Activity Remains Robust Despite Credit Challenges
Email Editor
If you picked up a newspaper or logged onto a financial website during the second half of July, you would think the markets, including the M&A market, were locked in a downward tailspin. The last full week of July saw the DJIA fall 311 points, or 2%, with the sell-off nullifying the takeover premiums that had buoyed up the share prices of many companies considered to be buyout targets. And the media teemed with stories of how the crisis in the subprime mortgage market would metastasize and dry up liquidity in the credit markets. So how do these portents of doom square with what is currently taking place in the health care M&A market?
First, let’s take a look at what actually happened during July. The month saw a total of 79 mergers and acquisitions announced in the 13 sectors of the health care industry that we traditionally cover. The four sectors of the technology segment produced 41 deals, or 52% of the month’s total deal volume, while the nine sectors of the services segment produced the remaining 38 transactions (48%). The Pharmaceutical sector led the pack in deal volume with a total of 18. Long-Term Care followed with 12 and Medical Devices with 11. Taken together, these three account for 52% of July’s deal volume. Straggling at the other end of the spectrum were Rehabilitation with one deal and Behavioral Health with none. Based on prices revealed to date, a total of $33.7 billion was committed to fund July 2007’s M&A activity. This included eight billion-dollar deals worth a combined total of $26.4 billion, or 78% of the month’s total expenditure. While July’s deal volume is in line with the 78 deals per month that the market averaged in the first six months of 2007, the dollar volume is a healthy 62% above the average $20.8 billion per month committed in the same time period. Overall, it looks pretty robust to us.
So why the dire predictions in the general media? It has long been conventional wisdom that the M&A market was floating the stock market on a rising tide because everyone was viewed as a takeover target in this market, helping to prop up valuations. While the past few months have shown signs that pricing and premiums are leveling off—the Long-Term Care sector being a case in point with cap rates at all time lows—that does not mean that prices and premiums are falling. It seems that the market has fully valued some of the potential targets so there will just be fewer bargains to be had on the assumption that values will keep rising.
We think the markets have to get much worse for lenders to become so squirrely as to cut back on funding by tightening conditions and raising interest rates to the point where it throttles dealmaking. And if they did, who would be affected? Perhaps the first would be the private equity firms who have been banking (literally) on low interest rates to conduct leveraged buyouts. The added cost of servicing debt at higher rates would probably lead some PE folk to question whether they could get the same bang out of their buck. One effect would likely be a slowdown in the pace of dealmaking, but not a cessation; after all, there is still an enormous backlog of capital waiting to be invested.
Further, the health care M&A market does not rely solely, or even primarily, on financial buyers such as PEGs, but on strategic investors who want to grow their businesses. The Medical Device sector, profiled this month (see page 1), is a case in point. As long as they retain strong fundamentals, strategic buyers can always use their own stock as an acquisition currency. The dominance of strategic buyers seems particularly strong within the core sectors of health care. As noted in Harris Williams & Co.’s analysis in last month’s issue, there are fewer financial buyers in the core “health care heavy” sectors than in the more peripheral “health care light” sectors. Strategic buyers will still be in the market for deals, regardless of what private equity does.
Individual sectors are naturally being impacted by changes to reimbursement protocols. Hospitals will continue to scramble until they can nail down their “bad debt” collections problem, and inpatient Rehabilitation will become more attractive as CMS raises rates. Overall, though, we see the health care M&A market as fundamentally strong in the medium term, and expect the midsummer’s market corrections will have subsided by fall. Even if the overall M&A market slows, health care will remain relatively robust. In its favor are two obvious factors: the industry is largely noncyclical and its growth is underwritten by the demographics of an aging population.
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