INDUSTRY INSIGHTS WHITEPAPER
Wealth in Health: The Current State of Healthcare M&A
The healthcare M&A market has been on a roll with a busy 2015. Year-to-date, 2,017 deals have already closed or been announced publicly, according to middle-market investment bank Kratos Capital (an Axial member). Year end 2014 saw a total of 2,813 transactions.More impressive is the year-to-date figure for invested capital in healthcare, which at $225.6 billion has far outpaced year end 2014 investments of only $96 billion. The increase can be attributed primarily to the mergers of large healthcare providers in the third quarter, according to Kratos Capital.This healthy pipeline is spurred by various factors.
The most prominent of these is the Affordable Care Act (ACA), the landmark legislation that has expanded health coverage to millions of Americans.Investment bankers and other M&A players are now at the center of industry consolidation and are using their expertise to help companies take advantage of deal opportunities presented by the regulatory changes.As strategic and financial buyers continue to compete for healthcare assets despite sky-high deal multiples, these experts are closely monitoring industry trends. The most impactful ones are discussed in this article.
The Affordable Care Act
The ACA has become a major feature in the healthcare deal making environment. “Whenever there is significant legislation, a large segment of smart players and money will always be looking around or chasing after growing areas,” says Josh Bammel, a principal at Kratos. Like any regulation, the ACA “has created a jump ball.”The Supreme Court declaring that aspects of the ACA are enforceable will create further consolidation in the market. “By default, acquisitions will be inherent thus spurning accretive synergies,” says Josh Bammel, a principal at Kratos Capital, a privately held M&A advisory firm and Axial member.
Under the ACA, companies with 100 or more full-time employees in 2015 and 50 or more in 2016 must offer health insurance to 70% of all full-time employeesin 2015 and 95% in 2016 — or pay a penalty for each month they fail to do so. “Naturally, merging and acquiring to offset this external growth factor will further influence this space,” Bammel says.Offsetting costs through M&A has also become more important because with the ACA, the market has had to restructure health plans by increasing co-pays and deductibles due to the ACA’s “Cadillac Tax,” an excise tax of 40% on high-cost employer-sponsored health coverage, says John Sarich, a vice president of strategy at VUE Software, a firm advising the insurance industry on automating business processes.
Payer and Provider Dynamics
The quest for survival — on the part of insurance companies, payers, and healthcare providers — is also driving M&A within mid-market healthcare.“There is a lot of activity in the area of health insurers putting together provider networks such as health practices, physical therapy, and ancillary medical providers,” Sarich says.Sarich explains that in some cases, if reimbursements and capitation fees are too low, a percentage of the provider networks will not be available to the payer.In major metropolitan areas, where there are usually four major networks, a health insurance company may buy out one of those players to lessen the number of networks by one, Sarich adds.
Private exchanges will also be a source of mid-market M&A. “Many mid-market companies are joining the healthcare exchanges for economic reasons,” Sarich says. “Mid-level insurance companies cannot make money, are exiting this business, and are focusing on something else. Companies can’t be too small or else they will fall apart under the current system. It’s that in-between where it’s optimum to be in the mid-market. If they get a better network, they get pricing power and are able to price products cheaper.”
There are multiple attractive investment opportunities in healthcare M&A as companies try to compete by gaining scale and obtaining operational efficiencies.Kratos Bammel, says, that deals are occurring in service areas that drive cost out of the system such as specialized practices, urgent care, outpatient services, and ambulatory care.
There have also been acquisitions of physician groups and specialized practices including neonatologists and oncologists, he adds. Private equity has been very active in this space through roll-ups and consolidations, Bammel adds. He expects the next step will be “providers and hospital systems acquiring doctor practices since they want to own the patient relationship.”Aided by legislation, hospitals are starting to step in.
The 6-3 ruling in King v. Burwell means hospitals can “confidently broaden their geographic reach and widen their care offerings by acquiring physician groups, imaging businesses, and urgent care facilities. They can also buy other hospitals,” says Kratos’ Bammel. Hospitals, he says “will move from a facilities-driven outlook to a patient-driven outlook. In addition, off- hospital mild trauma centers, which are increasing, will be very attractive targets.
”Deals involving digital health or tech-enabled products such as mobile devices for delivering laboratory or x-ray results have also been on high gear. “What has been driving these are megatrends in consumer choice where patients are actively engaged in their care through digital health and specialized services,” Bammel says.
There’s no doubt that fierce competition for quality healthcare assets has pushed valuations to elevated levels.“The current dynamics in the mid-market story are that the really big-bulge brackets companies are coming in, causing higher valuations,” says Bammel.“Private equity firms are also refreshing their portfolios and acquisition targets are preparing to be bought by larger companies to gain economies of scale and be ready for a healthcare market that is incentive and performance driven.”Experts say that purchase prices have been high across the board, although this applies to the healthcare sector in particular. “
Broadly speaking companies that would have traded at 10x now trade for more in the range of 12x just by way of example,” continues Bammel. “Strategic buyers are also very active and shareholders reward companies for being acquisitive. However, I expect that eventually markets will cool as they always do as we have seen in previous cycles, most recently in the 06/07 peak.”Even lower mid-market healthcare firms can now be paid top dollar. “Companies with $10-$100 million incremental EBITDA are currently good middle-market targets,” Bammel says.
“Previously, players in the $100 million and over mid-market range were paid top dollar, but that now has become muddled by companies with EBITDA even in the less than $100 million dollar range.”The EBITDA story is there for health providers and services to have higher profit margins and better negotiation power, Bammel says. An example is the transaction between cloud-based solutions provider Athena health and clinical app provider Epocrates, which was EBITDA accretive.
However, the investment banking community is confident that the soaring values are not going dampen healthcare deal making. “The current multiples are only as high as how badly parties to the transaction want to get the deal done,” Bammel says. “If you’re buying into a monopoly, for instance, you create pricing power and walk away with so much more.’And in terms of the bid-ask spread, “investment bankers look at where deals are clearing, and, even with sellers having fairly high expectations, buyers are looking for fast-growth and profitable companies right now, and we haven’t seen this being a problem in getting deals done, ” Kratos’s Bammel says.
Strategies’ vs. PE
Fierce competition and strong valuations have made it more difficult for certain investors to acquire quality targets.According to Kratos, 56 percent of the 2015 healthcare deals to date were by strategic and 44 percent by financial buyers.But private equity firms, which are competing with cash-rich corporates, are not taking this contest lying down. “There have been more preemptive bids ahead of auctions, “says Bammel, “We have seen numerous situations where private equity tries to jump ahead of the process and the competition and work very fast, even paying a premium sometimes. Valuations have been broadly bolstered by a combination of factors; active strategic buyers, robust equity markets, robust debt markets, and low interest rates.
”This trend of unsolicited bids is not expected to end anytime soon. “I would anticipate the circumventing of deal professionals by buyers would continue to trend higher in the healthcare space,” Bammel says. “Buyers are busting at the seams to put their capital to work.”But, the trick is to get ahead of the game. For instance, Bammel calls Kratos Capital a market maker. “One example of a recent client was a life sciences company that had an offer on the table for 9.5X EBITDA from an unsolicited offer.”
When they reached out to Kratos, Bammel says that the firm was “able to open up the market close around 12.7X for the deal by bringing added competition.”He suggests that “owners must find an advocate or I-bank who will create momentum in the healthcare buying community by getting your deal in the front of the line as mailers and broad marketing won’t work.”
Author: Karen Sibayan – Axil Market
York City-based journalist and communication specialist. Karen writes on a variety of finance subjects including M&A, private equity, leveraged finance, and other forms of company financing. Her twitter handle is @trackingfinance.