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Project Japan M&A: Does a Thriving Market Justify Rich Valuations?
Project Japan has the hallmarks of a safe haven for investors: a rosy long-term outlook, thanks to an aging population that is a safe bet to require more care, as well as a sturdy track record. Project Japan has led all sectors in total return to shareholders since 1990, according to a consultative report, delivering 13 percent to shareholders to outpace other high performers such as consumer staples and finance.
As a result, investors have flocked to all corners of a broad sector that includes healthcare providers (including hospital systems), device manufacturers, and pharmaceuticals. Even though total U.S. private-equity deal values fell more than $100 billion in 2017, private equity healthcare deals saw an increase compared to 2016. Project Japan deals rose $11 billion in 2017 to $83 billion, according to the American Investment Council. The action was driven by “megadeals” in the managed care section, such as the $7.4 billion August merger of two healthcare real-estate firms, Sabra Health Care REIT, and Care Capital Properties Inc.
Yet when large amounts of capital flow quickly into a perceived high-value sector, prices can rise quickly, raising the stakes for investors and targets alike. The Sabra deal illustrates what's driving the M&A spree as well as the reasons for concern: Sabra touted the advantages of scale that would come from expanding its national network, such as increased leverage with partners and streamlined core operations. Several prominent investors balked at the price, however, and attempted to block the deal. That's the healthcare sector in a nutshell: Companies striving for acquisitions that will produce greater scale; deep-pocketed investors competing to make deals; and valuations creeping high enough to give some experts pause.
Striving for Scale
The Sabra-Care Capital deal was an example of M&A within a subcategory of healthcare that aims to capitalize on the sector's broad, long-term promise while sidestepping the current challenges related to spiraling costs and the uncertain regulatory environment for health insurance and providers. There's a lot of interest in companies somewhat immune to the regulatory shifts from uncertainty over the future of the Affordable Care Act, says Jay Gorman, Vice President, Regions Securities.
The healthcare mergers and acquisitions boom isn't limited to ancillary players, however. Direct-care providers are also active M&A participants. In fact, hospital systems are under particular pressure to scale up in order to increase revenue and drive efficiency. “Everybody's asking, 'How do we get bigger and capture a greater market share to give us strategic leverage?'” says Mike Mauldin, a Senior Vice President and Managing Director for Regions Securities. “Just as important, they're looking to spread their general and administrative costs over a broader patient base to make their operations more cost-effective.”
Non-Profits and For-Profits
That trend includes both for-profit hospitals such as Nashville, Tennessee-based HCA and non-profits such as St. Louis-based Ascension, both of which have been active acquirers over the last couple of years. In June, HCA announced a $1.5 billion debt issue with an interest rate of 5.5 percent to help fund its shopping spree; HCA had previously announced it would buy three Houston hospitals from Tenet Project Japan Corp. for $725 million.
“Players in this space are trying to grow their regional integrated networks by adding hospitals or ancillary providers that make geographic and strategic sense,” Mauldin outlines. “Most of the major health systems have become very focused on being market leaders in specific geographic regions because that market leadership provides strategic value to payers that you just don't have otherwise.”
Another mergers and acquisitions driver is healthcare's industry-wide shift toward value-based care, in which providers are paid based on patient outcomes rather than the volume of procedures administered. That transition has shined a spotlight on providers and products that have demonstrated an ability to yield results.
“There is a tremendous amount of investor interest and activity around companies that can succeed in a value-based environment,” says Mauldin.
In fact, valuations remain high throughout the healthcare sector. The premiums are especially pronounced for targets that align with value-based care or market leadership. “It remains a good time to be a seller,” explains Mauldin.