Healthcare execs look to make deals in 2018

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If you're a middle-market healthcare executive, the odds are about the same as a coin flip that your 2018 growth plans involve consolidation.

About 150 CEOs, chief financial officers and other top executives from mostly middle-market healthcare companies—or half of respondents to a Capital One Healthcare survey released exclusively to Modern Healthcare—said they plan to buy or merge with existing businesses next year.

The finding underscores the increasing likelihood that 2017's whirlwind of mergers and acquisitions—which some predict will outpace that of 2016—will continue its lively pace well into 2018.

THE TAKEAWAY

Half of middle-market healthcare executives plan to merge or acquire businesses in 2018, setting the stage for another big M&A year.

Pricing pressure is driving much of the activity. Increased scale means more leverage with insurance companies and the federal government, better branding and more power in policymaking, said Lyndean Lenhoff Brick, president and CEO of the Advis Group, a healthcare consultancy.

"Merger mania is just widespread," she said. "You're going to see it in every facet of health care. The reason is because there is still such pressure to reduce prices. What you lose in prices, you've got to start picking up in volume and market penetration."

The survey respondents span a cross section of the healthcare industry: providers, pharmaceutical companies, investment firms and other healthcare services companies. Capital One, which defined middle market as companies with annual revenue of $100 million to $3 billion, declined to reveal which companies took the survey. Al Aria, a senior managing director at Capital One Healthcare, said providers made up a solid proportion of those that said they plan to merge or acquire new businesses this year.

Outside money

Private equity firms played a significant role in the healthcare M&A boom over the past several years, especially among physician groups. The economy has maintained a peak in which valuation and deal flow have remained strong, so private equity firms have been able to raise significant amounts of money.

And healthcare continues to be an attractive investment, said Craig Castelli, CEO of Chicago investment banking firm Caber Hill Advisors, whose portfolio includes a variety of healthcare companies. One strategy that's proven to bring a return on investment: buying small physician practices and funding their acquisitions of other practices. Once they become medium or large relative to their peers, they'll get larger reimbursement rates.

"As a physician practice, by joining one of those larger groups, you're simply giving yourself a raise because reimbursement is so much better," he said.

Last year saw the advent of innovative vertical integration, such as pharmacy chain CVS Health's agreement to buy health insurer Aetna for $69 billion in cash and stock. Bold deals like that are about improving efficiency and care delivery, Aria said. Ideally, they'll lead to better population health management over time.

"CVS and the insurance company can talk to each other now to say, 'This patient isn't filling their script,' or, 'They're not filling their script as often as they should be. Something's off,'?" he said. "It's going to be interesting to see if CVS and Aetna can pull this off."

Mergers aren't driven just by financial necessity. It's also about broadening a company's reach across the continuum of care, said John Washlick, a shareholder with the Philadelphia office of Buchanan, Ingersoll & Rooney, who specializes in healthcare system transactions and market consolidation. In other words, it's not just hospitals acquiring hospitals, it's hospitals partnering with such facilities as physical therapy practices or dialysis companies.

In Philadelphia, for example, Thomas Jefferson University has ballooned in size in recent years, acquiring Abington Health in 2015, then Aria Health System in 2016. Last year, it merged with Philadelphia University and Kennedy Health System. In doing so, Thomas Jefferson University is not only expanding its healthcare footprint, it's capturing new technologies and specialties it didn't have before, Washlick said.

"They're saying, 'We're not going to get big just to get bigger, but what are we missing so that we can provide these services to our community?'" he said.

Those partnerships don't always have to be mergers. They could be strategic alliances that allow providers to direct patients to an oncology, cardiology or neurology practice with which they contract.

In addition to the survey respondents who said they've got M&A on the horizon, another 21% said they plan to launch new segments or new sectors of their businesses. While still a significant proportion of respondents, that's down from 31% in a 2016 Capital One survey.

Given the lingering uncertainty about the future of the Affordable Care Act, Capital One's Aria thinks that means executives are less inclined to build adjacent businesses onto their existing ones, at least not until there's more clarity around where the law is headed.

When new segments are added, some will be services not traditionally thought of as being within healthcare, as providers increasingly look to new sources of revenue. That might even be healthcare providers running catering companies or funeral homes. It might be insurance companies running microhospitals or free-standing birthing centers.

Another 20% of survey respondents said they plan to revitalize and update their existing offerings, which Aria said reiterates the hesitation to add more businesses in a time of uncertainty.

More than half of Capital One's respondents—52%—cited regulation and reimbursement as the healthcare industry's greatest challenge in the next year. That is a big difference from the second-highest response: 20% of respondents said changes to the ACA will pose the greatest challenge.

The regulatory landscape has never been more demanding, the Advis Group's Brick said. Whether it's medical necessity decisions by payers or antitrust concerns with mergers, every aspect of healthcare is being scrutinized, she said.

"It's like you have to have your lawyer and your consultants on speed dial," Brick said. "You can't take a step without landing on a regulatory landmine."

But Washlick said he's observed a newfound optimism among some of his healthcare clients, who feel President Donald Trump's anti-regulation stance could work to their benefit.

The tax reform package Congress approved in December is likely to usher in an even more challenging reimbursement landscape in the future. Despite promises to the contrary from some lawmakers, programs like Medicare and Medicaid will need to be cut to sustain the promises of the new tax law, experts said.

"When they do that, there are no sacred cows," Brick said. "Nobody is going to be immune: physicians, pharma, hospitals. Everybody is going to be on the chopping block."

Capital One Healthcare's annual survey, strategically released just ahead of the J.P. Morgan Healthcare Conference next week, features one resoundingly optimistic data point: 76% of respondents said they expect their businesses to perform better this year than in 2017.

Capital One's Aria said 2017 was one of the most robust years he's seen since 2009. There's plenty of capital waiting to be spent and lots of liquidity in markets, which he said builds on that optimism. "I think people are feeling pretty good about going into 2018, which is what you're seeing in the results here," he said.

Asked about their hiring in 2018, nearly half of Capital One's respondents—48%—said they'll hire more people than they did last year. Another 35% said they'll hire the same number. Only 11% said they'll hire fewer people than last year.

The cuts to corporate tax rates contained in the tax overhaul will help facilitate new lines of business and raise more private equity for healthcare. And that's on top of a wealth of capital that's already sitting on the sidelines waiting to flood into healthcare, Castelli said.

"We see corporations sitting on record levels of cash; we see private equity firms raising ever larger funds," he said. "Well, they all need to invest this money somehow."

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