Medical technology is evolving every day. What trends are investment banks seeing, and what are some of the capital trends in the medical technology space?

In this episode of The Corner Series, McGuireWoods’ Geoff Cockrell chats with Brian Scullion, Senior Director, Medical Technology at William Blair, a boutique multinational investment bank and financial services company, to discuss how investment banks view emerging healthcare technologies.

Listen as Brian talks about private equity considerations in the healthcare industry, how AI and other emerging technology are impacting capital investments in healthcare, and when value-based healthcare might grow in the commercial healthcare arena.

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is The Corner Series, a McGuireWoods series exploring business and legal issues prevalent in today's private equity industry. Tune in with McGuireWoods partner Geoff Cockrell as he and specialists share real-world insight to help enhance your knowledge.

Thank you for joining another episode of The Corner Series. I'm your host Geoff Cockrell, a partner at McGuireWoods. I'm thrilled to be joined today by my longtime friend Brian Scullion, managing director at William Blair. Brian's one of the leading voices in healthcare-related investment banking, and is just pioneered the field in a lot of ways.

Brian, I'm thrilled that you're joining. If you could give a quick introduction of yourself and William Blair before we hop into some discussion.

Yeah, well thanks Geoff. Great to be on with you.

Brian Scullion, a 25 years investment banker. Over the course of that two and a half decades have really probably gotten involved in just every kind of healthcare deal imaginable. Of late, mainly focused on medical technology as well as on advanced primary care models, Medicare Advantage-focused businesses. And prior to getting into banking, I actually went to medical school and practiced medicine briefly and had second thoughts about that as a career and was successful in convincing the guys at Blair to bring me on as a new investment banker. The rest is, as Geoff mentioned, worked out very favorably for me.

Brian, A lot of discussions around private equity and healthcare generally have been difficult discussions of late. I was wondering if we might back the clock up a little bit, and especially with your background with medical technology, that's an area where the intersection of capabilities and capital has really accelerated the use of technology. Maybe give a little overview of how private equity and healthcare came into being.

Well, in the medical technology space it's sort of interesting because that's an area where you find private equity has had not as profound an impact as it has in, say, healthcare services or healthcare IT. And one of the big reasons for that is that there's a large R&D component, a lot of uncertainty with new product development in the medical technology world. It's similar that regard to biotechnology where you see very little private equity activity. And that's because for that kind of very risky undertaking of coming up with a new technology and a new product that has to go through the FDA regulatory approval process, there's a lot of risk, a lot of uncertainty, that's actually not really well suited to the private equity world.

Unlike biotech, medtech's on a continuum as far as that goes. There's some products that are actually quite low tech. The regulatory process is not particularly onerous. Others are very speculative, high risk, high beta sort of undertakings and really need a venture investor. And so in some ways I've gotten an education on the risk appetites of the different pools of capital and what kind of audience is suitable or not for a particular undertaking.

The short story is you find private equity getting involved with medical technology when you've got basically a commercial stage undertaking. When something is already proven out in the market, but it's not so high growth, it's not so high-tech where an Abbott, a Medtronic is going to take that and spread it out over a large established commercial infrastructure better. Something more like say a Medline for example, that's closer to the supply end of the spectrum where some of the dental businesses where the regulatory burden is low, the products aren't as differentiated, but they have much more traditional commercial metrics associated with which is to say promotion equals greater sales. As opposed to higher R&D investment is one of the big drivers of the product's attributes and ultimate success in the market.

Does any of that make any sense?

Totally. And what has been some of the impact of bringing this kind of focus technology into the healthcare arena?

Well, it's interesting. On the very high R&D end of the spectrum, that's really where you see the classic venture model, which has been around longer than private equity in some regards, where the venture dollars have proven to be a better way of funding individuals that have creative new ideas. What I mean by that, big corporates, they're not really great at breakthrough new product development. They're very good at product line expansion, at enhancing products to better serve a market once you've already established a technology.

But if you're talking about a totally new approach to a problem, you go to Abbott, a Baxter, not as many of those products are incubated. And the reason is because if you're an entrepreneur, if you're a founder, if you're a scientist or an engineer with a great idea, they can't give you the kind of economic incentives that you can get out of a venture-backed business. They also can't have the discipline as an organization to kill those projects when they are not proving to be as promising in his initial.

It's another way of saying that in the corporate world, funding new technology, you get into all the politics, you get into favoritism, you get into a whole bunch of externalities that deviate from the question, "Hey, is this a great new product idea? Oh, by the way, now that we're a year, 2 years, 5 years, 50 million into it, does it continue to be a great idea?" And the venture community and the venture funding model is very good at rewarding the people that do the work, as well as making those tough decisions saying, "You know what? Even though were 100 million in and 10 years in, maybe this isn't going to work." And some of those could die a very, very slow lingering death in the corporate world.

On the other end, the private equity world where they have really succeeded and made a difference in the medical technology space is some of the more lower tech products that are out there where you have a lot of maybe regional companies. Those companies have gotten consolidated and what I would kind of call redundant product offerings where two, three, four, five companies are offering products with very similar attributes, and all they're doing is effectively competing away any profits by offering very similar products. Well, private equity has been great at going and saying, you know what? We can make these businesses bigger. We can reduce some of those redundancies. We can streamline product line offerings and at the same time offer a larger array within that lower tech part of the product catalog. We're not going to do drug diluting stents or drug colored balloons, but maybe surgical drapes, maybe catheter holdings, maybe infusion sets, all those things that still need to be manufactured to FDA requirements, probably FDA approval process, but don't have the same sort of technological risks that a new pacemaker might have.

The kind of evolution of technology, if you think about going back further with the advent of the personal computer, which was before our professional times, the ascendancy of the internet, which was kind of at the beginning of our professional times, it feels now like we're standing at the precipice of another massive disruption in AI. What does it look like from where you stand?

The AI question, certainly that's a powerful new technology that we're, I think, just in our infancy in terms of understanding it. And what I'll say about it is there's much that we don't know. And the reason I emphasize that, Geoff, is I think back to dotcom boom in 1999, 2000 when people realized the power of a connected world being able to conduct commerce over the internet, obviously the cliche was it was all about eyeballs, et cetera, turned out not to be.

But here's the point. These new technologies arrive on the scene and there's just such enormous amount of interest and speculation about where they're going and probably certainty about what they're going to do that exceeds their ability to [inaudible 00:08:20] in the future. You think about like IBM was a monster, a leader in producing PCs. Turns out that wasn't going to be a great product line in the new information age, and in fact, today's IBM has totally exited that business. So all I'm saying is that's maybe a cautionary tale about, I think certainly speculating about where these technologies will go and what they'll do and that they'll have changes. I don't think there's any question about that. What those particular changes are, some of them we might correctly anticipate, many I think are still to be discovered.

How many of the technology related businesses that you're seeing have an AI component? Is that a mandatory element? I feel like every time we go into pitch work, every potential client's asking us what our AI angle is. Is that ubiquitous in every company now?

I think it is just because for the reasons we just mentioned, there is marketing buzz to be generated if you can highlight that aspect of a company or a product. I think about say Spotify. From what I can tell Spotify was an AI-driven company and technology, which maybe predated the common application of that term. I am seeing prospects, clients who are looking at their product offerings or service offerings and saying, we really do have AI in this or that aspect of our business. With our assistance, which our job is being advocates and promoters of our clients' businesses and securities, is to tease out those aspects that will enhance valuation, enhance interest from the investing constituents. We highlight those. We go to greater lengths to describe them. We explain what the economic impact of. That's part of our job as investment bankers, and you certainly see it in the marketplace now. I think the end result is some businesses are repositioning established R&D programs, technological capabilities as AI offerings now, and they're probably getting some benefit from that.

Probably at least benefit in pricing. Do you think some of that is being overplayed as to its at least current significance?

I'd like to give what I think is the tougher answer, which is, I don't know. Really, I feel like one of the hardest things for us as human beings to admit is, "Hey, how this will play out, there's a lot of uncertainty around it." And I think we can talk about what the implications would be. It's incumbent upon us to acknowledge how this technology might change the future and try to understand it. But I think we also have to have pretty wide error bands around that and avoid the trap of speaking with tremendous certainty about what the ultimate outcomes will be as a result of this technology.

There's been over the last, let's say five to seven years, just an immense amount of interest from a capital perspective of pursuing healthcare provider consolidation. I've found in the last 12 months, whether that's in response to some antitrust headwinds or labor pressure, a lot of desire to diversify healthcare portfolios by investors, and part of that has branched out into other areas of services, but also branched out into medical devices. Where is capital moving in the broad healthcare ecosystem?

Well, I think your point on what's happening in the provider world, that's a story that's been unfolding for 10 or more years and has gotten more and more visibility, and I think physicians in particular, but maybe beyond just physicians, we can also think about the allied health professions, the healthcare environment has only gotten more difficult, more complex, more challenging over the course of year and my careers. And grappling with the multitude of payers with the various payment mechanisms, you add in incentive structures and you add into that now perhaps the absorption, the providers taking on risk for the populations they serve, complications, complexity, it all rolls up into a much bigger managerial challenge than a lot of physicians in particular are prepared for or signed up for.

And sort of that I think many people end up in medicine with a mindset of kind of the craftsman paradigm. Is I'm going to be a very, very good physician and my success for me personally and as well as my success helping my patients is going to be dependent on that. Well, in fact, modern medicine as we currently know it's rarely about one physician and it's really about one practitioner's knowledge. It's really about delivering the product of a team. You think about all the people, all the services, all the areas of expertise required by your typical hospital, that's not all dependent upon one craftsman or even many craftsmen. You really need those people operating in a coordinated, collegial, cooperative manner. And that craftsman mentality where everyone has an independent contractors is not particularly well suited to that.

And consequently, you are finding that capital is stepping in and finding a way to organize these groups in some ways not necessarily to ensure cooperation or amongst them. And I'm thinking of some of the specialty roll-ups that's really about can we optimize that particular segment, particular economic corner of the medical spectrum. But in others, I think with these advanced practice models, advanced primary care, direct primary care, Medicare Advantage, risk assumption, by the groups they're trying to solve for that and they're solving for it... Physicians in some instances, but very limited, stepped up and came together to be able to handle risk. But the bigger entities, healthcare partners on the West Coast being a great example, but also now with the new wave of them, there's a need for capital. And capital is a catalyst to bring these disparate groups together, put the right economic framework in place to enable them to take that risk that the federal government through Medicare Advantage is looking to offload to the practitioner community.

I think that's a great point in that some of the dialogue around private equity's role in healthcare is a negative spin, but one of the obviously positive spins is that if value-based contracting and value-based medicine in general is both the way to improve outcomes and also the way to improve cost, you have to have capital and scale to be able to pull that off. And that part of the story, I don't think it's quite the right amount of play.

Oh, you and I are in violent agreement on this. No question. And the part the physicians don't want to hear and understand what people don't want to talk about because it's going to turn them off is you probably need to bring management in. This isn't about being a great doctor, great surgeon, it's about being a great manager. And you and I know that those people are going to look for market rates of compensation, which probably are at or above what physicians think they're entitled to. And again, that's the decision that, maybe I'll call it dispassionate capital, a solution that dispassionate capital can embrace. That's much harder for a group of physicians sitting in a conference room after a long day seeing patients is willing to commit.

Staying on the topic of value-based medicine, about four or five years ago it felt like value-based medicine was coming and it was going to be this wave that completely upended how healthcare was delivered, paid for, everything. You've been involved in some of the biggest and most recognizable value-based medicine players out there. It has still felt like a slower wave than I expected. Has that been a sensation to you and is that still a wave that's going to come crashing on the fee-for-service apparatus or is that going to be a slow burn for a long time?

Geoff, I'll tell you, I'm right there with you in terms of being both an early enthusiast as well as seeing how slow it's been to really take over as the dominant paradigm. Way back when, before I got into banking I was a medical director at a couple organizations briefly, including at a company called PacificCARE, which was all over what they called it then delegated risk or full risk contracting. Essentially the same thing you were talking about, it's value-based care with a different label on it. And they had a very, very successful model that became the Medicare Advantage business of UnitedHealthcare and grew into very, very big business.

But one of the real big principles they had was get as much of the risk managed by the physicians as possible, but they made sure that there were incentives also associated with, so there's a lot of upside associated with it if the physicians... And they delivered care very, very efficiently, and this is over 25 years ago. And I've been waiting for that sort of model to take over because it was so effective. I mean, they were delivering care very, very efficiently. And the challenge is... What do they say? The most expensive instrument in the hospital's, physician's pen or maybe now it's the keyboard because they ultimately make these decisions about resource allocation in the hospital and resource consumption associated with a patient's stay. And if they're not thinking about that and it goes unmanaged and having a third party come in and try to manage that, that's a very fraught exercise, difficult to get right.

We're seeing that right now where yes, you could sign a lot of patients up in Medicare Advantage plans, but if your medical margin was closely tied to getting the risk adjustments correct, what we're seeing now, the government's looking very closely at that, and there seems to be a disagreement between the Medicare Advantage organizations and the government about what that right risk adjustment is. Short story is there's probably going to be some fines and other revisiting of those risk adjustment metrics to the detriment, and you see that in Humana stock right now.

So I'm with you, I don't know that the right model... The consensus around what the right model, that hasn't emerged. And the ones that you and I maybe had a lot of enthusiasm for a few years ago, you saw the companies coming public, some of the leaders, I won't go into the names, but a number of them went public over the past few years and it's hard to necessarily see now that any one of them clearly has the solution that's going to deliver on the promise of value-based care.

The other aspect that's been slower to unfold is the migration of value-based contracting into the arena of commercial payers. And at one level, Medicare already owns the entire risk because they have people at that point for life. Whereas commercial payers' relationship with their populations can be a little bit more transient as one factor. That's made it more difficult to kind of take some of those same ideas in Medicare Advantage and apply them in a commercial setting. But that aspect of it has been even slower to evolve than I would've expected, and finding full capitation arrangements in commercial payers has been really tough to even encounter.

What's going to be the catalyst to move this value-based contracting idea more forcefully into the commercial payer arena?

I don't have an answer for it because I'm not sure that's what commercial needs. As you point out, that commercial population is constantly turning over. Any one insurer has that subscriber for 1 year, 5 years, 10 years. 40-year-old person, generally their healthcare burn is not that great. But then of course they do get sick, they do have accidents, they do require care. Those episodes of care, when you break your leg, you need to get it fixed. When you're in a car accident, you need to be taken care of.

It's very different from the Medicare setting where you're dealing with a lot of conditions. Higher percentage of the patients get sick, the burden of chronic illness is much greater and how you deal with that chronic illness, whether do you aggressively use physical therapy, occupational therapy, surgery on the patient with back pain or can you manage it with less intensive? The outcomes can look very, very similar. I think the commercial population doesn't necessarily have some of those characteristics. You have a lower incidence of very well-defined acute episodes in that commercial population as opposed to all the chronic, heart failure, hypertension, renal disease, osteoarthritis that crop up with old age.

So I'm not saying that value-based care doesn't have a role there. I just think it is a different population, a different problem, and certainly different payment mechanism that probably changes the thinking about how you best go about maybe applying lessons learned from value-based care to it.

One thing is certain all this stuff is going to change. Brian, it's been a ton of fun chatting with you. I've known you forever and you're an absolute pro. Thanks for joining me.

Thanks, Geoff. Thank you very much for having me on. Have a great day.

Thank you for joining us on this installment of The Corner Series. To learn more about today's discussion, please email host Geoff Cockrell at gcockrell@McGuireWoods.com. We look forward to hearing from you.

This series was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this series, you acknowledge that McGuireWoods makes no warranty guarantee or representation as to the accuracy or sufficiency of the information featured in this installment. The views, information, or opinions expressed are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.