Health Care Reform: Turning Risk Into Opportunity

Reforms in the Patient Protection and Affordable Care Act are changing the way health care companies do business. And one result of this type of industry game changer is an uptick in merger and acquisition (M&A) activity. Those companies that will be adversely affected by health care reform are going to need to merge to survive. Other companies may see growth opportunities through the acquisition of businesses that they may have never been able to acquire otherwise.

In this episode of Deloitte Insights, Simon Gisby, managing director of Deloitte Corporate Finance LLC, and Phil Pfrang, partner in Deloitte & Touche LLP, discuss how health care providers and health plans can prepare for industry overhaul and M&A conversations.

Guests

Simon Gisby, managing director, Deloitte Corporate Finance LLC

Phil Pfrang, partner, Deloitte & Touche LLP

Transcript

Sean O’Grady, Host, Deloitte Insights: Hello and welcome to Insights. Health care reform in the U.S. government passage of the Patients Protection and Affordable Care Act, are changing the way health care companies do business. But amid this change, there are some who see opportunity specifically for organizations aspiring to merge with or acquire new businesses. Joining the discussion today in the studio is Simon Gisby, Managing Director of Deloitte Corporate Finance LLC and Phil Pfrang, Partner in Deloitte & Touche LLP. So gentlemen, does this new environment create a positive place for mergers/acquisitions/joint ventures?

Phil Pfrang: Health care reform is really the most sweeping change to the healthcare industry that we have had since 1965 when Medicare and Medicaid programs were put into place by the federal government. Virtually every company is going to be impacted in some way, shape or form by this legislation. Anytime we have ever seen this type of change to an industry we tend to see a very significant uptake in the mergers and acquisition activity. Those companies that will be adversely affected by the healthcare reform are going to need to merge to survive. And other companies may actually see some opportunities, once in a lifetime opportunities, to acquire businesses that they may have never otherwise had the opportunity to acquire and grow their businesses. 

We typically breakdown health care into three sectors; Health care providers – hospitals, nursing homes that sort of things, Health care payors – managed care organizations, HMOs, PPOs that sort of things, and then Life Sciences, which is basically medical devices and pharmaceuticals. Each of those sectors are going to be impacted differently, but ultimately all three of those sectors will be impacted, and we believe all three sectors will see an increase in M&A activity.

SOG: Simon, do you agree or disagree?

Simon Gisby: Absolutely. This legislation transforms 17 percent of the U.S. economy, and anyone who thinks it is going to be two to three year window of activity in my opinion is very short-sighted. The big impacts they don’t kick in until 2016 and beyond. So we are talking about a 10 year transformation of that point 20 percent U.S. economy. This is a major piece of legislation. It’s going to have a major impact on every single company that is in and around health care industry in the U.S.

SOG: So if I am hearing you right, you are both saying that there will be an uptick or there could a potential for an uptick in M&A activity, which means that companies are going to have to prepare for these kinds of conversations. I think we have to bucket the industry into two pieces, and that’s providers and health plans. So first let’s go after the providers. Simon, what do providers need to be doing to think about those conversations for M&A?

SG: Well, it’s interesting because you actually came up with the key word ‘preparation.’ Any merger and acquisitions transaction is a very time consuming process. It can distract senior management; it can get employees all concerned about the nature of the organization post the transaction, so we’re very strong advocates in key preparation. Understand why you want to engage in a transaction, understand the type of transaction you want to pursue and understand how you are going to operate it. After you bought that business, and make sure everybody, board, senior management and all the way down the line understand the goal of the transaction. Another big belief is that there is a thing called candidate vs. opportunity. Everyone could identify a tremendous number of candidates; very few of them are real, live, and executable opportunities that enhance your business. Make sure you understand all that before you engage in any part of the process.

SOG: Now how about health plans? How are they going to prepare for M&A activity and is there anything different from health plan and a provider?

SG: The unique thing about providers is that their success is driven by a physician. And in the vast majority of cases in U.S., the physician is not employed by the hospital. So one of the first things this health reform legislation is really driving is how that hospital and physician relationship can work together. How are the hospitals able to work together with the physician to get that patient, and how a physician is able to ensure that the hospitals they admit to have the right services and the right cost structure to benefit? So again, a very unusual dynamic in this industry in that the hospital and the physician are two separate entities, both trying to collaborate together, both looking at this health reform legislation, both trying to figure it out and we anticipate a lot more arrangements and alliances, joint ventures, partnerships as hospitals and physicians get together to become more effective.

SOG: Now one thing we have not focused on much yet is divestiture – this idea of business sell-offs to focus on your core businesses. And are we going to see uptick in divestitures as well and if so where are those opportunities?

SG: Well, yeah, I believe that there will be some increase in divestitures. Our clients are taking a look at their portfolio of assets to see which ones they can operate most effectively. Again the overriding premise here is regardless of what sector of healthcare you are in – taking care of patients, medical devices, pharma, insurance companies that Phil is talking about, the expectations going forward is that you’re going to have do more and get paid less. And anytime an industry is faced with that dilemma, they typically look through their businesses and say “What am I good at and what I am not quite so good at?” 

So I do anticipate that we’ll see just like we are anticipating increase in number of acquisitions, we’ll have companies and business and organizations go through, and may be consider realigning, joint venturing, partnering and even some cases divesting, businesses they don’t feel as part of their core strengths. Again the whole industry is looking at this damping down the price expectations and we have to think what we are good at and what we are not so quite good at and adjust accordingly.

SOG: Phil your thoughts?

PP: Well, you know, we already are seeing some of those divestitures and Simon mentioned that physicians are really the core to the way our health care system operates and that’s absolutely true and if you think about reimbursement decreases across the board, the one group that’s going to most effected and adversely impacted is physicians. Large corporations can generally take it with their cost structure; can generally do things to react to cost reductions or revenue reductions. 

Physicians on the other hand, have a bit more difficulty doing that because it’s basically their own time and materials. So for a variety of reasons including reduced reimbursements, secondly the complexity of just operating in the health care environment as a sole practitioner or physician practice, thirdly, because some of the effects of the health care reform are directed towards limiting the amount of money or revenue that physicians can generate from other assets like orthopedic hospitals or ancillary assets and then lastly the potential for the change in tax rate. 

So what we are seeing and have been seeing for couple of years now is a shift in the practice of medicine from private practice, into an employment model where as Simon said most physicians historically have been employed privately, they do practice in hospitals, now they are actually selling their businesses and becoming employed by hospitals and we think that the implications for that are going to be very far reaching. It is fundamentally going to change the way our health care system operates.

SOG: Definitely it sounds like we are talking about change, large change. So as we are winding down, my final question for both of you is where do we see this industry in five years and where are the opportunities? How can health care companies make big gains so that they continue running for years to come?

PP: Well, nobody has all the answers, but I think Simon said it. Most people associate health care reform with the expansion of the coverage to the uninsured, but that’s only a piece of what healthcare reform is really all about. Health care reform ultimately is about bending the cost curve and health care cost in this country has been outpacing the general growth of our economy for decades. We are now approaching 17 percent of our gross domestic product is consumed by health care services. We have the aging population; we essentially have the baby boomers eventually becoming Medicare recipients. 

Ultimately, as Simon said, a big element around  health care reform is going to be bending the cost curve. The traditional structure in this country in terms of the way the health care industry work was volume equal revenue equal profit and now we are starting to see the departure from that. One of the things that health care reform talks about is a term that’s getting a lot of press, ‘comparative effectiveness.’ Basically what comparative effectiveness means, or might mean, is doing less at a higher or better outcome, but doing less and actually receiving less revenue at a more effective treatment. So we believe that the long term winners in the health care industry are going to be companies that are on the side of the angels if you will, the companies that can actually reduce cost, can actually improve quality, can bring new and innovative treatments and approaches to medicine that actually bend that cost curve.

SOG: Simon your final comments?'

SG: Yeah, this piece of legislation is sort of an indicator on trends that are already occurring. We can’t keep on sustaining the cost health care in this country. Point number one. Secondly, why is it that the U.S. is the only western developed society that doesn’t have a government sponsored health care system? So, lot of political influences is going on here and a lot of social influences are going on here. The end of the day is regardless what you think of this legislation whether you think it is going to be repealed, whether you think it’s going to be modified/changed, we are not going to be paying for and receiving health care in 10 years time the way it’s being received today and certainly nowhere like it was being paid for and being received 10 years ago. 

When you take an industry that is significant to U.S. population, to U.S. economy and U.S. global competitiveness as the health care industry is, you start changing it. There’s going to be 10 years of business combination, business dissolutions, new business models coming in, failures, we are all trying to figure out how to provide the best quality care at a reasonable rate, not the lowest rates, but at a reasonable cost and that’s a big societal change.

SOG: That’s definitely going to be an interesting couple of years as companies figure this out. He is Phil Pfrang, you are Simon Gisby, I am Sean O’Grady, and we are out of time for this segment. If you would like to learn more about Simon, Phil or anything we discussed on today’s show, you can find that at www.deloitte.com/us/podcasts.

We’ll see you next time.