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5 Factors Shaping Healthcare M&A

A couple weeks ago we put on a Healthcare Teleconference for our Members to help them get a better sense for where the market is headed. As a follow up to the event, we decided to interview both participants on how they see healthcare progressing over the next year.

Yesterday we interviewed Kevin Barnes from Premier, Inc. Today the conversation is with Charles Anderson, Principal at Exaltare Capital and Assistant Clinical Professor of Pediatrics and Public Health at Tufts University, to get a sense for where he anticipates the market heading in the next year.

What do you see happening in the coming year in Health Care? Is there a difference for PE vs Strategics in the coming year?

Charles Anderson: I think there are several things that will continue to shape the healthcare M&A ecosystem:

  1. Margin Erosion: continued pricing pressure as part of an overall federal deficit reduction strategy. Whether it be in the form of cuts to Medicare or shifting of risk to states, providers or consumers, the resulting impact on operating margins for companies that have greater reimbursement risk will have a significant impact on the healthcare deal landscape.
  2. Decreased “Bad Debt”: This margin erosion will however be somewhat balanced by the potential of decreased “bad debt” through increased Medicaid enrollment and expanded insurance coverage through exchanges and individual mandates as part of the Affordable Care Act (depending on the decision of the Supreme Court). The net result will be that for companies with direct reimbursement risk, scale and operating leverage will become more attractive to future acquirers. Therefore, I would expect ongoing consolidation in the provider service sector where financial buyers and strategics will collide over premium assets as platforms or add-ons.
  3. Focus on Efficiencies: I would expect that as margins get thinner and operational efficiency based on improved care coordination and business office performance becomes a requirement, IT and outsourced business solutions will continue to be prime acquisition targets.
  4. Focus on Information: companies that have managed to drive actionable information out of “big data” residing across disparate platforms will be extremely attractive. This will be further bolstered by the increased adoption of mobile technology in the provider sector and I would expect HIT winners to begin to emerge.
  5. Reimbursement Risk Avoidance: We are already seeing many financial buyers looking for pockets that are somewhat sheltered from reimbursement risk, such as contract manufacturing and CROs, and I expect this trend to continue. On the flip side, for opportunities that have a higher degree of risk, buyers are looking to be compensated for that risk through valuation, which often does not line up with the sellers expectations and thereby creating a greater transaction risk.

You mentioned there seems to be a lot of interest in add-ons this year. Do you see the trend continuing or are firms moving back towards platform acquisitions?

Charles: If you have a platform, now is a great time to do add-ons (especially in the provider services sector). A lot of the smaller companies without operating leverage are going to be experiencing eroding margins.

There was a short segment in the teleconference where you both mentioned the election wasn’t going to have a huge impact on health care. Can you explain that to me?

Charles: Largely I agree with Kevin. There have been fundamental changes made to our healthcare infrastructure through things like the HITECH Act as part of the American Recovery and Reinvestment Act, that I think we are poised to see significant changes in the delivery system regardless of who is elected president. Questions that remain are: 1) how the different administrations would address the federal deficit – increased revenue through taxes or decreased spending through deeper cuts in programs like Medicare? 2) Whether or not a Republican President and Republican Congress would mean a repeal of ACA and a replacement plan? Regardless of who wins I tend to think that home health and hospitals will continue to be under pressure while areas like Health IT will continue to present favorable targets and areas like hospice will remain stable.

What else do you see happening this year that will affect exits or acquisitions?

Charles: I think that some of the high profile mergers/acquisitions in areas such as laboratory and imaging that are experiencing growing pains will open the door to smaller local best of breed performers to emerge as exciting acquisition targets. So for these companies that can attract the right partner to help professionalize certain aspects of the business and provide capital to fuel organic growth, my “crystal ball” is showing me that high multiple exits are a real possibility.

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