What’s the state of M&A market post-pandemic? An expert weighs in

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One of the most compelling questions during the pandemic and immediately after had to do with the state of the mergers and acquisitions market in New Jersey. Getting deals usually requires a significant amount of in-person contact — something that was hard to accomplish during the period of social distancing.

But by most accounts, the M&A market continued to hum along, if quietly throughout much of the past two and a half years. Now, with the economy in general recovering, deals might be easier to do. Unfortunately, the resumption of nearly normal business activity has been accompanied by some pretty strong headwinds — namely, inflation and rising interest rates.

NJBIZ recently spoke with Scott Kobler, a partner at Newark’s McCarter & English and one of the most prominent M&A lawyers in New Jersey, about the state of the health care market – where he focuses his practice. What follows is an abridged version of that discussion. The questions and answers have been edited for length and clarity. The full interview is available at njbiz.com/njbizconversations.

NJBIZ: I wanted to start with the issue of hospital mergers. As you and I’m sure our readers are aware there was a wave of consolidation that resulted in the creation of several really large systems in the state. Then antitrust regulators stepped in and blocked Hackensack Meridian Health’s acquisition of Englewood Health and RWJBarnabas’ acquisition of St. Peters in New Brunswick. I guess the question then — is hospital M&A finished in New Jersey? Or is there a possibility that we can see it pick up again?

Scott Kobler: Well, I think we’ll see it pick up again. I think that if you were to look at the two largest systems in the state you would be toggling somewhere around six, seven, eight billion dollars a year in revenue, depending upon circumstances. And when you look at the large mega-systems across the country … when you look to our size, and you see Pennsylvania and New York, and you see $20 billion-systems. I think that that arguably is the wave of the future. …

For those who don’t know, the germ of the FTC’s [Federal Trade Commission] proposition is, and there are really two things that I look at, one is, what is the area of competition? And in both of those cases where the FTC stepped into oppose — in the Englewood case it was viewed to be Bergen County. With some disclosure, we do work for Englewood. And we do some work for Hackensack Meridian. In the RWJ-St. Peter’s case it was viewed to be Middlesex County. And those who are sophisticated purchasers of health care services in the state will know that they don’t stop at the county line. …

And if you were to read the briefs, one of which was filed by our firm, the briefs filed in the Englewood case you would see that there is an attempt to try to focus more on the delivery of quality care, which is really what a health system is supposed to do.

I’m doing a lot of financing work. How can we build centers of excellence in the state? How can we do them economically? But how can we also build a debt capacity for New Jersey to have robust systems? And we have several who are rated quite well to be able to access the best technology, the best medical information systems, electronic health records, so that New Jerseyans have absolutely the best available to them at reasonable prices.

Q: So, is it a matter of persuading the FTC that that’s possible within the state? Or are you really talking about the cross-border mergers that you mentioned at the top?

A: I really don’t know. At some point the FTC has looked for, I don’t want to call it guidance, but some suggestion about how to deal with health care. Remember, there are rulings that have related to the creation of ACOs [Accountable Care Organizations], trying to create circumstances where normally competitive entities would wind up joining forces to try to create savings … And what always strikes me, as I look at it through the lens of doing this for four decades, is that invariably health systems will compete against one another. You hear it on the radio. You see it on billboards. You get the flyers, you get the magazines in the mail. They’re trying to attract you. They’re trying to attract physicians …  I don’t know that we consider it to be anything other than annoying, but the moment that you leave … you’re getting an email that says, “tell me what your opinion is of your interface with this organization.” And, you know, the press, Leapfrog, all those reports are arguably seized upon to say, this is the best place to go.

Q: Now, with regard to cross-border mergers and the creation of, as you suggested, a $20 billion-dollar system, that would seem to mean basically the largest systems in the state. Those being Hackensack and RWJ Barnabas. Maybe Atlantic, if you want to work them in. Would they be buyers in that situation? Would they be targets?

A: I couldn’t tell you. They are among our clients. I would suspect that the line always in our industry is, you know, everybody takes a call from everybody else.

You know, this is an interesting state. It’s an amazing Home Rule state, right? Home Rule applies to our schools. Home Rule applies to our cops. Everybody says, why can’t we merge our municipalities? It happens very, very infrequently. And so, when you think about the delivery of health care it has gone from, when I started in the early ‘80s, from a state of north of 100 health systems, individual cities that would have three separate hospitals that were there historically. So, I don’t know who will be the dominant force.

But even within larger systems there are disparate locations. Where is capital going? Where is the focus going? Where, if you’re referred, are you going? Are you going within that system, or are you going outside of that system? And let’s not forget that we’re talking about competition among the hospitals. An extraordinarily learned and retiring CEO of a major health system has often said, the competition comes from the local CVS and Walgreen’s It comes from large organizations like Summit [Health]. It comes from the ambulatory care or ambulatory surgery center or the urgent care center that’s set up at the foot of the street where the hospital is.

I look at it as this kind of holistic view, that health care is delivered through all health providers, which is here to stay. So you can see that we shouldn’t zero in necessarily on the health systems. I just think that there is this historic view of competition where most of us in New Jersey would look at whether they would stop at a county border in deciding whether they were going to get health care is not necessarily being first in mind.

Q: Are there other areas, other sectors where we might see some acquisition activity in the health care industry at this point?

A: Well, I mean think about all the turnover in the sub-acute space. I think the sub-acute space could be considered the third rail of conversation. We were involved in the unwinding of the Woodland facility in Sussex County, which you know has been depopulated. The receiver did an outstanding job because [the Center for Medicare and Medicaid Services] had cut off the funding there, and there was really a compelling argument to move in that direction.

We’re all getting older. This is a graying population. We have to be mindful of where we want to go. … I’ve done almost all of the finances of the nonprofit systems in the state, and in nursing and subacute care, people will look at the price tags and say that they’re expensive. But when you think about the delivery of having to have Medicaid beds available for people, as they age and acute care isn’t necessarily the right setting from both an expense and a delivery perspective. That’s to me something that needs to be addressed.

And of course, this is a state coming out of COVID, where you’ve got elderly and infirm people together, where there are employees that are coming into the facility. The outcome was predictable. We as a society were making up rules as we went. So, I think that’s an area that we will all be watching across the country. …

The other thing that’s happened over the decades is the delivery of clinical care on more of an outpatient basis. Think about it. You’d have your appendix out. You’d be in the hospital for a week. Then to get your appendix out you’re in the hospital overnight. With all of the increases in knowledge, and where we’re going to go with this over time, it’s not ending right now. You want the best and it doesn’t necessarily require that intensive amount of capital.

Q: There’s no question that the pandemic has accelerated the evolution in the industry in a lot of different ways, which leads me to another question – in some of my conversations with health care executives, mostly on the technology side and particularly last year, and in 2020, there was a question about valuations. It was unreliable. It was very hard to do deals because you really couldn’t tell what your target was worth. Or what you were worth, if you had acquisition currency. Has that abated now? Have valuations stabilized?

A: What immediately happened on the health system side that you could see was, what are our expenses going to be relative to a decrease in volume? And so there was kind of a rush to make certain that there was sufficient liquidity.

I think health care is different than any other enterprise where cash is king. I mean liquidity is important, right? There were pandemic-oriented programs to shore that up, and there are other programs out there. But answering your question, yes, I think there is a stabilization in valuations now, because you can tease out of an income statement where particular revenues come from. People are feeling more comfortable with going back to electives. With elective surgery shut down that’s tough. Now you’re back.

Now the pressure – and I’m sure [Hackensack Meridian Health CEO] Bob Garrett would tell you the same thing – the pressure is staffing and expenses. And finding able people. It’s not necessarily the facilities. It’s the staff.

Q: Yes, well, he and others have said the same thing, particularly on the nursing front, that it’s been a huge problem. Another variable in M&A is interest rates. It looks like we’re going to get another increase very soon. Has it gotten to the point where you’re now seeing a pullback, is there still some slack in the system?

A: Well, the issue becomes now a pivot the financing side. The lower interest rates have always provided an opportunity subject to tax rules for nonprofit hospitals to refund out. I’m not talking about the acquisition of a medical group by private equity, but really more in the space of looking at debt and refunding opportunities that might be out there across the board. Not just in acute care, but in sub-acute care and skilled nursing, and so forth.

Interest rates still are arguably, historically low. It doesn’t make economic sense. Do you cut back on something? If you’re thinking about a particular project or proposal, your physical plant is aging so much that you need to actually get capital to fund out of cash flow. But interest rates still are fairly low, and there are mechanisms to borrow, using short-term floating rates — hedge them.

Everybody is trying to rush to market, not just on the M&A side, but with respect to new project finances. We’re funding simply because of the lifting of rates, and the predictable continuing of lifting.

Q: Well, that’s the other question, though. Is it predictable? Do you think folks in this industry have a good handle on where the Fed is going with this, and where interest rates are headed?

A: My perspective, I don’t want to say is somewhat amateurish because it’s a little more advanced than that, but I’m not sitting on the desk. But I am hearing, and none of us believes, that interest rates are going to fall.