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Publications

As we reviewed the results of the Amherst Partners 2nd Annual Lender Survey, we were struck by two headlines that sum up our perspective on the economy really well. The first was 3.2% GDP growth in the economy in the first quarter, which blew the top off of the expectations. The other, which was not so widely followed, was the earnings decline of several major Tier 1 auto suppliers: Lear was down 29%, Visteon was down 78%, and Borg Warner was down 35%. This was definitely not a strong signal for economic growth.

And this dichotomy was mirrored precisely in what the respondents to our survey told us. Some participants are seeing a very stable economy and others are think the tide is going out. We have record unemployment, a stock market that is hitting all-time highs, low interest rates/inflation, and strong consumer sentiment. Conversely, there is the ongoing threat of a trade war with China, low growth in the rest of the world’s economy, an unresolved Brexit, rising energy prices, and a significant degree political uncertainty in the United States.

From our perspective, the M&A markets have remained very robust. There is a lot of capital available for transactions, but the market does not seem as frothy as it was in 2018. Closed M&A transactions in the middle market in the 1st quarter of 2019 were down 17.9% from 2018. Note, 2018 was a record year in terms of the number of transaction by private equity companies.

But we are also seeing a big pickup in workout activity. While commercial bankruptcies are essentially flat from last year for the 1st quarter, we and many of our colleagues are seeing more companies in trouble with their lenders.

Let’s look at the data from the survey.

Over 80% of the respondents work at either a regional bank or a national bank. Approximately 40% are at institutions with $10-$100 billion in assets, 28% are with institutions with assets between $100 -$250 billion and 20% are at institutions with assets over $250 billion. Over 90% of the respondents are from the Midwest.

In terms of growth, 77% of the respondents said that their institution’s economic outlook is expecting limited growth in 2019 compared to 2018. And about the same amount (69%) expect that their own institution will have limited loan growth in 2019.

In regards to loan quality, approximately 45% of the respondents stated that the quality of their loan portfolio has not changed. Keeping with the theme that it is hard to determine which way the wind is blowing, 32% said that the quality of their portfolio is slightly or strongly improving and 22% said the quality of their portfolio is decreasing.

While there is a slight bent towards an increasing quality in the portfolio, the credit markets are tightening. 43% of the respondents said that their institution is slightly tightening credit standards with only 16% of the respondents stating that their institution is expanding or slightly expanding credit standards. This lines up with the expectation that the loan quality has peaked. 28% of respondents expect their institution’s loan quality to somewhat decrease. 21% expect an increase in quality. 51% expect the quality to remain the same.

In terms of the overall lending landscape, 36% of the respondents said that their competition is somewhat aggressive and 58% said the competition is significantly aggressive, with 78% saying that the aggressiveness of their competition will negatively impact their ability to win business in 2019.

Not surprisingly, the industries most predicted to contract in 2019 are Consumer Products, Retail, and Transportation.  Industrial and Healthcare were indicated as mostly likely to experience growth in 2019.

The survey results line up to what we see going on in the marketplace. According to data published by SPP Capital, lending multiples are coming down slightly in the leveraged loan market by approximately ¼ – ½ times EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) and pricing is inching up slowly.

In summary, while the economy on an overall basis is still doing very well, there are some cracks below the surface that are causing some concern. The respondents to our survey indicate that there is a lot of capital available to finance companies, but that the lending conditions and the quality of their portfolios will continue to tighten.

Based on all of this data, we believe that the economy can continue to do well if interest rates stay low, which implies low inflation, and that there are no geo-political events that trigger a sudden and dramatic change in sentiment.

The firm would like to extend a thank you to all the lenders who shared their insights in this year’s survey. A reminder to anyone who did not have a chance to participate but who would like to receive an invitation, you can subscribe to our mailing list through our website to be included in the 2020 edition. Survey respondents do receive a copy of the results.

Insights provided by:

Scott Eisenberg
Partner and Co-Founder
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The automotive sector is entering a period that will result in fundamental changes to how business is conducted up and down the value chain. A convergence of new technologies, evolving consumer preferences, and business model shifts points towards new opportunities – and new risks – particularly for those businesses that currently supply goods and services to the OEMs. Preparing for these changes today might mean the difference between success and failure five or ten years down the road.

At first glance, things are running smoothly for the U.S. auto industry: the sector has experienced over 60% sales growth in the last decade. From a low of 10.4 million cars sold in 2009, the sector has largely recovered and experienced seven years of continual growth until 2016. Annual car sales have been steady since 2015, at or around 17 million.

The auto sector is facing some uncertainty in the near term, however, due to the U.S.-China trade dispute and a potential economic downturn, and forecasts for 2019 are mixed – although the National Automobile Dealers association has forecast 16.8 million new vehicle sales in 2019, the Economist Intelligence Unit expects car sales to drop by 3.6%, with commercial vehicles sales to edge down by 0.3%.

Change within the industry is also happening at a more fundamental level, as consumers are altering how they choose, purchase and use vehicles. Additionally, technological changes have shaped consumers’ expectations, and they are increasingly demanding a “smart” personalized user experience inside their vehicles.

Changing consumer preferences lead to new business models

Historically, auto manufacturers relied on a certain number of sales per household, selling most vehicles through dealerships as well as car rental agencies. Although sales are currently stable, the industry’s business model is changing as follows:

  • A diverging path for smaller vehicles. U.S. consumers currently prefer to buy larger, heavier vehicles such as crossovers, SUVs and trucks. In 2018, the market share for sedans was at its worst level since 2009, falling below 30%. U.S. automakers have adjusted their lines accordingly, and nearly abandoned the sector. However, sedans continue to represent a sizeable proportion of the U.S. market, and long-term trends point towards an increasing market for lighter, more energy-efficient vehicles.
  • Direct-to-consumer car sales. This continues to be a controversial topic, as direct manufacturer auto sales are completely or partially prohibited in some states, but permitted (and regulated) in others, following challenges by electric automaker Tesla. While such restrictions were initially adopted to protect dealerships from coercive practices by manufacturers, and to increase competition among franchises, it is increasingly at odds with consumers who prefer to research and even buy their cars online. In 2015, the FTC came out in favor of direct sales to consumers, for any manufacturer, as it argued that “consumers would be better served if the choice of distribution method were left to motor vehicle manufacturers and the consumers.” If this business model becomes more widespread in the future, it will likely impact pricing and profit margins.
  • Transportation as a service. Consumers – especially younger consumers – are increasingly choosing not to buy cars, instead relying on ridesharing and public transit, especially in areas with more access to these services. Car rental is also becoming less common, as consumers prefer the convenience of being picked up and dropped off in the location of their choice. In response to these changes, car manufacturers are increasingly looking to ridesharing services as potential clients. In 2016, GM invested $500 million in Lyft, and set out plans to develop a network of self-driving cars with the ridesharing service. GM has since expanded its car-sharing service, Maven, to 10 cities and is focusing on drivers for rideshare apps such as Uber and Lyft. Meanwhile, GM’s subsidiary Cruise Automation is currently testing driverless food deliveries in partnership with DoorDash. Similarly, Toyota invested $500 million in Uber for self-driving cars, and $1 billion in southeast Asian ridesharing service Grab.

Although an economic downturn might slow the pace of technological investment, it could also accelerate some of the trends listed above, to the extent they are counter-cyclical. The more consumers need to be mindful about their expenses, the less likely they are to buy expensive vehicles, or to buy vehicles at all. Manufacturers are closely monitoring consumer preferences, not only as an indicator of potential economic headwinds, but also as a sign of potential business opportunities.

Electric, autonomous vehicles to impact automotive value chain

The auto sector is rapidly moving towards electrification and autonomous vehicles. Under the current growth trajectory, global sales of electric vehicles are expected to almost quadruple by 2020, to 4.5 million units or 5% of the global light-vehicle market. Additionally, global automakers are expected to launch approximately 340 models that are either electric or hybrid within the next three years, which should reduce supply as a barrier to adoption.

There are other barriers, particularly in the U.S. According to consulting firm Capgemini, U.S. consumers currently list battery capacity and the availability of charging stations as the biggest obstacles to purchasing electric vehicles. As for autonomous vehicles, American consumers are reportedly among the most reluctant to embrace the technology, due to concerns over safety, comfort and ease-of-use, with close to 25% of American drivers in one Ipsos survey saying they “would never use” an autonomous vehicle. Other notable barriers to adoption include a lack of support infrastructure, and data privacy.

However, consumers are also increasingly demanding a personalized user experience and in-vehicle connectivity, and younger drivers have more favorable views of autonomous cars and their benefits. These might include traffic congestion tracking and road-safety alerts, and could be more widely available if supported by regulation.

Developing, manufacturing, and selling electric and autonomous vehicles requires enormous investment from car manufacturers and suppliers. Although tech giants such as Apple and Google have also made large investments, car manufacturers and suppliers must generally contend with smaller profit margins. In the short term, these investments might decrease automakers’ profitability, as consumers’ appetite for electric or autonomous vehicles is tempered by lagging infrastructure and regulation, and uncertainty over the safety and effectiveness of new technology.

Automakers embrace new business models

This is a critical junction in the auto sector, because the auto itself is being reinvented amid the arrival of new entrants, new technology and innovative business models. As a result, automakers are rethinking their relationship to consumers, suppliers, and dealerships.

Manufacturers and suppliers are currently making significant investments in vehicle connectivity, renewable fuel, and varying degrees of automation. Although some consumers are skeptical of autonomous vehicles, and cautious about the range of electric vehicles, global sales of these vehicle types are poised for rapid growth in the next few years.

The bottom line is that the automobile as a product is about to be reshaped from the inside out. Parts and services suppliers that have become accustomed to working with major manufacturers based on today’s environment will need to adopt their own approach as well, or risk being left behind.

Insights provided by:

Sheldon Stone, Partner
Restructuring Practice Leader
view bio

From a global perspective, the volume of M&A transactions within the automotive sector remained robust in 2018, setting a high water mark and marginally outpacing the activity level of approximately 900 reported transactions in 2017. As is often the case when there are technology shifts fundamentally re-shaping an industry, much the way the dynamics of powertrain electrification and autonomous vehicles, among others, are changing the landscape for auto makers and their suppliers, there are often very large, transformative transactions amongst industry leaders in search of either gaining or maintaining access to the latest generation of advanced technology. The overall value of automotive transactions in 2018 was indicative of that dynamic, with the aggregate announced deal value reaching just under $100 billion and roughly doubling the prior year’s total. There were seven megadeals (deals valued at greater than $4 billion) during the year that comprised over half of the aggregate deal value, the largest of which was the announced $13.2 billion divestiture of Johnson Control’s (JCI) power solutions unit to private equity investor Brookfield Business Partners. The JCI power solutions business is the global leader in the manufacture and distribution of lead-acid batteries for nearly all types of vehicles, including hybrid and electrical models. The $13.2 billion valuation for this deal implies a multiple of 7.9 times trailing twelve-month EBITDA.

While there were a significant number of transactions focused on the pursuit of advanced technologies in 2018, including the JCI deal previously noted and the acquisition by Lacks Enterprises highlighted in this document, the majority of automotive supplier transactions last year focused on more traditional strategic rationale such as industry consolidation, product line extension, and diversification related to both platforms and customers. Tenneco’s $5.4 billion acquisition of Federal-Mogul during the year provides a prime example of transaction in which scale and diversification were primary drivers.

In spite of the substantial number of deals, there were a number of factors during the past year that created an increasing level of disruption and uncertainty to the M&A environment in the automotive sector as the year progressed. Concerns over supply chain risks, rising commodity prices, mounting geopolitical tension, broader imposition of tariffs, rising interest rates and slowing economic growth planted seeds of doubt among investors otherwise encouraged by solid economic fundaments, strong sales results, and ample, relatively low-cost capital. Illustrative of this rising level of uncertainty, the supplier barometer index, which is published by OESA (Original Equipment Suppliers Association) and based on a survey of North American automotive suppliers’ 12-month outlook, dropped during 2018 from a level of 57 in Q1 to 39 in Q4, where a level of 50 represents a neutral reading.

Despite these escalating headwinds, the industry seems poised for another strong year of M&A in 2019. Strong balance sheets and significant levels of liquidity among both strategic and financial investors, combined with the availability and attractive cost of debt financing, will provide the fuel for transaction aspirations that fulfill solid strategic objectives. As the automotive sector continues to experience rapid evolution related in large part to automated, connected, electric and sharing (ACES) technologies, M&A strategies will continue to provide an effective mechanism for companies to address these dynamic trends. In addition, despite significant consolidation in recent years, the automotive supply base remains highly fragmented. As suppliers struggle to maintain and enhance profit margins while striving to meet the escalating demands of OEM customers, M&A alternatives involving synergistic business combinations that deliver economies of scale and risk mitigation through diversification will be highly prized. Absent any significant and unexpected negative economic or geopolitical events, we believe 2019 will continue the recent trend of significant M&A activity for the automotive sector.

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Consolidation in the plastics industry continued as 2018 led to the second-best year for plastics M&A since 2010 at $34bn in transaction value, a $12bn increase over 2017. Although total transaction value was up over 2017, the total number of transactions fell slightly. M&A is expected to continue at a robust pace in 2019, despite a variety of mitigating factors.

Higher interest rates, the fading effects of U.S. tax reform, U.S.-China trade tensions and an economy that is expected to grow at a slower pace are all impediments to plastics M&A in 2019. In addition, recent stock market volatility may give investors pause. Despite these factors, the cost of capital remains relatively low and the economy is still strong, creating a favorable backdrop for M&A in the plastics sector.

The plastics sector will be driven by continued strong end-market performance as consumer spending is expected to rise; however, this impact will be curbed somewhat by a pullback in construction and higher prices for plastic resin and plastic materials. Furthermore, innovations in the industry, such as advances in biodegradable polyethylene, are currently being developed and are expected to be a source of growth in the future.

The draw of private equity interest in the space is expected to continue unabated as firms seek new platform opportunities and growth through add-on acquisitions. In 2018, PE firms were involved in 46% of plastics and packaging deals, well above the 2013 to 2017 average of 37%, according to Plastics News. Interest from domestic strategic buyers will be driven by a need to reach scale as they compete against international plastics manufacturers that are supported by a lower cost of labor and a strong dollar.  Moreover, the high level of competition in the industry makes it difficult for companies to achieve organic growth above GDP; M&A continues to be an attractive means for achieving growth.

While plastics M&A for 2019 may face some headwinds, we expect the number of transactions during the year to track closely to 2018’s results. In addition to continued strength from the economy and appetite from investors, multiples paid in M&A transactions, which may have peaked in 2018, are expected to remain at elevated levels and will likely bring more sellers to market, creating a unique environment that will make for another active year in the plastics industry.

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Geopolitical tensions between the U.S. and its North American partners, combined with minimal progress on Chinese trade negotiations likely played a role in the tempered metals sector deal activity in 2018. The number of transactions in metals declined to 133 in 2018, down 1.5% from the prior year. Conversely, the sector witnessed aggregate improvement on a deal value basis, with $5.0 billion of M&A deal value in 2018 compared to $1.0 billion in 2017.

Within the metals industry, steel continued to experience price increases driven by tariffs, higher oil prices, and supply chain disruptions. This was intensified by strong demand as steel shipments grew robustly, outpacing real GDP growth. Demand for steel from the automotive industry slowed, while the energy sector’s demand for the metal experienced significant growth. Capacity utilization for U.S. steel producers rose to above 80% – its highest levels since 2014. Growing demand and rising steel prices continued to drive the consolidation trend with interest from both strategic and private equity buyers. Strategic buyers accounted for the bulk of deal activity and have actively invested to increase their production capacity.

On the geopolitical front, while we saw some progress on tariffs between U.S. and China during the G20 summit and Beijing meetings, failure to reach a deal by March 1, 2019 would result in a tariff increase from 10% to 25% on $200 billion worth of Chinese imports and would further introduce uncertainty into the metals market. Signing of the United States-Mexico-Canada Agreement (USMCA) in November 2018 should ease trade tensions between the North American
trade partners. Despite the complex ratification and approval process ahead for the USMCA, the shift in tone between the three countries should bring relief to metals producers and downstream manufacturers and may lead to new opportunities for consolidation moving into 2019.

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M&A activity within the plastics industry remained robust for the first half of 2018, a continuation from a highly active 2017. While the number of completed transactions in the first half of 2018 decreased relative to the comparable period in 2017, average transaction value for 2018 increased. We believe that a robust M&A appetite within the plastics sector will continue throughout 2018.

Broader, macro-level factors, including 1) the abundance of low-cost capital available, 2) tax reform, and 3) current and prospective seller(s) taking advantage of the favorable “seller’s market” will continue to drive M&A activity in 2018. Within the plastics sector, growing demand for plastic products, expanding end-market applications (e.g., packaging, container products, building & construction, and medical), and innovations in recycling technology will continue the consolidation trend and drive interest from both strategic and private equity buyers. As strategic buyers struggle to achieve historical organic growth rates, they have turned to M&A to expand product and service offerings, reach additional end-markets and broaden geographic presence. In addition, private equity has increased its activity within the plastics industry and is focused on mitigating the cyclicality of their portfolios, identifying attractive platform investments and satisfying mandates to deploy capital for quality assets. These macrolevel and industry specific trends have yielded unprecedented competitive dynamics between strategic and private equity buyers for a limited number of high-quality assets, leading to high single and, occasionally, double-digit EBITDA (earnings before interest, taxes, depreciation, and amortization) valuation multiples within the sector.

M&A activity within the plastics industry, from both strategic and private equity buyers, should continue throughout 2018, driven primarily by the sector’s attractive underlying fundamentals in combination with the macro-level dynamics of 1) the limited availability of high-quality assets, and 2) the abundance of low-cost capital.

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The current metals M&A environment has benefitted from strong economic tailwinds as original equipment manufacturers around the world demand more raw material inputs to satisfy increased growth. We expect M&A activity to remain at a robust pace through 2018 driven by a healthy economy, lower corporate taxes, strong corporate balance sheets with ample levels of liquidity and access to capital available through both debt and equity markets. Strategic buyers continued to account for the bulk of deal activity in the metals sector during the first half of 2018. Given that higher interest rates will increasingly make debt financing more expensive for financial sponsors, we expect that strategic buyers, which can access existing cash balances and are less inclined to use debt financing, will continue to maintain a competitive edge when competing for deal opportunities through the remainder of the year.

As overcapacity remains a concern in this sector, particularly for steel producers, industry participants continue to pursue product extensions which will allow them to move up the value chain. The need for lightweight, corrosion-resistant solutions for use in the automotive, energy, and construction sectors is creating ample opportunities for producers looking to invest in innovative technologies. As a result, we expect companies with strong technological underpinnings or value-added product offerings to become increasingly attractive as acquisition candidates.

The volatile policy environment and its impact on M&A activity in the metals sector is still to play out. President Trump’s announcement that the U.S. will withdraw from the Iran Nuclear Deal primarily impacts the energy sector; however, higher oil prices may lead to broad raw material cost increases, and as a result, have the potential to dampen the global economic momentum presently benefitting the metals market. Conversely, industry players may look to rebuild their supply chains within the U.S. in the event the administration issues a NAFTA termination letter. Tariffs on steel and aluminum are certainly signs of increasing political tension; and although the ultimate economic impact remains unknown, foreign companies looking to compete in U.S. markets may look for domestic acquisition targets in order to lessen the negative consequences inherent in a higher tariff environment.

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Expanded Overview

Auto supplier M&A activity continued at a robust pace in the first half of 2018, although down modestly in the number of deals closed during the period versus the same period in 2017. This is a continuation of a trend we saw during the first quarter of the year. Trends impacting the appetite for M&A opportunities are generally segmented according to tailwinds and headwinds. Among the tailwinds are the following:

  • Supportive economic underpinnings – low unemployment, rising housing starts, relatively low interest rates (although headed up), consumer confidence tracking at historically high levels, and rising levels of disposable income per capita characterize an economic picture of relative strength in spite of the consensus view that we are very late in the current positive economic cycle
  • Tax reform – passage of The Tax Cut and Jobs Act, with the stimulative impact of lower rates offsetting restrictive elements such as limits on interest and NOL deductibility
  • Demand/supply imbalance – for several years now, the demand for high-quality acquisition targets has significantly exceeded the supply of those assets available to be acquired, hence ever-escalating valuation multiples. Corporate buyers are leveraging strong balance sheets while financial buyers continue to experience unprecedented levels of fund-raising success, creating a competitive deal market which favors the well-positioned seller

Headwinds to M&A activity include:

  • Declining vehicle sales volumes – having peaked in 2016 at approximately 17.5 million units, sales of light vehicles in the U.S. are expected to decline steadily through 2021, with the trough occurring somewhere between 16.5 million units (a 6% decline from peak) and 13 million units (a 25% decline from peak), depending on which analyst you believe
  • Shifting macro factors – escalating gas prices, tightening monetary policy (i.e., rising rates), rising raw material costs, and shifts toward more restrictive trade policies (including tariffs) create an environment of increasing uncertainty within a complex, global automotive value chain

Against this backdrop of shifting forces impacting auto suppliers, there are a number of prevalent trends which are driving M&A activity and will continue to do so into the foreseeable future. These include:

  • Technology advancements – the growing emphasis on automated, connected, electric and sharing (ACES) vehicle technologies is increasingly driving M&A activity as both OEMs and suppliers search for differentiated and proven technological advancements that exceed those obtained from in-house R&D efforts
  • Globalization and vehicle lightweighting trends – pressure by OEMs for suppliers to be able to efficiently support global vehicle platforms is not a new dynamic within the supply chain, but one which continues to influence M&A activity nonetheless. Likewise, regulatory policies mandating escalating fuel efficiency targets continue to drive acquisition activity as suppliers search for technologies that will enable lighter vehicles, particularly in light of driver-assist and communication products that add to a vehicle’s weight
  • Evolving product portfolios produce more spin-offs – as suppliers shift resources to support product portfolios more reflective of ACES technologies, we are increasing seeing those companies spin-off business units containing more traditional mechanical, non-core products

For the remainder of 2018, we believe we will see a continuation of the healthy M&A momentum experienced in 2017 and through the first half of 2018. Well-capitalized suppliers and private equity buyers with deep pockets will (i) increasingly seek ACES technologies that leap frog those of competitors, (ii) look to enhance their global supply capabilities, (iii) pursue lightweighting technologies that assist OEMs to achieve tightening emissions standards, and (iv) spin-off business units that fail to contribute to long term strategic objectives, all while being mindful of shifting economic and geopolitical forces beyond their control.

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Explore the insights and news from our Restructuring Advisory practice in our new Restructuring Quarterly.

Highlights from Q1 2018 include:

• Practice Leader Sheldon Stone on “Predicting the Next Recession”
• Results from our 2018 Lender Outlook Survey
• Details on our upcoming Current Trends in Bankruptcy panel event in Chicago on May 15
• A look back at our recent webinars: Interim CFO and Exploring the Basics of Due Diligence
• Upcoming speaking engagements and other items of interest

Much has been written in recent years about the impact of a burdensome regulatory environment on innovation. The focus more recently has been on the potential impact (positive or negative, depending on the political views of the commentator) of the current U.S. administration’s push to reduce regulatory burden on various industries. With respect to healthcare, the regulatory environment is pervasive, encompassing life sciences, medical technology, and healthcare services. However, given the industry’s ultimate goal of preserving and enhancing human life, people seem to be generally more favorably disposed toward regulation in healthcare than in other sectors of business.

That said, the cost of dealing with regulations in product development or regarding compliance with mandates associated with the delivery of healthcare services, to name but a few, can significantly reduce returns and make investing in particular businesses or products less attractive. It seems reasonable to assume that, on the margin, the regulatory burden on healthcare has a somewhat depressive effect on innovation; however, the fact remains that with the intellectual horsepower available in this country, incentives in place to reward success and capital to implement, innovation continues to thrive. Much like the flowers beginning to push up through the early spring snow, new products and services, and new ways of attacking long-standing issues seem to shrug off the burdens — justifiable or not — placed on businesses by governments.

Interestingly, with respect to healthcare services, despite the turbulence the industry has been subjected to recently (ACA, transition to value based reimbursement, DOJ opposition to significant M&A transactions, etc.), business leaders continue to explore ways to connect assets in unique ways that address the issues of cost, quality, and patient satisfaction. While it’s unlikely that all of recent transactions in the healthcare sector will fully achieve their stated objectives, progress will be made. There are too many bright people, too much available capital and too much incentive for it not to. The prize is greater access to care, quality, and patient satisfaction, which, when combined with sustainable cost containment, will yield solid financial performance for industry participants able to achieve these broad metrics.

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