Paduda: What's Driving — Or Not Driving — M&As?

Remember back a couple years ago, when every few weeks there’d be yet another announcement that a big investment firm had bought a work comp services company? With a couple exceptions, it’s been noticeably quiet of late.  Outside of Genex’ acquisition of Coventry Workers’ Comp Services was completed a few weeks ago, and ProCare bought AccessOnTime – but other than those transactions it’s been crickets.

Is this a temporary pause, or a sign of things to come?

To answer that we need to understand the three factors driving M&A – the most important (for now) is COVID19. With claim counts expected to drop by a fifth this year, and little certainty about what is to come in 2021 many private equity (PE) firms have pulled back, waiting to see which businesses survive, which thrive, and which meet their demise.

Many, but by no means all.  A few investors are watching carefully, paying especially close attention to the operators that have moved quickly, adapted business models to accommodate work from home and on-shoring of operations, and kept their focus while others have struggled.

The good news is there’s no shortage of funds available to potential acquirers. A lot of private equity money is sitting unused in PE firm accounts; $1.45 trillion (trillion with a “T”) according to research company Preqin Ltd. That puts pressure on private equity firms as investors want their money earning big returns, not sitting in some bank earning a percent or two.

Debt financing also shouldn’t be an issue as interest rates are very low and likely to stay there for months if not years. Most private equity deals are primarily funded with debt; as debt is cheap and surprisingly plentiful these days, that’s no obstacle.

Strategic buyers - companies in related businesses - may also be bargain hunting.  Big firms with lots of cash are looking to grow by acquisition. While many sectors have been hurt badly by the COVID19 recession, some are doing quite well – none more than health insurers. Profits are robust indeed, cash is flooding in and not going out, and some may be looking to diversify.

Okay, things on the buy side look pretty good. Of course, potential buyers need owners looking to sell.

Things there are a little cloudier.

Some service providers - mostly the smallest – have already disappeared, while others are looking for a lifeline.  Don’t be surprised to see a few fire sale-type transactions as owners look to get anything they can while they still have a business to sell.

Undoubtedly a bunch of service providers are hurting. As claims dropped precipitously and have yet to return to pre-COVID19 levels, there are a lot fewer new claims to service. Even more worrisome has been the impact on existing claims. With treatment facilities closed and injured workers justifiably leery of going to medical facilities, care has been delayed. Fewer visits means less PT, fewer bills to review and prior authorizations to conduct, fewer MRIs, and less need for transportation. While DME and home health care have also taken a hit, the impact has been much less severe as these services are mostly used by long-term patients. Eventually the big drop off in claim counts and more specifically the decline in serious injuries will cut into revenues for those service providers.

Emotions may play an outsized role.  It’s no secret that valuations have been awfully high for quite a while, with many in the investment community unable to justify paying 14 – 16 times earnings.  Of course, many investors did pay those numbers, and are quite happy they did.  Whether those multiples persist is an open question. It will be tough indeed for owners to accept that their baby isn’t as pretty now as it was just 9 months ago. As a result, one of the most difficult obstacles will likely be owners’ expectations.

But it’s not just multiples. Fewer claims, fewer services, lower revenue, add up to much lower profits. With acquisition prices tied closely to earnings, service company owners who thought their businesses were worth a lot may be unwilling to believe their company’s value has shrunk.

And, investors may be much more cautious, as our nation’s success in controlling the pandemic and managing the devastating economic fallout has been poor at best. PE firms may well be reluctant to pay a high price with so much uncertainty surrounding the near- and mid-term economic outlook.

Finally, after a decade plus of consolidation, there’s just not that many companies left to buy. The number of Pharmacy Benefit Management firms has dropped by two-thirds and start-ups are mostly struggling. Same thing in bill review; only application providers with any market share are still in business (although a couple more are emerging).  Paradigm and Mitchell/Genex have snapped up a rather diverse set of businesses, adding to the consolidation of the case management and UR sectors. Meanwhile Sedgwick has snapped up several TPAs, reducing targets in that business as well.

Solid, well-managed businesses with low debt and strong cashflow will always be attractive. These days, operators that kept their operations state-side are finding that decision is paying off in better service and happier customers – and greater interest from potential buyers.

By Joseph Paduda

Joseph Paduda, the principal of Health Strategy Associates, is a nationally recognized expert in medical management in group health and workers' compensation, with deep experience in pharmacy services. In addition to consulting with managed care organizations, employers, health care providers, insurers and private equity firms, Health Strategy Associates conducts regular surveys on managing work comp pharmacy costs, utilization review, bill review systems and claims systems.

Paduda is also the prolific author of the controversial Managed Care Matters blog and a founder of Health Wonk Review, a collaborative blog on health care policy.

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