Factors that Shaped 2014 Healthcare Mergers & Acquisitions (M&A)

Healthcare M&A in 2014 was characterized by seismic changes. More than 40 deals were announced or closed with a value over $1 billion – 8 were over $10 billion. Here are the key factors that shaped the environment for healthcare mergers and acquisitions and healthcare investment banking.

• Healthcare Reform’s Effects Continue to Ripple Through The Medical System
  Healthcare Reform has expanded health coverage for millions of previously uninsured people. But to fund the benefits involved, Medicare reimbursement have become more challenging. The controversial 2.3% medical device tax has taken its toll (and hopefully will be repealed), and new high deductible/high co-pay plans became popular to enable companies and em-ployees to afford rising monthly premiums.  Healthcare reform has led to many dislocations without directly addressing rising costs.  One major effect is a reimbursement regime that is transitioning from a fee-for-service system to a bundled, episodic system where there are no incentives to hold down costs.
• The Tax Inversion Window Has Mostly Closed
  Following the U.S. Treasury Department’s proposed new restrictions, in many cases tax inversion deals have lost their attractiveness.  While Medtronic/Covidien is the biggest inversion ever, the window is closing.  AbbVie, Pfizer, Salix Pharmaceuticals and others, all terminated tax inversion deals.
• The U.S. has Emerged from the ‘Great Recession’ in Better Shape than Other Key Regions
  By emphasizing fiscal stimulus and quantitative easing monetary policies, the US has lowered unemployment, created lean manufacturing opportunities, and raised GDP rates.  Major income disparity issues remain, and inflation-adjusted income levels are too low for many Americans. But even the Federal Reserve Board has signaled that the country is on a positive track.  Europe, by contrast, is in a precarious state due its disparate economies, and its decision to emphasize austerity over stimulus.  With such large consumer markets as Europe not in a growth mode and internal debt mounting, China's export economy has also slowed down.  However, tricky market conditions create opportunities for well-capitalized firms to prepare for conditions to improve.  (See Bayer’s $680m purchase of Dihon Pharmaceutical Group, and Medtronic’s $816m acquisition of China Kanghui Holdings).
• Broadscale Demographics and Mega-Health Issues are Inexorable Growth DriversWhatever the economic climate, there are inexorable forces at play. Global populations are aging, people are living longer and chronic diseases become more pronounced as we get older. These diseases include heart failure, cancer, diabetes, and dementia.  Healthcare companies will continue to focus on these large markets while laying the foundations for advances in molecular diagnostics and other new technologies.
• The Market is Absorbing New Technology, but ‘Herd’ Effects Lurk Beneath the Surface
  New standards of care take time and money to get through clinical trials, approvals, reimbursement hurdles, and market acceptance. Minimally invasive surgical techniques have proven their effectiveness and many specific applications have won favor: transcatheter heart valve replacement, intraocular lens replacement for cataract surgery, and new spinal implants. However, sometimes a promising advance is over-hyped and millions of dollars are invested in early-stage companies whose products are not yet proven. Such was the case with renal denervation, cardiovascular stenting and certain advanced woundcare modalities.
• Hospital Consolidations May Be Limiting Competition and Raising Costs
  These are among the findings of the Robert Wood Johnson Foundation.  Hospital-to-Hospital mergers and Physician-Hospital integrations are motivated in part by economies of scale and gaining negotiating strength against healthcare payors.  Many argue that consolidations not only result in higher prices and lower competition, but reduce the quality of patient care, as physicians become employees with lower compensation and higher workloads.  Large healthcare consortia are reducing device vendor rolls. In turn, this places a premium on large device companies who have massive sales, clinical staff and established business networks.
• The Uncertainty Permeating Healthcare in the Aftermath of the ‘Great Recession’ is Clarifying
  Following a multi-year period of instability, analysts are now predicting improvements in orthopedic growth rates and an easing of pricing pressures.  The ‘challenging’ market over the past few years has engendered a shift to higher margin, ‘niche’ orthopedic markets such as those involving peripheral joints (see Stryker’s purchase ofSmall Bone Innovations and Wright’s purchase of Tornier).
• The Era of Uncertainty Has Motivated Corporate ‘Pruning’
  To adapt to a more cost-conscious environment, larger corporations have shed non-core assets and/or otherwise re-structured internal operations to save costs and re-focus on core strengths.  In an effort to unlock an estimated $7b of value, Siemens divested several businesses and Phillips announced it will be splitting its healthcare business and lighting businesses into separate entities.
• Consolidation of Larger Firms Leaves Innovation Gaps for Smaller Companies to Fill
  As larger firms focus on high volume product lines that ‘move the needle,’ their R&D departments are constrained by organizational priorities. This creates opportunities for entrepreneurial companies to penetrate niches.  As emerging companies validate success with clinical data and gain traction, they hit the ‘radar screens’ of acquisition-minded companies.  Yet, as the industry consolidates, there is a greater technology burden on smaller companies to differentiate themselves.
• There Will Always be a Need for M&A
  In its recent earnings call, Stryker’s Kevin Lobo, Chairman and CEO, stressed the importance of M&A. Stryker is rumored to be preparing a bid for Smith & Nephew.  Following a number of acquisitions and investments in its core business, Danaher has recently posted impressive revenue growth of around 4% for 2014. Danaher has recently made more than 14 small acquisitions in developing regions to expand its market share and revenue base while expanding its footprint in the developed markets with the acquisition of Nobel Biocare.