Where Does Healthcare Fit in The New Normal?

It seems lately like every new deal announcement that comes across the wire somehow involves a healthcare company. Perhaps it is just one out of every ten transactions that actually does involve a healthcare industry business; nevertheless, I cannot get over the fact that there just seems to be an influx in activity within this segment of the markets lately.

Just within the past month, we’ve practically seen every kind of possible transaction that we can imagine involving medical companies, from buyouts of UK-based home health companies to HCA’s $1.75 billion special dividend, for which it received a significant amount of criticism from the financial media. And it seems like everyone is trying to get a seat on the healthcare value train, including Richard Branson’s Virgin Media and The Kroger Company, both of which have announced recent deals acquiring healthcare services companies.

This past week, as another round of earnings reports were released from healthcare firms, a number of CEO’s commented on their companies’ aggressive pursuit of investment opportunities this year, as a result of better-than-expected financial performance in the fourth quarter of 2009. These developments came after a series of bond financing-related announcements at JP Morgan’s High Yield & Leveraged Finance Conference earlier in March.

And the strategic buyers are not representing all of the action in this flight to the seemingly value-rich and cash-heavy healthcare sector. Multiple buyout shops and VC’s have recently announced new healthcare-focused funds from Linden LLC to EDG Partners, an Atlanta-based private equity firm, led by veteran industry operators Steve Eaton and Alan Dahl, who recently closed on their second healthcare-focused fund. Even the unconventional want in on the wave – hedge fund FrontPoint Partners launched an alternative investment vehicle this month that will focus on opportunities to acquire stakes in emerging market healthcare companies.

Finally, what would a market recovery be without a healthy dose of drama? Our appetites were satisfied as we observed the unfolding situation of buyout shop Thoma Bravo’s efforts to take private healthcare technology firm AMICAS Inc. (Nasdaq: AMCS), which has now stretched on for almost six months. PE Hub has followed the drama with each announcement, but the quick version goes something like this:

Bravo made a bid to buy out the provider of healthcare imaging technology solutions back in December, with plans to take it private. AMICAS’ board accepted the deal tentatively until Bravo confirmed financing was good to go. However, while Bravo was completing its process to obtain financing for the deal that totaled $217 million ($5.35 per share), fellow HCIT firm Merge Healthcare (Nasdaq: MRGE) came along and made a rival bid at $6.00 per share (approximately $220 million), with financing all teed up. AMICAS ultimately scrapped Bravo’s offer, accepting a revised bid from Merge earlier in March, which at the end of the day came out at $248 million. Merge even agreed to pay Bravo’s termination fees, which according to the Wall Street Journal came out to more than $8 million.

Performance Enhancing Results

While the sector has accomplished significant financial value creation in the last year, blasting through the economic downturn with positive growth, uncertainty around healthcare reform in Washington remains high, keeping many executives on their toes for the time being. However, this does not appear to be enough to keep all investors on the sidelines; indeed, many are approaching the current environment as an opportunity for value creation that we have not witnessed in decades.

The moral of the story here is that better-than-expected performance throughout the financial downturn is proving to be the prescription for driving future growth through new and alternative options that many healthcare companies are now able to consider for the first time in years. And since the healthcare sector often represents a cross-section of multiple various sectors and business types (e.g., technology, real estate, etc), changes within the industry can prove to be much more systemic than the broader marketplace initially realizes or understands.

Growth trends are particularly compelling within the healthcare IT (HCIT) sector, which is experiencing an era of consolidation that for now has no real end in sight. Many people, including those in the US government, are putting a great deal of stock in the ability of HCIT to change the landscape of our nation’s healthcare delivery system. The first quarter of 2010 was busy for HCIT firms with every doctor in America wanting a portion of the $19 billion promised under the American Recovery and Reinvestment Act. The Healthcare Information Management Solutions Society (HIMSS) geared its entire theme at this year’s conference held in Atlanta around the question of how the stimulus bill will allow providers to reduce costs and improve patient care through the adoption of technology. These trends have caught the eyes of many investors since early 2009; however, a new data point that has attracted many new investors came from an industry report released in February, which forecasted the US market for electronic health records (EHR) to exceed $4.5 billion over the next five years.

This news was even more enticing for healthcare industry newcomers when they realized that the EHR space represents a relatively small segment of the overall HCIT market, particularly considering physician adoption of EHR remains below twenty-five percent. Clearly we have a long road of adoption ahead of us before all of the new opportunities within this market are completely tapped.

Still, this segment is already growing at historical levels and it continues to attract new interest from the broader markets, such as Dell Inc., which acquired Perot Systems in 2009 for more than $4 billion; and, Google, whose healthcare-focused application continues to be touted by some as the first healthcare information management solution that fully operates in a “cloud” environment.

Transactions involving HCIT companies grew an astounding 824% from Q3 to Q4 of 2009, with 58% of these deals being private placements and 42% M&A transactions. While I don’t think we can expect to see that same level of raw growth in the first quarter of 2010, if we remove the $5.3 billion buyout of IMS Health led by Texas Pacific Group, activity so far in 2010 is trending towards another healthy growth period for the HCIT space.

Global deals involving healthcare services companies, which include healthcare providers and managed care firms, have also exhibited positive trends recently, sparking interest from new market participants and the traditional usual suspects alike. Transactions involving healthcare services firms within the US represented more than 50% of total healthcare deals since the beginning of 2010; although, these deals only represented 6% of the aggregate transaction value for the healthcare industry. Nevertheless, healthcare services remains on the radar as a target for growth in 2010, according to both financial and strategic sponsors alike.

Many of the major players in the healthcare services haven of Nashville have announced their intentions to make acquisitions in 2010 and 2011. Despite the ongoing financial burden of uncompensated care and looming threats of declining Medicare reimbursement, many of these entities are readily seeking opportunities, including Community Health Systems (NYSE: CYH) and Health Management Associates (NYSE: HMA). Both of these health system operators have aggressively moved to expand their reach of not-for-profit health systems after experiencing better-than-expected growth in the second half of 2009.

Nashville’s usual suspects are under increased pressure to more aggressively tackle alternative growth strategies so they can gain any edge they can over the emerging regional systems, such as Ohio-based Catholic Healthcare Partners, which recently closed on a $180 million acquisition of a Cincinnati hospital; and, Ascension Health, which last week finalized its $1.35 billion bond financing that company executives say will allow the largest not-for-profit health system in the country to finance its growth efforts.

Speculating on the “New Normal”

Despite the above commentary about how the global healthcare sector is attracting all kinds of new investment activity and consolidation like never before seen, I firmly believe that this is not any sort of “new normal” or “black swan” or any other crisis-era book title to which you may want to peg these trends. Let’s be perfectly clear that the current healthcare market landscape is not necessarily the end all-be all of where the markets are going. While many opportunities are emerging in the current phase of market evolution, there are still plenty of outstanding questions as to what the long-term landscape for healthcare businesses will ultimately look like.

Specifically, as hospitals and physicians align towards clinical integration, the idea of the small medical practice and independent physician may become antiquated for the next generation of providers. As doctors are turning to technology for gaining economies of scale and operational efficiencies that the healthcare delivery system has lacked, much of the hospital alignment push is driven by the opportunity to adopt the solutions that can enhance both the quality of care and the revenue cycle process simultaneously. What the market now realizes, though, is that many disjointed systems that do not communicate efficiently will not be the answer.

As a result of this consolidation occurring on the ground floor of the delivery system, large provider organizations are already considering how they can offer IT as a solution and to facilitate this process better for doctors. The downstream net result of this will be the upper level consolidation we are already seeing taking place. Moreover, this consolidation is happening much faster than it did in the tech boom of the 1990’s, which will result in fewer providers gaining access to the marketplace as consumer (i.e., patient) access will be controlled at the health system level.

While it is sometimes easy to assume healthcare is a sure thing, a recession-proof alternative to anything risky, it is also the only industry where the government is likely to completely change the business model of every healthcare business practically overnight. It is certainly natural to want to wait out healthcare reform. However, as long as the baby boomers continue to age and Americans continue to spend four times as much on healthcare as we do on defense, companies offering a sound business model contributing to the efficient delivery of healthcare will ultimately be positioned to achieve these growth and value opportunities.

Mark Reiboldt is a vice president at middle market investment bank Coker Capital Advisors, where he specializes in mergers and acquisitions for healthcare technology and services companies. He can be reached at markreiboldt@cokercapital.com