* Lower returns, pressure on health costs discouraging investors
* Funding levels steady, but young companies struggle to do deals
* Debt financing soars among larger medical device makers By Susan Kelly
CHICAGO, Oct 1 (Reuters) - Venture capitalists, long the lifeblood of medical technology firms, are growing cautious on the sector after seeing their returns squeezed in a time of growing cost pressures for healthcare, a report by Ernst & Young said.
While venture capital investment levels have stayed fairly steady over the past five years, those funds were mostly raised before the financial crisis, the report said. The medical device industry's recent challenges have prompted investors to seek out more mature companies that can offer quicker and less risky exits and have made it harder for start-ups to finance their operations.
"Young companies are really struggling to get financial deals," Glen Giovannetti, head of Ernst & Young's global life sciences practice, said in an interview.
Venture capitalists invested $4.34 billion in U.S. and European medical technology companies in the 12 months ended June 2012, up from $4.03 billion the prior year but below the 2006-07 peak of $5.40 billion, according to Ernst & Young.
In recent years, venture capital investors have had trouble raising new funds at those levels, which will translate into less capital available for emerging companies in the future, the audit and consulting firm said.
"There is less dry powder ready to be deployed in the coming years than in the last cycle," Giovannetti said.
Pricing pressures, slower economic growth and greater regulatory scrutiny that has lengthened the time it takes to bring new products to market are making venture capitalists wary, the report said.
The intense focus on lowering runaway healthcare costs and improving the value of treatments means medical device makers can no longer count on getting funding or reimbursement for technologies that provide only marginal improvements to the existing standard of care.
To get funded, companies with new technologies will need to show they can both improve health outcomes and reduce payer costs.
"The net effect is there is a higher bar being placed on the kinds of deals to back with an investment," Giovannetti said.
DEBT FINANCING SURGES
Total capital raised by U.S. and European medical technology firms surged 26 percent to $27.4 billion in the 12-month period ended June 30, compared with the year before, according to the report.
However, 80 percent of that capital was in the form of debt financing, as a few large, established companies took advantage of low interest rates to fund general operations, restructure balance sheets or make acquisitions, Ernst & Young said.
Companies that issued debt in excess of $1 billion included Hologic Inc , Kinetic Concepts Inc, which was taken private by Apax Partners, and Thermo Fisher Scientific Inc .
The market for initial public offerings remained anemic, with just three U.S. medical technology companies going public for a total of $194 million in 2011-12, down from eight for $539 million in 2010-11, the report said.
U.S. publicly traded medical device companies overall saw a 4 percent increase in revenues to $204.3 billion in 2011, a slower rate of growth than the 6 percent seen in 2010. The industry had enjoyed double-digit annual revenue growth for many years before the recession.
(Reporting by Susan Kelly; Editing by Chris Gallagher)
Keywords: MEDTECH INVESTING/