The Health Care M&A Monthly: M&A Meets The Credit Crunch--

Turmoil in Market Sparks Creativity to Get Deals Done

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Turmoil in the capital markets, building for a year, has made itself felt throughout the economy. Although the health care merger and acquisition market has proved its mettle during the past year, it has not remained wholly impervious to the contraction of credit. Over the past few months, we have discussed a number of ways in which the M&A market has responded to the credit crunch. September’s deal activity illustrates the ways these different factors continue to influence the market, and how dealmakers are responding to meet them.
Health care sectors involving real estate, such as Hospitals and Long-Term Care, have seen a decrease in activity from a year ago, as might be expected from the general decline in real estate values. Yet, there seems to be the will to get deals done. Cambridge Realty Capital Companies tells us that the number of senior housing/health care borrowers initiating loan origination requests remained on an even keel during August, when it received 33 loan requests totaling $450.6 million. The problem dealmakers face is the tortuous process of "price discovery," in which the markets work to determine what a reasonable valuation is. Uncertainty in the markets is doing little to narrow the gap between what buyers are willing to pay and sellers are willing to accept.

Accessing the capital needed to get deals done has sent some dealmakers scrambling. In March, Allscripts Healthcare (NASDAQ: MDRX) and Misys Healthcare (LSE: MSY) committed to a $330.0 million merger in which Misys would acquire a 54.5% share in MDRX. Ex-investment bank Lehman Brothers (PK:LEHMQ) had agreed to lend MSY $305.0 million for the deal, but that tap was turned off when Lehman filed for bankruptcy on Sept. 14. After two weeks of wracking its brains and its nerves, MSY was able to cobble together a new funding package. It is borrowing $175.0 million from its largest shareholder, ValueAct Capital, and $150.0 million from a revolving credit facility from HSBC Bank PLC, the Governor and Company of the Bank of Ireland and The Royal Bank of Scotland PLC. Completion of financing is now seen to be such an important milestone that many companies are issuing press releases trumpeting events that used to be taken for granted a year ago. Invitrogen Corp. (NASDAQ: IVGN), for example, recently announced it had completed syndication of the financing for its $6.7 billion acquisition of Applied Biosystems (NYSE: ABI).

Over the past year, companies and their financial backers have not been able to count on the drowsy, if not dormant IPO market to raise capital. Sales from a smaller to a larger private equity group, going up the food chain, have been common, as have been reverse mergers, often with publicly traded corporate shells. (Brian Keating of Keating Investments has observed that reverse mergers have increased in popularity and frequency so much over the past year that the cost of corporate shells has increased.) Novacea (OTCBB: NOVC), a small pharma company, is undertaking a reverse merger with Transept Pharmaceuticals, a specialty pharma. In effect, this deal throws a lifeline to NOVC after Schering-Plough (NYSE: SGP) ended a collaboration agreement in April for developing a prostate cancer drug. The combined Novacea-Transept will have a cash horde of between $88.0 million and $92.0 million. For its part, Transept benefits by going public and funding the final stages of its Intermezzo sleep drug. In another display of creative financing, ARCA biopharma, a private company that makes cardiovascular treatments, is acquiring Nuvelo (NASDAQ: NUVO), whose blood clot-dissolving drug failed earlier this year. ARCA is primarily targeting NUVO’s $76.0 million in cash. And who knows? ARCA might be able to sell off NUVO’s technology and recoup some of the acquisition costs.

As the dollar falters against other currencies, foreign buyers are capturing a larger share of the U.S. health care M&A market. Due to a sagging domestic economy, a shrinking population and largely untouched by the subprime crisis, Japan’s companies have been placing their M&A dollars overseas. The first half of 2008, for example, saw a total of $24.0 billion in outbound acquisitions. In this environment, strategic buyers are faring better than financial buyers because banks are leery about lending to financial buyers. As noted in our third quarter results, the dollars committed to health care M&A in Q3:08 totaled $88.7 billion. Among the top 20 deals of the quarter, $74.9 billion was spent by foreign buyers and only $5.8 billion by domestic buyers. This reverses the historical relation in which domestic buyers outspent their foreign counterparts; for example, in Q4:06, when $82.4 billion was spent on health care M&A, within the top 20 deals, domestic buyers spent $61.7 billion and foreign buyers just $5.6 billion.

Despite these considerable constraints on M&A activity, the third quarter figures suggest to us that dealmakers and investors remain confident both in the viability of the health care M&A market and in their continued ability to make money and enhance value in this market. Taking a longer perspective, we believe that the challenges it poses will be met, the opportunities it offers will be pursued and the potential for making money will be realized.
 

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