A few months ago, we wrote in a research note that we expected a significant increase in healthcare information technology mergers and acquisitions, but the Allscripts/Eclipsys merger is not exactly what we were expecting.
Nonetheless, there are several important lessons for HIT CIOs and investors.In this post we take a look at the potential cross-selling synergies, the deal structure itself, and financial considerations.
There is an old saying in the construction and home improvement industries that is absolutely true all the time: “You can have it done right, you can have it done cheap, and you can have it done fast. Pick two.”
In mergers and acquisitions there should be a saying: “A public company cannot acquire another public company in an all-stock transaction at a fixed premium over the trading price of the acquired company, at a specific valuation, and at a fixed stock ratio.”
Consequently, alarm bells started ringing when we read the press release from the company reporting that Allscripts would acquire Eclipsys at a 19 percent premium to the June 8th closing price of Eclipsys, give Eclipsys shareholders 1.2 shares of Allscripts for each share of Eclipsys, and value the deal at $1.3B.
Note that on June 8th Allscripts closed at $18.42 and Eclipsys closed at $18.51.In fact, this year the stocks have pretty much traded within a buck of each other.
As implied in the announcement Allscripts was offering just over $22 per share to Eclipsys shareholders.But after the dust settled on the 9th (the next trading day) the market had something to say about the deal. Instead of Eclipsys being up 19 percent, the stock was only up 3 percent, and Allscripts was down nearly 10 percent. Instead of the stock-swapping ratio being 1.2 to 1, the market determined 1.14 to 1 was better. As of Tuesday the 24th the gap narrowed to about 1.18 to 1, or $20.60 per share.
The lesson is, you can be a public company, offer a fixed price in cash, or let the market determine the price, but not all three.
Typically, when one company buys another company the goal is to reduce competition in a marketplace, or even more often, the merger is thought to be a cost effective way to get more products to sell to existing customers.
For example, if a company sells and distributes auto paint to auto body shops it might want to acquire a company that sells and distributes body filler to the same customers. A second example: back in the day people that sold gasoline also sold oil, because most people took their cars to the gas station for oil change service.Now gas stations sell gasoline and beer because they figured out that most people that drive also drink beer – hopefully not at the same time.
Allscripts primary customer base is physician practices (ambulatory care) and Eclipsys’ primary market is hospitals (acute care), but a lot of the technology (i.e. EHR) overlaps. So, we don’t see how this merger provides a lot more products to either company to sell to its particular market segment, and we do not see how the deal eliminates a competitor.
So this is probably not the end of M&A for Allscripts. More M&A is likely in order to consolidate their market place and add new features and products. For example, ambulatory care providers need technology to help them be more productive and manage reimbursements. Acute care needs much of the same plus an integrated suite to deal with all the departmental needs (such as OR, ER, ICU, and radiology).
Both need better technology to allow providers of both categories to secure health records and institute manage patient-driven privacy and health information sharing consent. The merger may fill in some of these gaps, but the challenges of integrating bits and pieces of each other’s technology into each other’s core platforms will be difficult to say the least.
So just why would a company whose primary customers are doctors buy a company that sells primarily to hospitals? For one thing the companies know each other pretty well, and since they had different core markets, there was probably not a hostile relationship.
But the best reason to do this deal becomes apparent when you look at the financials.
Valuations for publicly traded Healthcare I.T. companies are not exactly cheap, and this merger is no exception. At $22 per share Allscripts would be paying almost 30 times Eclipsys’ 2010 consensus earnings of $.74, at the time of the announcement. A high earnings multiple typically correlates with fast earnings growth, but analyst earnings estimates for Eclipsys were only up $.10 year over year. On a revenue basis, the valuation is more modest – 2.3 times Eclipsys’ 2010 revenue estimate of $559M, but again the consensus forecast reflects a relatively slow top line growth of only 6%.
So, it appears on the surface that Allscripts did not get a particularly good deal, but we still think under the covers the deal is well worth it for both sets of shareholders. Here’s why. Despite protestations to the contrary, there is significant potential cost savings from reducing headcount in the combined entity. A large part of the combined company’s operations and administrative costs can be cut. There is no need for two accounting, HR and IT departments. Legal, filing and other regulatory costs can be cut. This should save 5 to 10 percent of total expenses.
But bigger savings can be accomplished in product R&D, and this is the nugget that really makes the deal look good for shareholders.
Much of the actual software being sold to the two market sub-segments has duplicate functionality. Managing medical inventory, EHR, scheduling, and many other business process in acute and ambulatory care are similar if not identical. And having a single product line on a consolidated technology platform will leverage the burden of getting regulatory approval for the software.
Plus, there is a lot of work to do to improve software in the healthcare industry and this merger allows all the coming changes to be more efficiently developed and delivered to the market place.
The challenge, of course, is making sure these changes do not upset the customers.
Rob Tholemeier is a research analyst for Crosstree Capital Management in Tampa, Fla., covering the heath I.T. industry. He has over 25 years experience as an information technology investor, research analyst, investment banker and consultant, after beginning his career as a hardware engineer and designer
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