Q4 INDUSTRY UPDATE
Overall, healthcare M&A slowed down in 2017 as the U.S. awaited changes to the existing healthcare environment. However, the announcement of several insurance mega-mergers in the fourth quarter of the year signaled rapid consolidation in the market.
Insurance companies have combined at a fierce pace since the passage of the ACA in 2010. After federal antitrust regulators blocked the merger of the two insurance giants, Aetna and Humana, as well as an Anthem/Cigna transaction, large insurers are looking to vertically integrate instead. Aetna and Humana have each announced new transactions with non-insurer parties:
qAfter the failed CVS/Express Scripts merger earlier this year, CVS returned to the market with the announcement that it was acquiring Aetna for $69B, combining one of the biggest health insurers in the country with the drugstore and pharmacy benefits manager (PBM) giant. CVS aims to create community-based healthcare centers that would enable consumers to receive information on illnesses, health benefits, prescription drug coverage and to remotely monitor chronic conditions, all in one place.
qHumana is taking a 40% stake in the home healthcare arm of Kindred Healthcare, a national provider of home health, personal home care and long-term acute care assistance, with TPG Capital and Welsh Carson acquiring the remainder. As a significant Medicare insurer, Humana focuses on insuring the elderly and disabled and stands to benefit from providing home care to improve health outcomes and reduce overall medical expenses.
Also this quarter, the insurer UnitedHealth Group’s Optum unit agreed to acquire DaVita Medical Group, which owns and operates almost 300 medical clinics, urgent care centers and outpatient surgery centers, for $4.9B. UnitedHealth had previously declared its strategy to build an ambulatory care business and began acquiring doctor groups and surgery centers as part of that strategy.
Of note, these insurers have rapidly grown their revenue from Medicare and Medicaid in recent years. Since 2010 and the signing of the Affordable Care Act, the top five insurers, including the three above that announced transactions in the fourth quarter, have increased Medicare and Medicaid revenue from $92.5B in 2010 to $213.1B in 2016.1
The insurance companies appear to be replicating trends in the not-for-profit sector. Innovative not-for-profit systems have successfully combined insurance with delivery mechanisms to provide high-performing medical systems, such as Kaiser Permanente and Intermountain Healthcare of Utah and Idaho. These medical systems have found ways to deliver better care at lower costs…
Q3 INDUSTRY UPDATE
The uncertainty surrounding the U.S. healthcare market hasn’t put a damper on the strong M&A environment in 2017. The third quarter saw the highest number of overall transactions this year and 2017 is on pace for a record in digital health deals – in terms of both dollars invested and number of transactions.
Sizable hospital systems and health organizations continued to drive the higher end of the M&A market. In August, the University of Pittsburgh Medical Center (UPMC) announced the acquisition of Pinnacle Health System, a seven-hospital system based in Harrisburg, which greatly expands UPMC’s reach out of western Pennsylvania and enables the health system to sell its insurance products to a larger coverage area.
Hospital systems and health organizations face a host of unknowns around:
- Insurance coverage
- New reimbursement models
- New care delivery through Medicare’s Quality Payment Program
- Compliance and regulatory environment
To remain competitive, health systems are looking to M&A to provide stability amidst this undefined landscape. Beyond the obvious, such as building scale and creating multi-region organizations, hospitals and health systems are consolidating to enable more seamless delivery of coordinated and cost-effective care.
Software and the digitization of healthcare delivery are key to meeting these goals. As part of the FDA’s Digital Health Innovation Action Plan, the FDA launched its Software Precertification (PreCert) Pilot Program this quarter. The program will determine quality metrics for software and digital health technology developers, rather than waiting to evaluate the final products. It is designed to speed up time-to-market for new and innovative digital health tools, while safeguarding quality and effectiveness of those tools for patients. Nine companies, including Apple, Fitbit and Verily, have been chosen for the pilot program. The FDA’s objectives to drive innovation also will encourage continued investment in the space…
Q2 INDUSTRY UPDATE
CONSOLIDATION IN PHARMACEUTICAL SERVICES
Developing a new drug takes over 10 years and $2.6B of R&D spend when considering all of the unsuccessful attempts it takes to get a successful one. As a result, with the exception of the largest players, most drug development companies outsource a significant portion of the services for development. The core competency of most drug companies, whether startups or those with a track record of getting to market, is innovation, research and discovery. Drug developers have long outsourced many of the necessary execution, monitoring and analysis functions of development. The largest players in the outsourced pharmaceutical space tend to be Clinical Research Organizations (CROs), with Contract Manufacturers (CMOs) owning a substantial share as well. However, there are many other service providers focused on areas such as regulatory affairs, quality & compliance (GxP), pharmacovigilance, biostatistics, chemistry manufacturing and controls (CMC), and marketing.
Recently, there has been a significant rise in consolidation in the pharmaceutical services space starting with CROs. Two major CRO deals happened in Q2; it was disclosed that INC Research and InVentiv Health are merging and Pamplona Capital Management announced that it was taking PAREXEL private. On May 10, Alistair MacDonald announced the INC/InVentiv merger saying, “biopharmaceutical companies of all sizes face increasingly complex challenges… [and] are seeking comprehensive outsourced solutions across the clinical and commercial spectrum.” On June 20, PAREXEL revealed that it will be taken private by Pamplona. In announcing the deal, overtures of CRO consolidation were a major topic. “The market for biopharmaceutical services is evolving,” CEO Josef von Rickenbach announced after the transaction almost exactly two years after being quoted that competition among CROs was “ferocious.”
As CROs consolidate, the rest of the industry is following suit. In the lower middle-market, German-based PE firm, Auctus, has created a pharmaceutical services roll-up within the Pharmalex platform. In April, Auctus added its first U.S.-based company to the platform, Safis Solutions. (The diagram on page 4 outlines Auctus’s outsourced pharma services platform in detail.) Numerous private equity groups have crafted a similar thesis and SDR expects that there will be continued linkage of the various aspects of pharmaceutical services through aggressive M&A activity…
Q1 INDUSTRY UPDATE
At the risk of sounding like a broken record, our thesis on the drivers of M&A in healthcare remains unchanged. The two overarching narratives remain: (1) driving cost out of the system, and (2) improving patient outcomes. As long as a business model articulates value created for key stakeholders (payors, providers, patients and physicians), the fate of Medicaid, albeit important, does not alter this over-arching theme.
We will continue to see consolidation in the following areas:
- Providers with large patient management systems acquiring smaller add-ons
- Business processes, services or technologies that make practices more efficient or better at collecting reimbursement
- Providers and business services surrounding areas that do not have significant reimbursement risk…
Q4 INDUSTRY UPDATE
In 2017, the healthcare industry will take its first step in what we believe is one of the most significant developments of the recent era. In April 2015, Congress passed the Medicare Access and CHIP Reauthorization Act (MACRA). Part of MACRA is something called the Quality Payment Program (QPP), a form of Medicare Repayment reform that shifts the methodology by which providers are compensated from “fee for service” (or similar models) to a model based upon long-term patient management. “Under the new system, doctors will be rewarded if they improve the way they track and manage patients over time, work in teams to make sure patients get the best, most appropriate treatments, use electronic health records and prioritize wellness and prevention,” says Steven Findlay of Kaiser Health News.
While this is rather old news, 2017 marks a very important step in this implementation. Although new payments begin in 2019, they will be based on quality measures that are collected and reported beginning in 2017. Physicians who do not implement such tracking and reporting systems will be subject to upwards of a 4% penalty on Medicare reimbursement.
A major question in the minds of many is whether physicians will stop accepting Medicare patients. We view this as unlikely for two reasons. First, physicians were already threatening to abandon their Medicare constituents because of the constant threat of declining reimbursement rates for core services. The new formula will carry less risk of rate pressure if it is successful. Thus, in the short run we expect physicians to assess the success of the program prior to taking a stance. Second, Medicare enrollment represents over 22% of Americans. For reasons we’ll discuss below, physicians are further incentivized to join large practices and large practices (simply because they are large) are not incentivized to cut off a quarter of their addressable market…
Q3 INDUSTRY UPDATE
Regardless of the outcome of the 2016 U.S. Presidential election, it is tough to foresee a scenario in the healthcare industry where the true economic cost of providing care is sufficiently covered by the reimbursement rates from government and private payers.
If a declining rate environment is a given, two types of healthcare businesses (or one type when combined) are positioned to benefit: (1) companies with sufficient scale to possess and employ efficient business processes and (2) companies with lower cost structures than peers.
Thus, we find ourselves witnessing two trends within healthcare M&A: (1) companies are pursuing specialties that allow them to establish repeatable processes, best practices, safer environments and better clinical outcomes, and (2) these companies also are pursuing scale in doing so.
This has created an ecosystem very conducive to M&A, and here is how it typically plays out throughout the healthcare industry:
- Providers – Specialty providers are acquiring other specialty providers in pursuit of economies of scale and market leadership.
- Practice Management – Practice management companies are on-trend because they help providers reduce costs and add efficiencies. Practice management companies with scale can do so more than their cohorts; thus, roll-ups are taking place throughout the space.
- Medical Devices – Devices that improve procedural outcomes and reduce patient stress, hassle and time in the office are more likely to gain market share than others. These help providers improve market leadership.
We expect to see this very fragmented space continue to consolidate through M&A in the coming years. Additionally, companies that provide products and services around the pursuit of market leadership and economies of scale will likely be takeover candidates.
Q2 INDUSTRY UPDATE
Every business school student learns about Porter’s Five Forces: threat of new entry, supplier power, buyer power, threat of substitution and competitive rivalry among existing firms. Participants in today’s Healthcare industry are affected by rapidly shifting landscapes in at least one, and sometimes all five, forces.
Players who are differentiating themselves in what are sometimes called the “4 Ps”, as defined in the graphic on the next page, are becoming attractive candidates for growth investment and M&A due to the rapidity of this evolution.
A great example of this evolving landscape is in the Specialty Providers segment (i.e., niche providers of specialized care facilities or services). MEDNAX has grown rapidly (nearly doubling since 2011) due to an intense M&A focus on neonatology, teleradiology and anesthesiology, among other specialties. By standardizing best practices and standards of care in neonatology and anesthesiology, MEDNAX has been able to improve outcomes, organizational communication and reduce overhead. Its large corporate infrastructure enables it to improve revenue cycle management in its acquisition targets, making it attractive for its physician partners to sell to them, but also to retain ownership in specific facilities. In teleradiology, each incremental physician adds efficiency to its system. With more physicians in its system, studies can get from the radiology center to the right licensed and credentialed radiologist faster, and diagnoses can be made faster, improving outcomes and profitability for each center. These drivers not only make specialty providers in fragmented industries like neonatology, teleradiology and anesthesiology better takeover/growth investment candidates, they also make MEDNAX a better partner for larger hospital systems and care networks. The seven acquisitions that MEDNAX has completed in 2016 (at the time of this report) all point to this thesis. AmSurg Corp., a provider of ambulatory services (gastroenterology procedures, ophthalmology procedures and orthopedic) and physician services (anesthesiology, radiology and neotalogy) has grown at a similar rate and has been aggressive through M&A in a similar fashion.
Activity within the Healthcare industry in the first quarter of 2016 continued to be driven by the growing cost of providing care. Although medical cost trends are continuing to outpace inflation, advances in telehealth, new payment models and a focus on value-based care have reduced the healthcare cost growth rate from 6.8% in 2015 to an estimated 6.5% in 2016. Conversely, the number of adults aged over 65 is growing at 3.4% per year which, teamed with the continued implementation of the Affordable Care Act’s penalty tax, has resulted in significant coverage expansion for customers with pre-existing conditions. This, in turn, has contributed to industry cost appreciation. However, an overall deflation in spending growth is indicative of industry trends that are aimed at propelling more affordable care.
Consolidation has become a common strategy for industry players to capitalize on corporate synergies and back-office support, which has resulted in larger health systems. A PwC Health Research Institute consumer survey revealed recently that Americans are willing to travel further to receive care from a respectable or well-known care provider, enhancing the importance of branding for these conglomerates. However, the continued expansion of M&A regulations in the industry may force a portion of deal activity away from traditional acquisitions to affiliations, partnerships and joint ventures. For example, in February, McKeeson Health Solutions announced an alliance with Health QX designed to aid insurers to create and modify bundled payment models. Additionally, regional and niche companies are becoming more common acquisition targets due to unique strengths that could increase the capacity of larger healthcare providers to deliver value-based care.
The emergence of innovative healthcare technologies designed to improve treatment access, enhance data storage and monitor cybersecurity threats has continued to be a major trend within the industry. As the telehealth movement gains momentum, care access is shifting to mobile platforms, fulfilling the public’s desire for value-based treatment and helping reduce industry costs. According to a health industry issues report by PwC, over 32% of consumers claimed to have at least one health related app on their mobile device, as compared to only 16% just two years prior. By improving mobile connectivity and expanding data analysis capacity, many industry players are engineering marginal costs out of the system and making primary care more accessible and fluid. However, with the estimated value of Internet-connected healthcare products exceeding $280 billion by 2020, vulnerability to hackers has prompted increasing cybersecurity regulation. Medical product manufacturers will therefore need to proactively invest in securing and protecting customer data.
As costs to U.S. businesses associated with mental illness now exceed $440 billion, compared to $200 billion in 2013, many industry stakeholders are recognizing the importance of behavioral healthcare, propelling the sector in 2016. Additionally, advances in telehealth technology have allowed mental healthcare providers to conduct virtual appointments, streamlining access to behavioral healthcare.
The Healthcare Industry experienced a strong fourth quarter, recovering from market volatility seen earlier in 2015. Activity within the industry was primarily driven by the growing cost of providing care and a shift of the financial burden from institutional payers (insurance providers, Medicare, Medicaid, etc.) to consumers. According to a medical cost report by PWC, the healthcare industry experienced a cost increase of 6.8% in 2015, mostly associated with wages, equipment and information system costs. The use of defensive medication to avoid malpractice litigation became more common throughout 2015, also contributing to the industry’s cost appreciation. This cost escalation further progressed the movement towards specialized care, as players throughout the sector continued to focus on lower-cost, patient-specific solutions. Growing consumer participation, demonstrated by a 6% decrease in uninsured Americans by the end of 2015, combined with higher industry costs, led to a decline in reimbursement rates, higher deductibles and stricter standards for claim submission and payment. Additionally, as costs increase and shift towards consumers, collection periods are becoming further delayed and have the potential to affect industry cash-flow cycles over the coming years.
The shift in payer mix fortified acquisition strategies that improve service, reduce liability, improve outcomes and provide value-based care. In particular, industry acquirers are targeting companies that will diversify their service and product portfolios. This trend is likely to drive continued consolidation, with industry players targeting specialized firms that service markets that are complementary to their core businesses. Due to the emphasis on value-based solutions, industry players are also moving toward preventative care. Improved diagnostic and monitoring technologies are becoming cost-effective substitutes for hospitalization, reducing overall inpatient visitation. Moving forward, experts are expecting to see a substantial shift, with a growing number of payers moving toward coverages with a more limited scope. As a result, smaller, independent providers face the risk of coverage exclusion and will need to seek strategic partnerships to remain competitive.
On account of these industry trends, the total transaction value of mergers and acquisitions in the U.S. Healthcare Industry increased by 262%, moving from $93.5 billion in 2014 to $245.3 billion in 2015. “Mega deals” among larger healthcare and insurance providers will have an impact on the cost of healthcare, although there is debate as to what this impact will be. The acquisition of new Healthcare Tech companies has also been a recent trend, as companies look to drive out costs and improve profitability by offering products or services within telehealth, clinical trial management, electronic health/medical records, robotics, laboratory testing and mobile-health solutions. These new business segments will not only help companies cut costs and improve care, but will also streamline business processes and increase profitability. Observable Q4 2015 M&A trends also included PE groups acquiring physician practices, particularly those offering value-based care and payment models, and heightened investor interest in behavioral health, as demographics and the effects of the Mental Health Parity and Addiction Equity Act of 2008 come to fruition.
The Healthcare industry had a highly volatile third quarter, primarily driven by macroeconomic concerns and the consolidation of a few of the industry’s largest healthcare payors and providers (Anthem/Cigna, Aetna/Humana and Teva/Allergan). This consolidation highlights the 2015 trend of growth through acquisitions that focus on driving costs out of the system for payors. Frequently seen acquisition strategies are those that target firms with industry-leading discretionary services (behavioral health, fertility services, etc.) or that have physician-based clinics with strong patient/physician relationships. Specifically, industry acquirers are seeking non-core reimbursable healthcare companies that offer patients less-expensive, yet more specialized care. Due to this trend, industry experts are anticipating that both hospitals and large care providers will continue to target specialized clinics that have low overhead costs and the ability to easily scale.
As a result of a heightened regulatory environment and an increase in the nation’s demand for healthcare services, industry players are scrambling to promote operational innovation in efforts to drive out costs and improve outcomes. Many companies are looking toward digital health as a means to use data and technology to improve internal processes and track patient results. As many costs decrease and/or transition out of the system, consumers are continually looking for the next cost-savings opportunity within the traditionally high-priced healthcare industry. Potential acquirers are recognizing this trend and looking toward outsourced pharmacy services as the next industry development after the recent consolidation within the PBM industry. Companies that offer these services (medical therapy management, custom formulary management, etc.) are acting as smaller PBMs and have been successful in addressing the cost savings movement for both the individual and/or the small and medium-sized business market segment.
Regardless of legislation, the prevailing trend in Healthcare M&A revolves around the “4 Ps,” Payors: Any comparable service that provides lower costs to payors is positioned to trend favorably in coming years. Providers: Ease of service, best practice and niche expertise each reduce liabilities and streamline systems. Patients: Safer, more convenient, and less stressful offerings are poised for growth, reduced liabilities and streamlined costs. Physicians: Somewhat overlapping “Providers,” anything that improves clinical outcomes, especially as market forces drive the industry this direction, is primed for M&A. Accordingly, some of the subsectors best primed for M&A are post-acute care, outpatient services, mobile laboratory services and digital health.
The Healthcare M&A transaction value for the first half of 2015 was $60.9 billion, 16.4% greater than the first half of 2014. The Healthcare Industry as a whole accounted for $29.6 billion in transactions in Q2, a 5.4% decrease from Q1. Transactions within the Providers & Services segment made up 73.6% of the value and 44.0% of the total activity. This is reflective of the trend exhibited in the past several quarters and is likely to continue. Equipment & Supplies saw increased activity in Q2 with a 37.7% rise in the number of deals compared to Q1. Transaction value within the segment made up 14.5% of the industry total, despite accounting for 28.1% of transaction activity, indicating that more smaller deals are being made.
The Healthcare industry has seen a substantial increase in M&A deal value for Q1; in total, it saw a 31% increase as compared to Q1 2014. Healthcare Providers & Services made up 47% of the M&A Activity, and the Healthcare Industry as a whole accounted for $30 billion in transactions in the quarter.
Legislative influence has continued to be a leading driver in shaping the industry. Medicare & Medicaid expansion has reduced out-of-pocket expenses, driving increased healthcare utilization. With an aging population, emphasis on preventative care and disease prevention have contributed to industry growth, while technological advances in molecular and genomic diagnostics have led to improved accuracy and treatment of disease. However, these innovations have also contributed to rising medical costs. In addition, Federal restrictions employed by the government to limit the cost of care have resulted in compressed profit margins of healthcare companies.
Across the industry, consolidation has continued, with providers hoping to develop synergies that will improve profit margins, such as UnitedHealth Group’s recent acquisition of Catamaran. Diagnostic laboratories, in particular, are benefitting from previous acquisitions that formed large operations, which allowed for the ability to handle high test volumes and to secure supply-side contracts with hospitals and medical centers. LabCorp embodied this notion with its Q4 $5.6 billion acquisition of Covance, Inc., a major player in clinical trials testing. The acquisition allowed LabCorp to combine its database of 75 million patients with Covance’s drug testing business, giving pharmaceutical companies access to potential clinical trial volunteers.
The Healthcare Industry performed well this quarter as provisions within the Affordable Care Act (ACA) continue to take effect. The ACA has been a prevalent catalyst for recent hospital merger activity as it provides incentives and opportunities for healthcare providers to reduce costs. M&A activity in Q3 was at an industry high, leading many companies to realize these cost savings and increased revenues in Q4. An additional profit generating regulatory change has been the expansion of Medicaid in many states, leading to a significant number of Americans enrolling for coverage. Increased enrollment led to a dramatic increase in patient visits. Higher insurance enrollment decreased uncompensated care, leading to an estimated $5.7 Billion cost savings across the industry, further adding to increased realized revenues in the fourth quarter.
2014 was also banner year for biopharmaceutical companies. The FDA approved 41 news drugs, the largest total number of New Medical Entities (NMEs) approved by the FDA since 1996. This is a 50% increase in NMEs over 2013. These approvals launched up and coming healthcare companies into the spotlight as their products competed directly with older, more expensive drugs. The release of these medications, paired with more individuals seeking healthcare coverage, has proven to be incredibly profitable within the healthcare industry throughout 2014, and specifically in the fourth quarter.
The Healthcare Industry has benefited from the overall economic upswing experienced throughout most of 2014. In addition, increased healthcare coverage and an overall rise in non-elective procedures, due to the U.S.’s aging population, have contributed to increased utilization of healthcare. This increase has driven revenue growth for providers and subsequently trickled down to manufacturers and distributors of healthcare equipment and supplies as well as providers of supporting services. Supporting services, particularly healthcare IT (HIT) are also benefiting from the rollout of Affordable Care Act (ACA) provisions by helping providers meet the ACA’s performance requirements. Given these demand-cultivating conditions, the healthcare M&A market has sustained a high deal flow and premium valuations.
Providers will continue to consolidate to take advantage of synergies. However, this horizontal consolidation cannot continue indefinitely, and the FTC has already begun to intervene in some transaction that it deemed would result in local marketplace advantages. As a result, healthcare providers are trying to invest in technology and traditional cost cutting measures as ways to remain profitable in the face of shrinking payments from Medicare/Medicaid and the shift toward an outcomes-based revenue model. This change of focus is bringing more M&A activity to healthcare technology companies delivering key services such as revenue cycle management, data analytics, and other IT solutions.
Today’s trend in healthcare consumerism has generated a greater focus on value-based care. The line between payers and providers is blurring as many healthcare organizations position for vertical integration. Reportedly, some 50% of US health systems have applied, or intend to apply for an insurance license. Correspondingly, provider transactions have become increasingly strategic in nature. The spike in value-based contracting initiatives has intensified the need for improved IT, analytics (big data), and streamlined operations. Given the current pace of change in the industry, and especially as the vertical integration trends grow, further consolidation is inevitable. Despite the rocky Exchange implementation in January 2014 (and corresponding market angst), this year’s transaction totals have outpaced 2013 by 16%. The 269 transactions in Q2 foreshadow a strong 2014, as Q2 has been the low season for healthcare deals in each of the last three years. Capital investments are on pace to reach the $100B mark – a 55% increase YoY and the greatest annual total since 2011 ($74B excluding Zimmer’s $13B acquisition of Biomet). Regardless, if Medtronic’s $43B acquisition of Covidien closes this year, it will tip the scales and potentially surpass the $136B total from 2012.
A perfect storm has brewed within the healthcare industry as a result of the parallel forces of eroding margins (hospitals may see 0% margins in 2014, down from about 4% in 2013) and increased competitive pressures (e.g. the paradigm shift to consumerism). Progressive executives within the three largest industry segments are approaching this challenge by insulating core revenues with customer-centered service models. Hospitals are consolidating and centralizing their supply chains. Equipment and technology firms are focusing R&D spending on solutions for clinical IT and analytics, operations management and efficiency, and education, training and compliance. Despite seismic shifts in the landscape, January reported an astonishing 227 deals in the middle market, quelling concerns surrounding a dismal 2014. All total, Q1 reached 562 deals, on par with previous years. Capital formation also exceeded expectations with healthcare REITs, for example, raising nearly $2 billion in March. If Q1 is any indicator for the remainder of the year, industry majors will drive consolidation and integration horizontally and upstream, boding well for lower middle market companies that can provide benefits to patients and help reduce utilization among service providers.
Q4 2013 saw a slight uptick in M&A activity in the US healthcare industry. The trend is expected to continue for the duration of
the year, though not without some fits and starts. The challenges facing Healthcare CEOs and CFOs in the coming year will be many and diverse as the industry continues to work through the uncertainties still present in the marketplace. The stuttering start of the HelathCare.gov rollout and the continuing trickle of regulatory rulings coming from HHS are indications that the industry may not yet have the clarity that much of the marketplace expected to have by the New Year. In any event, shareholders seem to be growing impatient with the amount of sidelined capital as evidenced by how far the index trailed the broader market in Q4. Nimble executives will need to find ways to manage the transition of their current portfolio away from the old volume based fee for service model to the new value based healthcare paradigm. In addition, they need to be ready to make swift decisions on which operating units and businesses to keep, which to exit, and which to acquire. This bodes well for the lower middle market, and is evidenced by the deal count and trend line in value of invested capital seen in 2013. We expect to see deal value to rise as horizontal consolidations continue, and deal count to rise as vertical integration becomes
one of the last cost control measures available to CEOs requiring rapid structural change.
The $2.8 trillion US health industry is in the midst of significant disruptive transformation. The full deployment of the Affordable Care Act, and related upheaval in the regulatory landscape; an industry-wide shift to consumerism; consolidation among providers, pharmaceuticals, and insurers; and emerging incubator industries such as electronic records management, and customized healthcare technology (HIT) development is creating both uncertainty and opportunity for strategically positioned companies. Taken together, these factors have begun to define a new health economy, focused on flexibility, technology leverage, and customer “stickiness”. In the short-term this may create a sink-or-swim dynamic, and success will largely be accomplished through focus on patient experience, effective cost management, and smart capital outlay. The shift may portend increased vertical integration, expanding patient choice including price transparency and retail delivery, and more efficient use of technology such as big data and sophisticated analytics to identify and predict patient preference and clinical outcomes.
Positive signs are beginning to reappear in the middle-market healthcare sector. Q2 saw an uptick in M&A activity over the previous quarter indicating that the deal fatigue left over from the record setting Q4 2012 is relenting. The trend line of deal flow for the US Healthcare Sector has stayed ahead of the broader market with the sector producing a Q over Q increase in both deal count and deal value while the economy as a whole dipped in both categories. Expect that this trend will continue as the rollout of ACA forces CEOs to identify ways to address the inevitable changes. While public company valuations in the sector have lagged the broader S&P, the trend in deal flow is a positive sign for healthcare companies. An active M&A market will result in higher multiples and lower dividend and interest requirements for preferred equity and subordinated debt investments. However, whether you’re buying or selling questions abound in the sector as we navigate ACA implementation, sequestration, and interest rate trajectory.
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