Jon Phillips is founder, managing director, and partner with Healthcare Growth Partners of Elmhurst, IL.
It’s been a couple of years since we’ve talked officially. Your predictions back then were strong M&A through 2011 then falling off significantly in 2012, multiple billion-dollar deals by the end of 2011, and HITECH payouts that would be a fraction of the potential amount. Want to revisit those?
I certainly missed it in terms of the projection related to 2012 M&A activity. When we tallied up the transaction activity for 2012, it was at a record level for the space. I think we’re continuing to see a lot of activity related to a number of different macro trends that are impacting healthcare overall. Transaction activity has continued to follow along with the growth in healthcare spending and then also the increasing need and understanding of the need for healthcare information technology to solve the other challenges and healthcare more broadly. I definitely missed on that one.
On the Meaningful Use side of things, as you look at the stimulus payouts and look at the distribution of those payouts, we were somewhat on the mark. You still have a fairly hefty proportion of the physician market that has not yet been able to become eligible. You’ll see those physicians falling into a couple of different categories. You’re still going to see more people trying to get systems in place so that they can capture some of the Meaningful Use incentives. But I think you’re having some other physicians who are looking at the impact that the systems are going to have on their practice productivity and are saying that a one-time stimulus incentive may not be enough to get them over the hump in terms of deploying systems.
There’s a little bit of a battle there, especially in the physician practices. In smaller practices, the adoption curve is probably a little slower than many people would have said going back several years. Just like we’ve always seen in healthcare IT it just takes a long time to adapt technology. It doesn’t mean that we’re not going to see adoption rates for EHRs in any provider heading up into the 80 to 90 percent range at some point. It just seems to be taking a little longer than some of the cheerleaders expected.
Everybody wanted to buy HER-related vendors and consulting firms a couple of years ago. Now it seems like everybody’s chasing analytics and population health technology vendors. Do you think that latter group is going to be as successful as acquirers seem to think they will be?
A lot of it depends on the type of solution that the analytics and business intelligence and population health folks are providing and that the capabilities that they have. You’re going to see some situations where there is a sense that if an acquirer purchases an analytics vendor, that in and of itself is going to drive success, because there is a tremendous amount of data that’s being created, and so tools that can sift through the data and can drive meaningful conclusions from data can be very valuable.
That being said, part of the challenge is that a lot of the analytics solutions and BI solutions out there are much narrower in their capabilities than people may expect. There is still a lot of hype around the big data solutions that has yet to pan out. There’s a pony in there somewhere, but I don’t know that a lot of people have found the pony yet.
It’s going to depend on continued execution rather than just buying a business or developing a business or investing in a business that has strong analytics capabilities and a strong business intelligence footprint. That’s not going to be everything that it’s going to take. You have to focus in on how those solutions are going to be used and the value that they’re going to generate.
I had a conversation with a hospital exec a little while back. He was talking about the fact that they have a clinical system that they deployed. The system is fully operational, and yet they’re still having to go through and do manual reviews of charts to pull relevant information because the system captures a lot of information, but it doesn’t necessarily make it usable. For analytics-type solutions to really be valuable, they have to close that gap from taking data that’s being captured, drawing meaningful insight from that, and then helping it to be actionable so that hospitals and physicians can actually do something with the reports that are coming out.
The trap with data is that you can fall into a situation where you say, “Just because we have a lot of data and we can run a reports on that data, that that means that we can make a difference in terms of how we’re providing care or how we’re running our hospital or physician practice.” It doesn’t necessarily mean that. Look at the proliferation of data across the economy. It’s a much smaller subset of data that actually drives decision making. In healthcare, the data sets are incredibly complex and the decision processes are incredibly complex, so it’s just going to take some time to bridge those gaps.
The other interesting thing related back to how a few years ago there’s a lot of focus on consolidation in the EHR and PM space and among consulting firms. Consulting has been kind of up and down. That sub-sector tends to be going waves, where you’ll see some significant acquisitions and then you’ll see a lot of the principal spinoffs start their on firms, build these firms up, and then you’ll see another wave of consolidation.
On the EHR and practice management side of things, there were a few deals last year in that space, but at least the rumblings that we’re hearing right now is that there are a number of other companies in the physician software space that are exploring raising capital or finding an acquirer. You’re starting to see a pickup in activity in that part of the market, which is not tremendously surprising, but it’s interesting because I think you have people trying to figure out how they position themselves for a market that as the impact winds down on the incentives associated with Meaningful Use, how do you get yourself positioned as a company to continue to have success in the physician software market?
The winners haven’t necessarily completely emerged yet. You have companies of very different sizes who are both doing very well and who are not doing very well. I think you’re going to see some real strategic moves in that space over the next year or two as businesses try to build real strong strategic positioning to become long-term participants in that market.
Do you believe that Humedica really got hundreds of millions of dollars in its acquisition, and what do you think that deal means for the market?
A lot of times what you’ll hear with deals like that is the rumor will tend to be substantially higher than the actual deal. It could be that that deal was structured with a portion of the consideration paid upfront, and then some of it depending on performance going forward. I look at that transaction as being much less about the existing footprint that Humedica had than the ability for Optum to be able to take the capabilities and tools that Humedica has been developing and gain a lot of additional value out of those capabilities based on the much broader reach that Optum has.
If you look at the number that businesses that Optum has acquired, in certain situations, they’ve paid prices — and they don’t have to publish a lot of the multiples given how big they are — but that certainly seemed to be at the far end of the valuation distribution. Yet in a lot of the situations, they’ve paid big prices and then have it in turn really been able to generate a lot of value out of those businesses. It probably was a smaller deal size than is going on than the rumor might otherwise imply, but Optum is going to have a very disciplined financial model in terms of how they look at it and how they generate a payoff. That’s how they came to the value that they were willing to pay.
It does present a trap for other companies in the space. As we looked at the deal environment in 2012, we saw a little bit of a bimodal distribution in values, where you would see certain transactions happening at very high revenue and earnings multiples and then the majority of transactions happening at lower multiples. If you’re thinking about selling a company, the temptation is always going to be to say, “We’re better than anybody else, so we should deserve to get a three, four, five, six times revenue multiple.”
If you look at the distribution, even in 2012 but especially if you look at it historically over the last five or 10 years, the multiples for deals done in the space — whether it’s a recurring model or a license model, it’s not entirely dependent on profitability although profitability impacts it, growth impacts it, the level of recurring revenue impacts it – but what you see is that most deals in the space happen at two or three times revenue.
When you see deals like that get announced and there’s a really high value, sometimes everybody says, “That means that my company is worth a lot more.” It doesn’t necessarily mean that. It means that Humedica was worth that much to Optum. It’s more of a one-off than a hallmark of the much broader trend that deal values are going to be permanently high.
Give me one example of each of an M&A deal that you did like and one that you didn’t like in the last couple of years.
In terms of ones that I’ve liked, I think athena has done some fairly interesting things. Epocrates is obviously very intriguing in terms of the footprint that they have and the reach that they have. But I also think that athena’s acquisition of Healthcare Data Services is pretty intriguing as well in terms of looking at different ways to look at the information that’s flowing through their customers and being able to draw lessons from that. A smaller-type transaction, but certainly presenting a significant upside.
In terms of some other ones that are pretty interesting — a caveat, we were a strategic advisor on this transaction — the Hearst acquisition of MCG was very intriguing given the footprint that Hearst already has and the ability to really generate strategic value through what MCG has already built.
The things that I tend to like are situations where you have businesses that have a strong footprint and are looking at pieces that are truly additive in terms of where they’re building and the directions that they’re going, that are going to generate growth that’s faster than either of the businesses could effectively do on their own without the bigger footprint that they’re going to have together and the better reach that they’re going to have together.
Some of the ones I don’t totally understand. Perceptive buying Acuo. The vendor-neutral archive space is certainly an intriguing space and I think there’s opportunity there, but you always get a little nervous about sectors where it feels like the technology could, in effect, be disintermediated over the long term, that there’s not necessarily a long-term presence that the technology helps you to establish. In situations like where you’re buying something that may have strong momentum today but certainly presents a fair amount of risk for there down the road in terms of replacement capabilities that could be much less expensive and more flexible — those feel like deals that are tough to make pay off over the long term.
Who needs to sell or find a partner?
If you’re a physician-oriented software vendor and you are under $10 million in revenue — just to draw a bright line which may or may not be fair — I think you have to be thinking about a sale. The level of investment associated with continuing on Stage 2 and then the level of investment in terms of sales and marketing to be able to continue to go after a market where the individual incremental sales are going to be smaller in terms of the deal size, and yet there are still a lot of sales and marketing investment that’s required to get there.
Those groups are going to have to find bigger companies to take them over. In some situations, there will be scenarios where the products won’t survive. In other situations, the products will survive, but they’ll be able to have common sales and marketing and they’ll get some savings on the development side. Smaller ambulatory vendors absolutely need to look at selling.
This isn’t necessarily a 2013 trend but certainly one that will carry on over time is the question about what happens with traditional best-of-breed vendors in a hospital environment. There is certainly still a market for best-of-breed vendors in hospital environments and I think that market will continue. But the challenge is, once again, you have to have scale. When you look at a lot of the public results that have come out and then just the conservations that we’ve had with the folks who don’t publish their results, 2012 was a challenging year unless you’re selling core clinicals and you’re Epic or unless you’re selling things around ICD-10 and code migration. It was not a year where everybody had a lot of success in selling into hospitals.
If you’re a single product best-of-breed vendor in the hospital market, there’s likely going to be a lot of variability in your revenue streams over the next couple of years as the capital flows in hospital vary up and down unless hospitals react to the reimbursement pressures that they’re going to be seeing. You really do need to broaden out capabilities, which entails finding a buyer or a merger partner for a lot of new kind of single-product, best-of-breed vendors in the marketplace.
Give me three predictions about anything related to healthcare IT over the next one to three years.
In the next three years, there will be certain significant winners and a much larger number of significant losers in business intelligence and analytics. Some people will figure out how to draw connection to what hospitals need, whether it’s what they need for operating in an accountable care or coordinated care environment, or what they need in terms of dramatically improving their operations. You’ll have some other groups who don’t draw the connection to meaningful return on investment and those will be the ones that will fall by the wayside.
You will see ongoing consolidation in the physician software market. In 2013 and 2014 ,we’ll see a significant increase in the number of transactions among physician software vendors.
A lot of Epic’s competitors will see resurgence in their opportunities in the marketplace. Epic has an unbelievable momentum. They’ve done a great job executing. They’ve done a great job in sales. But I also think that there are reasons why people can choose other solutions, whether Epic still has core clinicals but then there are people who are providing solutions that go around the fringes, or whether it’s groups selecting alternatives to Epic because they feel philosophically and capability-wise there are other directions that they can go. Epic is going to be a very strong player in the marketplace for a long time to come, but three years from now, they won’t look as invincible as they seem to today.