“C” stands for “competition” when describing the market dynamics between corporations and financial sponsors looking to acquire or invest in profitable, growing healthcare technology firms. Profitable growth in an emerging market segment, however, can be illusive – it takes time and capital to build the fixed cost infrastructure necessary to develop and support products, and generate and capture customer demand necessary to produce operating leverage. Moreover, price expectations for businesses that have achieved such a position are understandably high. Consequently, “C” also stands for “conundrum”.
Corporations, especially those with publicly traded equity, face a growth imperative that has fueled an appetite for mergers and acquisitions (“M&A”). However if M&A fails to generate profits that exceed an acquirer’s cost of capital, equity devaluation is a virtual certainty. Similarly, private equity firms compete, intensely, to invest capital received from limited partners, which bolsters equity valuations making it more difficult to deliver hurdle rates of return at exit. This context mandates that we embrace two additional “Cs” – “creativity” and “collaboration” – as the means by which corporate buyers and financial sponsors can solve the quandary of how to accelerate and de-risk the path towards value creation.
No better recent example of “creative collaboration” between a strategic buyer and a private equity firm exists than the acquisition of Netsmart Technologies (“Target”) by Allscripts (“Corporate Buyer”) and GI Partners (“Financial Sponsor”). In this case, the Corporate Buyer and Financial Sponsor parlayed financial and operating assets to create the industry’s largest health and human services (“H&HS”) and post-acute technology provider. Corporate Buyer possessed the strategic intent to expand beyond its core hospital and ambulatory physician markets into the post-acute segment. Yet, undoubtedly, it realized that its sub-scale home care business and an infirm balance sheet likely would have prevented it from prevailing, alone, in a competitive M&A process. Financial Sponsor, unquestionably, appreciated the attractive growth characteristics of the H&HS market, but also the robust valuation expectations for Target. The difficult circumstances faced by Corporate Buyer and Financial Sponsor, inspired the inventiveness to harness the complementariness of the H&HS and post-acute market segments, by collaborating creatively to prevail in a competitive contest to acquire Target.
Corporate Buyer contributed 100% of its existing homecare software business into a joint venture established by the parties. Additionally, equity contributions by each party, along with third party debt, enabled the venture to acquire the Target with the intention of merging it with Corporate Buyer’s homecare business, which would generate synergies leading to a reduction in the pro forma acquisition multiple. In order for this collaboration to be successful, the parties had to reach agreement on an array of issues, such as the value of Target and the to-be-contributed home care business, relative equity contributions, which would drive ownership percentages, leverage ratios, preferential return requirements and exit scenarios, and governance rights, including actions that would effectively require unanimous consent.
Without substituting a “mutual problem solving attitude” in place of a “negotiations mindset”, collaborations between corporate acquirers and private equity firms will face a daunting barrier to success. However, price conscious buyers acting alone in a competitive M&A process, whether corporate or financial, face no less a challenge. The alignment that corporate buyers and financial sponsors share around value creation, and the increasingly intense competition that exists to own high growth, profitable businesses, undoubtedly, will serve to inspire more frequent creative collaborations in the future. Count on it!!