UPDATE: Robust analytical methodologies can provide executives with insight regarding industry trends. This blog, previously produced by Diane Borska, Global Principal at Fuld + Company, on mergers and acquisitions is a demonstration of the power of strong industry understanding and well-executed analysis
Nearly 18 months after the Aetna – Humana deal was first announced, a federal judge has ruled the transaction would violate antitrust laws. As a result, it is all but certain that the deal will not go forward and analysts believe the closure of the other significant industry transaction involving Anthem and Cigna, is also in jeopardy. Observing the parallels of merger activity in another industry with relevant characteristics to health insurers, allowed us to recognize early on the risks these transactions would face and conclude that the pace of industry consolidation may be slow and face considerable challenges.
The announcement of Aetna’s acquisition of rival Humana, triggered a deja vu moment for me. It took me back to my days as a utility industry analyst reviewing the “urge to merge” that overtook that industry beginning in the mid-1990’s. Motivated by a combination of recent and anticipated regulatory changes, rising capital investment requirements, and shareholder earnings growth expectations, merger mania struck the sector. In the ten-year period from 1995 to 2005, there were more than 50 mergers of investor-owned utility companies, most, if not all, predicated on the notion that "Bigger is Better."
Thinking about the series of completed and impending mergers of the healthcare payers, I can't help but see the parallels and wonder if there are some important lessons to be gleaned from the utility experience. I see that many similarities between the dynamics, risks, and issues associated with M&A activity in both sectors, not the least of which is the underlying belief that scale (and often scope) is the way to not only survive but thrive in response to changing market conditions. But due perhaps to the degree of not only federal, but state, regulation and oversight that firms in both these industries must contend with, M&A transactions are often embroiled with all sorts of tumult and commotion and unusual risk that cause them to fail to live up to their intended outcomes.
High Corporate Drama of the Predator and the Prey
It seems to me that these “industry consolidation” motivated transactions often involve high corporate drama and 11th hour boardroom decisions. Sometimes it just isn't clear who is the predator (I mean the acquirer) is and who will be the prey (the acquired), and as a result the company CEOs jockey around with their investment bankers almost until the deal is done. The back-story on the Humana deal is a case in point.
According to various press reports, UnitedHealth Group, Cigna, and Anthem were among the companies interested in acquiring Humana, who is apparently desirable prey due to its large multi-state Medicare Advantage enrollment. Cigna was reportedly particularly interested in acquiring Humana even though it was facing a bid from Anthem. And Anthem had made public its bid for Cigna last month. But press reports indicate that Cigna executives were still inquiring about doing a deal with Humana less than 24 hours before the Aetna deal was to be publicly announced. Humana’s board was apparently faced with dueling offers and had to decide if Cigna were truly interested in acquiring Humana or if they simply wanted to use the prospect of an alternative transaction as leverage in their negotiations with Anthem. To make this situation even more twisted, press reports say that Aetna itself had been approached by UnitedHealth Group for a potential merger. Aetna apparently declined to consider the offer and proceeded with the Humana deal, which was nearly finished until last minute disputes regarding a break up fee emerged.
While these last minute machinations may seem like schoolyard wrestling, there are many similar tales in the utility M&A annals. One unique scenario that comes immediately to mind is what happened during Duke Energy's acquisition of Progress Energy. In July 2012, the Duke Energy board had just voted to approve the acquisition of Progress Energy, along with the agreement that Bill Johnson, the Progress Energy CEO, would become the CEO of the newly combined company. Duke Energy's CEO, the iconic Jim Rogers, was voted in as Executive Chairman, a first step toward his long-anticipated retirement. For reasons that have never been fully explained, the Duke Energy board reconsidered its vote two hours later, ousted Johnson as CEO, and reinstalled Rogers. Accusations quickly surfaced that Duke had "suckered" Progress into the merger deal by holding out the prospect that their CEO would be the new company’s CEO.
Who knows what really happened? The point is healthcare payer executives need to buckle up. The ride is about to become pretty bumpy.
First the Announcement, then the Regulatory Hurdles
Beyond the jockeying of executives and boards, healthcare payer mergers face the prospect of an uncertain, risky, and time consuming regulatory approval process. As in the case of investor owned utility transactions, these deals must pass muster with several federal agencies. In the case of Aetna and Humana, the deal is apparently structured in such a way that it requires review and approval by the Securities and Exchange Commission, the Federal Trade Commission, and the Department of Justice. The focus of the FTC and DOJ inquiries will be market power and anti-competition, once again, just same as in the utility industry.
But, that’s not the end of the regulatory process. The deal will face same kind of scrutiny at the state insurance commissioner level and it's entirely possible that each state will have its own criteria for assessing market power concerns (both monopoly and monopsony) as well as potential harm to consumers, making for a complex and lengthy process. By way of comparison, a typical investor owned utility transaction of the early 2000's vintage took anywhere from 12 to 18 months to close, if at all. Thinking back to December 2005, Baltimore-based Constellation Energy announced a plan to merge with FPL Group. After months of regulatory review, Maryland regulators and legislators became embroiled in a dispute over utility rate increases and potential harm to consumers, leading the parties to cancel the merger 10 hard fought months later. As a postscript to this story, Constellation successfully completed a merger with its neighbor Exelon in May 2012. Constellation customers received a $100 credit on their bills as a result of regulatory negotiation.
According to Bloomberg, Aetna-Humana may have to make significant divestitures of their Medicare Advantage businesses in order to remedy market power concerns, either voluntarily or by regulatory fiat. The ACA and its impact on the healthcare product market creates some significant uncertainty about product definitions and the manner in which the various federal and state agencies will evaluate them. In the utility sector, there were numerous instances of asset divestitures or business restructurings in states where market power concerns arose. But we need to keep in mind, as concessions are made, the benefits of the transaction to both shareholders, and ultimately to consumers can become rather diluted. S&P has already weighed in on the Aetna-Humana deal saying that although the combined entity will benefit from improved size, scale and diversity, “the transaction could be a drawn-out process, involving a potentially high degree of deal risk and regulatory scrutiny.” With this kind of risk, healthcare industry observers and participants should keep two things in mind:
- There may be a number of failed deals. Sometimes, during the protracted regulatory approval process, other players enter the fray and deals get disrupted. I think, given the dynamics here, there is certainly some potential for that.
- It may be very difficult, if not impossible to do a hostile takeover, meaning this ongoing wrestling among the players will persist for some time to come.
Overall when the dust settles, it is not at all certain that we will see significant consolidation in the healthcare payer space. It’s just hard to pull these deals off.