As health care organizations continue to struggle with the issues of reimbursement and the costs of technology and compliance, mergers and acquisitions (M&A) have become an avenue for revenue and market share growth. This uptick in M&A activity is driven by an increasing cost of doing business, favorable credit markets and clarity surrounding the implementation of the Affordable Care Act (ACA).
What's trending in health care M&A?
Health care industry spending currently accounts for approximately 18 percent of gross domestic product (GDP). By 2022, health care spending may comprise as much as 19.9 percent of total GDP. Much of this growth in spending will be driven by new Medicaid enrollments as promulgated by the ACA, an aging American population and technology spending related to electronic medical records and ICD 10 conversions. As the already large pie of health care spending gets larger, competitive players will seek to capture growth through acquisition. Additionally, the aforementioned information technology (IT) costs and costs of regulatory compliance will increase the costs of doing business, such that smaller or less profitable players will be forced to sell. As a telling statistic, a recent survey found that 88 percent of health care executives expect to pursue some sort of M&A activity in 2014.
This macro trend of increased consolidation will impact the various subsectors differently. The traditional acute care hospital subsector will likely see deal activity increase slightly, while valuation multiples increase. However, ambulatory surgery center transaction activity will ramp up considerably, but multiples will remain flat, or even fall for both single-specialty and multispecialty centers. The difference is primarily that much of the hospital space is already consolidated, whereas there exists in the marketplace a bevy of independent ambulatory surgery centers (ASCs). The independent acute care hospitals that have so far avoided acquisition are typically well-run, and are therefore priced accordingly. On the other hand, ASCs have not experienced the same consolidation shakeout that hospitals have. There are still thousands of ASCs, and it is much more of a buyer's market, which will depress multiples, or at least widen the range of multiples paid for ASCs.
While well-run providers such as hospitals or ASCs may be able to postpone acquisition for a few years, they are unlikely to do so indefinitely, and should prepare now to maximize value in the forthcoming transaction. These providers should identify the most suitable acquirer that is consistent with their geography, will support their mission, and whose continuum of care would benefit most from the specialties the provider brings to bear. The more valuable, in terms of financial performance, physician specialties and geography, a potential target can make itself to an acquirer, the more leverage that acquirer will have when it is eventually acquired. Transaction leverage is particularly important to nonprofit providers because such leverage can be used to secure funding from the acquirer for additional capital expenditures. These capital improvements will enable the local facilities to better serve their communities and fulfill their missions.
M&A preparation – small and large providers, ACOs
What can health care providers do to best position themselves in the M&A landscape?
For smaller providers like individual practices, small hospitals or medical service vendors, their preparation focus should include identifying the most suitable acquirers that are consistent with their geography, mission and continuum of care. In addition, they should prepare for the financial and operational diligence that will be performed by potential acquirers to help secure highest purchase price and optimal transaction structure.
Large providers and Accountable Care Organizations (ACOs) should focus on measured approaches to acquisition. For example, a community hospital acquiring a local ASC may not consider future implications of an acquisition relative to joining an ACO. It's important to weigh out the ramifications of this. In addition, they should consider local demographics, disease profiles, culture and continuum of care. Also, larger providers must understand that the health care sector is overcapitalized. Assets will soon leave the sector, and acquirers will only focus on the best of the best acquisition targets.
Steps for a successful transaction
And when providers find themselves entering M&A negotiations, what are some of the necessary steps to assure a smooth transaction? The following outlines the various phases of a successful deal.
Step 1: Pre-deal valuation
- Give management an idea of the value of the target or their enterprise
- Garner board approval
- Support deal negotiations
Step 2: Due diligence
- Search for skeletons, both financial and nonfinancial, like operational issues or compliance challenges
- Finalize the purchase terms and price
Step 3: Final decision and board approval
Step 4: Closing
- Legally execute the negotiated transition, assuring there are no surprises related to the organization or transaction
Step 5: Post-closing allocation
- Prepare meaningful and thorough financial statements
- Categorize finite and indefinite-lived intangibles
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Health care industry's big issues in 2014, Part 1 – Mergers and acquisitions