Medtech faces looming 'innovation gap' amid plummeting M&A, IPO, VC activity: EY report

After the COVID-19 pandemic brought many businesses and regular healthcare activities to a screeching halt in 2020, it’s no surprise that the medtech industry looked especially strong in 2021 as normal(-ish) operations resumed and demand for pandemic-related products remained high.

But that has all come crashing down, as IPOs and SPAC deals have all but dried up—with only four companies going public between July 2022 and June of this year—while M&A deals slow and venture funding takes a nosedive, according to EY’s annual Pulse of the Industry report.

To wit: M&A spending during that yearlong period fell 44% compared to the previous 12-month stretch, while VC investments dropped 21% to reach their lowest levels since the period spanning mid-2015 to mid-2016. The venture capital proceeds that did enter the industry went largely to the pockets of larger, later-stage companies, which took home nine of the 10 biggest funding rounds.

Indeed, as John Babitt, a life sciences partner at EY, shared during a roundtable discussion with reporters last week, “The venture capital firms were told, coming into 2023, to turn off a little bit of the spigot, as they were overallocated to venture capital.”

Meanwhile, revenues across the medtech industry clocked in at $573 billion for all of 2022, marking annual growth of just 3.5%—the industry’s lowest rate since 2015. So far, revenues have slowed even further in 2023, with year-over-year growth of just 0.4% in the first half, per EY.  

All of that adds up to a particularly difficult environment for early-stage medtech startups that may be sitting on goldmines of innovative technologies but will have trouble actually extracting any shiny new ideas without venture backing, support from larger companies or an otherwise clear path to the public market.

So, what’s a fledgling medtech to do? According to Jim Welch, EY’s global medtech leader, early-stage startups still have a few options for getting their feet in the door.

“A couple of organizations, some of the larger medtechs, are actually spinning up a little bit of their venture arms to look at those earlier stage companies, to get more attention paid to them—so that will help,” Welch said during the roundtable call.

“There’s a lot of capital on the sidelines right now. The hope is with some of the macroeconomic headwinds fading a little bit into the new calendar year, that could open up some opportunities,” he continued.

Babitt echoed that sentiment, saying that among VC investors, in particular, “The general feeling is that it’s been a tough 2023 but, in general, that it should stabilize and be productive going into the fourth quarter and into 2024.”

Despite the doom and gloom of much of the report, there were some bright spots. R&D spending, for one, is up: Internal investments reached a record-high $24.7 billion in 2022, though its growth rate fell to the single digits after three straight years of double-digit increases.

Certain focus areas have also proven resistant to the downturns of the broader industry, including artificial intelligence. According to EY’s data, 384 AI algorithms have passed the FDA's muster since 2017, including at least 91 in the first 10 months of 2022 alone, and Welch noted that early-stage companies focusing on AI have had a better go of finding their footing in the industry.

Meanwhile, among pure-play therapeutic devicemakers, those working in the realm of orthopedics reigned supreme, turning in far and away the highest revenue growth of all categories in 2022 with a respectable 21%, thanks in large part to Stryker’s success for the year. The next highest-growing categories were ophthalmic and cardiovascular, which registered growth rates of 10% and 8%, respectively.

And while evidence has shown that megamergers traditionally “don’t work” in medtech, according to Babitt, the appetite for smaller, bolt-on M&A deals is “decent,” especially as investors look to help their maturing portfolio companies leave the nest without an active IPO market in sight.

In the opposite direction, “the spin is still in,” Babitt said, pointing to a spate of recent and planned spinoffs from Baxter, GE HealthCare and Medtronic as “a recipe that’s working.”

“We actually now have statistical evidence that spins outperform the broader markets once they’re liberated from their parent companies and can deploy capital more efficiently and are willing to take more chances and make investments both internally and inorganically through accretive M&A,” he said, referencing a recent EY and Goldman Sachs analysis.