Richard Martin (The M&A Guy), Senior Director, Merrill Corporation | June 01, 2017
Executing Effective M&A: May 2017
Recently, I moderated a panel discussing how to create and execute a M&A “masterpiece”, identifying key focus areas for successful transactions. To move this from the all too common theoretical “best practice” review, we examined this topic using real-life examples against the backdrop of healthcare.
Healthcare was selected as a result of examining our internal data and the high–level of activity in the sector. This was corroborated in discussions with many private equity professionals and via numerous data outlets. Merrill has shared some of these internal insights in our April edition of the Merrill M&A Forecaster.
As we all know well, healthcare is a hot topic, with an ongoing debate around the repeal/ replacement of the Affordable Care Act. While the politics are debatable for many, what is not is the fact that there is a great deal of uncertainty in this sector. This creates inefficiency and ultimately leads to opportunity for those intrepid enough to navigate that uncertainty.
Activity slows, fundamentals remain strong
As a backdrop, our data partner Pitchbook notes in the US PE Breakdown, 2017 1Q, after several years of strong PE activity, US deal flow started off slow in 2017, with 745 transactions closing for a total $118.7 billion in value, compared to $138.7 billion across 867 deals in the final quarter of last year.
That slow down, while not easy to dismiss, should be taken with a grain of salt. Quarter-to-quarter activity varies greatly and the most recent figures will likely be revised upward. What’s more, market fundamentals and our own data point to strong deal flow in the year ahead, especially as fundraising has continued at a rampant pace. By many accounts, PE dry powder sits at record levels between $550 to $800 billion as of 3Q 2016.
While we have not seen as many mega-deals so far in 2017 (just two completed in the first quarter), Blackstone’s $6.1 billion take-private of healthcare administrator Team Health Holdings is notable and demonstrates the opportunities in the sector.
I expect to see more as the year progresses for several reasons:
- Our internal data has served as a valid indicator of future announce activity, and signs point to a lot of announced activity over the next six to nine months
- The capital necessary for such large deals is at hand. Although federal guidelines limit lending to 6x EBITDA, the gargantuan funds that PE firms have raised in recent years allows them to write proportionally larger equity checks when necessary.
- Seven mega-deals have been announced, but not yet closed, since November 2016.
Specific and fascinating case studies
Our panelists were very generous to share specific examples of the deals they have worked on. We discussed how successful healthcare mergers are best orchestrated. The observation was made that often, medical groups merge thinking bigger is better, and that increased scale can bring negotiating power with insurance companies, ability to attract top talent, volume discounts from vendors, upgrades to technology and leverage with hospital systems.
However, these benefits aren't enough for a merger to be called successful. There must be a strategic plan that incorporates vision and mission statements, goals and key performance indicators (KPIs) and most importantly, that those goals and KPIs are shared and agreed with providers. A common, upfront understanding and agreement on the goals of the transaction is critical to success.
A great example of the level of detail provided was our discussion around a bio repository company that specializes in depositing research samples for long term storage. This was a corporate purchase that was unaffected by regulatory changes, had secure payments streams, a specialized expertise and a multinational footprint. The deal closed successfully for the strategic purchaser and highlights the types of opportunities that exist in the market today.
In contrast, we also discussed an unsuccessful attempt to integrate a dental practice with other specialties (pediatrics and ortho), which on the surface makes sense in terms of integrating ancillary services to achieve efficiency and scale. In this case, the deal did not close for several factors including valuation challenges and a “generational” change in practitioners focus. The younger dentists wanted to focus on providing care, rather than being business managers.
The trend of companies pursuing transformational M&A continues, influenced by several factors:
- Low cost of capital and acquisition financing
- Balance sheet capacity
- Challenges with driving growth organically
- Benefits of scale in driving down costs and competing (especially as a provider)
- Willingness to utilize stock currency at current valuation levels
However, recent breakups of transactions highlights risks in today's environment and the importance of deal protection. Due to regulatory environment uncertainty, 2016 saw more than $800bn of withdrawn deals due to regulatory reasons, so it is not a forgone conclusion that divestiture remedies will get through.
Organizational preparedness for a potentially drawn-out regulatory process is paramount. – as is having a backup plan.
Preparedness: The key ingredient for success.
As noted in these examples, preparedness is a central factor to success, and we shared how to best handle “deal anxiety” through preparation. For the buyer, comprehensive due Diligence, maximizing value, having a clean close and optimizing integration are primary focal points.
For the seller, the focus is on expediting due diligence, maximizing price and minimizing post-deal risk. Balancing these competing needs is central to achieving the best outcome and early preparation, using sophisticated VDR tools and services, is a key ingredient for a positive outcome.
Frothy valuations increase the importance of up-front due diligence
Due to higher multiples and strong competition, capital deployment will be a challenge, but one that PE firms can overcome with heightened attention to sourcing and due diligence.
Pricing advantage makes this a seller’s market and the hurdle rates are relatively low, but valuations are high – too high in some cases – making thorough due diligence critical to make sure you are placing the right bets and achieve the “best” valuation (one that meets the requirements and expectations of both parties).
A great market for the intrepid
Four key factors leading to why now is the right time: Uncertainty, Complexity, Regulation and Security. Typically, this can sideline people, but changing demographics, access to capital, the large quantity of dry power among PE, low cost to capital and the ability to achieve a premium for smart execution has never been greater.
Our panel also discussed the impact of MACRA, and the fact that the reporting mandates, done properly or not, represents an 18% pricing spread for organizations. It highlights inefficiency and suggests that much of the activity is based on an uptick in optimism and a generally improved disposition toward opportunities.
But who really has the upper hand? The best answer is the “better prepared, smarter part” – meaning a higher visibility in documentation and the requirement to share complete information up front.
My prediction is that the healthcare sector continues to be a viable and present opportunity for those organizations with the ability to weather a continuingly uncertain environment for those prepared and positioned early to investigate and take advantage of opportunity.
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Richard Martin, The M&A Guy