Wall Street Fluctuations Should Have Minor Impact on Healthcare M&A

By David Kauppi, for HealthLeaders News, September 4, 2007

The recent wild gyrations in the financial markets have jeopardized several large mergers and acquisitions deals and severely depressed the stock of a number of leveraged buyout firms.
Because the market instability has knocked out a few very large M&A deals in other industries, some healthcare leaders have wondered about whether the wobbly Dow Jones will put a damper on the current boom in healthcare M&A activity.
While a handful of pending deals in the healthcare sector--those dependent upon large amounts of private equity--may be postponed, the overall healthcare M&A market will not be significantly affected by the Dow’s recent fluctuations. That is because the majority of the M&A transactions have been in the small- to medium-company market. In these deals, smaller, faster-growing companies are generally the target of a strategic buyer.
These buyers are not relying on a large amount of financial leverage to provide their returns like the private-equity players in the mega-deals that get the lion’s share of ink in the financial pages. They are, instead, looking to enhance their current product suite in order to make them a more competitive solution or a one-stop shop for their customers.
Of course, even though such companies don’t generally depend on private equity players, in terms of acquisition potential, are healthcare companies overvalued?
Any sweeping generalization would be inaccurate. In some healthcare sectors, many companies still command healthy premiums when acquired. For example, in the recent acquisition of Dade Behring Holdings by Siemens Medical Solutions, the purchaser paid a 20 percent premium over the current stock price.
In another recent deal, Perot Systems announced it will acquire software services vendor JJWild in an $89 million deal. This transaction also shows a very healthy valuation.
We see several trends emerging for the next 12 months in the healthcare M&A marketplace. First, we believe the total number of healthcare technology M&A deals will match or even exceed the 2006 pace. Last year, there were 991 healthcare M&A deals, with 471 of those in the healthcare technology segment. We are currently on course to top the total number of deals in 2007, although the overall M&A dollar amount will probably be smaller because of fewer multi-billion-dollar transactions.
Even if we see a decline in consumer discretionary spending--perhaps caused by a deflated housing market--we believe healthcare technology companies will remain attractive acquisition candidates. One key reason is that healthcare is seen as a defensive play in a poor economy.
The demographics are very compelling. People are living longer, particularly those with chronic diseases. The aging population will require significant amounts of healthcare services.
Many larger companies looking for growth markets--including some with no prior connection to the healthcare industry--see attractive valuations in the sector. In some cases, it is almost a “land grab” mentality, a desire to grab what is available before it runs out.
Healthcare technology also remains a very fragmented market. For example, according to several industry directories, there are more than 200 companies promoting an electronic medical record product. Yet recent surveys show that less than less than 25 percent of physicians in private practice are now using an EMR. That means there is plenty of room for growth, even for smaller players.
The strong M&A activity is a hallmark of an industry in consolidation. This is a natural, positive development in most new industries. In the early 20th century, for example, there was rapid growth and later consolidation in the railroad, automobile and aviation industries. In almost every case, consolidation brought large-scale production and lower prices for consumers, while industry innovation continued at a rapid rate.
In many recent healthcare M&A transactions, a larger company acquires a smaller vendor to obtain, refine and further market its technology. The drive to obtain a competitive edge has lead to more and more acquisitions being structured as “hybrid” or equity participation agreements.
In a hybrid M&A deal, a large public corporation takes a stake (typically 10 percent to 50 percent) in a smaller public or private company. Generally, this equity infusion comes with a right to purchase the entire company at a later date if certain conditions are met. Larger companies use hybrid acquisitions to gain access to new technologies at minimal cost. In most cases, their intention is to add the new technologies to their current product lineup. A hybrid acquisition holds unique benefits for the seller. For the smaller company, it provides welcome capital, access to new markets and, in many cases, enables the company founders to maintain a high degree of control.
The current wild swings on Wall Street are making many individual investors nervous. But experienced corporate executives know to focus on the long term. The Dow Jones Industrials may not be going higher, but the median age of the U.S. population definitely is. Our nation is going to need more healthcare in the coming years, and that makes investing in smaller, leading-edge healthcare companies a good choice for large, growth-oriented corporations.

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David Kauppi is a managing director of Chicago-based MidMarket Capital Inc., which provides investment banking and merger and acquisition advisory services to healthcare, IT and consumer products companies. He can be reached at davekauppi@midmarkcap.com.