Healthcare Expected to Dominate US M&A Deal Market

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Screen Shot 2016-04-18 at 4.12.24 PMConway MacKenzie study details forces created by Affordable Care Act

By Joseph M. Geraghty and Gregory A. Charleston, Senior Managing Directors, Conway MacKenzie Inc.

A recent study commissioned by Conway MacKenzie, a leading business and financial advisory firm, reveals that merger and acquisition (M&A) transactions in the U.S. healthcare sector that significantly increased in volume in 2011 have continued to be sustained well into 2015. Importantly, the analysis also forecasts that the momentum in healthcare M&A’s is expected to continue over the next few years.

The study was conducted for Conway MacKenzie by The Smart Cube, a global professional service firm. The research assesses healthcare M&A activity over the past several years, describes factors that drove increases in M&A, and examines the dynamics that will continue the trend in the near term.

Driven by lower interest rates, higher stock prices, and large amounts of cash within healthcare services enterprises, the total number of transactions grew from 427 in 2011 to 531 in 2014. By the end of the second quarter of 2015, the number of transactions had already reached 270.

For example, major healthcare services deals during the first two quarters of 2015 include Barnabas Health and Robert Wood Johnson Health System joining hands to form New Jersey’s largest healthcare system. Another example from that period is the $1.7 billion acquisition of Ardent Health Services by Ventas, an entity of Equity Group Investments.

As might be expected, a major element driving healthcare M&A activities can be attributed to the Affordable Care Act (ACA) and resulting healthcare reform as healthcare organizations consolidate in order to generate cost savings and gain deeper access to information technology resources and capital. 

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The study suggests that as a result of the passage of the ACA, healthcare providers face additional revenue pressures due to lowered reimbursement rates. This pressure, along with an increase in patient volume from health insurance exchanges and Medicaid, has spurred consolidation in the industry, as players are looking to scale-up in order to increase their bargaining power and manage costs more efficiently. In addition, providers will have continued headwinds given extension through 2017 of the U.S. government sequestration reduction in Medicare payments.

When those revenue pressures are combined with the increasing expenses associated with the growing costs of technology and the costs associated with compliance measures, healthcare providers are seeking potential relief through M&A activity.

The study finds that, concurrent with revenue and expense pressures, healthcare providers are also looking to grow top-line revenue, consolidate and improve market share, and diversify to lower cost acuity settings through M&A.

“These are all factors which, in part, are driving valuations of healthcare-related entities,” said Greg Charleston, a senior managing director at Conway MacKenzie and leader of the firm’s Healthcare Advisory Services Group. “Perhaps an example of a point where strategic mergers run up against increased valuations can be found in TeamHealth Holding’s rejection of AmSurg’s acquisition attempt. AmSurg’s all-in offer of $71.47 per Team Health share, a 36 percent premium to the stock’s Monday, October 20, 2015 closing price, was rejected with Team Health stating its decision was “based on the insufficient value indicated in the AmSurg proposal.”

In contrast to healthcare services industry M&A, private equity (PE) healthcare transactions are expected to lose momentum because of high valuations, the large amounts of cash that is available within healthcare organizations, and the increasing willingness of strategic investors to pay higher values.

According to Brian Rich, co-founder and managing partner of Catalyst Investors, “High prices continue to keep many PE firms out of the deals market. PE firms use leverage and it’s very difficult to put a significant amount of debt against these companies because the regulatory environment has gotten harder.” 

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Restructuring in US Healthcare

In addition to increased M&A among providers, M&A activity among insurers has also grown and appears to be driven, as well, by the ACA. In July 2015, Anthem, the U.S.-based health insurer and parent company of Blue Cross Blue Shield, announced the acquisition of its peer Cigna for approximately $48 billion. Also in July 2015, Aetna announced the acquisition of Humana for approximately $37 billion. This will leave the healthcare insurance industry with only three major insurers, Anthem, Aetna, and UnitedHealthcare.

Insurers are also being challenged by providers with some hospital systems creating their own insurance entities. Employers can effectively go directly to providers through these insurance vehicles thereby cutting out the insurers altogether.

In turn, insurer consolidation is expected to encourage even more mergers among providers in order to counter the greater bargaining power of the few big insurers.

Bankruptcy and investor activism are also factors in the restructuring of U.S. healthcare, according to the study.

In 2014, 16 hospitals filed for bankruptcy compared to 11 hospitals filing in 2013. According to the Conway MacKenzie/The Smart Cube study, increases in bankruptcies were driven by factors such as poor financial management by the hospitals, delayed government reimbursement payments, overall reduced reimbursement, failed mergers, litigation/tort claims, and change in the payer mix and market.

In addition, rising medical costs, which may create difficulty for some patients to pay their medical bills, also contributed to declining financial performance at some hospitals. Some hospitals find that while expanded insurance options created by the ACA create a safety net for formerly uninsured patients, there has not been a corollary behavior change and some continue to use Emergency Departments as their primary care option. With some patients facing deductibles and unable to resolve their copay, the hospitals are forced to record higher levels of bad debt on their books. 

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The study also found that increasing investments in the healthcare services sector has drawn attention of several activist investors in this space. In example, Health Management Associates (part of Community Health Systems), post-acute care operator Amedisys, and wellness program developer Healthways have also witnessed activist shareholder activity in the last two years.

While M&A transactions have allowed the healthy hospitals to get stronger and weaker hospitals to align with health systems, bankruptcies, which are the symptom of these market dynamics, will continue given potential interest rate hikes, further reduction in government reimbursement programs like disproportionate share payments and other factors. “Hospitals with limited affiliation, rural or community hospitals and urban-based safety hospitals are greatest risk of failure during this transition period,” said Joe Geraghty, a senior managing director at Conway MacKenzie.

Gregory A. Charleston manages Conway MacKenzie’s Atlanta office and also leads the firm’s Healthcare Advisory Service Group. His healthcare experience has involved hospital, home care, diagnostic imaging, medical equipment and other healthcare service organizations. Mr. Charleston also has extensive experience in various other industries, including transportation, aviation, publishing, government, distribution, construction and automotive. He has served as Chief Restructuring Officer (CRO) and as interim CEO and CFO on several engagements.

Charleston is a Certified Turnaround Professional, Certified Public Accountant and Chartered Financial Analyst. He is a member of the Turnaround Management Association, American Bankruptcy Institute, American Institute of Certified Public Accountants and the CFA Institute. Mr. Charleston is the president of the Atlanta chapter of the Turnaround Management Association.

Joseph M. Geraghty manages the Dayton office of Conway MacKenzie. He specializes in turnaround and crisis management, insolvency and bankruptcy matters, mergers and acquisitions, operational reviews and interim executive management. He has directed, managed and led the restructuring and turnaround of companies with sales ranging from lower middle market to over $1 billion in revenues. Industry specialization includes manufacturing firms, firms supporting the automotive, aerospace and paper industries as well as, textile, quick serve restaurants, healthcare, construction, contracting, service and technology firms.

Geraghty is a Certified Public Accountant and has a Bachelor of Science in Business Administration from the University of Dayton. He is a Certified Turnaround Professional and is a member of the Turnaround Management Association, American Institute of Certified Public Accountants, Association of Insolvency and Restructuring Advisors and TriState Association for Corporate Renewal. He is the Board Chair of Dayton/Montgomery County Port Authority.

Conway MacKenzie is the premier consulting and financial advisory firm to the middle market. Across industries, and across the country, Conway MacKenzie delivers hands-on financial, operational and strategic services that help healthy companies grow and troubled companies get back on track. www.ConwayMacKenzie.com