Last year, I wrote a column on "Choosing a Buyer: Private Equity vs. Search Fund vs. Strategic." As the title would suggest, this well-received piece discussed the three predominant buyer types — private equity group (PEG), search fund, and strategic buyer — healthcare business owners are likely to encounter when they decide it's time to sell their company and what sellers should know about them. I have had the good fortune of closing deals with each of these buyer types over the past few months, so I thought it would be worthwhile to do a follow-up piece to this column — one that discusses the challenges associated with getting transactions involving these buyers to and across the finish line.
Each buyer type has its own challenges, and understanding how to navigate them most effectively and efficiently is one of the most important roles I play as a healthcare M&A advisor. As I collaborate with seller clients to overcome these roadblocks and any curveballs, I am focused on achieving not only the best valuation for clients but also the deal structure that would most benefit them. Understanding how buyer types differ in how they structure offers and prefer to proceed through the due diligence phases is essential to achieving a seller's goals and ultimately a successful transaction and transition.
Let's take a closer look at each of these three buyer types and key points to know about their acquisition approach.
Private Equity
PEGs are also referred to as financial buyers. As this name suggests, their approach is largely based on a healthcare company's financials. Broader due diligence focuses primarily on intense auditing of documents like profit and loss (P&L) statements, balance sheets, and bank statements for the trailing 12 months up until 30 days prior to close.
Legal due diligence will focus on areas like contracts, state boards, and regulatory issues. Sellers should expect weekly due diligence calls with a PEG's legal, tax, regulatory, management, accreditation, licensing, and human resources representatives, and must be prepared to answer their questions and produce any documents requested. At closing, other legal steps must be completed, such as a reorganization.
The deal structure will likely include shared risk, rollover equity, non-competes, earnouts, and employment agreements. Given this continued involvement from ownership, it is worth noting that PEGs used to largely approach acquisitions with a 5-7-year turnaround plan. That plan can now last longer, even surpassing 10 years.
A PEG is more likely to desire keeping the existing management team in place, unless a necessary change is identified during due diligence.
Search Fund
Also referred to as unfunded sponsors, search funds take a "buy-and operate" approach to acquisitions. This translates to current owners usually only remaining for a short consulting period post close.
Search funds come to transactions with previous and fairly extensive knowledge about the company's sector and what's required for success within it. These buyers focus less on financials and the likes of P&L and balance sheets. They look for profitable companies with strong potential growth and return. These are important given that search funds usually have no growth capital, which places greater emphasis on current and potential legacy growth.
Search funds tend to require strict non-competes and expect that current, essential staff will remain with the company while also usually turning over upper management. Scrutiny and audits of an acquisition focuses on regulatory issues, changes of ownership (CHOWs), and any legal issues past and present.
Following the signing of a letter of intent, search funds work to secure funding for the acquisition. The capitalization table (i.e., cap table), which shows a company's ownership structure, will change daily or weekly depending on what's discovered in due diligence up until the day a transaction closes. Each search fund investor has its own requirements.
Finally, search funds tend to hold onto assets longer than PEGs.
Strategic Buyers
These are typically what are referred to as "non-financial" (to contrast PEGs) or "buy-and-build" buyers. They tend to already be well-established in the industry in which they are pursuing an acquisition. Thus, they come to the transaction table with vast knowledge but not necessarily the personnel, so they tend to need the talent and resources that come with the acquisition.
As the descriptor of non-financial buyer suggests, strategics are less focused on financials of the company. Rather, the acquisition is motivated by one or more of needing the acquisition's location, talent, contracts, or customers, or a desire to eliminate a competitor. Strategic buyers also view acquisitions as a way to pursue and further achieve economies of scale.
Strategic buyers tends to have a shorter due diligence period than the other buyer types.
Private Equity, Search Fund, and Strategic: Completing Your Sale
If you're operating a good company, finding interested buyers is usually easy. What comes next is much more difficult, which points to the value of working with a healthcare M&A advisor, like those at VERTESS. Determining a desired exit strategy and optimal buyer type, bringing a company to market, attracting the right buyers, properly vetting buyers, selecting a buyer, and finally navigating the subsequent transaction processes all include challenges that can derail an optimal and successful outcome.
The VERTESS team is comprised of advisors with extensive experience operating healthcare companies and working with all buyer and seller types. We support clients through the entire M&A process and beyond, which includes helping clients achieve a smooth post-transaction transition.
Reach out to learn more about how VERTESS is helping business owners like you achieve successful sales.
Alan Hymowitz, CM&AA
During the past decade I have facilitated numerous, diverse M+A transactions in the pharmacy marketplace across the country, as well as providing strategic consultation to national pharmacies and similar organizations. Prior to becoming an M+A advisor, I was a “hands on” owner and manager in the pharmacy and home infusion healthcare marketplace for over 15 years, and successfully sold my pharmacy to a national company after growing and diversifying our income streams in a very competitive market. My specialties in the pharmacy and home infusion marketplace include long term care, retail pharmacy, specialty pharmacy, and home healthcare, and I have attained the URAC Accreditation and Specialty Pharmacy Consultant designations, in addition to other recognition. My educational background includes a Bachelor of Arts from Rutgers University and a Master of Arts from the John Jay College of Criminal Justice.
We can help you with more information on this and related topics. Contact us today!
We will occasionally hear from the owner of a healthcare company something along the lines of the following: "I know someone who just sold their [type of healthcare business] with the help of a business broker. What's the difference between working with a broker and an advisor like you?"
In this column, I will strive to answer this question, which should also help you understand why working with a healthcare M+A advisor is likely to be in your best interest when you determine it's time to sell your company. I'll start by providing some background information on a typical business broker who works in the healthcare space and instances where the role's deliverables may overlap with that of an M+A advisor. Then I will provide further information on what you can expect from working with a healthcare M+A advisor and how this experience is likely to lead to more successful sales.
Role of a business broker
A business broker facilitates the buying or selling of a business. This individual can either represent the buyer or seller in a transaction. The same can be said of a healthcare M+A advisor. Both brokers and advisors can act as intermediaries between buyers and sellers. Both will privately negotiate deals, and both will help with the transfer of ownership of a business to complete a transaction.
That largely defines the role of a broker: making introductions between buyers and sellers, helping with negotiating deals, and aiding in the transfer of ownership. Payment to a broker is typically a pre-established commission contingent about the completion of a transaction.
What is also important to know about most brokers is they tend to serve a wide range of clients operating in a wide range of industries. It's not unusual for a broker to be involved in healthcare transactions as well as those in manufacturing, software, construction, electronics … the list can go on. Brokers can be the jack of many transaction trades and help with many successful transactions. But as a result, they may not build up significant experience and knowledge of a single vertical.
Role of a healthcare M+A advisor
Now let's break down what a healthcare M+A advisor offers to the seller or buyer of a healthcare company. Note: To help with readability, I will focus on what an advisor offers to a seller.
Active from start to finish — and beyond. A healthcare M+A advisor is more of a partner throughout the entire transaction experience, and then some. They are active in the sale process from the initial valuation of a company, through all the extensive work that follows leading up to a company coming on the market, through the bringing in and reviewing of prospective buyers, and through the transfer of ownership. They can advise on any part of the transaction, including valuation, financial, and legal requirements, and help bring on other team members who can assist further in these areas. An M+A advisor will also stay involved after completion of the transaction to help ensure the transfer of ownership is successful and sellers receive any necessary post-close support.
Advisors manage the entire M+A process for a seller, making sure all the boxes needed for a successful transaction are checked (and double-checked). This management helps reduce the likelihood that a critical step is overlooked or not completed properly.
Management by the advisor also enables owners to focus much of their time on the running and needs of their business. Transactions usually take at least several months and sometimes much longer. During this period, it is essential that the business continues to operate as usual. If an owner must allocate extensive time to the M+A process, this increases the risk of harm to the operations and bottom line, and thus the potential sale and sale price. A healthcare M+A advisor who handles the heavy lifting greatly reduces this risk.
Experts in the field. Healthcare M+A advisors tend to be experts in their healthcare field and generally do not work outside of that vertical. They often become advisors after owning and/or operating healthcare businesses in that vertical. This expertise and experience helps a seller and the execution of a successful transaction in many ways.
Communication between advisor and seller tends to go more smoothly since they can speak "the same language." The advisor is also able to identify opportunities for improvement more effectively. Following completion of a valuation, an advisor will discuss the positives and negatives about the business that are affecting the valuation and the avenues that exist to increase the valuation or help a seller hopefully receive an offer on the high end of the valuation. These may be changes or fixes a seller should consider or worthwhile growth initiatives to pursue.
These pre-listing efforts can help ensure the business is in a better position to attract multiple buyers willing to offer higher prices when the company comes to market. This contrasts with a broker, who will generally list a company as soon as they are engaged by a seller.
Larger geography. Healthcare M+A advisors tend to have national and global experience whereas brokers often work in a narrower geography. Broader geographic experience often enables advisors to better understand more of the trends and developments affecting the vertical they serve and attract more potential buyers to a sale of their client's business.
Paid as a percentage of payout. Advisors are generally paid a retainer fee and then a percentage of the total payout (sale price), with the bulk of the payment coming from the payout. This financial model serves as motivation for an advisor to help a seller undertake initiatives that can help increase the sale price. While money is important, the experience an advisor has in the vertical can also serve to help a seller identify the buyer that not only makes a good, fair offer, but is also the right fit for the future of the business — someone who can preserve the company's legacy, maintain high staff and client satisfaction, and preserve other qualities like culture that have come to define the business.
Making a Sound Business Decision for Your Business
A seller typically sells one business in their lifetime. While a broker can help you sell your company, a healthcare M+A advisor may be in a better position to help you sell your company the best way possible. By working with an advisor, you will put yourself in a strong position to make a deal that is the right deal — one you can walk away from feeling like you have passed your business along to the right company and with a payout that reflects the many years of blood, sweat, and tears you put into the company.
At VERTESS, each Managing Director focuses on specific healthcare verticals and brings insights into the ways deal structures should be created for the companies they serve. Please reach out if you have questions about what our team of advisors can do for you or any other matter concerning the future of your business.
Alan Hymowitz CM&AA
During the past decade I have facilitated numerous, diverse M+A transactions in the pharmacy marketplace across the country, as well as providing strategic consultation to national pharmacies and similar organizations. Prior to becoming an M+A advisor, I was a “hands on” owner and manager in the pharmacy and home infusion healthcare marketplace for over 15 years, and successfully sold my pharmacy to a national company after growing and diversifying our income streams in a very competitive market. My specialties in the pharmacy and home infusion marketplace include long term care, retail pharmacy, specialty pharmacy, and home healthcare, and I have attained the URAC Accreditation and Specialty Pharmacy Consultant designations, in addition to other recognition. My educational background includes a Bachelor of Arts from Rutgers University and a Master of Arts from the John Jay College of Criminal Justice.
We can help you with more information on this and related topics. Contact us today!
About six months ago, the Cost Plus Drug Company, entrepreneur Mark Cuban's online pharmacy, officially launched. As of late, the pharmacy is receiving significant media attention, including a study published in the journal Annals of Internal Medicine which showed Medicare could have saved nearly $4 billion in 2020 by purchasing generic drugs at the same prices offered by Cost Plus. Cuban took to Twitter to share the results with and tag President Joe Biden and other elected officials.
Here's a brief overview of Cost Plus: The company launched in January offering 100 generic drugs. Medication pricing is easy to follow. Cost Plus takes the cost to manufacture the drug, marks it up 15%, adds $3 to cover labor, and finally adds the cost to ship the medication and applicable taxes. To avoid working with pharmacy benefit managers (PBMs), Cost Plus is currently cash-only (i.e., patient out of pocket). The pharmacy uses Truepill for all its fulfillment needs. While Cost Plus currently acquires medications on the open market, it is building a pharmaceutical facility in Dallas to produce its own medicines, with an expected opening in the fourth quarter of 2022.
With the considerable buzz surrounding Cost Plus, I wanted to share some thoughts on the company, its competition, what I believe is the long play for Cost Plus, and how this and other online pharmacies are affecting and likely to affect retail pharmacy and independent pharmacies.
Cost Plus isn't a New Concept.
The company joins a host of other online pharmacies, including those operated by established drug chains like Walgreens and CVS; other newcomers like Amazon, Honeybee Health, and ScriptCo Pharmacy; and more established companies like HealthWarehouse.com and Costco.com. The proliferation of online pharmacies was recently the cover story for an issue of Consumer Reports.
Cost Plus undoubtedly benefits from Mark Cuban's name recognition, which is important as the company has indicated it has no immediate plans to invest in marketing. The company is hoping the Cuban name and reputation, fueled by his work as owner of the NBA's Dallas Mavericks and as one of the investors on the popular television show "Shark Tank," combined with the ease of purchasing and price transparency will help build awareness of the company and grow its customer base.
Cost Plus is Growing. Fast.
As noted earlier, Cost Plus launched with 100 generic drugs. That number recently surpassed 800. Running the business through an established company like Truepill helped the company avoid the hiccups often associated with the launch of a new company and allowed Cost Plus to expand its offerings with relative ease. The opening of the Dallas facility should further help the company improve its offerings and possibly what it charges for medications.
Cuban has indicated that generics are just the start for Cost Plus. Longer-term plans include adding brand-name drugs to its offerings. It wouldn't be surprising to see Cost Plus eventually accept insurance — getting into the PBM/retail space — and offering telehealth services.
Brick and Mortar is Likely in its Future.
It also won't be surprising to see Cost Plus — and other online pharmacies — establish brick-and-mortar locations. If they hope to begin billing insurance, some states require the operation of a physical location within the state. We're currently seeing companies like Ro, the parent company of Roman and Rory, and Hims & Hers getting more aggressive with establishing physical footprints.
Increased Accessibility to Medications is Good News for Consumers.
Medication adherence is a significant health challenge. Research has shown that nonadherence can account for up to half of all treatment failures, around 125,000 deaths, and up to 25% of hospitalizations annually in the United States. One of the biggest obstacles to adherence and achieving "optimal therapeutic efficacy" (often defined as adherence rates of 80% or more) is cost. When patients struggle to afford their medications, they will often fail to fill or refill a prescription or skip or ration doses. Online pharmacies that can reduce cost and make it easier for consumers to acquire their medications should help with adherence.
Are Cost Plus and Online Pharmacies Bad News for Retail and Independent Pharmacies?
Although an online pharmacy, as mentioned earlier, is not a new concept, the launch and growth of Cost Plus likely presents yet another potential challenge to retail and independent pharmacies. More competition, after all, is rarely good for business, although it can serve to motivate more mature companies to innovate and invest in improvements. The Mark Cuban name, the company's strategy to focus on low prices and price transparency, and the significant attention the company is getting may motivate more consumers to order their medications online.
Concerning the proliferation of online pharmacies, when a consumer purchases their medications over the internet, this means the individual is not purchasing the drugs at a retail pharmacy. In addition, eliminated visits to the retail pharmacy also eliminates the potential for non-medication purchases that have become increasingly essential to retail pharmacy success. If the likes of Cost Plus open a brick-and-mortar pharmacy, it's likely to be a simple operation where a consumer walks in, picks up their medications, and leaves rather than have the bells and whistles one associates with retail pharmacy. Some consumers may find a simplified, in-person shopping experience more attractive.
Retail and Independent Pharmacies Must not Remain Stagnant.
Cost Plus and other online pharmacies aren't going anywhere. Retail and independent pharmacies need to be considering how they can compete with this business model. One way could be to offer online medication sales with both delivery and pickup options. For consumers who have prescriptions that cannot be legally distributed and dispensed via the internet (e.g., controlled substances), they will still need to go to a physical location to pick up these medications. If retail pharmacies can make this experience easy, consumers may be more inclined to continue filling all their prescriptions with their local pharmacy.
Another important strategy for building and maintaining customer loyalty is to emphasize the value of the customer/patient-pharmacist relationship — something typically not available through an online pharmacy experience. Pharmacists at independent pharmacies must interact with customers and take on a role that goes beyond the "sale" and dispensing of medications. Pharmacists should be engaging with customers around issues like adherence and health goals, offering guidance, and undertaking other initiatives that can make the relationship with the pharmacist feel indispensable to a customer. The good news for retail and independent pharmacists is there will always be those consumers who want and value the interaction and personal relationship with their local pharmacists.
A third strategy is to embrace telemedicine. Virtual services can help independent pharmacies expand the types of services they provide, meet the growing demand for telepharmacy, and better meet the needs of those patients who would benefit from collaboration between their pharmacist, a physician, and possibly a case manager around medications. As I wrote in my column, "Retail Pharmacy Update: Opportunities, Challenges, and Valuations," the addition of telepharmacy services can help pharmacies reach new patients and strengthen support for existing patients, all while improving patient care.
Cost Plus may be a Prospective Buyer.
As noted, online pharmacies that want to accept insurance are increasingly looking to establish physical footprints, particularly in those states that require a brick-and-mortar location to bill insurance. The easiest path to that physical store is to acquire an existing pharmacy. That acquisition tends to check several requirements and do so fast. The buyer gets the license, contracts, and personnel (assuming they want to remain on the staff). Once the acquisition is complete, the buyer can immediately begin (i.e., continue) operations.
While online pharmacies are likely to be looking for deals on brick-and-mortar locations, owners of independent pharmacies interested in selling but not at a discount can still make themselves an appealing prospect to online pharmacies. Ways to do so include good contracting, a high-performing staff that likes the physical location, and establishing the infrastructure to provide telemedicine.
Mark Cuban Cost Plus Drug Company: Another Player, but Not Likely a Market Changer
Despite the buzz, Cost Plus Drug Company's entry in the online pharmacy space is not likely to have a significant effect on retail pharmacy. The company is most likely to put pressure on others already in and entering the online pharmacy space — a space that's quickly becoming overcrowded.
While there's every reason to believe Cuban's latest venture will prove successful, it won't likely transform the pharmacy industry. But what the launch and rapid growth of Cost Plus shows are that online pharmacies are here to stay and will likely grow in popularity as awareness and appreciation for the service grows. Retail and independent pharmacies must continue to take this competition seriously and be identifying how and whether they can remain competitive. If pharmacy owners do not believe they are in a strong position to effectively keep their company afloat for the long term, they will be well-served to engage with an M+A advisor who can provide the guidance necessary to help them prepare for and execute a successful sale.
Volume 9, Issue 8, April 19, 2022
Depending on your healthcare company's corporation type, there are different tax implications you will want to be aware of long before you are ready to sell your business. One type of company that brings with it tax implications that often catch owners off-guard or create challenges when owners are ready to pursue a transaction is C corporations (C-corp).
Many companies, including most major corporations, are treated as C-corps for U.S. federal income tax purposes. C-corps and S corporations (S-corp) both enjoy limited liability, but only C-corps are subject to corporate income tax. The primary difference between a C-corp and S-corp from a tax perspective is the C-corp's profits are subject to "double taxation." This means that the corporate entity is taxed and then the shareholders are taxed whenever monies are dispersed out of the company.
Factors That Can Affect the Sale of a C-Corp
Now let's look at some of the key tax implications owners of C-corps should understand about their classification that could affect a sale, positively and negatively.
The issue that often arises when owners of a C-corp are ready to sell is that a buyer may not want to buy the stock in the company but rather the assets, such as inventory, equipment, and goodwill. According to most industry analysts, well over 90% of sales are asset sales rather than stock. Why? In this scenario, the buyer wants to get the tax deduction for depreciation and amortization associated with the assets while also avoiding any future liability due to actions associated with the company when it was under the control of its prior owners. For sellers, an asset sale will lead to double taxation whereas a stock sale will not.
Some sellers try to change the status of their C-corp to S-corp immediately prior to a sale to avoid the potential for double taxation. This strategy will not prove successful. There is a look-back period in tax law that prevents owners from executing such a conversion and immediately reaping the tax benefits. The current look-back period is 5 years.
There is upside for a seller of selling a C-corp. Some buyers are willing to pay a higher purchase price based on the amount of the purchase price allocated to goodwill or fixed assets. In addition, the reduction in corporate tax rate to a flat 21% under the Tax Cuts and Jobs Act of 2017 makes a C-corp asset sale more palatable. While the corporation will need to pay 21% on the gains, the shareholder(s), when they receive the remaining sale proceeds through a liquidating dividend, can use Section 1202 (i.e., Small Business Stock Gains Exclusion) to avoid tax on that cash.
Now let's look at a few other significant and related factors that can affect the sale of a C-corp: a covenant not to compete and personal goodwill. Following the sale, any remaining purchase price not allocated to the company's tangible or intangible assets is often allocated to a noncompete or goodwill. One of the differences between these two is that money received on a covenant not to compete is taxable as ordinary income to the seller in the year received whereas goodwill is taxed to the seller as capital gains.
One strategy a seller will often take is to allocate as much of the proceeds to personal goodwill as possible. Personal goodwill is purchased directly from the seller, not from the corporation, so it can be written off by the buyer. However, the IRS tends to challenge personal goodwill cases. The key to personal goodwill allocation is to carefully document it, use appropriate agreements, and keep money flow segregated.
The IRS previously argued that the distributed goodwill should be taxed as any other distribution. But the U.S. Tax Court held that the goodwill was due to personal ability and relationships. The goodwill was of the person, not the corporation. Personal relationships of a shareholder-employee are therefore not considered corporate assets when the employee has no employment contract with the corporation.
If the company is being taxed as a C-corp and is only owned by a single owner or shareholders, the company's goodwill is an asset of theirs, not the C-corp. In other words, personal goodwill is the bulk of the firm's value.
Building Your Transaction Team
Selling a C-corp is complicated. The points discussed here scratch the surface of what sellers need to understand about the tax implications for a transaction and how buyers might pursue a C-corp acquisition. Tax implications are just one key consideration before sellers proceed with taking their healthcare business to market. That's why it's imperative for sellers to assemble a team of professionals who can help them successfully sell their company.
One member of this team should be a merger and acquisition (M+A) advisor — preferably one with healthcare experience and experience selling C-corps. Such an advisor will advise you on how to best prepare for a sale and guide you through the process. In addition, experience in these types of transactions can help you pinpoint bumps in the road that might hinder a successful transaction. Ultimately, the more educated the seller, the more successful the sale.
Another member of the team should be a qualified tax accountant with C-corp experience. This accountant will walk you through the tax liabilities of the sale and review tax responsibilities following the sale. This will help with short- and long-term post-transaction planning.
Finally, make sure you work with a qualified, healthcare M+A law firm. They'll help ensure everything from the letter of intent to the purchase agreement is executed properly and in accordance with state and federal law. They'll also play a pivotal role with structuring the deal based off asset allocation, if that's the path you end up taking.
Volume 8, Issue 18, November 23, 2021
by Alan Hymowitz, Managing Director, and David E. Coit, Jr., Director, Finance + Valuation
Freestanding emergency departments (FSED) have seen substantial growth over the past two decades. Research published in the Western Journal of Emergency Medicine states that the National Emergency Department Inventory determined in 2001 that about 1% of all emergency departments (ED) in the United States were FSEDs. Fast forward to 2016 and the Medicare Payment Advisory Commission reported that FSEDs had accounted for 11% of all EDs nationwide. Grand View Research is projecting that the U.S. FSED market size, which was valued at around $3 billion in 2019, is expected to expand at a compound annual growth rate (CAGR) of around 5% from 2020-2027.
This rapid growth has been welcomed by some and pushed back against by others. As such, the FSED market is experiencing a mix of headwinds and tailwinds. In this column, we'll begin by providing a general overview of FSEDs and the market and then dive into some of the key points owners of these organizations should consider if they are contemplating a sale in the short or long term.
Overview of Freestanding Emergency Departments
An FSED is a facility that is structurally separate and distinct from a hospital and provides emergency care. There are two types of FSEDs:
A hospital outpatient or off-site hospital not located on the hospital campus
A satellite ED not associated or located near a hospital
What's important to understand off the bat is that an FSED is not the same as an urgent care center. FSEDs, also referred to as standalone EDs, can provide services like basic imaging (e.g., X-ray, CT scans, EKGs, ultrasounds), laboratory services, and emergency and trauma care while generally serving lower acuity patients. FSEDs are currently concentrated in certain markets, notably in Texas and Colorado, and they tend to locate in areas where patients have above-average incomes.
Independent Freestanding Emergency Departments
Independent FSEDs not affiliated with a hospital cannot bill for Medicare reimbursement. In addition, private insurers tend not to contract with these organizations. As a result, these independent FSEDs bill as an out-of-network provider, meaning that patients are often left to pay the balance of the charges.
According to several news reports, out-of-network independent FSEDs often charge private insurers significantly higher rates and receive these increased payments. As word of this billing tactic has spread, communities have soured on independent FSEDs, which has motivated many such organizations to affiliate with hospitals so they can bill Medicare. The majority of independent FSEDs are in Texas, where the number increased from none in June 2010 — when state licensure of these facilities began — to 191 facilities in 2016. Colorado, Minnesota, and Rhode Island also have independent FSEDs. More than 50 unique entities own these facilities, most of which are for profit.
Off-Campus Emergency Departments
This brings us to a discussion about another type of FSED: hospital-based, off-campus emergency departments (OCED). In 2016, 363 OCEDs operated in 35 states. They were affiliated with about 300 hospitals. These facilities represented 64% of all standalone EDs. About 6% of hospitals reported having at least one OCED, with these hospitals tending to be urban, relatively large facilities affiliated with a health system. Most of these hospitals operate a single OCED, but about 30 hospitals operate multiple OCEDs. Between 2008 and 2016, the number of hospitals with an OCED nearly doubled.
State Regulations of Freestanding Emergency Departments
Thus far, 21 states have issued policies regulating FSEDs, with California implementing specific hospital regulations prohibiting these facilities, while 29 states lack regulations. The net effect of this variation is that most states (e.g., Florida, Ohio) allow OCEDs but not independent FSEDs and these states view OCEDs as an extension of the hospital. A few states — Colorado, Minnesota, Rhode Island, and Texas — permit OCEDs and IFECs.
Last year, the Centers for Medicare & Medicaid Services (CMS) issued guidance permitting licensed, independent FSEDs in Colorado, Delaware, Rhode Island, and Texas to temporarily provide care to Medicare and Medicaid patients to help address patient surges associated with the COVID-19 public health emergency. This action was intended to increase hospital capacity to help ensure the states could quickly and effectively care for their most vulnerable citizens.
At the time, CMS Administrator Seema Verma stated, "Expanding the number of providers available to Medicare and Medicaid beneficiaries eases some of the burden shouldered by traditional hospitals and allows the healthcare system to treat more patients at a time when capacity is often limited. We must leave no stone unturned as we seek to bolster the healthcare system during this unprecedented crisis."
Selling Your Freestanding Emergency Department: Key Things to Consider
If you're thinking of selling your FSED, understand the following:
The market is strong now because of the vast amount of money/capital searching for well-performing organizations. It's unclear how long this will last and when it will inevitably slow down. The market can change quickly, and you may lose your opportunity to sell at a favorable price if you wait too long.
As acquisitions and consolidations continue, you'll likely be competing against larger, better-capitalized companies. The competitive landscape is changing. Larger competitors are likely to offer a broad range of services, a strong marketing campaign built around an established brand, efficient business processes, and the ability to bid for value-based contracts with large payors.
Owners of FSEDs are aging. One estimate is that 60% of owners are over the age of 60. As such, we expect an increasing number of FSEDs seeking buyers during the next few years.
Many FSEDs have already found value in merging to create economies of scale and the resources to better compete with larger organizations.
How Much Buyers Will Pay for a FSED (Market Multiples)
Pricing rules of thumb are a quick but somewhat inaccurate way of estimating value. One of the rules of thumb is that FSEDs are priced by buyers at 1.0x to 2.0x annual revenue. The problem with this method is that some organizations are more profitable and have more growth opportunities than average. As such, those more profitable FSEDs should be priced higher than the average. Moreover, larger organizations sell for higher relative purchase prices than smaller organizations.
Accordingly, buyers most often determine an offering price based on a multiple of normalized or adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). Adjustments to EBITDA include nonrecurring expenses, such as one-time legal fees, and discretionary expenses, such as charitable contributions, owners’ compensation, and owner-related personal expenses.
For FSEDs, the industry average net profit margin is approximately 23.0%, and the average adjusted EBITDA margin is approximately 31.25% of revenue.
Market multiples refer to the estimated purchase price, or enterprise value, related to adjusted EBITDA. The typical range of market multiples for FSEDs is 3.0x to 6.0x of adjusted EBITDA. A particular provider falls within the range based on quantitative factors, such as historical and projected financial performance, and qualitative factors, such as location, the remaining term of property lease, employee turnover, type, technology, and age of equipment. Moreover, size matters, as larger revenue organizations typically attract more buyers than smaller organizations.
The following are estimated market multiples of adjusted EBITDA for FSEDs by revenue, assuming positive qualitative qualities:
$1 million to $3 million in annual revenue: 3.0x to 4.5x adjusted EBITDA
$3 million to $5 million in annual revenue: 4.5x to 5.0x adjusted EBITDA
$5 million to $10 million in annual revenue: 5.0x to 5.5x adjusted EBITDA
$10 million to $20 million in annual revenue: 5.5x to 6.0x adjusted EBITDA
For example, an FSED with $4.5 million in annual revenue and $1.4 million in adjusted EBITDA (31.25% adjusted EBITDA margin) would have a market value in the range of $6.3 million to $7.0 million, or a 1.41x to 1.56x multiple of revenue.
There are outlier market multiples in unique merger and acquisition (M&A) transactions where optimal buyer/seller synergies push valuations above the norm. Moreover, market multiples change over time depending on the overall economy, regulatory and reimbursement modifications, and industry trends.
Please note that using market multiples is an excellent way to estimate a company's value. It is most often accompanied by using a discounted cash flow approach. The discounted cash flow approach estimates a company's value by calculating the future cash flows expected from the company and putting the future cash flows into today's dollars. However, the market multiples approach provides a reasonable shortcut for estimating the value of a company.
Volume 8 Issue 10, June 22, 2021
by Alan Hymowitz, CM&AA, and David Coit, DBA, CVA, CVGA, CM&AA, CBEC
Prior to the pandemic, the retail pharmacy industry was experiencing significant disruption. We were witnessing a steady increase in transactions and consolidation, Amazon's entry into the market, significant changes to strategic alliances between major payers and pharmacy benefit managers (PBMs), and the introduction of a wide array of new technologies, just to name a few noteworthy trends and developments. It's safe to say that COVID-19 not only disrupted some of these disruptors, but it also brought with it new disruptors.
By understanding how the market is changing, retail pharmacies can determine how to best shift gears so they can remain viable and competitive in the coming years. To help you make more sound decisions concerning the future of your pharmacy, below are some thoughts on a wide range of current opportunities and challenges followed by an update on retail pharmacy valuation.
Retail Pharmacy Opportunities
These are some of the tailwinds for the retail industry.
Mobile apps — It's never been easier or cheaper for retail pharmacies to offer and leverage mobile apps. Not only can an app make it easier for customers to refill prescriptions, get refill reminders, and take advantage of discounts, but providing customers with an app can enhance loyalty and improve satisfaction.
Mail order — Prior to the pandemic, mail-order prescriptions were on the decline. COVID-19 reversed this trend. Some consumers who used mail-order delivery for the first time or relied on it during the pandemic will revert to filling their prescriptions in person. However, other consumers who appreciated the convenience and potential perks of mail order will likely make it their default delivery method. Offering mail-order prescriptions can help you attract and retain these consumers and should prove appealing to potential new customers — including the growing number of people working from their homes.
Telehealth/telepharmacy — It's safe to say that telehealth is not only here but it's here to stay. Telehealth claim lines increased more than 2,800% (not a typo) nationally from December 2019 to December 2020, according to FAIR Health's Monthly Telehealth Regional Tracker. Retail pharmacies that effectively leverage telehealth and telepharmacy can give their business a boost. While rules and regulations concerning the delivery of telepharmacy — including coverage — are evolving and vary from state to state, the addition of telepharmacy services can help pharmacies reach new patients and better support existing patients, all while improving patient care.
Digital pharmacy — For retail pharmacies looking to undertake a more dramatic overhaul, going the "digital pharmacy" route is an option. While there's no clear consensus about how to define "digital pharmacy," in this case, we're referring to a pharmacy that significantly embraces digital technologies to deliver pharmacy services, such as mobile apps, telepharmacy, and online ordering.
Testing and vaccines — The pandemic has been a boon for those pharmacies offering COVID-19 testing and vaccines as these services not only generated revenue, but they brought consumers physically into stores. This presents an opportunity for pharmacies to sell products and educate consumers about available services, including the delivery of other screenings, vaccines, and immunizations. The trend also provides a pathway for retail pharmacies to pursue the conversion of retail space into clinics and primary care service locations. The expansion of pharmacy companies into primary care has driven "significant increases in both satisfaction and consumer spending," according to the J.D. Power 2020 U.S. Pharmacy study.
Human experience and loyalty — Pharmacists remain one of the most trusted professions. This helps explain why some pharmacies are leaning much more heavily on their pharmacists. In October, Rite Aid indicated it was revamping the its business strategy and the layout of pharmacies to put pharmacists "front and center." As Jocelyn Konrad, Rite Aid's executive vice president and chief pharmacy officer, toldDrug Store News, "We want to ultimately enable our pharmacists to address mind, body, and spirit of each of our customers, so that they don't only get healthy, they get thriving."
Such initiatives that highlight the role and value of pharmacists while emphasizing the critical services they provide can help retail pharmacies remind consumers about the importance of a human experience for health and wellness. This can drive better outcomes and build consumer loyalty to the pharmacist and their pharmacy.
Customer base — While competition for customers is and will remain fierce, the good news for retail pharmacies is that their number of potential customers and the services required by customers is on the rise. This is fueled largely by the prevalence and increase of chronic diseases and an aging population. On a per capita basis, health spending has increased over 31-fold in the last four decades, from $353 per person in 1970 to $11,582 in 2019.
In addition, the pandemic has brought a new patient population into pharmacies: those who postponed receiving care as part of their efforts to reduce the amount of time spent outside of their homes. Subsequently, many of these individuals saw their health worsen. Some have chosen pharmacies as the first place to begin catching up on their neglected care. Pharmacists who effectively support patients as they restart their care journey can earn the loyalty that generates ongoing business.
Medicaid enrollment rising — As the Kaiser Family Foundation (KFF) reported, enrollment in Medicaid has soared during the pandemic. This will help bring new business to retail pharmacies because, as KFF also notes, "A large body of research shows that Medicaid beneficiaries have far better access to care than the uninsured and are less likely to postpone or go without needed care due to cost." Medicaid pharmacy benefit coverage is currently split at roughly 70% managed care and 30% fee for service.
Catering to the demographic — The days of running a cookie-cutter pharmacy and being successful are waning fast. Pharmacies that can distinguish themselves are more likely to succeed. We've highlighted some of the ways they can do so above. One other approach that's becoming increasingly vital is a pharmacy's ability to adapt products, services, and marketing activities to better serve its demographic makeup. For example, one step that a pharmacy with a large Hispanic consumer population will want to consider is hiring bilingual staff to properly serve Spanish speakers. Understanding one's target audience(s) and modifying operations to better cater to their needs can help a pharmacy focus its marketing efforts, facilitate lasting relationships, and achieve faster growth.
Electronic prior authorization (ePA) — Historically, pharmacists have spent substantial time securing prior authorizations. As research has demonstrated, implementing ePA can have a significant, positive impact on the process, including reducing the time between a request for prior authorization and a decision, decreasing the time to a patient receiving care, and reducing the time and resources allocated to prior authorizations. States like California have mandated the use of ePA and electronic medical records, with other states following suit. While such electronic tools can enable pharmacists more quickly and easily complete prescribing and care planning, there are some downsides to this migration, which is noted below.
Retail Pharmacy Challenges
These are some of the headwinds for the retail business.
Competition — Competition is projected to intensify in the coming years, particularly from big-box retailers and mail-order and online pharmacies. The pandemic motivated many consumers to use mail-order and online pharmacies to reduce their risk of exposure to COVID-19, some of whom will continue to use these services rather than go back to their local pharmacy. Payors have also steered consumers toward mail ordering, such as by covering a 90-day supply of medications delivered to the home versus only a 30-day supply available at a brick-and-mortar pharmacy. Finally, Internet pharmacies are aggressively targeting cash-paying customers by offering medications at a reduced cost.
Pharmacist bandwidth — The time that pharmacists can spend directly supporting patients and delivering care is being squeezed by requirements, such as securing prior authorizations and performing care planning. Even with electronic tools, these processes still require a fair amount of time, as does implementing and learning how to use such solutions properly and effectively. The more time spent performing back-end tasks, the less time that's available for pharmacists to help and build relationships with customers.
Retail sales — Pharmacies that rely on in-person sales to remain viable have had it rough over the past few years. Retail sales were already declining before the pandemic. Then, as Fortune recently reported, "Most pharmacies … saw a decline in prescriptions last year as customers hesitated to visit their doctors for anything but emergencies. That drop in business also meant fewer sales of over-the-counter medicines and ancillary items sold by the stores." While there are ways to get foot traffic into pharmacies, some of which are highlighted above, growing retail sales will continue to be an uphill battle, especially as competition grows and shopping increasingly moves online.
Amazon — In a November 2020 SalientValue column discussing pharmacy trends from 2020, Amazon was highlighted several times, and for good reason. The company is a threat to retail pharmacies on multiple fronts. Initially, the emergence of Amazon.com gave consumers less of a reason to do in-person shopping for general merchandise. Then the company got into the prescription game with its 2018 acquisition of PillPack and the 2020 launching of Amazon Pharmacy and an Amazon Prime prescription discount benefit. And then, just a few months ago, Business Insiderreported that Amazon was looking to create physical pharmacies. Whether that comes to fruition — and what it would look like — remains to be seen, but one thing is clear: Amazon will continue to be a thorn in the side and strain on the bottom line of retail pharmacies.
Margins — Retail pharmacies continue to face downward pressures on their profitability. Reimbursement is tightening and costs are on the rise for everything from salaries to rent to more cumbersome accreditation and licensing requirements. In addition, pharmacies are finding themselves forced to invest in new technology (e.g., ePA) and products that can help keep them compliant and competitive. All of this contributes to continuously shrinking margins that threaten long-term viability.
Woman's hand is drawing a growing graphs. Forex chart on the background.
How Much Will Retail Pharmacy Buyers Pay (Market Multiples)?
Now that we have touched on some of the most significant tailwinds and headwinds facing the retail pharmacy industry, let's take a moment to acknowledge another trend that's also going to cause significant disruption going forward: increasing mergers and acquisitions (M&A). We have witnessed a notable uptick in transactions in recent months, buoyed by the gradual winding down of the pandemic here in the United States. If you're like one of the many retail pharmacy owners contemplating a sale, read on to gain a better understanding of the value of your pharmacy.
Buyers of companies, including retail pharmacies, go through a risk/reward analysis when determining an offering purchase price. The offering price is typically based on a multiple of normalized or adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).
Adjustments to EBITDA include nonrecurring expenses, such as one-time legal fees; discretionary expenses, such as charitable contributions; and owner-related personal expenses, such as excess owners' salaries and auto lease expenses.
Market multiples refer to the estimated purchase price, or enterprise value, related to annual revenue, annual scripts, adjusted EBITDA, and other performance measures. The current range of market multiples of adjusted EBITDA for retail pharmacies is 2.5x to 5.5x. A particular pharmacy falls within the range based on quantitative factors, such as historical and projected financial performance, earnings trends, annual number of scripts, annual inventory turnover, and qualitative factors, such as insurance contracts, payer mix, brand versus generic drugs, new prescriptions versus refills, location(s), competition, and number of full-time pharmacists. Moreover, size matters, as larger revenue pharmacies typically attract more buyers than smaller pharmacies.
The following are estimated market multiples for retail pharmacies by revenue, assuming positive quantitative and qualitative factors:
· $1 million to $5 million in annual revenue (2.50x to 3.50x adjusted EBITDA)
· $5 million to $10 million in annual revenue (3.25x to 4.25x adjusted EBITDA)
· $10 million to $25 million in annual revenue (4.00x to 5.00x adjusted EBITDA)
· $25 million-plus (4.50x to 5.50x adjusted EBITDA)
For example, a retail pharmacy with $5.5 million in annual revenue and $550,000 in adjusted EBITDA (10% adjusted EBITDA margin) would have a market value in the range of $1.8 million to $2.3 million. Additionally, many buyers add the value of inventory to the values determined by the market multiples above.
Note that buyers are keenly attracted to retail pharmacies with increasing annual revenue, greater than 5.0% profit margins, greater than 10.0% adjusted EBITDA margins, and greater than 10 times inventory turnover.
There are outlier market multiples in unique M&A transactions where optimal buyer/seller synergies push valuations above the norm. Moreover, market multiples change over time depending on the overall economy, regulatory and reimbursement modifications, and industry trends.
While using market multiples is an excellent way to estimate a company's value, it is most often accompanied by using a discounted cash flow approach. The discounted cash flow approach estimates a company's value by calculating the future cash flows expected from the company and putting the future cash flows into today's dollars. With that said, market multiples provides a useful shortcut for estimating the value of a company.
Volume 7, Issue 17, September 1, 2020
by Alan Hymowitz, CM&AA, and Jabali Wells, MD, MBA, MSc
Pre-COVID-19, a merger and acquisition (M&A) deal that followed an 80/10/10 structure was fairly common. In such in a transaction, up to 80% of a company's purchase price would be afforded to the seller as an upfront, cash proceed, at least 10% of the company's purchase price would be in the form of rollover equity, and at least 10% of the company's purchase price would be in the form of deferred proceeds (e.g., an earn-out or seller note).
During COVID-19, capital providers (i.e., equity sponsors and lenders) are less keen to such a structure since COVID-19 has increased capital underwriting risks. As a result, capital providers are implementing more conservative approaches to structuring transactions. These often include less upfront cash to sellers at closing, increased rollover equity, and greater deferred payments.
As capital providers are more closely scrutinizing a company's 2020 financial performance via the findings of the quality of earnings and other financial due diligence activities, several common themes have arisen in the COVID-19 environment. They include the following:
Increased cost of debt capital. Interest rates for acquisition debt have increased.
Increased cost of equity capital. Secondary to any financial decline a company may have experience secondary to COVID-19, capital invested by equity sponsors may need to "work harder" to attain their desired return on investment.
Decreased leveraged ratios. Both equity sponsors and lenders have a decreased appetite for over-leveraged transactions (i.e., including an excessive amount of debt in a transaction).
Increased focus on net working capital. Both equity sponsors and lenders remain focused on a company's operating liquidity (i.e., Does a company have the liquidity necessary to continue to pay its bills and keep the lights on?).
Downward pressure on EBITDA multiples. The realized and unrealized macroeconomic effects of COVID-19 have not only increased investment risk but also placed downward pressure on valuations.
Thinking Outside the M&A Box
To consummate a deal in the COVID-19 era, buyers and sellers should weigh pursuing creative solutions to reflect the investment risks that persist in the current environment. Here are a few options to consider that may help mitigate investment risk incurred by capital providers and push a deal over the finish line:
Larger and longer earn-outs (i.e., getting a "second bite of the apple" later/less cash on closing)
More seller equity rollover, as this sends a message to equity sponsors and lenders that the seller has meaningful "skin in the game"
Seller-backed financing as a way of delaying capital gains and earning extra interest
COVID-19 M&A Quick Tips
If you are working through a deal during this health crisis, here are a few more points to keep in mind:Some buyers are issuing letters of intent that include valuations of companies that are more reflective with the higher, pre-COVID-19 purchase prices. Understand that when lenders consider the structure of their debt financing, they may be inclined to propose a different structure that reflects a lower quantum of debt or a lower debt-to-equity ratio than those seen before COVID-19. Cash at closing is only one piece of the total proceeds that sellers can receive from the sale of their company. Ideally, a deal should be structured that affords sellers a second bite of the apple in which the value of their rollover equity will be greater than the value of their cash proceeds that they receive at closing. Buyers and sellers should remain open-minded and maintain a willingness to be as inventive as necessary for structuring and completing a transaction.
Key takeaway: COVID-19 has forced healthcare businesses to navigate uncharted waters. Completing a transaction during these uncertain times will likely require buyers and sellers to take unconventional approaches.
Jabali Wells, MD, MBA, MSc, is a private equity investor with 20 years of experience as a clinician, healthcare executive, and investor in the healthcare sector.
Volume 7 Issue 3, February 4, 2020
In July 2015, Diplomat Pharmacy was the talk of the town. The company's stock had surpassed $51 per share — an all-time high and nearly quadruple its October 2014 initial public offering price. The company and its share price were buoyed by some noteworthy investments. In April 2015, Diplomat had completed its acquisition of BioRx, a major competitor. And in June 2015, it had acquired Burman's Specialty Pharmacy in a smaller, but still significant transaction.
Momentum seemed like it was on the company's side, with Diplomat looking poised to be a major player for many years to come. One writer penned a piece for Seeking Alpha titled, "Diplomat Specialty Pharmacy: A True All-American Success Story!" in May 2016. The latter half of 2016 and 2017 saw Diplomat make numerous investments as the company pursued a growth-through-acquisitions strategy that also led to the expansion and launching of new service lines.
But, as it is often said, "the higher they rise, the harder they fall." In December 2019, UnitedHealth Group's OptumRx agreed to acquire Diplomat for about $4 a share in cash. That was a 31% discount (!) on Diplomat's previous closing price and, as Reutersdescribed, "… a far cry from the company's peak market valuation in 2015 …"
What caused this "All-American success story" to come up so short on expectations? As is the case with a company of Diplomat's size (it describes itself as "the nation's largest independent provider of specialty pharmacy and specialty infusion services"), failure is rarely attributable to a single reason or even just a few. Rather, it's a confluence of factors. Some played more significant roles than others, but each contributed, and each offers crucial lessons for other independent pharmacies and healthcare businesses to learn from.
Diplomat Pharmacy Downfall
Here are 10 things that went wrong with Diplomat pharmacy.
Inability to adapt
Diplomat showed a tendency to struggle or take too long to adapt to changes and trends within the specialty pharmacy industry. These include developments concerning reimbursement, valuations, and cost of goods.
One prime example is seen in how Diplomat approached hepatitis C virus (HCV) medications. When there were reports of new HCV drugs in the pipeline that would be considerably cheaper, some companies responded proactively to the news and shifted their business model. Others, like Diplomat, believed that they would have at least a few years before the landscape changed. This decision proved shortsighted.
Increased competition
Diplomat's rapid ascension brought with it a target square on the company's back. Major players (e.g., Walgreens, CVS, Optum) set their sights on Diplomat in an effort to take away business and reduce market share. As the cracks that will be highlighted in this piece started appearing in Diplomat's armor, competitors pounced and exploited weaknesses for their own gain.
Margin Compression
Not unique to Diplomat, but increasing pricing pressure from third-party payors resulted in margin compression. Whereas some companies become more conservative when faced with tightening reimbursement, Diplomat took the opposite approach. The company spent and spent and spent, acquiring competitors left and right — and often seeming to spend too much to do so. In commenting on Diplomat's acquisition of National Pharmaceutical Services in November 2017, Baird analyst Eric Coldwell told Reuters, "… it feels like Diplomat overpaid for another asset …"
Opting out of pharmacy provider networks
It's a bit hard to knock Diplomat for this factor. The company made the wise decision not to continue participating in certain pharmacy provider networks because of poor pricing. Such an approach can often bring networks back to the table for negotiations and eventually improved pricing. But in this case, the tactic backfired, and the effects snowballed. Networks called Diplomat's perceived bluff and didn't cave, leading to substantial business losses.
Failure to win new business
While Diplomat was the darling of the industry for a period, not everyone looked favorably upon the company. That included some provider networks, which found Diplomat's aggressive acquisition strategy unappealing. This led, in part, to these networks choosing Diplomat competitors as partners.
Diplomat also failed to capture some new business it desired when it was unable to match the offerings of competitors. The combination of losing existing business and an inability to capture new business is typically lethal for any company.
Integration shortcomings
Acquiring a company can be relatively straightforward. Integrating an acquisition, on the other hand, is usually quite difficult. Integrating many acquisitions in a short amount of time and hoping for a positive outcome is close to impossible, as Diplomat discovered.
As noted, the company went on a buying spree in the years that followed its IPO. With major business changes coming every few months — and sometimes even every month — the company struggled with effectively integrating each new acquisition while maintaining its core business, identity, and chain of command. The result was a foundation that started falling apart. This contributed to…
Exit of talent
The acquisitions created significant stress and uncertainty for some of Diplomat's top talent. As new companies came aboard, leaders often found themselves unsure of their job roles and responsibilities or discovered that an acquisition introduced management redundancy. The absence of clear company direction drove a lot of talent to the exits, often leaving those worker bees who stayed with Diplomat lacking strong leadership.
Unable to differentiate
In an industry where there is significant overlap in products and services delivered, companies must effectively differentiate themselves wherever and whenever they can to stand out from competitors. For a time, Diplomat seemed to do an impressive job of distinguishing its brand. But as the acquisitions and service lines increased, what made Diplomat "special" became muddied, and the company struggled to stand out against larger competitors.
Alienating PBMs
In April 2018, Diplomat introduced its CastiaRx specialty benefit manager. This was a culmination of Diplomat's efforts to enter the pharmacy benefit manager (PBM) market. CastiaRx combined Diplomat's two recently acquired PBMs — LDI Integrated Pharmacy Services and National Pharmaceutical Services — with Diplomat's specialty pharmacy and infusion capabilities.
Unfortunately, as a report from The Motley Fool noted, Diplomat's move into the PBM space did not go smoothly. While CastiaRx generated millions in revenue from new business, this was "… overwhelmed by the loss of $200 million in previously disclosed Medicare Part D contracts, and the loss of an additional $120 million from new client losses and the pricing impact of contract renewals."
The decision by Diplomat to become a PBM was not welcomed by many existing PBM partners, some of which dropped Diplomat. Other challenges facing Diplomat at this time included the introduction of cheaper generics, volume declines, and competition from specialty pharmacies run by larger PBMs, which were eager to prevent Diplomat from achieving market penetration.
In February 2019, Diplomat announced it was postponing the release of its fourth-quarter and full-year 2018 earnings, sending the stock down more than 50% to under $6 per share and an all-time low at the time. By August, reports came out that the company was considering a sale or acquisition.
Loss of major payer
Nearing the end of 2019, Diplomat was starting to look like a shell of the company it once was. In mid-November, Diplomat announced that by the end of the month, "… we will no longer participate in a significant group of specialty and retail networks with one of our largest payers. We were unable to reach an agreement to renew network participation rates. While this group of networks is not the only network group that we participate in for this payer, it does comprise the vast majority of the specialty pharmacy business that we do with this payer."
The news, together with a greater-than-expected loss, sent shares down to just over $3 per share and another record closing low. The stock would rebound a bit in the coming months, fueled, in part, by the prospects of Diplomat selling some or all of its assets, but would come crashing down again following the news of Optum's pending acquisition.
Diplomat Pharmacy Collapse: Closing Thoughts
A Drug Channelsreport summarizes the rise and fall of Diplomat Pharmacy well. It begins by praising the company's leadership for taking a family-owned community pharmacy and turning it into the largest independent specialty pharmacy and a public company, but notes, "Alas, the specialty pharmacy market is reaching maturity, as PBMs and insurers dominate specialty drug dispensing channels. Diplomat has been unable to navigate the industry's evolution."
There are many lessons one can learn from Diplomat's rise and fall. I would welcome the opportunity to discuss them further with you and how they apply to the short- and long-term plans for your pharmacy.
by Alan Hymowitz, CM&AA, Managing Director
Volume 6 Issue 9, April 29, 2019
With thousands of pharmacy professionals coming together in Las Vegas over these next few days for Asembia's 15th annual Specialty Pharmacy Summit, this is a good opportunity to examine some of the key trends, developments and disruptions in the retail pharmacy. Here are eight statistics and figures that help paint a clearer picture of where the industry is now and where it may be heading.
1) 5% — Projected compound annual growth rate (CAGR) from 2018-2023 for the global pharmaceutical retail market, according to an Azoth Analytics research report. Analysts note that the independent pharmacy retail segment has witnessed noteworthy growth in recent years attributable to an increasing consumer base together with rising healthcare spending, and they project growth to remain strong in the coming years.
Specific to the North America region, analysts point to "rising healthcare expenditure; increasing cognizance about various respiratory diseases, such as asthma and chronic obstructive pulmonary disease; [and a] paradigm shift of consumers towards organized players which offer high-quality drugs and medicines" as driving the demand for retail pharmacy.
2) 27.6 — Number of prescriptions the average senior age 50-64 filled in 2017, according to an IQVIA report. This figure is up from 25.5 in 2012. We can expect the number of prescriptions to continue to rise for most age groups, and pharmacies are still in a strong position to meet this demand. The same report projected that the outlook to 2022 is for 2–5% net spending on medicines growth, with 1–4% growth in retail and mail-order prescription drugs primarily driven by a large number of new medicines.
3) $70 billion — Approximate price paid by CVS Health to acquire health insurance company Aetna. The deal was finalized in late 2018 (just a few weeks before the $54 billion merger of Cigna and Express Scripts was finalized). While the long-term implications of the CVS/Aetna merger are unknown, the deal will likely have significant implications for retail pharmacy.
As Theresa Rohr-Kirchgraber, MD, past president of the American Medical Women's Association and a founding member of the Doctor-Patient Rights Project, wrote in a CNBC column, "Aetna could … require patients to fill their prescriptions only at CVS pharmacies, severely limiting patient options for where and how they get their medications. Requiring Aetna customers to use CVS pharmacies could also sound the death knell for independent pharmacies and cause drug prices to rise, particularly in underserved communities."
4) $1 billion — Price Amazon.com paid to acquire PillPack, an online pharmacy that packages and delivers medications to consumers, in mid-2018. How significant was the news that Amazon was becoming an even bigger player in the pharmacy business? Shares of Walgreens Boots Alliance, CVS Health, and Rite Aid collectively lost $11 billion in market value on the day news of the acquisition was announced, CNBC reported.
At the time, Neil Saunders, managing director of GlobalData Retail, told Reuters, "Amazon's acquisition of PillPack is a warning shot in what is about to become a major battle within the pharmacy space."
Just this week, Amazon began marketing PillPack more aggressively, contacting Prime members via email and building a webpage for the service, Healthcare Divereports.
5) 98% — Percentage of individual Part D plans that included preferred pharmacy networks in 2018, according to a study by the Coalition for Affordable Prescription Drugs. That figure is up from just 7% in 2011.
While advocates for these networks point to potential cost savings for consumers and the federal government, the decision for
retail pharmacies to participate isn't cut and dry. As a McKesson report notes, participation can affect reimbursement. Criteria required for participation includes more "stringent performance metrics." Once a pharmacy gains access, maintaining the status isn't assured. Unfortunately, choosing not to participate or losing access likely means missing out on a large consumer base.
6) 1,100+ — Number of MinuteClinic locations inside CVS Pharmacy and Target stores in 33 states and the District of Columbia. Just how important are MinuteClinics to CVS? Consider that MinuteClinic opened its first walk-in medical clinic in CVS Caremark in early 2005. One year later, CVS acquired the company. There's been rapid growth since. With the Aetna acquisition completed, some analysts are expecting CVS to undergo a significant change to its business model, leaning heavily on the MinuteClinic.
A report from U.S. News & World Report notes that MinuteClinics are only in 12% of CVS' retail locations and offer about 40% of services typically provided in primary care facilities. Analysts expect CVS to launch more MinuteClinics and expand its offerings. How much? Thomas Moriarty, CVS' executive vice president, chief policy and external affairs officer, and general counsel told a congressional panel last year that CVS is aiming for 90% of primary care services, according to a CNBC report. By giving consumers more reasons to visit a brick-and-mortar location, CVS — and the many other pharmacies now with retail clinics — are helping bolster front-end sales.
7) 61% — Number of community pharmacies offering immunizations, according to the National Community Pharmacists Association website. Administering vaccines has become an effective way for pharmacies to generate revenue. Not only do vaccines represent a new revenue stream, they also provide the same boost to front-end sales as retail clinics.
A Pharmacy Timesreport notes that, according to one estimate, "A 20% vaccination rate can drive a 6% increase in front-end sales." More good news for pharmacies: The vaccine market is experiencing rapid growth. The Pharmacy Times reports that the market is expected surpass $49 billion by 2022, up from about $32 billion in 2016, at a CAGR of 7.5%.
8) 28 — The number of Albertsons Cos. pharmacies providing a genetic test to mental health patients, according to a Supermarket Newsreport. While a newer trend, don't be surprised if you start seeing more pharmacies following suit and beginning to provide genetic/genomic testing.
Thanks to the success of companies like 23andMe and Ancestry.com offering direct-to-consumer genetic testing, consumers are more interested in and willing to embrace the potential benefits of the testing. Pharmacists are in a great position to provide testing to select patients. The Supermarket News report explains the Albertsons Cos. pharmacies' genetic testing process, which involves pharmacists administering the test and reviewing the results with patients. These services can generate new revenue, grow the pharmacy's consumer base, and further support front-end sales.
An Industry Transforming
A key takeaway from the stories behind these statistics: The retail pharmacy industry is undergoing a significant transformation. What we believed not all that long ago were the keys to pharmacy success have changed significantly thanks to developments such as the rise of e-commerce and rapidly evolving consumer expectations. What will be the critical components for maintaining a solid foothold in markets and achieving growth in the coming years are still coming into focus. And there will inevitably be new developments that will force us to further adjust our expectations.
I look forward to spending several great days discussing the many dynamics shaping and reshaping the retail pharmacy with all of you attending Asembia!
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