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How to Get Rich Investing in Stocks by Riding the Electron Wave

Medical Tech Shifts from High Gear into Overdrive

Companies / Healthcare Sector Aug 20, 2014 - 10:45 AM GMT

By: TLSReport


Rapid growth in the medical device industry and changes in the regulatory environment have propelled valuations in the medtech sector to the high end of the range. But new technologies create new investment opportunities. In this interview with The Life Sciences Report, William Plovanic of Canaccord Genuity highlights investment opportunities in medtech companies with innovative products targeting high-impact areas such as obesity, diabetes and wound care.

The Life Sciences Report: Canaccord Genuity is an investment banking firm focused on growth companies. Can you comment generally on the outlook for medical devices?

William Plovanic: I would say the medical device sector has, over the last couple of years, provided very solid returns for investors—especially in 2013. As we've moved into 2014, it's been more challenging for some of the high-growth companies. Valuations moved up significantly in 2013, and companies fundamentally did very well also. But given where valuations stand, it's been a tough road in 2014 for medical device company stocks. These stocks are at the higher end of long-term ranges.

TLSR: Are you looking at limited, short-term growth for medical devices?

WP: Fundamentally, there continues to be innovation. There is always room for advancement and improvement in procedures, and in related outcomes. The goal is to achieve a result less invasively, more quickly and with a better outcome for the patient.

TLSR: Are medical devices advances then the focus of the stocks you cover in this sector?

WP: Yes. Typically, we take a thematic approach. I co-cover medical devices at Canaccord Genuity with Jason Mills. In my universe, I think wound care, obesity and diabetes are growth areas going forward, with almost epidemic proportions of these types of diseases affecting the U.S. and global markets. Jason covers cardiovascular, women's health and imaging.

TLSR: What about orthopedics?

WP: I would say orthopedics is still growing but is, as medical devices are concerned, a more mature market. If you think about wound care, obesity and, to a lesser extent, diabetes, the technologies are still advancing, providing potentially improved outcomes for patients. We're in the earlier stages of the growth curve for medical device technologies for these indications. We're probably earliest on the growth curve for obesity, with wound care and diabetes following, respectively.

TLSR: What draws you to the medical device sector?

WP: I believe in the tangibility of these technologies. They're something you can hold in your hands. You can talk with patients about the outcomes and potential benefits. You can also talk with physicians about faster and easier procedures, and better and more reproducible patient outcomes.

TLSR: What are some of your favorite medical device companies?

WP: In the wound care space, my favorite company is MiMedx Group Inc. (MDXG:OTCBB), which is providing better, faster and cheaper technology compared to current therapies.

In obesity, we believe that EnteroMedics Inc. (ETRM:NASDAQ) is about to gain U.S. Food and Drug Administration (FDA) clearance for VBLOC, the first medical device for obesity to come to market in the U.S. in the past decade.

In diabetes, we like the continuous glucose monitoring technology developed by Dexcom Inc. (DXCM:NASDAQ) and the disposable patch insulin pump developed by Insulet Corp. (PODD:NASDAQ). These two fairly well-known small-cap medtechs are on the larger size, with market caps at about $2 billion ($2B) for Insulet and $3.3B for Dexcom.

In the orthopedics space, we think it's more about incremental improvements to existing procedures. Our favorite play in that space is NuVasive Inc. (NUVA:NASDAQ), which focuses on spinal fusion. It is a sizable company at this point, with a $1.68B market cap. We also cover Exactech Inc. (EXAC:NASDAQ)), which is one of the smaller players in knees and hips but has done a great job in the extremity market with its shoulder product.

TLSR: There are a lot of players in the orthopedic space. What makes Exactech and NuVasive stand out?

WP: Exactech has created a reverse shoulder, in which the location of the ball and socket are reversed, and a regular shoulder trauma product line that have been extremely well received, gaining approximately a 15% market share. The company's products allow reproducible procedures that are easier for surgeons. In the reconstruction segment of orthopedics, one usually thinks of knees and hips, and not extremities. The extremity segment continues to be a high-growth market. The shoulder is the largest joint after the knee and hip, and represents the fastest growing total joint market, growing in the low to mid-teens annually.

NuVasive works in spinal fusion. While a more mature market, spinal fusion is also considered a more discretionary market. With the recent recession, procedure volume slowed, and pricing has dropped by 3–5%/year over the last couple of years. NuVasive pioneered a new market—lateral approach for spinal fusion, which comes in from the side rather than the back or the front. The benefits of the lateral approach include a smaller incision, a shorter hospital stay, reduced blood loss and a quicker overall recovery time. Since 2013, NuVasive has been able to maintain its share and reinvigorate its standard fusion product line. The company is the leader in education for lateral approach, and a primary source for surgical training in that area.

TLSR: Let's move to obesity. What makes the EnteroMedics product stand out when compared to more traditional obesity treatments, such as gastric bypass or simple diet/exercise programs?

WP: Diet and exercise does not last long term for a majority of the patients, and therefore, an alternative is needed. Statistically, about two-thirds of the U.S. population is obese or overweight, and this does not include the childhood obesity epidemic. We are looking at a pretty large market opportunity. The fallout of obesity is type 2 diabetes and related comorbidities including high blood pressure, all of which are improved by weight loss. If you look at surgical interventions such as gastric bypass, sleeve gastrectomy and gastric banding, something like 200,000 (200K) procedures are performed annually, but that is only a fraction of the potential patient population, which is in the multimillions. Of the approved interventions, Lap-Band (gastric band; Apollo Endosurgery Inc. [private]) and Curved Adjustable Gastric Band (Ethicon/Johnson & Johnson [JNJ:NYS]) are the only devices in use in the U.S. today. Furthermore, gastric bands are the only reversible intervention, with gastric bypass and sleeve gastrectomy being physically altering procedures.

The EnteroMedics' VBLOC system involves a totally reversible surgery that doesn't alter a patient's anatomy. The implantable VBLOC device incorporates connecting leads from its generator to block the vagal nerve, giving patients the feeling of satiety. With VBLOC, patients can lose weight without diet restrictions or the need for nutritional supplements. There is competition developing in this space, but EnteroMedics is positioned to be first to market in the U.S., with FDA approval expected by the end of 2014.

TLSR: You mentioned a couple of companies in the diabetes space. Can you tell me about Dexcom and Insulet?

WP: Dexcom and Insulet are both servicing the type 1 diabetes market. Dexcom is one of two players in continuous glucose monitoring, along with Medtronic Inc. (MDT:NYSE). Today, a patient with type 1 diabetes will prick a finger, on average, four to eight times a day to measure the glucose level and to determine how much insulin is needed. Dexcom's continuous glucose monitoring system utilizes a seven-day patch that measures glucose levels under the skin and sends a reading to a handheld device every five minutes. With Dexcom covering 60K patients and Medtronic covering another 60–100K patients, current market penetration into the type 1 market is approximately 10%.

TLSR: I am intrigued with the possibility of continuous glucose monitoring for type 1 diabetics coupled with an insulin pump.

WP: The dream is the artificial pancreas. However, we believe a fully functional, commercially available device of that nature is at least five to 10 years off. That said, Dexcom is the lead technology in that field, as it is used in 18 of the 20 artificial pancreas development programs underway worldwide.

Regarding the pump component, Insulet's product makes perfect sense. Typical insulin pumps are tethered to an 18-inch cord connecting the pump to the patient's body. Insulet developed a patch pump that is smaller than a computer mouse and is controlled by a handheld device. The device has been on the market since around 2008 and, with about 60K patients, garners about 15% of the U.S. insulin pump market.

TLSR: Let's switch to wound healing. Tell me about MiMedx's amniotic membrane-based technology.

WP: Regarding advanced wound care, a patient will present with a diabetic foot ulcer or venous leg ulcer. These are different than standard wounds, with blood flow to the extremities being an issue. The continuum of care begins with a standard bandage. If that doesn't work, the next step is a more advanced bandage: silver coated or honey coated. If those don't work, more advanced technologies are required and can include negative pressure wound therapy, hyperbaric oxygen chambers, and advanced wound-covering technologies. MiMedx is focused on advanced wound-covering/regeneration technologies in the skin substitute market.

MiMedx uses amniotic tissue derived from live birth placenta. Published clinical data demonstrated a 92% wound-healing rate in diabetic foot ulcers. Patients typically require two or three grafts, with a total cost per patient of $2-3K.

Since commercializing its products over the last several years, MiMedx has grown significantly and has taken a significant portion of market share. The products work well, reimbursement is in place and distribution continues to ramp to properly address the U.S. market.

TLSR: Are there other technologies in the medical device space that attract your interest?

WP: I also cover the aesthetics market. In that space, I'm most interested in Zeltiq Aesthetics Inc. (ZLTQ:NASDAQ). Zeltiq pioneered the use of cryotherapy for the noninvasive ablation of fat. Past puberty, fat cell proliferation halts. Therefore, if ablated, they don't come back. The Zeltiq CoolSculpting technology kills 20-25% of fat cells in a targeted area, helping patients get rid of stubborn fat pockets on their bodies. Zeltiq has been in the U.S. market for three or four years, and has done extremely well.

TLSR: Is this an alternative to liposuction?

WP: Generally, no. CoolSculpting is more about fine-tuning, while liposuction is typically used on somebody with much larger areas of fat to eliminate. There is a point at which CoolSculpting and liposuction would overlap. But for the most part, CoolSculpting is for a lower body mass index (BMI) patient, whereas liposuction would be for a higher BMI patient.

TLSR: Is there any competition in this space?

WP: There are a couple of technologies that compete today. In the ultrasound space, there is Valeant Pharmaceuticals International Inc. (VRX:NYSE; VRX:TSX), which now owns Solta Medical Inc. and its LipoSonix technology. Additionally, Syneron Medical Ltd. (ELOS:NASDAQ) just gained approval for its ultrasound UltraShape technology. There are also some radiofrequency (RF) technologies on the market. Unlike cryo and ultrasound, RF technologies don't ablate fat cells, but merely empty the existing fat cells.

Of all the technologies, cryo has been the most successful.

The noninvasive fat ablation market is a newer segment within aesthetics, and was pioneered in the U.S. within the last five years. It's unique in terms of aesthetics because female patients typically make up 90% of aesthetic market. However, cryo fat ablation is being adopted by men. The result is a much broader market opportunity than we've ever seen in the aesthetics space.

TLSR: These devices appear to be real solutions to real problems. How do you feel the Patient Protection and Affordable Care Act (ACA) will impact innovation and venture capital (VC) investment in the medical device arena?

WP: That's an interesting question. I think the regulatory and reimbursement environments have had more of an impact on VC investments than the ACA, because investments are typically based on technologies that improve procedures and patient outcomes. If I'm a venture capitalist, that's what I'm looking for—better, quicker, faster, cheaper. To my knowledge, the implementation of the ACA has not impacted that.

What had a more negative impact were changes at the FDA. Without knowledge of regulatory pathways to FDA clearance, cost projections to commercialization cannot be modeled. From 2008 to 2010, the convergence of the financial crisis and FDA regulatory changes significantly slowed investment in medical devices. We are now seeing investments start to pick up. I don't think the ACA has impacted investments in the medical device sector yet.

TLSR: Any last words for investors?

WP: I try to focus my coverage of medical devices on those large areas of growth within medical need. That's why I am, today, very excited about obesity, diabetes and wound care. As I look forward for the next five to 10 years: In my opinion, those are going to be the biggest areas of growth and innovation in this space.

TLSR: Thank you so much for your time.

William Plovanic joined Canaccord in 2007 as a managing director, medical technology equity research analyst. He has been a publishing sellside analyst with coverage of medical devices for over 18 years. Plovanic's areas of coverage include orthopedics, diabetes, obesity, wound care, neuro-technologies, dialysis, aesthetics and general surgery. He has won awards for both stock picking and earnings accuracy. He is a frequent presenter at medical and industry meetings. He graduated from Bradley University with a bachelor's degree in finance and is a Chartered Financial Analyst.

Want to read more Life Sciences Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

1) Daniel E. Levy conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: MiMedx Group Inc. Streetwise Reports does not accept stock in exchange for its services.
3) William Plovanic: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Valeant Pharmaceuticals International Inc. MiMedx Group Inc., EnteroMedics Inc. and Zeltiq Aesthetics Inc. are investment banking clients of Canaccord Genuity. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
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