MoveOverAutosandHeavyIndustry–TheBiggestIndustryRestructuringofthe2020’sisComing!!!
It’stheMedicalIndustry’sTurn!!
In a recent article, we made comments about the valuations and structures of buy/sell transactions happening today, and were forced to ask ourselves, “Is it the 1980’s again?” Over the past few years, many in the turnaround/restructuring industry have likely been engaged in an increasing number of projects in the “Medical Space.” Medical Space includes: local & national labs; independent physician practices; stand-alone technology centers; medical staffing; high care and transitional nursing homes; home health care; medical equipment manufacturers & the suppliers to these players and hospitals. As the volume of transactions and restructuring in medical space has increased over the past few years, it seems time to look back to see what could be driving the increased volume in this space.
As usual, the increase is in activity is because that is where the money is and everyone is trying to figure out how to get a “taste” of that wave. The entry of many of the Private Equity and Investment firms into the Medical Space have been brought about by a number of factors including investors looking to cash-out to private owners looking for their next steps. With regional and national roll-ups going on, and with tons of money chasing the cashflow, it is a great time to be a buyer or perhaps a seller.
It’s no secret that Medical Space spending is on the rise nationally. The $933.5 billion increase in healthcare spending from 1993 to 2013 has been driven by a number of factors[1].
- The increase in population during this timeframe accounted for a 23.1% increase in spending – $269.5 billion
- Aging accounted for an 11.6% increase – $135.7 billion
- Pricing and intensity of treatment drove a 50% increase in spending – $583.5 billion
- Disease actually accounted for a decrease in spending of 2.4% – $28.2 billion
Nationally, population has been hit with both the baby boomers aging and needing care. People over 65 years of age experience 3 times more hospital stays than the general public, while those over 75 years of age have four times more days. These simple demographic facts create a huge opportunity for doctors, hospitals, labs and care givers in general to deal with demand beyond anything experienced previously. Adding to that idea, much of the payments for healthcare are, for the most part, covered by either government or insurance, means investors can easily see strong sustained cash flow to rely on when paying huge multiples. What we find surprising when looking at deals in this space is to be discussing multiples of SALES and not EBITDA at huge valuations—sometimes double from normal industry rates when the operation being pursued is running at or above industry performance levels.
When we began in the early 1980’s, we did our first leveraged transactions, most of these transactions were in the manufacturing or retail spaces and continued throughout the 1990’s. The prices being paid then reflected the “value & cost” of funds being used in the marketplace, with 3-5X EBITDA being the norm. That isn’t anywhere near where transactions in the Medical Space are today—but the valuation dynamics are so similar it is DEJA-VU!
In our experience, the Medical Space buyers have been paying tremendous multiples of EBITDA, often 10-20X, and in many cases, where volume is a driver, 1.5-3X of Sales! With these kinds of multiples, it is certainly the time to be active in the Medical Space by understanding what the incremental purchased volume will bring to a “core company” in order to justify these huge prices and competitive situations. Restructuring professionals most certainly have role by helping drive earnings and reducing this industry’s widespread and significant profit leakage!
Looking back and then reflecting on today’s Medical Space marketplace, we are finding similarities to the evolution that has overtaken the auto industry. The increased use of medical services by both boomers and even the younger generations is forcing the medical industry to innovate and change just as it did the auto industry. This increased volume has put a strain on the system, stimulating ways to grow capacity, manage personnel shortages and innovate—by an industry that has never had to closely manage transactional costs or inventory dynamics.
As you may recall, the auto industry evolution really went to the next level in the 80’s when the Japanese entered the market with lower costs and better production approaches. The Big 3 hadn’t worried about anything but making sure there were sufficient cars on lots to meet the demand. Sales and profit were sure to follow they believed, with prices rising as needed to insure their targeted results. It worked until the Japanese arrived with lower prices, standard features and consistent quality–all driven by a lower average cost of production brought about through improved equipment and a reduction in the capital, primarily inventory, that was needed for each car sold.
We all remember how the restructuring of the auto industry impacted the entire supply base, and the current supply chain model in most of manufacturing reflects that evolution. Not only did the industry change and streamline, but every newly-christened “just in time” supplier down the channel had to adopt “lean” and “quality” as the new way of life or die! Not only did the production cost matter, but with the cost of funds in double digits, the capital needed for every part in inventory drove them to change how every production plan was formalized.
In our view, the Medical Space appears to be on the verge of that same industry evolution. The demand for increased services in an industry with a critical shortage of workers, means doing business the same way it’s always been done will no longer work. This rapid growth and increase in spending is priming the search for cost savings and productivity improvement. Providers are embracing telemed and other technologies hitherto shunned in order to help meet these challenges. PA’s and NP’s are becoming more prominent as they take some of the workload off physicians to improve the efficiency of providing healthcare. Medical innovation hubs are becoming the norm rather than a novelty, tie this situation to the rapid increase in the cost of funds (25-35% in the last year) and it feels just like the auto industry all over again!
With the Government teaming with the Insurance Industry through the implementation of the Affordable Care Act, each are starting to search for price compression with volume. At the same time, individuals are being asked to pay the highest deductibles in history. According to recent data from the Centers for Medicare and Medicaid Services (CMS), the average American spent $9,596 on healthcare in 2012 compared to $7,700 in 2007. In 2016 the average annual cost per person hit $10,345, while in 1960 the average annual cost per person was $146. In this instance, the forces of consumer, provider and payer are all united in trying to address the increasing cost of healthcare and what can be done to stem that tide.
Much more “leakage” exists in Medical Space engagements than we have seen in manufacturing and service industry projects. We’re reminded of 30 years ago when companies tracked the price of steel, but the shipping, rework, overtime and packaging were viewed as “small money” –“immaterial” – “rounding” and not watched very much at all. For those of us who came from “penny business” backgrounds like the grocery industry, life was all about single bites and we attacked those small areas vigorously.
In virtually every medical project we’ve had lately, the CFO has commented that many of our initiatives were “immaterial” and “not worth our valuable time” to worry about. But as we all know, every “penny” that can be saved is valuable and ends up in most engagements helping management to get incremental margins where most thought it wasn’t worth it. In one notable situation, where revenues were about $80MM, we were able to recapture $6.5MM in savings in the “immaterial” areas that we had identified.
Although the Medical industry is experiencing some of the challenges, we all saw in the ‘80’s, the size of the industry along with its dramatic growth will bring prospective buyers plenty of opportunities as long as they make sure they gain control of the train. We all need good healthcare and often times we can’t put it off like we sometimes do when buying a new car! But for those of us in the operational improvement & turnaround business, there will be abundant opportunities to again assist our investor, lender and owner friends who are in, or considering the exploding medical marketplace. If not, they will likely be run over in the next few years, and with the prices being paid—it will be ugly. If we add in the growing cost of funds, the time for attention is now, not tomorrow!!
And as us “seasoned” professionals know, “We’ve been there—we can help!”
[1] Dieleman, J.L., Squires, E., Bui, A.L., et al. Factors associated with increases in US health care spending, 1996-2013. (2017, November 7)