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The oligopolistic nature of medtech

August 29, 2023
Jacob Celermajer, Portfolio Manager

Key takeaways:
•  Sub-sectors of the medtech industry tend to form into natural oligopolies due to deep and wide economic moats.
•  Medtech companies typically have strong pricing power due to this competitive dynamic.
•  This oligopolistic industry structure has driven a period of strong risk-adjusted returns that we believe is likely to continue over the long-term.

In the Cordis Global Medical Technology Fund, we have built out an investment opportunity in which we believe the deck is already stacked in our client’s favour. We have previously discussed the insatiable demand for medtech that is driving top-line revenue, and in this article we outline the medtech industry’s natural tendency towards oligopolies, which drives earnings and ultimately share prices.

While each sub-sector within medtech has its own competitive dynamics and structural nuances, there has always been a trend for early players to corner the market. This is in the most part due to extremely high barriers to entry – also known as economics moats – that protect the early-to-market device developers. This first mover advantage often renders the time, effort and up-front cash required for sub-scale players too onerous. And unlike in the pharmaceuticals industry, there is no market for generic low-cost alternatives in the world of high consequence medical devices. The key barriers/moats that protect medtech incumbents include:

  • Development & regulatory; medical device development requires costly up-front investments in research, development and clinical trials
  • Brand reputation; a critical factor in an industry literally dealing in life and death
  • Intellectual property protection; patent holders are granted a temporary monopoly when coverage is broad enough
  • Distribution networks; the ability to get devices into the hands of physicians and operators
  • Economies of scale; manufacturing cost advantage makes it difficult for smaller companies to compete

The natural oligopolistic structure is then further perpetuated by the industry standard practice of tuck-in M&A. Typically, large established medtech conglomerates will seed fund early-stage medtech ventures to guarantee first right-of-refusal to buy and own intellectual property should the technology develop into a winner. This plays out in fewer bigger competitors dominating the market.

A pertinent example of a medtech oligopoly is the market for blood glucose monitoring technology, a space in which the Cordis Global Medical Technology Fund has significant positions. CGMs (continuous glucose monitors) have been one of the most important steps forward in the treatment of diabetes in the past 20 years. The ability to track glucose continuously, rather than intermittently, has allowed patients with diabetes to better pre-empt and therefore treat their condition, all without the requirement for painful and socially burdensome finger-sticking to obtain a blood sample.

The first continuous glucose monitor was approved all the way back in 1999, and despite almost 25 years of progress, the market remains a three-way oligopoly today where the leading players hold >95% of global market share. These three key players – DexCom (DXCM:NASDAQ), Abbott (ABT:NYSE) and Medtronic (MDT:NYSE) – have used this 25-year head start to build deep customer relationships, expansive distribution networks, efficient manufacturing scale and comprehensive clinical data that will protect them against new competition for many years to come.

An even more profound example is in the surgical robotic space, where Intuitive Surgical (ISRG:NASDAQ) – the global leader in surgical robotic systems – maintained a natural (non-regulated) monopoly for over 15 years. Its first generation da Vinci system was approved for general surgery by the U.S. FDA (Food and Drug Administration) in 2000 and remained the only approved device until 2017, as other players struggled to overcome the R&D hurdles that Intuitive overcame in the early 2000s. In the 17 years of monopoly operation, Intuitive’s stock returned over 5,800%, or greater than 25% per annum. In the period of duopoly operation since, Intuitive has continued to return in excess of 15% annually for shareholders1. As more competition comes to market, new players with little track record will find it very tough to compete with Intuitive’s body of clinical evidence, which includes a global network of 8,000 da Vinci systems that have performed 13 million procedures and over 34,000 peer reviewed published articles2. Intuitive’s trusted brand reputation is likely to remain a key competitive advantage against new upstart competitors long into the future.

This favourable competitive landscape affords medtech companies the ability to be price makers, rather than price takers. Gross margin is our favoured indicator of pricing power, as it evidences a company’s ability to set the price level, based around competitive market forces and the need or desirability of a given product. Medtech’s customers – which are typically governments or private insurers – willingness to pay these higher prices is the first layer of defence when building up a firm’s profitability. This ability to pass on price is also an important characteristic in protecting earnings during inflationary periods and supported the medtech industry through the recent period of high inflation. These characteristics have manifested themselves in the Cordis Global Medical Technology Fund, which has a weighted average gross margin of 64%, well above that of the S&P Global 1200 Healthcare, S&P Global 1200 and S&P ASX200, with marks of 58%, 51% and 46% respectively1.

The nature of this industry structure has led the medtech sector to a period of significant outperformance, as illustrated by using the Dow Jones U.S. Select Medical Equipment Index as a sector proxy. Since its inception in 2006, the index has outperformed the global equities market, as represented by the S&P Global 100.

During this history of long-term outperformance, the medtech sector has also delivered on a risk-adjusted basis. Although absolute volatility – as measured by the standard deviation – is higher, the excess returns translate into significantly higher Sharpe and Sortino ratios.

The returns generated by medtech have also been consistent rather than unpredictable and lumpy. The batting average suggests that medtech outperforms the market approximately two thirds of the time, while the capture ratios indicate that medtech typically rises by more and falls by less than the broader share market.

With little to suggest the growth momentum evident today in medtech will be derailed, exposure to medtech remains one of the few avenues for investors to capture resilient growth that is largely independent of economic cycles, to deliver very attractive risk-adjusted returns.

1. CapIQ financial data, as at 23/8/23
2. Intuitive Surgical Q2 2023 Investor Presentation, 20/7/2023

This report was prepared by Cordis Asset Management Pty Ltd ABN 68 637 078 490 a corporate authorised representative (No. 1282680) of Avenir Capital Pty Ltd ACN 150 790 355, AFSL 405469 (“Cordis”)”, the investment manager for the Cordis Medical Technology Fund (“Fund”). Equity Trustees Limited (“Equity Trustees”) ABN 46 004 031 298 AFSL No. 240975, is a subsidiary of EQT Holdings Limited ABN 22 607 797 615, a publicly listed company on the Australian Securities Exchange (ASX:EQT), and is the Responsible Entity of the Fund. This document has been prepared for the purpose of providing general information only, without taking account of any individual person’s investment objectives, financial circumstances or needs. Whilst every care has been taken in the production of this document, no warranty is given as to its accuracy and persons relying on this information do so at their own risk. The information contained in this document is not intended to be relied upon as a forecast and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy, nor is it investment advice. Any forwarding-looking statements or forecasts are based on reasonable assumptions, but cannot be relied upon as guarantees or representation as to what future performance will actually occur.  Unless otherwise specified, the information contained in this document is current as at the date of issue and all amounts are in Australian Dollars (AUD). You should consider the Product Disclosure Statement (“PDS”) in deciding whether to acquire, or continue to hold, the product. A PDS and application form is available at Cordis and Equity Trustees do not guarantee the performance of the Fund or the repayment of the investor’s capital. To the extent permitted by law, neither Equity Trustees, Cordis, nor any of their related parties including its employees, directors, consultants, advisers, officers or authorised representatives, are liable for any loss or damage (including consequential loss or damage) arising directly or indirectly as a result of reliance placed on the contents of this report. Past performance is not indicative of future performance. The unit price performance calculation methodology follows the FSC Standard No.6: Investment Option Performance – Calculation of Returns (July 2018). Total returns are calculated based on changes in net asset values, at the exit price after the deduction of fees and expenses. Due to individual circumstances, your net returns may differ from the net returns quoted above.

Innovative medical therapies

These opportunities may involve early-stage ventures, unexplored markets, or underappreciated trends that have the potential to redefine industries and create new sources of returns.

Emerging opportunities need to be defined by a combination of hard criteria.

Strong management

For emerging opportunity companies, we look for management teams with a proven track record in scaling an idea into a business. Many of these companies are still run by founders, and while this is not a requirement, a strategic long-term plan to deliver strongly defendable market positioning while growing towards positive earnings and increasing shareholder wealth is. 

Disruptive innovation

Emerging opportunities often stem from disruptive innovation, breakthrough technologies, or paradigm shifts that challenge existing business models and create new market dynamics. They may involve frontier technologies such as artificial intelligence, blockchain, genomics, or renewable energy.

Untapped markets

We like to look at underserved or overlooked markets with latent demand and untapped potential. These arise from changing consumer behaviours, evolving regulatory landscapes, or demographic shifts that create new market niches or unmet needs.

Risk-reward profile

Investments in emerging opportunities typically carry higher risk due to uncertainty, market volatility, and execution challenges. However, they also offer the potential for outsized returns for early movers who can identify and capitalize on nascent trends before they become mainstream. 

Dynamic growth, strong discipline

This Strategy is very dynamic and exciting. We are looking here for disruptive business models, revolutionary products, or transformative technologies. While high-growth investments offer the potential for substantial returns, they also entail higher risk.

High growth needs a very strong and disciplined approach.

Strong management

For high growth companies, we love management teams with a proven track record of product commercialization and driving scalable growth. It is important at this stage of a company’s lifecycle that management is able to coherently and concisely communicate with investors and outline the path to profitability that we require. Cordis uses a unique scorecard to measure and assess Management trust and attitude towards long term value versus short term profit. An awareness of generating shareholder value can be an important factor is assessing management strategy at this juncture.

Expanding addressable market

These companies target large and expanding addressable markets with significant growth potential. They may capitalize on emerging trends, demographic shifts, or global megatrends driving demand for their offerings.

Scalable business model

High-growth companies possess scalable business models capable of rapidly growing operations, entering new markets, and capturing market share without proportionately increasing costs. They may benefit from network effects, platform economies, or leverage digital distribution channels for rapid expansion.

Agile and adaptive

High-growth companies are agile and adaptive, capable of quickly responding to market dynamics, customer feedback, and competitive pressures.

Long-term compounding returns

These companies typically have strong fundamentals, stable cash flows, and competitive advantages that enable them to generate consistent profits. Their policy tends to be to reinvest profits back into the business for further growth, allowing compounding effect to accelerate earnings and free cash flow.

Strong management

Earnings compounders are often led by capable and shareholder-friendly management teams that prioritize long-term value creation over short-term gains. They make strategic decisions focused on sustainable growth, prudent capital allocation, and shareholder returns. Cordis uses a unique scorecard to measure and assess Management trust and attitude towards long term value versus short term profit.

Stable business model

Companies with a predictable and resilient business model that generates recurring revenue streams are often considered earnings compounders. They tend to operate in industries with steady demand for their essential products, driving consistent profitability.

Competitive advantage

This is specifically hard to assess. The strong team at Cordis allows us to identify companies that typically possess durable competitive advantages such as strong brands, intellectual property, proprietary technology, or economies of scale that protect their market position and profitability against competitors.

Rock solid balance sheet

This is a non-negotiable. We want to be able to sleep easy at night, and can do so knowing the strength of the cumulative balance sheet of our portfolio. A solid balance sheet allows protection during the inevitable periods when external factors go wrong, and flexibility to be opportunistic when those rare chances arise. 

Investment Committee Former MD of Medtronic in ANZ

Tim is an international business leader with 30 years of diversified experience as a member of executive leadership teams at two global MedTech conglomerates, Medtronic and Boston Scientific. He has a proven track record of delivering results, substantially increasing revenues and operating profit across Australia & New Zealand, the Asia Pacific region and globally.

Executive Director and Chairman of Investment Committee

Donal has over 35 years of experience in the medical device/healthcare sector – initially as a senior executive in the global cardiovascular and medical devices industries and more recently as a Non-Executive Director. He was global President for Cordis Cardiology, a division of Johnson & Johnson’s Cordis Corporation. He was previously the European President of the Cardiovascular Group of Baxter Healthcare, now Edwards Lifesciences and formerly a director of Cochlear. Donal is currently on the Board of Directors of several Healthcare and Medical Device companies, including Fisher & Paykel Healthcare, Mesoblast and NIB Health Funds.

Intensive Care, Device VC Brisbane

John is a medical disruptor, who started Australia’s largest multi-disciplinary research group - Critical Care Research Group - based in the country’s largest cardiothoracic centre in the region, The Prince Charles Hospital. He has built a team of more than 80 leading clinicians, engineers, scientists and economists with global links – connected to all of the major cardiothoracic hospitals across Queensland, Australia, and the world. He has been a serial entrepreneur working with leaders in medicine, engineering, science and industry in a truly global network of mature collaborations. He simultaneously runs Australia’s first ever international Centre for Research Excellence in Bionic Hearts and Lungs. Professor Fraser has published over 400 peer-reviewed publications (including NEJM, Circulation, Lancet, AJRCCM, JACC) and has earned in excess of $41 Million AUD in competitive grants.

Cardiovascular Surgery, Texas

Mike is a cardiovascular surgeon and the Director of the Cardiovascular Service Line at Baylor Scott & White Health System, Chairman of the Board of Baylor Scott & White Research Institute in Dallas, Texas and co-chair of the Heart Valve Collaboratory. He has been in practice since 1982 and performed thousands of cardiac surgeries, of which well over 4,000 have involved heart valve procedures. He is one of the key global figures at the forefront of Transcatheter Aortic Valve Replacement (TAVR), having been a pioneer since the early days of this life-changing procedure. Michael has also authored or co-authored over 750 publications in peer-reviewed journals. He sat on the Board of the American College of Cardiology Foundation from 2015-2019 and has previously served as President of the Society for Thoracic Surgeons, Thoracic Surgery Foundation for Research and Education, Southern Thoracic Surgical Association and the International Society for Minimally Invasive Cardiothoracic Surgery.

Cardiologist, Sydney

David is an experienced Advisor and Investor in the Medical Devices area. He is the Founder of Corvia Inc (a Boston based cardiac devices company) and the Founder and Chief Medical Officer of the Brain Protection Company. He is a former University Medallist in Medicine from the University of Sydney, Rhodes Scholar and since 2014, has been an Officer of the Order of Australia. He has been involved in supporting and advising many successful MedTech companies, in Australia and the USA, over the last 20 years. David is Professor of Cardiology and Head of the Discipline of Cardiology at The University of Sydney and an Academic Cardiologist at Royal Prince Alfred Hospital. In addition to these roles, David is also the Clinical Director of the Heart Research Institute and serves on the Board of Directors of Heart Kids Australia. He has been a Fellow of the Australian Academy of Science since 2006 and a Fellow of the Australian Academy of Health and Medical Science since 2018. David sits on the Editorial Boards of many of the world’s leading Cardiology Journals, including the European Heart Journal, the Journal of the American College of Cardiology and Heart. He has published over 400 papers, with career citations of over 60,000 and an H-index of over 100. In recognition of this, he was awarded the inaugural Charles Blackburn Medal from the University of Sydney in 2019, for outstanding Clinical Research.

Founder and Chairman of the Medical Advisory Panel

Michael is one of the founding partners of Cordis Asset Management. He is currently a Professor of Surgery & Surgical Director of Structural Heart at the Ohio State University Wexner Medical Center. Michael has a special interest in elderly and high-risk patients, anaortic off-pump coronary bypass surgery, transcatheter and open-heart valve surgery, minimally invasive heart & lung surgery, and electrophysiological device implants (e.g. pacemakers, defibrillators, and CRT). He has authored or co-authored more than 130 scientific publications in peer-reviewed journals, multiple book chapters and has been active in international clinical trials and first-in-man procedures and device trials. Professor Vallely is an Industry Advisor with the McKinsey and a consultant to Medtronic and other medical technology firms.

Chief Investment Officer

James formerly the Chief Investment Officer at U Ethical Investors, having worked for over 20 years in global equities investing. He has been involved at all levels of equities analysis, with a proven track record of consistently strong investment performance over rolling three year periods. James brings a wealth of experience in asset management to our team given his significant skill set.

Medical Device Specialist

Michael is an active clinical engineer for medical device start-ups and a Founder and shareholder of Cordis. Michael has 10 years of global industry experience in Healthcare Informatics and Cardiovascular Device Technology. His industry experiences span senior management and technical roles with major medical technology companies, giving him invaluable insight into the companies we concern ourselves with.

Senior Equity Analyst

Jacob joined Cordis at its inception as an equity analyst, quickly becoming an instrumental part of the portfolio construction process. He has 10 years of experience analysing companies and as a stockbroker, after beginning his career in the Equity Team at Deutsche Bank in Sydney, where he covered both domestic and international Healthcare companies as a part of the local sales team. Jacob has a Bachelor of Commerce and Engineering with Honours from the University of Sydney and is also a Chartered Financial Analyst (CFA).

Investment Committee

Simon has over 40 years’ experience in portfolio, wealth and investment management in Sydney, London and Chicago with ANZ, Credit Suisse, J.P. Morgan and Mercantile House. He is a former Portfolio Manager for ANZ Optimix and Head of Alternative Investments for ANZ Wealth. Simon is currently a Trustee at the Centenary Foundation for Medical Research at Royal Prince Alfred Hospital in Sydney. He is a former Managing Director of Credit Suisse, Head of Alternative Investments for Asset Management, Co-Head of the European Pension Advisory and Structuring Group, Co-Head of Fund-Linked (Hedge Fund) Products, Global Head of Commodity Marketing and former Director of Advice for Life Pty Ltd, Capricorn Financial Advisors Pty Ltd, Financial Lifestyle Solutions, the London Gold Fixing and on the Markets Committee of the UK National Association of Pension Funds Investment Council. 

Cardiac Electrophysiologist, Ohio, USA

Dr Toshimasa Okabe is originally from Japan where he obtained his medical degree from University of Tokyo in 2006. He then completed his internal medicine residency and cardiology fellowship at Thomas Jefferson University in Philadelphia. During his time at Thomas Jefferson University, he was the recipient of several awards, including the best teaching resident and the best teaching fellow award. Dr Okabe also received a master of science degree in clinical investigation from Thomas Jefferson University in 2014. He went on to complete his cardiac electrophysiology fellowship at the Ohio State University, Columbus, Ohio. Dr Okabe joined the faculty at the Ohio State University in 2016, and is currently Assistant Professor of Internal Medicine. He is American Board of Internal Medicine certified in Cardiovascular Disease and Clinical Cardiac Electrophysiology. Dr Okabe has authored or co-authored more than 50 peer-reviewed publications, and 4 book chapters, and has presented at numerous national and international meetings.

Dr Okabe’s areas of special interest are complex catheter ablation of various arrhythmias, ablation of epicardial ventricular tachycardia, fluoroscopy reduction techniques, and novel leadless pacing technologies.

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Marketing Coordinator

Melissa’s experience in marketing and communication over the past 5 years expands over the Finance, Wellness and Arts industries, working in Australia and the United Kingdom.

Director of Operations

Rudi is the Founder and Managing Director for Paradigm Global Solutions, which designs innovative technology and administrative solutions for financial services. He is also a co-founder and joint-CEO for Latus Solutions. Prior to this, he acted as a director and Chief Technology Officer for Equinox and Tradestream in South Africa.

General Counsel and Company Secretary 

Megan has over 30 years of legal experience and is currently a legal contractor for AMP Australia. Prior to AMP, she acted as legal counsel for Zurich Financial Services Australia and Macquarie Group for twenty years, across various financial services businesses. Formerly, she has practised as a tax lawyer for KPMG and Touche Ross.

Andrew Inwood is the founder of the CoreData Group and brings with him deep knowledge of the financial services industry. CoreData is a financial services research and consulting business which owns CoreData and CoreData Research and has operations in Australia, the UK, the USA and the Philippines. He focuses on the area of Behavioural Economics, with a particular interest in the process of trust transfer between individuals and corporations.

Non Executive Director and Director of Marketing and Distribution 

Thomas has over 25 years’ experience in Wealth Management and Asset Management, at Bankers Trust, Merrill Lynch, Bell Potter and Next Financial before Co-founding Mason Stevens in 2011. As Managing Director of Mason Stevens, Thomas worked across the Asset Management and Wealth Management business and was responsible for driving its distribution into the advisory channels. In 2019, he became Co-Chief Investment Officer. Over the last 2 decades he has advised Family Office, HNW clients and worked closely with Advisory groups on managing investments across all asset classes. He currently is the Chair of Investment Committee for Norwest Asset Management, and is a director of private investment advisory firm Tenix Capital.

Non Executive Director, Investment Committee

Stephen has 30 years’ experience in leadership roles across globally recognised blue-chip investment, superannuation and financial services companies at CEO or Senior Executive level. He is currently Chairman of Growth Farms Ltd, a Non-Executive Director of AMP Superannuation Limited and Longreach Wealth Pty Ltd, a Member of the Supervisory Board of Pyrolyx AG, Germany and a Member of the Leadership Council of Social Ventures Australia. He was formerly CEO of Mercer Investments Asia Pacific and Russell Investment Consulting in Australia. Stephen brings a wealth of experience in investment consulting and asset management to our Board given his significant senior executive and non-executive board experience across Asia Pacific. Stephen has proven track record of successfully leading people and organisations through period of exceptional growth and change.