May 29, 2012

Dow Jones

Medical Devices as Drug Replacements

Two venture capital firms are on the lookout for medical devices that can replace drugs. Morganthaler Ventures
and Advanced Technology Ventures (ATV) say this investment thesis helps to expand the possible alternatives
for exit by attracting interest from both device manufacturers and pharmaceutical companies.

Their first and biggest success with the thesis to date was Ardian Inc., which pioneered renal denervation (RDN),
a device technology to control hypertension by severing nerves connecting the kidney to the sympathetic
nervous system. Although physicians knew by the mid-twentieth century that severing renal nerves could lower
blood pressure, the surgery was invasive and sometimes fatal. Ardian's achievement was to make it minimally
invasive by using radiofrequency energy delivered through a proprietary catheter to sever the relevant nerves.

Founded in 2003, with ATV and Morganthaler among the original investors, Ardian had a fundraising round in
2009 that valued the company at $200 million. Medtronic Inc. participated in this round, buying about 11% of
Ardian. After a randomized clinical trial demonstrated the success of RDN on patients resistant to drug therapy,
Medtronic agreed about a year later to acquire Ardian in full, for an upfront payment of $800 million and
commitments to contingent payments that, combined, implied an enterprise value of about $1 billion.

Notably, Medtronic wasn't the only bidder. "One of the last three bidders was a large pharmaceutical company
without any medical device presence," says Hank Plain, Partner, Morgenthaler Ventures. "Because the therapy
had the potential to replace drugs, pharmaceutical companies bid." Bank of America analysts estimate that the
U.S. market for RDN could exceed $10 billion.

The same investment thesis brought both Medtronic Inc. and Johnson & Johnson Development Corporation to
the table as investors in last year's IPO of GI Dynamics, Inc., whose EndoBarrier is in clinical trials for diabetes.
EndoBarrier could also address the much larger obesity market. It's a sort of sleeve, implanted endoscopically
without surgery, which mimics gastric bypass surgery by putting a physical barrier between food and the large
intestine. Clinical trials so far have demonstrated both diabetes improvement and weight loss, allowing patients
to cut their dosage of oral anti-diabetes medications. Headquartered in Massachussetts, GI Dynamics raised
about AUD80 (then $85, now about $80) million in an IPO on the Australian Securities Exchange last year.

In addition to the use of medical devices as drug replacements, both Ardian and GI Dynamics have another
common feature - initial randomized clinical trials in non-U.S. markets. Historically, venture-backed device
makers have sought CE (Conformité Européenne) mark approval allowing them to market products in Europe
but did not invest the millions necessary for clinical trials until they were ready to seek approval for marketing in
the U.S. The CE mark is relatively easy to get, as it is only necessary to demonstrate safety. Efficacy
demonstration comes from clinical trials. With Ardian, the backers opted to conduct clinical trials in non-U.S.
markets. "That was a tweak from what we've done historically. We would typically run first randomized trials in
U.S.," says Mike Carusi, general partner in ATV. However, the European trials demonstrated the efficacy of the
product and helped spur bidding interest in Ardian. "Many strategics then wanted to control the clinical trials in
U.S. themselves, because that in itself can be a point of differentiation," says Carusi. GI Dynamics also
conducted a randomized clinical trial outside the U.S., prior to its IPO.

ATV and Morgtenthaler have other companies in the pipeline with similar device-as-drug-replacement profiles.
Both are investors in Innovative Pulmonary Solutions Inc. (IPS), which is working on a denervation approach for
the treatment of such chronic obstructive pulmonary diseases (COPD) as chronic bronchitis and emphysema.
The hope is that the severing of nerves which cause the airways to close could replace the medications used by
COPD sufferers, much as renal denervation can replace drugs used by hypertension sufferers. IPS raised $8
million in its Series A in 2010, and followed up in March of this year with a Regulation D equity issue that raised
about $10.6 million from sixteen investors.

Morganthaler is also backing SetPoint Medical Corporation, which has raised about $17.8 million in private
placements since 2007 and is developing implantable neuromodulation devices for the treatment of such
inflammatory diseases as Crohn's disease and rheumatoid arthritis.

The success of Ardian has already inspired imitators , such as St. Jude Medical Inc., Boston Scientific
Corporation, and Johnson & Johnson, who are trying to develop and market their own renal denervation
technologies. A few more successes like that could turn the medical-device-as-drug-replacement investment
thesis into a venture mainstay.

(Gregory J. Millman is a senior columnist with Dow Jones Banking Intelligence. He holds an MBA and has
worked in banking and as a business analyst in the U.S. and Asia, and has more than 20 years of experience as
a financial writer. He is the author of The Vandals' Crown: How Rebel Currency Traders Overthrew the World's
Central Banks, and several other books. He can be reached at +1 (212) 416-2352 or by email at
gregory.millman@dowjones.com.)