March 28, 2017    7 minute read

With Trumpcare on Life Support, What Will Happen to Healthcare M&A?

The Trump Effect    March 28, 2017    7 minute read

With Trumpcare on Life Support, What Will Happen to Healthcare M&A?

Repeal and replace, that has been the Republican mantra when it comes to healthcare reform in the US for more than seven years. As one learned on Friday, it is easier to come up with a catchy campaign slogan than it is to formulate a policy which will effectively fix the broken market that is healthcare in the US.

The situation is so bad that last Friday’s decision to call off vote may have placed not only Trumpcare on life support but the entire industry too. While it might be tempting to blame the failure on Republican obstruction, or on the shortcomings of the Affordable Care Act (ACA or Obamacare), the reality is that the system is slowly collapsing under its own weight.

Mounting Problems

The challenges are well chronicled – incomplete coverage, inconsistent quality of care, high costs, and a tendency of policymakers to focus on ‘coverage’ and corporate welfare over cost certainty. In addition, the entire ecosystem is undergoing changes.

New technologies such as gene mapping, virtual reality, and even artificial intelligence are disrupting the industry, and it is quite possible that healthcare delivery may soon look nothing like it does today.

However, the promise of a future of healthbots and nurses does not alleviate the underlying issues in American healthcare today. The situation is so dire that the Chicago Tribune’s recently published an article spelling out the reasons why the healthcare system is not fixable.

He may be right. Recent research by 375 Park Associates noted that the shear cost of healthcare in the US is a drag on growth. In fact, the cost disparity is so high that it effectively represents a 7% tax on businesses.

This comes from indexing the average of healthcare on a per GDP basis in the US and eleven of its top trading partners. While the cost of healthcare in countries such as China and India is significantly below the average of 12 countries in the study. Removing the data points does little to improve the positioning of the US, and the effect is a broken healthcare system which disproportionately affects middle market companies and the self-employed.

Doing Nothing Risks Catastrophic Failure

While significant healthcare reform remains elusive, the status quo is not sustainable and doing nothing risks catastrophic failure on several levels.

1. Costs Are Out of Control

The rising cost of healthcare in the US might be the single biggest example of how government intervention has failed by ignoring the root causes of the problem:

  • Prevalence of chronic diseases, such as diabetes and heart disease;
  • Patient demands for access to cutting edge technology;
  • Inability of either market forces or regulation to contain prices;
  • Inefficiency, over administration, and high overhead costs;
  • Over-treatment.

However, neither market forces or policy makers have addressed these issues. Instead, the fixes enacted by the government have been nothing more than corporate welfare.

Name one other industry where providers can charge the public $10,000 for a product or service but will accept one-third the amount in payment from an insurance company. It simply defies logic.

2. Insurers Are Heading for the Exit

First, all four leading insurers (Humana, Aetna, Cigna, and Anthem) either exiting or planning to, exchanges across the country.

While it is possible that other insurers will enter this segment, the reality is that the reinsurance market has little appetite for high-risk policies sold through the exchanges. Thus, putting the individual markets at risk of collapse unless there is quick action.

3. Voters Want Change

Healthcare has been a significant issue since 2010. While a small minority of voter would prefer to do away with Obamacare, the reality is that such a move would shift the electoral map almost overnight.

Healthcare has become such a Gordian Knot that a large number Trump voters rely on the program they despise. It is an odd situation as the Gallup-Healthways Well-Being Index shows that the protections granted under Obamacare have older voters in several states that went for Trump in the last election.

In fact, healthcare insecurity amongst the older Americans has fallen since the enactment of Obamacare. However, voters in many of the states benefitting from Obamacare has flocked to the Republican mantra of ‘Repeal and Replace’.

4. Rural Care is in Crisis Mode

According to a recently published study in Becker’s, nearly 650 rural hospitals in the US are on the verge of closing. Many of these hospitals are in states which chose not to expand Medicaid – Georgia, Kansas, Louisiana, and Mississippi.

One cannot underestimate the impact of mass closures of rural hospitals. Nearly 60 million Americans rely on these hospitals, and most of them are older, poorer, and sicker than the broader population.

As such, a failure to address what is happening in rural healthcare will disproportionately affect Americans who have very few options.

5. Medicare and Medicaid Are Running Out of Money

Granted, deficit hawks have been singing this chorus since the 1970s, but this time it might be for real. Even the Center on Budget and Policy Priorities optimistic assessment from 2016 acknowledges the underlying trust fund will be exhausted by 2028.

While the fund will continue to operate after 2028, the level of service will need to be cut back, and even then, payroll taxes will need to be increased to remain ahead of rising costs. As such, working Americans will see an ever-increasing share of their income dedicated just to funding the current obligations of Medicare and Medicaid.

What Does This Mean for M&A?

Across the industry, there is agreement on three drivers of the future of healthcare:

  1. Government will have to address market issues in some way;
  2. Technology will revolutionise the industry;
  3. There is money waiting to be deployed in the sector.

Based on the previous observations, the need for point 1 should be obvious. With regards to technology, there are several advancements across the industry which have the potential to revolutionise healthcare. These include advances in treatment, drug discovery, and even in medical records.

In fact, the Growth Opportunity Index (an AI-enabled decision-making engine which measures insights into markets, technologies, and other factors to determine the best strategic options) noted highlighted several developments which have the potential to revolutionise the industry.

In some cases, the underlying technologies have already gone through FDA approval or in well-advanced trials, while other emerging technologies (e.g. blockchain, IoT, artificial intelligence, and FinTech applications) do not require FDA approval prior to their rollout.

This would help transform the US healthcare system into a value driver for the economy. Even though certain sectors have underperformed in the public markets, healthcare overall continues to be an attractive sector for private equity investment.

Resilient, But…

The 2017 Global Private Equity Report from Bain & Company noted that healthcare has “proven resilient through and after recession.” The report went on to note that “some of these subsectors will continue to outperform if investors have the skills to find and vet them.”

However, 2016 was a mixed year for healthcare deals. Aetna aborted its $37bn takeover of Humana and Anthem’s $53bn acquisition of Cigna is awaiting regulatory approval. Overall deal value fell by nearly 60% compared to 2015 – though it did rebound slightly in the fourth quarter. On the plus side, deal volume for the year contracted only slightly.

Another take away from 2016 healthcare M&A was that it was a mixed year for deal pricing. While mean EV-to-EBITDA multiples decreased by roughly 0.5%, three of seven subsectors increased over the year.

The Domino Effect

Back to deal activity, the action did not stop at insurers. 2016, saw Allscripts Healthcare Solutions partner with GI Partners to complete a $950m acquisition of Netsmart Technologies or Tenet Healthcare’s $425m investment in United Surgical Partners.

As such, there is reason to believe that healthcare M&A will rebound this year, even though Trumpcare is officially on life support. Inaction by Congress should provide some certainty in the near-term.

$160bn was the value of the Pfizer-Allergan deal

Another potential reason to be bullish on healthcare M&A for 2017 is the expectation that tax reform will result in lower corporate tax rates, thus reducing the need for conversion deals such as the $160bn Pfizer-Allergan deal, which was eventually called off.

However, this might be placing too much faith in Washington. The reason to be bullish on healthcare M&A may be the simplest – large corporate buyers need to rebuild their pipelines at a time when several emerging technologies are nearing critical mass.

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