Jenks Healthcare Business Report January 2003

In the January 2003 issue:

M&A Market Ends 2002 On Positive Note; Strong Beginning To 2003

As the blessing (curse?) goes, “May you live in interesting times.” In the markets, 2002 was certainly an interesting year. While no sector came away unscathed, health care proved amazingly resilient. The M&A market saw increases in both number of deals and dollar volume. We discuss what happened, why, and what comes next. See page 1

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Public Equity Market

IPOs are still limping along; this month, we report one pricing and one new filing. Plus, two secondaries priced, and six firms managed to raise $42.5 in PIPEs among them. And we look back at 2002’s 17 health care IPOs. See page 5

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Venture Capital Market

Health care outperformed the broader markets in per-deal dollars in 2002, attracting more than 20% of all last year’s VC investment. This year is off to a good start, with 42 deals this month worth over $440 million.
See page 10

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Feature Stories

Biotech 2002. Public markets weren’t kind last year, but VC came to the rescue in a big way. See page 5

Whither Pharma in ‘03? Fewer blockbusters, more biopharma, and lots of M&A in store. See page 7

The Year of UTIMCO. The pub- lic’s right to know vs. the “private” in private equity. See page 13

Jenks Healthcare Business Report

M&A Market Ends 2002 On Positive Note; Strong Beginning To 2003

Much has been made in the business media about the woes of Wall Street during 2002. Stock offerings were down, merger advisory fees plunged, layoffs escalated to unprecedented levels, and guaranteed bonuses became a thing of the past (at least for now). The health care market, however, has been another story.

Although the total will probably adjust upwards, the number of health care mergers and acquisitions jumped by nearly 15% in 2002, compared with a more than 20% drop in the overall M&A market. The dollar value of health care deals (with prices disclosed) increased by more than 33% to just over $100 billion last year, compared with just over $75 million in 2001. While it’s true that 60% of the dollar volume came from one deal, Pfizer’s (NYSE: PFE) proposed acquisition of Pharmacia (NYSE: PHA), previous years with large dollar volumes were also dominated by large transactions (see chart on page 3).

It is no secret that large mergers are, in general, out of favor with shareholders, primarily because it is so hard to make them work, causing little appreciation (if any) in the buyer’s value. That may explain why the breadth of the market has grown, with many more smaller deals and a significant drop in the billion-dollar deal club from the previous two years.

One of those billion dollar deals, Guidant Corporation’s (NYSE: GDT) proposed acquisition of privately-owned The Cook Group for $3 billion, fell apart at the end of 2002 when one of Cook’s clinical tests failed to yield an agreed-upon result, one of the contingencies in the original offer. Guidant will now have to pay Cook a $50 million breakup fee. The combined company would have been a strong competitor to Johnson & Johnson (NYSE: JNJ) in the new drug-coated stent business, a market for JNJ that is estimated to reach almost $1 billion in 2003.

Just before the Guidant/Cook deal collapsed, General Electric Company (NYSE: GE) announced its agreement to pay just over $2 billion for Instrumentarium Corp. (NASDAQ: INMRY), Finland’s largest medical equipment maker with 80% of its $1.1 billion in revenue coming from sales of anesthesia and critical-care equipment. About 36% of INMRY’s sales are in the United States. GE believes it can increase Instrumentarium’s total sales by 20% a year, compared to the 30% annual increase GE accomplished for Marquette Medical Systems, a company it bought in 1998 for $810 million. GE paid a 47% premium over INMRY’s stock price, and paid multiples of 1.86x and 15.6x (revenues and EBITDA, respectively). Despite the large size of the transaction, it will increase GE’s annual revenues by less than 1%.

Even though billion-dollar deals are out of favor, management will still pursue them when they make strategic sense. At the beginning of 2003, Merck (NYSE: MRK) announced the year’s first mega-deal when it offered to buy the remaining 49% interest in Japan-based Banyu Pharmaceutical (TSE: 4515) that it did not already own , for $1.5 billion. Established in 1915, Banyu is one of the top 10 pharmaceutical companies in Japan (the third largest pharmaceutical market after the U.S and Europe) and has revenues of more than $1.3 billion. Merck may have been frustrated by Banyu’s performance lately and will want to expand its presence in Japan by strengthening Banyu’s marketing. The 32% premium offered over the stock price should ensure shareholder approval, and the board’s acceptance of the transaction is another sign that Japan’s market is continuing to open to foreign entities. Last year, Roche Holding AG (SWX: ROCZ.S) bought a 50.1% interest in Chugai Pharmaceutical Co. (TSE: 4519).

Pharmaceutical companies, with many drugs going off patent and few new blockbuster drugs in the pipeline, are looking to the acquisition market to obtain both drugs in development and existing products. Since Christmas alone, there have more than a dozen product acquisitions, ranging from under $10 million in price to over $100 million (see chart on page 4). We expect to see more of this type of activity during the rest of 2003.

In the senior care market, which has been in an acquisition slump for more than two years, activity picked up at the end of 2002 and into 2003. Although Sunrise Assisted Living (NYSE: SRZ) had previously revealed that it was one of the bidders for Marriott International’s (NYSE: MAR) senior care division, Marriott Senior Living Services (MSLS), on December 30 it announced an agreement to pay $89 million in cash for MSLS and to assume $38 million in working capital liabilities.

MSLS manages 126 communities with a resident capacity of more than 23,000 and total revenues of $846 million. The combined company will become the largest senior housing company in the country, eclipsing its next largest competitor, Colson & Colson/Holiday Retirement, by 30% in terms of resident capacity and number of properties. But it will also change the nature of Sunrise, which has been a traditional assisted living company.

Although 50% of MSLS’ resident capacity is assisted living, 34% and 16% are independent living and skilled nursing, respectively. In other words, Marriott’s combined IL and SNF resident capacity is more than 11,500, compared with SRZ’s 15,000 assisted living residents. And many of the IL residents are in CCRCs, a type of community with which Sunrise has little experience. Marriott International decided it did not want to be in the health care business, and it had experienced difficulties in filling up many of the newer MSLS facilities.

This is a huge deal for Sunrise, which will more than double its size (in terms of resident capacity) and turn the company into a true senior care operator, instead of a traditional assisted living provider. The key to Sunrise is that it takes little economic risk, since it will own none of the properties and will receive a management fee of 5.9% of revenues for contracts with an average life of 19 years. SRZ expects the transaction to initially contribute $22 million annually to EBITDA, before any increases in occupancy for the portfolio, which is just 85% occupied. Consequently, at 4x EBITDA, the pricing appears to be reasonable, especially with little financial risk. The real risk is in assimilating such a large acquisition, and the jury is still out on that one. If it works, however, it will be a defining deal for Sunrise and perhaps the most important senior care transaction of the decade.

Coincident with the Sunrise/MSLS deal, CNL Retirement Properties (CNL) announced the acquisition of the nine remaining MSLS properties for $170 million. This was in addition to the previously announced acquisition of 12 MSLS properties for $89 million. Combined, the two portfolios contain 3,368 units, and the price comes to just under $77,000 per unit. CNL will transition management of these facilities to Sunrise.

In the opening days of 2003, ARV Assisted Living (AMEX:SRS) announced it entered into an agreement to be sold to Prometheus Assisted Living, LLC, an affiliate of Lazard Freres, for $3.90 per share. Last September Prometheus had offered to buy the 56.5% of SRS it does not already own for between $3.25 and $3.60 per share, and at least two other buyers indicated they were also interested, but at higher prices. After the most recent announcement, privately owned Summerville Senior Living, backed by Apollo Real Estate Funds, disclosed that its $4.00 per share offer was still on the table, apparently falling on deaf ears. Lazard will merge the SRS operations with its Atria Senior Quarters business, putting the combined entity into the top five AL providers.

The e-Health sector, which has also been in an acquisition slump since the technology meltdown a few years ago, started 2003 with ProxyMed’s (NASDAQ: PILL) announcement to buy MedUnite, a provider of physician office transaction processing services. The price was $23.4 million, or 1.1x revenues, and included $10 million cash and the remainder in convertible debt. MedUnite was founded by seven major health insurance companies, and the acquisition will create the second largest physician-based transaction processing company, with $70 million in annual revenues and 200 million health care transactions processed annually, after WebMD (NASDAQ: HLTH). We expect the health care M&A market in 2003 to be dominated by small and middle-market transactions such as these.

Read the past headlines.