to acquisitions and increased product development. The company plans to funnel this increased revenue into leveraging its sales force and cost structure in order to increase operating margins from 4% in 2000 to 17.9% in 2002. These expectations, coupled with a new management team and a strong product pipeline for the next four years, position AMS nicely for future growth.

Wilson Greatbatch Technologies develops and manufactures power sources, feedthroughs, and wet tantalum capacitors for implantable medical devices, allowing such devices to become progressively smaller, longer lasting, more efficient, and more functional. Customers include leading defibrillator makers such as Guidant (Indianapolis), St. Jude Medical (St. Paul, MN), and Medtronic (Minneapolis). The company has also leveraged its core competencies to develop and produce power sources for commercial applications in such other fields as aerospace, oil and natural gas exploration, and oceanographic equipment.

Wilson Greatbatch went public on September 29, raising $80 million on the sale of 5 million shares at $16 each. Since debuting, Wilson has performed quite well compared with the other medtech IPOs of 2000, ending its first 30 days up 56% from its offering price. This momentum has continued; Wilson's stock was up 61%, to $25.81, on December 15. This strong growth is accentuated when compared with the average –17% performance evidenced by other 2000 medical technology IPOs.

Wilson Greatbatch is well positioned to ride the present growth in cardiac rhythm management, allowing it to expand its product offerings to the medical device industry. The company also has an excellent management team and operations process in place. Lastly, the proceeds from Greatbatch's IPO free up its capital structure, enabling it to consider additional acquisitions that will ultimately add to revenue growth.

Looking Ahead

As election uncertainties fade and expectations of lower interest rates are realized, the new-issue market will undoubtedly heat up again in the first quarter of 2001. The market in general should stabilize, and this year's IPO candidates should then benefit from a renewed emphasis on performance as well as an overall calming of the broader markets. Investors will have a wealth of companies to choose from: the adversity of 2000 has left several quality medical technology IPOs in backlog, all of which should make their debut this year. Thus, analysts, investors, and entrepreneurs alike are greeting 2001 with optimism.

Jason Brillantes and David DuBois are investment banking analysts on the medical technology team for U.S. Bancorp Piper Jaffray (Minneapolis).

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