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Deal volume dips while value soars in first quarter


By Beth Kutscher
Posted: April 19, 2014 - 12:01 am ET
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In the Front Range urban corridor of Colorado, where most Coloradans live, five health systems dominate the landscape. Only a fraction of hospitals are still independent. Executives there say any further consolidation among the industry giants is likely to encounter heavy scrutiny from antitrust regulators.

Across the country, a historically fragmented hospital market is organizing around a select group of for-profit and not-for-profit systems. And that means competition has increased for fewer acquisition targets that still remain on the market.

“There aren't a lot of independents left,” said Michael Slubowski, president and CEO of the Denver-based Sisters of Charity of Leavenworth Health System, which operates 11 hospitals in Colorado, California, Kansas and Montana. The remaining independents aren't necessarily feeling any urgency to find a partner. As an acquirer, he said, “if you're not first to market, you're going to find it hard” to find deals.

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Fewer deals and higher prices was the prevailing theme across the four healthcare industry sectors tracked in Modern Healthcare's first-quarter M&A Watch report for 2014. Much like last year—when the number of deals did not match expectations—merger and acquisition activity started slowly this year, even though expectations were high that it would be a busy year for deal-makers.

Providers, with 77 announced deals boasting a disclosed value of $4.8 billion, were the lone sector to show a greater number of deals than in the prior-year period, with an increase of 42.6%. However, after a spike last year in second-quarter deals, volume has been decreasing sequentially. The value of provider deals in the first quarter was more than five times higher than in the same period last year, when the total didn't even break the $1 billion mark. And it was 33.3% higher than in the fourth quarter of 2013.

Overall, however, the drivers of consolidation—easy access to financing, a 2013 bull market and greater competition for quality assets—made for eager buyers but choosier targets. As a result, the first quarter of 2014 was a seller's market, with strong assets commanding higher prices. In some cases, that caused would-be buyers to walk away from transactions.

The first-quarter M&A Watch tracked 235 deals among payers, providers, vendors, and pharmaceutical and biotechnology companies, representing a 4.9% decrease year over year and 4.5% quarter over quarter. If dealmakers were expecting a turnaround this year, it hasn't materialized yet.

Values take off

M&A deals by transaction value
Click to enlarge
On the other hand, deal values skyrocketed. Total disclosed value for the first quarter was $48.9 billion, or nearly 3 times greater than this time last year and 36.6% greater than in the fourth quarter.

More than half of that value was in one huge deal—Actavis' $25 billion play for Forest Laboratories, which will add more specialty products to a portfolio previously built around generics.

But the spike in deal value also illustrates what dealmakers call a valuation mismatch, where rising prices are leading acquirers to do fewer transactions. “Somewhere around 2013, the markets decided they were bullish on healthcare,” said Chris Gordon, a managing director at Bain Capital, a private-equity firm. As a result, he said, it's been harder to get deals done over the past 18 to 24 months. “We looked at a large number of deals that didn't trade.”

The rising valuations are driving cash-flush private-equity firms to look at smaller companies that previously would have flown under the radar, said Raul Gutierrez, managing director and head of healthcare M&A at SunTrust Robinson Humphrey. He pointed to workers' compensation as a subsector that's been seeing more private-equity interest in the past 12 months.

Deal multiples have been increasing even among not-for-profit healthcare providers, which aren't necessarily looking for a partner that can pay top dollar. “It's not only about who can pay the highest prices,” said Philip Pfrang, lead partner of Deloitte's healthcare and life sciences M&A transaction services group. “It's all about who can bring me the most capital so I can benefit my community.”

Independent, not-for-profit hospitals are also looking for more intangible factors, such as cultural integration among physician groups as well as clinical integration through health information technology. In addition, they're looking for partners that enable their patients to access tertiary and quaternary care while also expanding services at their own facility.

“Hospitals are pillars of their communities,” said Dr. Scott Lichtenberger, chief strategy officer at University of Colorado Health, Fort Collins. “When you talk about value to an independent hospital, it's really about keeping care local.”

At the same time, the narrative of the struggling community hospital desperate for a buyer isn't the prevailing story anymore—though such hospitals definitely are out there. Instead, independent hospitals on solid financial footing know they will need size and scale in the payment and delivery reform environment, and they are starting the partnership hunt well before they face the risk of shutting their doors. “We have been finding that hospital systems and their boards are much more strategic in their thinking,” Pfrang said. “They're looking for partners earlier in the process.”

Year-over-year deals for providers
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Provider deals also are taking longer to close after they're announced, and parties have shown a greater willingness to walk away from a transaction, said Ellen Federman, senior consultant for global M&A services at Towers Watson.

In provider M&A activity, the two largest deals reflected continued interest in the senior housing and care space, which is expected to grow as the U.S. population ages. Brookdale Senior Living, Brentwood, Tenn., spent $1.4 billion, plus the assumption of $1.4 billion in mortgage debt, to acquire Seattle-based Emeritus Corp. and expand into a company with operations in 46 states.

The following month, NorthStar Realty Finance Corp., a New York-based real estate investment trust, spent $1.05 billion on a portfolio of skilled nursing and senior housing properties.

The transactions reflect a growing interest in higher-end facilities that offer a broader range of services in a homelike setting, Gutierrez said.

On the acute-care side, Duke LifePoint Healthcare, Brentwood, Tenn., signed one of its largest deals, committing a half-billion dollars to acquire Conemaugh Health System, a three-hospital group based in Johnstown, Pa.

Higher deal prices wouldn't be possible without the easy access to financing that healthcare companies have enjoyed. For publicly traded acquirers, the bull market helped boost their own share prices as well as the market capitalization of their targets. And both buyers and sellers showed more willingness to accept deals financed with a mixture of stock and cash, rather than demanding all cash, Federman said. “The debt markets and the equity markets are providing currency for deals that we haven't seen since probably the Great Recession,” she said.

Another factor driving up prices is that strategic and financial bidders had to compete against the lure of an initial public offering, as the equity markets handsomely rewarded many companies that chose to go public rather than be acquired.

IMS Health, which provides data and analytics primarily to the pharmaceutical industry, had the second-largest IPO of the quarter when shares sold at $20 to raise $1.3 billion. That valued the company at close to $7 billion.

But the first quarter's most talked-about IPO was Castlight Health, which provides price and quality information to workers in employer health plans. Underwriters for Castlight priced shares at $16, already above the expected $13 to $15 range listed in the IPO prospectus. But on its first day of trading, shares soared as high as $41.95, which had some observers warning of a bubble. The company's shares since have dropped to below $20 as of mid-April.

In total, 34 companies filed a registration statement for an IPO in the first quarter, up from 25 in the fourth quarter of 2013. Smaller pharmaceutical and biotechnology companies, which also flocked to the public markets last year, represented almost two-thirds of the filings.

MH Takeaways

Easy access to financing, a bull market in 2013 and greater competition for quality assets made for eager buyers but choosier targets.

Retreat from mega-consolidation?

Life sciences companies also took the opportunity to do some pruning in the first quarter and simplify their stories for analysts and investors. The second-largest deal in the period was Johnson & Johnson's $4.15 billion disposal of its Ortho-Clinical Diagnostics unit, which it plans to sell to the Carlyle Group, a private-equity firm. In addition, Baxter International announced plans to spin off its biopharmaceuticals division to focus on its medical technology business.

These deals suggest a retreat from mega-consolidation in the pharmaceutical industry. “For many years, the debate was, could you survive in the middle?” Federman said. “Midsize pharma now seems to be back in vogue. Some of those divisions being sold are very attractive to buyers.”

Despite the slow start, dealmakers and consultants say the stars are aligned for an active M&A year.

Bain Capital's Gordon predicted that buyers and sellers will begin to gain clarity on how much companies are actually worth now that healthcare reform is firmly underway. That should bring valuations more in line with expectations, especially in emerging subsectors such as cost comparison tools and data analytics.

“We'll see the reality of what healthcare reform will bring,” Gordon said.

Follow Beth Kutscher on Twitter: @MHbkutscher


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