Medical Device Outsourcing: Expansive Backlog of Elective Procedures to Fuel Robust Demand

In the first half of 2021, the Medical Device Outsourcing sector has benefited from feverish deal appetite from both private equity and strategics resulting in a significant uptick in valuations and closed transactions.

Eric WilliamsManaging Director, Capstone Partners

After a rollercoaster year in 2020 in which elective surgical procedures were abruptly halted in many regions, procedural volume continues to rebound. A key component for the recovery is highly dependent on patients’ willingness to return to hospitals for procedures which could be negatively impacted by a resurgence of COVID-19 cases that many states in the U.S. are currently experiencing. Supply chain disruptions also severely challenged outsourced providers at the onset of the pandemic. Although these issues have largely abated, direct labor constraints, delays in research & development, and regional variability in the recovery of elective procedures have persisted. However, amid these headwinds, leading original equipment manufacturers (OEMs) have enjoyed strong sales growth as elective procedures have rebounded, evidenced by Intuitive Surgical (Nasdaq:ISRG) and Stryker (NYSE:SYK) recording year-over-year (YOY) revenue increases of 17.5% and 10.2% in Q1, respectively, according to their earnings releases.^1,2 Despite high sales growth, overall industry performance remains below pre-COVID levels, with overall sales trailing by approximately five to seven percent, according to Integer.³ The vast backlog of procedures, however, is definitely a bright spot providing support for heighted demand for medical devices and instruments in the second half of 2021 and fiscal 2022.

M&A Activity and Valuations Surge Year-to-Date

Merger and acquisition (M&A) activity has continued at rampant levels through year-to-date (YTD), with 29 deals announced or completed, an increase of 45% YOY. Heightened demand and competition in deal processes has driven valuations for outsourced providers to historic levels with the median EBITDA purchase multiple from 2020 to July 5, 2021 reaching 15.6x, exceeding the 2018-2019 median valuation of 13.3x. In addition, the average transaction enterprise value from 2020 through YTD has reached elevated levels at approximately $273 million. The rapid projected growth of the Medical Device Outsourcing market, which is forecast to increase by nearly 11% through 2029 (Research and Markets)⁴, has drawn buyers to allocate significant capital to gain enhanced market penetration. In June, Tecan Group (SWX:TECN) acquired leading OEM development and manufacturing provider Paramit for an enterprise value of $1.0 billion and equivalent to approximately 20x expected full year 2021 EBITDA before acquisition related costs, according to a press release.⁵ The transaction marks one of the highest disclosed acquisition values in the sector in recent years, indicating the focus industry participants are placing on building robust outsourced solutions and gaining scale.

The healthy pricing environment is also supported by expansion of trading multiples among top public OEMs, with the average EBITDA multiple in Capstone's Medical Device Index rising to 22.9x from 21.3x in the prior year. Notably, CONMED (NYSE:CNMD) and Teleflex (NYSE:TFX) have led valuations in Capstone's Medical Device Index, trading at 26.3x and 27.6x, respectively.

Private Equity Realizing Value from Buy-and-Build Playbook 

Private equity firms have aggressively targeted the Medical Device Outsourcing sector, comprising 55.2% of total transactions through YTD. Outsourced providers with entrenched OEM relationships, sophisticated design or manufacturing expertise, recurring revenue streams, and track record of growth have garnered strong interest from the sponsor buyer universe. In addition, low interest rates and historic levels of dry powder have created a favorable backdrop for healthy private equity transaction activity in the near term. Anecdotally, dealmakers are fielding elevated inquiries for middle market outsourced providers as sponsors are actively looking for platforms to enter the space or pursue add-ons to holding companies. Notably, Frazier Capital completed an add-on to its portfolio company Eptam Plastics through its acquisition of Mendell Machine and Manufacturing in May for an undisclosed sum. The addition of Mendell significantly expands and diversifies Eptam's offerings, creating an expansive precision metals and plastics manufacturing platform.

Select private equity firms have also realized significant value from their efforts to scale platform investments through add-ons. Prior to Altaris Capital's sale of Paramit to Tecan Group for an estimated 20x full year 2021 EBITDA, it completed two add-on acquisitions in 2020. In addition, leading product development provider Ximedica, previously backed by SV Health Investors, was acquired by Veranex in June for an undisclosed sum. Under SV Health's ownership, Ximedica facilitated the acquisitions of Bridge Design (August 2015, undisclosed) and Accel Biotech (July 2016, undisclosed). Robust private equity exit activity provides insight to sponsors' favorable view of the current M&A environment, launching sale processes while valuations and buyer demand remain high.  Private equity firms are anticipated to continue to utilize smaller transactions to gain scale, leverage existing infrastructure and sales and marketing resources, acquire new capabilities, and diversify client bases. With M&A volume approaching historic levels, high quality sector targets are likely to attract premium multiples from private equity firms flush with deployable capital and demonstrated sector expertise.

Strategic Buyers Bolster Design and Development Capabilities

Private strategic buyers have remained active through YTD, accounting for 41.4% of transactions, seeking sophisticated contract development and manufacturing organizations (CDMOs) or design specialists to bolster service capabilities. The prospect of capital gains tax increases has also encouraged a flurry of sellers to come to market to lock in potentially favorable rates before year end.  Recently, contract manufacturers have increasingly targeted design and development providers through M&A. Buyers have recognized the high-growth nature of the Product Development segment of the market, as revenue growth among design and development firms is forecast to grow at a robust rate of 16.7%, according to Alira Health.⁶ Notably, Zeus Industrial Products acquired leading catheter design engineering, prototyping, and manufacturing provider, CathX Medical in June for an undisclosed sum. While component manufacturing will remain Zeus’ core offering, the addition of design and engineering capabilities demonstrates the initiative of industry players to create an expansive service offering platform for their OEM customers. In addition, Resonetics, a leading micro manufacturing and contract manufacturing services provider acquired Distal Solutions in May for an undisclosed sum. The purchase of Distal, a provider of design and development of catheter-based delivery systems and Implants, marks Resonetics' seventh acquisition in the past four years, according to a press release.⁷

Endnotes

1. Intuitive Surgical, " Intuitive Announces First Quarter Earnings," https://isrg.intuitive.com/news-releases/news-release-details/intuitive-announces-first-quarter-earnings-1, accessed July 6, 2021.

2. Stryker, " Stryker reports first quarter 2021 operating results," https://investors.stryker.com/press-releases/news-details/2021/Stryker-reports-first-quarter-2021-operating-results/default.aspx, accessed July 6, 2021.

3. Integer Holdings, " 1Q21 Earnings Conference Call," https://investor.integer.net/investor-relations/default.aspx, accessed July 6, 2021.

4. Research and Markets, " Medical Devices Outsourcing Market Size, Market Share, Application Analysis, Regional Outlook, Growth Trends, Key Players, Competitive Strategies and Forecasts, 2021 to 2029," https://www.researchandmarkets.com/reports/5330866/medical-devices-outsourcing-market-size-market, accessed July 6, 2021.

5. Tecan Group, "Acquisition of Paramit," https://www.tecan.com/investor-overview#, accessed July 6, 2021.

6. Alira Health, "The 2021 MedTech Contract Manufacturing Report," https://alirahealth.com/education-hub/medtechreport2021/, accessed June 20, 2021.

7. Resonetics, " Resonetics Announces Acquisition of Distal Solutions," https://resonetics.com/about-us/news/resonetics-acquires-distal-solutions/, accessed July 6, 2021.