It seems there’s always a new article about Amazon’s latest Alexa news, or a trendy startup trying to disrupt the shopping experience. Or, more soberly, a downtown now dominated by empty storefronts. Americans living and shopping in the country that invented the modern shopping mall, the supermarket, and e-commerce seek out the latest and greatest retail experience. Traditional retailers are now getting into the health business. Amazon bought Whole Foods, a grocer that began as a health food store. Walmart is considering buying PillPack, an online pharmacy startup. Albertsons is buying Rite Aid. And, in the biggest retail healthcare deal yet, CVS is buying Aetna, bringing together a retail chain with nearly 10,000 stores and a major national health insurer.
What does all this activity mean? Will the average American soon be going to the drugstore to pick up a quart of milk and have someone look at their rash while they’re there? Will my family physician deliver care at the same place that sells my Cheerios? The short answer to both questions: Maybe.
Retail’s entry into healthcare reflects three major trends in how the healthcare industry—and consumer behaviors—are evolving:
Consumers are in the driver’s seat. In 2017, the average single plan deductible for those with employer-sponsored health insurance was $1,505. Since 2006, the average consumer’s annual out-of-pocket healthcare spending has increased by 230 percent. Consumers are spending mostly their own money for basic healthcare services, and they want to see value for that money like they do in other industries. They want reasonable prices, convenient hours and locations, and great service—not exactly attributes for which traditional doctor’s offices or hospitals are known. So, they’re turning to retailers and others to meet their needs, and it’s working. Oliver Wyman researchshows consumers who visit a clinic in a drug, grocery, or discount store are highly likely to return—with just the opposite being true for conventional medical offices.
Primary care is being redefined. The shortage of primary care physicians nationwide has been well-documented. Yet primary care is provided by a physician in many locations beyond the traditional exam room. Providers such as Kaiser Permanente now conduct more than 50 percent of primary care visits electronically. And in the United Kingdom, through a partnership with the artificial intelligence company, Ada, the National Health Service provides round-the-clock care via a chatbot. Also, in states such as California, pharmacists are beginning to be licensed to provide basic medical services, which could have a significant impact, given that there are more pharmacists in the US than there are primary care physicians. A drugstore chain with a pharmacist on every corner, or an online retailer with an app on every smartphone, is well positioned to get into the modern primary care business.
Pharmacy matters more than ever before. We’ve seen some miraculous drug innovations in recent years—from a cure for Hepatitis C to using a patient’s own immune system to fight cancer—but those innovations have been accompanied by significant increases in pharmacy costs. According to Mercer, increases in pharmacy spendingare one of the biggest concerns for employers when it comes to managing healthcare costs. Yet controlling that spending requires careful coordination long after a physician writes a prescription, from ensuring drugs are being taken correctly to understanding which consumers represent most of the spending to monitoring effectiveness. (Overall, just 0.3 percent of Americans account for a full 20 percent of drug spending.) And retailers—with big local footprints, large pharmacist workforces, and years of experience with consumer analytics—are in an advantageous place to deliver real value.
What does this mean for corporate directors?
Well, for those on retailer and healthcare boards, what’s vital is making sure that experience, value, and consumer preferences remain front and center on the company’s agenda, and that a range of innovative partnership and M&A options are being considered.
In other industries, directors should be asking hard questions to probe how these retail healthcare trends are being reflected in employee benefits and the company’s role in the new retail healthcare ecosystem. Health is affected by nearly every part of a consumer’s life, from technology to transportation, to food, to housing choices. Pretty soon, every company could be a healthcare company.
Sam Glick is a partner in Oliver Wyman’s Health and Life Sciences practice who focuses on consumer-centric healthcare.
It is easy to get caught up in the excitement of a deal—the unvarnished optimism of the corporate development team, the bullish spreadsheets from the bankers, the juicy steaks at the closing dinner. The numbers, however, don’t lie. It is estimated that at least half of all merger and acquisition (M&A) deals ultimately fail, destroying shareholder value for the acquirer instead of increasing it. A disciplined valuation analysis—ideally conducted with minimal involvement of the deal team and bankers—can help board members avoid unsuitable matches and support deals that are a good long-term fit.
A Synergistic Match
Assume your company has identified an acquisition target operating in your business and serving similar customers. Cost savings from the combination are expected as the result of an overlapping distribution network and because redundant production and administrative staff can be eliminated. This is a classic synergistic deal, where the acquirer boosts overall profit by adding the target’s revenue to its topline while eliminating many costs associated with achieving that revenue.
The first step in evaluating such a transaction is establishing the market value of the target without regard to buyer-specific synergies. While acquirers are usually most interested in the valuation of the combined company, there are good reasons for first establishing a baseline market valuation of the target on a stand-alone basis:
It gives the buyer insight on a valuation the target might expect to receive in the deal.
It provides a reference point the buyer can use to evaluate how much synergy it brings to the table.
Determining Baseline Value
There are several common approaches for deriving the market value of an acquisition target, and an acquirer should undertake as many of them as possible to establish a baseline valuation matrix. The two common techniques for publicly traded entities are straightforward. They entail analyzing the target’s historical stock price and the premium at which its stock trades after the deal is announced. For our purpose, assume the target is not public and review the four valuation approaches commonly applied to private companies.
One of the most common techniques is by referencing the trading multiples of comparable publicly-traded companies. Care is required in the selection of comparable public companies to ensure similarity of operations, size, and growth prospects with the target company.
Another common method is to consider recent M&A deal multiples for similar companies. For this approach, make sure to distinguish between financial sponsor deals and strategic deals, as strategic deals frequently pay higher multiples due to acquirer-specific synergies. Value indications from these approaches entail applying observed market multiples to the target’s standalone earnings, typically before interest, tax, depreciation, and amortization (EBITDA).
If a long-term forecast is available for the target, financial advisors sometimes use a discounted cash flow (DCF) analysis. It should be stressed, however, that this analysis is only as accurate as the underlying forecast, which may be suspect. For this reason, a DCF analysis often is underweighted—and sometimes omitted altogether—from a valuation exercise. Additionally, a “haircut” may be applied to the forecast itself before it is put into the model.
Finally, if the target is likely to attract financial buyers, advisors may employ a leveraged buyout (LBO) analysis. This approach values the target by establishing what a financial buyer would be willing to pay for the company under the financing structure it might be expected to use—often a combination of debt and equity. If a company is underperforming its peers, the LBO model may also include some assumptions about reorganization and/or add-on acquisitions.
Once as many of the preceding approaches as practicable have been performed, financial advisors triangulate the various pricing indications to establish a baseline market valuation range for the target.
Establishing Pro Forma Value
The next step is assessing the value of the acquirer after acquisition. This analysis is different than the market valuation analysis because it factors in synergies to show the value of the acquisition to that specific buyer. A word of caution: Board members should be wary of synergy projections from bankers or corporate development personnel who are emotionally or financially invested in the deal. Considering the stakes, engaging an outside advisor not connected to the prospective transaction to provide an independent valuation and estimate the potential synergies can be a sensible course of action.
No matter who is performing the pro forma analysis, a number of factors should be evaluated: the amount of expected synergies, the costs associated with realizing those synergies, the amount and type of purchase consideration, and the trading multiples for the acquirer’s stock.
Even for a disinterested third party, it is challenging to estimate synergies with accuracy, so it is prudent to perform a sensitivity analysis of the transaction’s impact on the acquirer’s share price. This is best revealed in a sensitivity table that varies both the amount of assumed synergies and the purchase consideration. Layering in an additional variable to the sensitivity analysis, the estimated one-time integration costs incurred to achieve synergies can further enhance precision. These costs can be just as difficult to project as synergies, so a range of estimates is appropriate.
The resulting sensitivity table can provide board members a powerful visual tool to understand how much it makes sense to pay at varying levels of synergy and costs. If the resulting analysis shows that a deal increases shareholder value—even if actual synergies realized are at the low end of expectations and one-time costs incurred to realize those synergies are at the high end—the deal likely will turn out well from the acquirer’s standpoint. An even better deal is one that increases shareholder value if synergies are below the low end of the estimated range and integration costs are above the high end.
Conversely, deals that are only accretive at or near the most favorable ends of the two ranges are likely to destroy shareholder value.
Other Impacts on Value
What about the impact of the type of purchase consideration on value? An acquisition can be financed with available cash, new debt, stock, or some combination of these. Debt financing will create a drag on future earnings in the form of interest expense, another cost of realizing synergies that must be considered. If acceptable to the seller, using stock may be advantageous to the buyer.
A final factor to consider is the valuation multiple of the acquirer. If historically it has been somewhat volatile, it is a good idea to run a sensitivity analysis on the pro forma value of the stock, assuming a range of valuation multiples for the acquirer consistent with its recent trading history. The lower the valuation multiple, the lower the increase in value from transaction synergies.
Know the Difference
Board members are unlikely to bless a strategic acquisition with the intent to destroy value. Yet, too often, that is exactly what ends up happening. A disciplined, thorough, and independent valuation analysis can make the difference in helping a board distinguish a suitable match from a bad one. After establishing both the market value of the target and its pro forma value to a particular acquirer, a buyer is well-positioned to negotiate and—if all goes well—finalize the deal.
Justin Johnson is co-CEO of Valuation Research Corp. where he sits on the firm’s board and is a member of the firm’s Private Equity Industry Group and Financial Opinions Committee. Prior to joining VRC, Johnson held positions with Arthur Andersen, Merrill Lynch, and PricewaterhouseCoopers.
American Airlines Group director Alberto Ibargüen recently led a fireside chat with the company’s CEO and Chair Doug Parker during the NACD Florida Chapter’s season kick-off event at Miami International Airport. With more than 100 in attendance, the program featured insights into the highly competitive airline industry along with some key considerations for directors.
A New Day for the Airline Industry
From left to right: Sherrill Hudson, NACD Florida Chapter Chairman; Lauren Smith, NACD Florida Chapter President: Doug Parker, American Airlines Group Inc. and American Airlines CEO and Chairman, and American Airlines director Alberto Ibargüen
From 1978 until deregulation of the airlines, the airline industry yielded no return on capital; however, since the merger of American Airlines and US Airways less than four years ago, American has generated $20 billion in profits. Three airlines—American, Delta, and United—are now leading the pack in rationalizing and leveraging the hub model to offer passenger service across the globe while generating positive returns. Parker insists this is the industry’s “new normal” and spends a great deal of time convincing constituents that the industry is not simply experiencing a temporary “up” in a long-term cycle.
Parker explained that the company must now invest in its people and its products, taking a long-term view of the business. For example, American invested in new aircraft and now has the youngest fleet of any U.S. airline. With regard to employees, many of whom are unionized, Parker raised wages in the middle of a contract term in order to fulfill his promises to them during the merger. He explained, “I use the ‘look them in the eye’ test when it comes to the 120,000 people on the American payroll,” emphasizing the importance of transparent communication with employees. Another area of investment is data protection, and the board routinely raises the issue of cyber risk.
“Never undertake a merger when there’s not a clear strategy,” cautioned Parker, when talking about the successful US Airways and American merger. Recognizing the herculean amount of work required to meld systems and go-to-market philosophies, he added, “You shouldn’t put your team through one unless two plus two will equal five, not 4.2.”
In terms of building a post-merger board, the merged company board consisted of two American board members, three US Airways board members, including Parker, and five members from the creditors’ committee. With this blended group, directors did not focus on the “this is how we did things” historical perspective, but rather the group was able to move forward as a relatively cohesive unit from the beginning.
Communication and tone at the top became priorities for the board and management after the merger as well. Parker began holding town hall-style meetings, taking questions from employees. These sessions are recorded and offered to American’s employees worldwide.
A Strategic-Asset Board Focused on the Customer Experience
Parker emphasized that by asking the right questions, the board has had an enormous impact on management, “ensuring that the team has a strategic focus.” Given the day-to-day demands of running an airline, pulling the team from those responsibilities can be challenging. Still, the board insisted on an offsite focused on strategic planning, which proved to be very valuable. “I put off the retreat for two years because we were so busy with the integration,” said Parker. “But the offsite was valuable because we were forced to articulate our strategy in a way that could be understood by others, like the teams and investors.”
American Airlines director Susan Kronick, who was in the audience, added that the board works well because it is diverse. “Our board is diverse in terms of gender, ethnicity, and, most importantly, points of view,” she said. “We have rich discussions, and everyone is moving forward together.” She added that a keen focus on the customer experience is a unifying factor. “We take the proactive perspective that the culture of the company is a competitive advantage for us with customers.”
Parker added that the board members aren’t afraid to speak up, and his job is to ensure his team is communicating well to the board. He also echoed the board’s focus on the customer.
“We are transporting people at 525 miles per hour, so we are constrained by the laws of physics,” said Parker. “But we can make sure the rest of the experience is as efficient and comfortable as possible.”
The NACD Florida Chapter would like to thank American Airlines and Miami International Airport for supporting this event and the behind-the-scenes airport tour that preceded the program.
Kimberly Simpson is an NACD regional director, providing strategic support to NACD chapters in the Capital Area, Atlanta, Florida, the Carolinas, North Texas and the Research Triangle. Simpson, a former general counsel, was a U.S. Marshall Memorial Fellow to Europe in 2005.