Making sense of healthcare M&A in 2014

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

The tax inversion window is closing

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. emerges in better shape

By emphasizing fiscal stimulus and quantitative easing monetary policy, the U.S. 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 European consumer markets 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).

Inexorable growth drivers

Whatever 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.

New technology, but…

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 wound care modalities.

Hospital consolidation may limit competition, raise costs

Hospital-to-hospital mergers and physician-hospital integration are motivated in part by economies of scale and gaining negotiating strength against healthcare payers. 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.

A clarifying uncertainty

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 of Small Bone Innovations and Wright’s purchase of Tornier).

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 would split its healthcare business and lighting businesses into separate entities.

Consolidation leaves innovation gaps

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.

Always 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 percent 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.

Adam Cohen works for the Walden Group, a strategic investment banking and consulting firm fo-cused on the healthcare industry. Click here to access Walden's 2014 Strategic Healthcare M&A Report.