VentureBeat

I didn’t write about Medtronics’ $3.9 billion acquisition of Kyphon when it was announced almost two weeks ago, largely because it seemed to be a pretty straightforward merger of two big public companies with relatively few implications for the venture medical-device business.

The good folks at the In Vivo Blog beg to differ, and weighed in earlier this week with a sharp analysis of the deal. To summarize, Kyphon was seen as an upstart in the spinal-device market — a venture firm that grew up, went public, and appeared on the verge of threatening the hegemony of the Big Three device makers by snapping up promising little companies before they could. (In Vivo doesn’t name the Big Three, but they have to be Medtronic, J&J and Boston Scientific.) Yet Medtronics’ decision to take out Kyphon may do little to stem a new wave of competition from spinal-device startups.

As In Vivo tells it:

Kyphon’s rapid recent growth and willingness to pay a premium price to acquire new technology marked perhaps the largest shock waves threatening to disrupt the status quo in the spinal market, where small companies have had little choice other than the Big 3 when looking for potential acquirers. Recently, however, that sector has been undergoing a bit of a shake-up with the major companies losing market share…. These losses have largely come at the hands of the many burgeoning spine start-ups. Analysts now estimate there are as many as 150 spinal device companies, compared with one-third that number just a few years ago….

[R]ather than entering a period of slower growth and retrenchment or consolidation, this group of spine industry veterans predicted that a number of product, market, and clinical forces are coming together to drive significant future growth, with one panelist suggesting that the current $4 billion spine market will more than triple in the next few years.

The factors contributing to this perfect storm in spine include innovations in diagnostics, particularly new imaging technologies, along with new implant designs, and a patient population growing not just from overall aging but from younger patients looking to take advantage of new treatment options. Clinically, the spine market is characterized by variety of conditions that can be treated by numerous therapeutic approaches; doctors are not wedded to any single therapy and continue to explore different options, resulting in a fertile environment for companies with innovative technology.

We’ve certainly seen no shortage of spinal-device companies getting funded here at VentureBeat Life Sciences over the past few months — a group that includes Active Implants, Amedica, Gentis, Interventional Spine, Orthopedic Development and Pegasus Biologics, among others. (I’m sure I missed a few.) There’s certainly no shortage of innovation in the space, even though it’s far from certain that most — or even many — of these innovative techniques will end up being safe and effective. (There are also plenty of spine-related device horror stories out there as well, with the tale of J&J’s Charite spinal-disc replacement perhaps chief among them.)

In any case, there’s no question that hegemony is boring, and the idea that one or more of these startups could hit it big and keep shaking things up is certainly appealing. On the other hand, if market share at the Big Three is shrinking while innovation proceeds apace among startups, that may just cause the big companies to step up their M&A activity while they can — perhaps reaching even further down to earlier-stage companies, the same way Big Pharma has done recently in biotech. As it turns out, it’s awfully hard for smaller companies to compete against big, cash-rich incumbents, especially ones who can make a buyout offer the startups can’t refuse. As Kyphon itself ultimately realized, I guess.

Updated

St. Francis Medical Technologies, of Sunnyvale, a company that treats spinal injuries, will be acquired Kyphon of Sunnyvale, for as much as $725 million, the companies said.

This must be especially welcome for Silicon Valley venture firm US Venture Partners, a backer of St. Francis which has performed poorly lately (see data below). This deal comes just as St. Francis was about to go public; the offer was too good for St. Francis’ private investors to pass up.

Kyphon will pay $525 million in cash when it closes the deal, and up to $200 million more in cash or stock payments based on future revenue.

Venture backers, including Essex Woodlands, Trellis Health, Versant and US Venture Partners had invested about $27 million into the St. Francis over several rounds since the company was founded almost a decade ago. USVP owns 26.7 percent of St. Francis, and so is likely to get on the order of $140 million. Philip Young tells VentureWire (sub required) his firm will see a return of between 15 and 20 times its investment. We’re not sure what one of its funds USVP invested from, but you’ll see below that it hasn’t done too well lately.

It is another firm that has become bloated over the years, raising larger amounts of money and struggling to invest it all. The data shows USVP has lost more money for its investor so far than it has made from its funds raised in 1996, 1999 and 2000, as published by the Washington State investment board. It is the most recent data available, valid as of March 31. And this doesn’t included results from USVP’s 2001 fund, which is also clearly in the red. The table below shows the following, from left to right: 1) The date of Washington State’s investment into USVP; 2) the amount actually handed over to USVP so far to invest; 3) current market value of USVP’s private portfolio; 4) the total money returned by USVP, 5) the total value [3+4]; 6) gain since inception [(3+4)-2]; and 7) the Internal Rate of Return. Since Washington State is only one of dozens of investors, it will only get a sliver of the St. Francis bounty, so it’s not clear if it is in the black yet on USVP. Washington State continues to ignore our requests for more information about its investments (we’ve called and emailed at least five times over the past year). But St. Francis will go a long way in helping compensate for that $23 million loss you see in the last column.

Over the past few months, we’ve also tried several times unsuccessfully to contact partner Steve Krausz (the venture firm’s site is Flash-based, so there is no direct link to his profile) to ask him how he manages to sit on 13 boards, which is a tremendous amount of work. Boards meet, on average nine times a year. This means Kraus has a board meeting every three days, and that includes weekends. (Update: Gosh, in addition to the 13 mentioned on the USVP web site, we’ve just found evidence that he’s on most, if not all, of the following boards, too: Xponent, Occam, Montavista Software, Xirrus, Electric Cloud, Megapath Networks, Asempra and X1. We’re still verifying this, but the end result is profound, and must surely be a record: How do you hold a board meeting every day and a half, including weekends?).

We’re not sure how much success USVP has had in its IT investments. However, health care investments are doing well now, and USVP is smart to have to stayed diversified (other firms abandoned the sector during the last Internet boom). Partner Phil Young (left), responsible for the investment in St. Francis, sits on ten boards. So he has a more relaxed schedule: Only one board meeting every four days.