When Health Care Mergers and Acquisitions Flatline
April 19, 2017
This podcast focuses on the business financial advisor's need to act as a facilitator between the parties in a health care merger and acquisition in order to successfully close the deal.
When consolidation deals move forward, there is usually an agreement that for some period of time both parties share governance, either at the CEO or COO level. Then, after that initial period of time, there is another vote taken as to who should in fact represent the organization.
A health care merger and acquisition requires additional due diligence since the health care industry is fraught with over-regulation. There is a constant review by health care attorneys at different points of the process to make sure that the deal isn’t going to run afoul of federal or state law. One such recent consolidation attempt failed because it had gotten the attention of the department of justice over concerns about the size of the market share that these two organizations would control, and in particular over Medicare advantage.
DP: Well, let’s jump into it. We recently saw a couple of high profile insurance mergers get derailed. So there was Aetna/Humana, $34 billion transaction and Anthem/Cigna a $48 billion transaction. So what happened here?
EA: Basically those two opportunities for consolidation had even in the very beginning when it was being discussed had gotten the attention of the department of justice and the main reason was there was concern about the size of the market share that the combination of these two organizations would control, and in particular for one product line called Medicare advantage. So as a result of that review by the department of justice and also federal judges that were involved in the reviewing the cases for each of these consolidations, basically they were given a no go to go forward for further consolidation. And again the explanation from the court was that the market share would basically be over-controlling, would violate antitrust laws and would diminish competition.
DP: Ok. What are some of the other reasons that a health care mergers and acquisitions might not go through?
EA: Well for most mergers and acquisitions what we see when we’re out in the marketplace is a very basic first step is called due diligence. And all that really means is that each party gets a better understanding of what the capabilities are for each organization. It turns out that on a lot of cases this due diligence process which should be fairly comprehensive is oversimplified and organizations start to go forward into the negotiation and they don’t realize until they get further down the road a little bit that there are some issues there that they didn’t think about. So that causes part of the issue. The other thing is sometimes when you can get the right data you realize that when the organizations come together that financially the payoff for the new larger organization is not as good as you thought. There’s also a big issue that you always see written up about consolidations that has to do with culture.
DP: That seems to be a big one
EA: It’s a big one David and basically the way to think about that is it’s more about behaviors. In most cases how do organizations in health care behave towards their patients and how do they provide services. So if that approach to providing health care services is somewhat different, or looked upon maybe more short term than long term the two organizations might not get along too well there. And it doesn’t happen that much in health care because as you can imagine there’s a lot of disclosure agreements that are signed by both sides but occasionally there are leaks that come out about these pending consolidations that are very negative and sometimes the negative feedback from the media will also stop the deal.
DP: How often do you see a scenario where you have, let’s say the leader from one group and the leader from another group and they can’t get together on who is going to be the CEO or who is going to steward the ship forward so to speak?
EA: Usually what happens in most of these consolidations, if the deals are going well or going forward, is that there is an agreement basically to share governance. So whether it’s at a CEO level or a COO level or a board finding its committee there usually is an agreement that, for some period of time, typically 3-5 years, members of both companies in effect share governance. And then after that initial period of time there is another vote taken as to who should in fact represent the organization. And at that point what typically happens is the larger well financed resource organization of the two over time ends up really taking control of the new organization.
DP: And how are mergers and acquisition’s in the health care world different than other sectors?
EA: Well, besides all the normal challenges you have when you bring two companies together, health care is over-regulated. Unfortunately it seems like literally everyday there is a new regulation that comes out of the industry and everybody is trying to understand the impact. So as you’re going through the normal process of consolidation, the regulatory issues – and I’ll give you two examples. Even just coming up with the valuations for each of the organizations that are involved in being consolidated, there are federal and state fair market value concepts that have to be followed. Also in addition to that there may be situations where again, depending on how the deal is structured, it might be looked on as some kind of an incentive that might go against certain regulations to induce patients to go to the new organization. So, it’s very challenging and we see it ourselves when we’re involved, whichever party we’re representing – a large organization or a smaller one that’s trying to merge or get acquired. There’s always this constant review by health care attorneys at different points of the process to make sure that the deal that’s coming together isn’t going to run afoul of federal or state law.
DP: Now, when these deals fall apart, it’s not simply just, “ok well, didn’t work out, see you later” - there’s a little bit more to it than that.
EA: Yeah usually in most of these deals there are breakup fees that are part of the contract which are set up ahead of time to negotiate these potential mergers. And the breakup fee actually can go two ways. It can be a situation where whoever is in effect selling their organization to another one could pay a fee if it doesn’t work out. Or the contract may actually say in kind of a reverse type fee that the larger acquirer if this doesn’t work out has to pay a fee and when you see the later it’s almost always because the larger organization is being very aggressive in approaching the smaller organization in saying the time is right, we have to do this, there’s a huge benefit for us, and so the organization in effect that is selling says well, this isn’t something we we’re doing strategically but if you want to move ahead with this we want a breakup fee in there is the case.
DP: And I heard in the case of Aetna/Humana, Aetna is going to owe a breakup fee of about $630 million and Cigna is going to look for $1.85 billion from Anthem. So this is substantial. We’re not talking about cab fare here.
EA: No, it’s substantial and again, the idea of these fees, whoever is paying, whichever organization is paying, is to make sure that they’re serious - both sides are taking it seriously - because each organization, whether they are under a fee or not, has to take substantial resources to the table to get these things done. And literally it’s almost like everything else stops at a senior level as far as planning goes until the decision is made - are we going to be acquired or not? - Are we going to merge or not?
DP: Now, your role as a business financial advisor – tell us what your role in all of this is.
EA: Well, whoever we represent, we normally tell people that the success we’ve had over almost now 15 years doing this work, is, we’ve take the position as a facilitator. There are folks that are out there who will take on these jobs more in a contentious manner where they’re going to fight for whoever they are representing. We certainly are making sure that whoever we represent gets what we believe to be a fair deal or a competitive deal in the marketplace. But what we’ve found that makes deal works verses what makes them fall apart is if we can get both sides to understand what’s realistic in the deal and what isn’t. So sometimes we’re in a situation where the people we represent for example might say to us, well, you got to get us $10 million for our organization. Well, our valuation people do a review of our client and we’ll come back to them and say, well $10 million sounds great, but your organization at the most might be worth $5 million. Now that’s something where we could have gone to the table and try to demand $10 million and given the other side a hard time and see what happens versus getting in this case our client to accept the fact that this is what the fair market value is, and yes, we want to try to get them the highest end of that. But it’s certainly, when we get to the table and the other side has their valuation people present the data and say we think at the most you might worth $5 million, well ok, we’re already pretty much on the same page for that part of it. And we’ve had a very high success rate of about almost 80% of the organizations we’ve represented in these deals we’ve closed. And we really think a big part of that is facilitation. Even with the other side. For example, we’ve represented physician organization and had major health systems get to a point in negotiation where everything stopped and the health system people said to us “have you ever seen anything like this before, do you have any suggestions”? You know, when we threw out a bunch of suggestions from our experience and hopefully one or two of them the health system people say, “you know what, we could probably live with that one”, and just try to keep moving it. We have found ourselves sometimes offering advice to the other side so to speak. But if you present yourselves more as professionals, and more as facilitators it just seems the nature of the whole negotiation goes better.
DP: Setting those realistic expectations.
DP: So in closing, if you had a client or a potential client come to you who was looking at mergers and acquisition’s, thinking about mergers and acquisition’s, what’s one pearl of wisdom that you’d give to them?
EA: Probably from our standpoint especially if we’re representing physician organization or a surgery center or some ambulatory group that’s going to go into a billion dollar heath system, the one thing we tell these folks right up front is they’re not going to be able to self-govern themselves. They’re going to become part of this large bureaucratic organization and they typically report to a section of that and they’re going to get from that section direction, a budget and those types of things. If they have a problem they have to go up through that section and say this is what our issue is, we need assistance. Versus sitting in a board room with yourselves, deciding on exactly what you do or don’t want to do, everybody raising their hands saying that sounds good, let’s go to the next item. So if you look back on health care organizations going to these larger systems, assuming that they understood the deal going in - in other words, what their compensation was going to be, and their benefits, and how things were going to work – the number one complaint is the fact that they miss being able to self-govern themselves.
DP: Well, good being with you again and thanks for your insight.
EA: Thank you David
DP: And thank you for listening to the EisnerAmper podcast series. Visit EisnerAmper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.