Recent deals offer hope for beleaguered VC model

By Larry Haimovitch

Medical Device Daily Columnist

November 29, 2010

As I was enjoying my delicious and very satisfying Thanksgiving meal on Thursday, I could not help but ponder about the gratitude that must have swept through the beleaguered medical technology venture capital (VC) community in the aftermath of two hugely successful deals that were recently announced.

On Nov. 19, Boston Scientific (Natick, Massachusetts) said it was acquiring venture-backed Sadra Medical (Campbell, California) for $225 million in cash upfront, with the potential for up to $225 million more in milestone payments (Medical Device Daily, Nov. 22, 2010). Through an earlier investment, Boston Scientific already owned 14% of Sadra.

Sadra, which raised its first venture money in mid-2004, is developing a device for performing a percutaneous aortic valve replacement procedure. An estimated $60 million in VC money has been invested so the gain to the VCs, especially if any milestones are met, would generate a very handsome return.

On Nov. 22, Medtronic (Minneapolis) announced the purchase of VC-backed Ardian (Mountain View, California) for $800 million in cash plus commercial milestones equal to the annual revenue growth through the end of Medtronic's fiscal year 2015 (Medical Device Daily, Nov. 24, 2010). Through an earlier investment, Medtronic already owned 11% of Ardian.

Founded in 2003, Ardian has developed a unique catheter-based therapy to treat hypertension through renal nerve denervation. Stellar data was reported at the American Heart Association (Dallas) 2010 Scientific Sessions in Chicago (Medical Device Daily, Nov. 18, 2010) with patients treated with the Symplicity catheter system experiencing a significantly greater reduction in systolic blood pressure at six months than the control group.

Roughly $65 million in VC funding has been invested in Ardian, suggesting that this deal will provide a phenomenal rate of return for the VC investors.

What is intriguing about these agreements is that both companies are developing products with very lengthy and expensive regulatory paths that will require a pre-market approval (PMA) from the FDA. Based on recent company statements, it appears that each company's device will have taken about a decade from their founding until their projected final PMA approval.

In spite of this lengthy road, which has a big impact on a VC's ultimate investment rate of return, both companies were highly successful in raising the required funds to meet arduous clinical and regulatory requirements.

In sharp contrast, we note the recent announcement (MDD, Oct. 29, 2010) that publicly-traded Endologix (Irvine, California) was acquiring privately-owned, venture capital-backed Nellix (Palo Alto, California) for $15 million upfront in stock, plus additional milestone-based payments of up to $39 million. While this transaction was hardly a watershed event in the med-tech space and certainly pales in comparison to the two deals that were just announced, it does raise some significant questions.

Endologix is the fourth largest player in the nearly $900 million global endovascular aortic repair (EVAR) market. One of the larger med-tech markets globally, EVAR has been exhibiting excellent growth in recent years, fueled by increasingly positive clinical evidence that it offers significant advantages over open surgery.

Over the past few years, Endologix has recorded strong annual revenue growth (66% CAGR from 2005 through 2009), despite vigorous competition from three med-tech industry powerhouses - Medtronic, W. L. Gore (Flagstaff, Arizona) and the Cook Group (Bloomington, Indiana).

While Endologix is a distant fourth with an estimated 10% of the global market share, it has doubled its share in recent years due to a tremendous buildup in its direct sales network, technology upgrades (notably the introduction of its Intuitrack system) and its laser focus on the EVAR market.

What motivated Endologix to acquire Nellix? The answer is simple - Nellix has developed a highly differentiated EVAR technology platform that enables it to treat a wide range of abdominal aortic aneurysm (AAA) anatomies. Although there is no agreement on how large the AAA unserved market actually is, it is generally accepted that about 30-40% of AAAs fall outside of the current indications for these devices.

On a Nov. 11 conference call that was organized for the financial community by Endologix, Andrew Holden, MD, professor and director of interventional radiology at Auckland City Hospital (Auckland, New Zealand) asserted that the Nellix device is a "radically different endovascular system for AAA repair." Holden is an EVAR veteran who has been performing these procedures for 16 years.

On the call, Holden also stated that because this device relies on a polymer that quickly seals the aneurysm sac, "endoleaks are highly unlikely." The elimination or significant reduction of endoleaks, which is defined as leakage of blood into the aneurysm, would be a major competitive advantage.

Moreover, Holden said that "post-procedural surveillance may be reduced." This could also be a substantial positive, since today's EVAR devices typically require regular CT scans to assess the status of the AAA stent graft. These scans are costly and inconvenient for the patient.

Nellix's early clinical results have been outstanding. There has been 100% implant success, 100% freedom from AAA-related mortality, no aneurysm ruptures, no surgical conversions and no stent-graft migrations for patients with up to two years follow-up.

Since its formation several years ago, about $45 million has been invested in Nellix. The VC funding has been led by Essex Woodlands Health Ventures (Palo Alto, California), which owned over half of Nellix at the time of the Endologix transaction.

So, the "$64,000 question" is this: if Nellix's technology is so promising, if EVAR is a rapidly growing and very large market (exceeding $1 billion in 2011) and if there are still opportunities for technology improvements, why was Endologix able to scoop up Nellix for such a paltry sum?

There appear to be several reasons: (1) The risky and unpredictable FDA regulatory environment; (2) The long road, perhaps four years or more, to a PMA approval; (3) The huge amount of capital that this project would take to reach positive cash flow and, more importantly to VCs, to experience a liquidity event.

In that regard, another private EVAR company, TriVascular (Santa Rosa, California) has raised over $150 million to fund its operations since mid-2008. My sources speculated that the huge amount of capital raised by TriVascular might be also required by Nellix and this may have "spooked" some VCs from investing.

Based on interviews with reliable industry sources, I am aware that several prominent med-tech VCs were intrigued with and impressed by Nellix's technology and its promising, albeit, early clinical data.

They performed extensive due diligence and were very close to a positive funding decision, but in the end, they declined to invest.

Despite Nellix's valiant efforts to raise VC money, it failed and was forced into a corporate deal. That other potential players like Abbott Laboratories (Abbott Park, Illinois) did not step forward to snatch up Nellix at this bargain price is quite surprising.

What is even more surprising, however, is that Essex Woodlands, which apparently was not willing to continue funding Nellix as a private company, committed to a $15 million equity investment in Endologix as part of the Nellix acquistion.

It is not uncommon for venture firms to invest in public companies, this is generally done through a private investment in a public equity. Rather than pump more money into Nellix, it is noteworthy that Essex Woodlands took a far more conservative route and invested directly in Endologix. With that investment, it could reap some of the benefits of Nellix's success while mitigating its investment risk.

So what is the takeaway from this story, particularly in the context of the VCs enthusiasm to fund both Sadra and Ardian, who are in the midst of lengthy regulatory cycle? Have venture capitalists, who formerly funded risky and early stage startups, become risk averse? Are they shunning investments that have a longer-term horizon? Are they unnerved by the uncertain FDA climate?

It appears, based on this interesting transaction that all of the above are true. Recent released data from Dow Jones Venture Source showed that San Francisco Bay area VC investment fell a shocking 45% in 3Q10 versus 3Q09.

This news, coupled with the sad demise of Nellix, a company with highly innovative technology, certainly is discouraging for med-tech startups and their entrepreneurs.

Editors Note: Larry Haimovitch, founder of Haimovitch Medical Technology Consultants (Mill Valley, California), can be reached at Larryhaim@aol.com. Larry is a frequent "angel investor" and discloses that he is a shareholder in both TriVascular and Nellix. His opinions do not necessarily reflect those of Medical Device Daily.


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