A summary of breaking news, and capital markets and M&A activity in the metals industry as of January 31, 2020.
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It seems clear, all else being equal, that patients prefer to receive care in their homes. Now, the “all else being equal” is a big caveat that encompasses severity of the patient’s condition, the situation at home, availability of suitable care options, technology, and many other factors. However, it should not come as a surprise that people would rather be in their homes (which includes senior housing) than in any kind of institutional setting, such as hospital, skilled nursing facility (“SNF”), long-term acute care hospital (“LTACH”) and such. And, due to advances in technology (remote monitoring, telemedicine, etc.), new bio-pharmaceutical therapies, assistive devices, and home modifications, home health care has become a viable option for many more patients.
The Balanced Budget Act of 1997 (“BBA97”) was enacted into law on August 5, 1997 during the second term of President Clinton. In response to explosive growth in the costs associated with paying for Medicare-related home health care from the late 1980’s through 1997, BBA97 mandated that the Health Care Finance Administration (“HCFA”), the precursor to The Centers for Medicare and Medicaid Services (“CMS”), adopt a prospective payment system (“PPS”) for reimbursement of home health care costs as a replacement for fee-for-service (“FFS”) payments.
The first phase of the move from FFS to PPS was the introduction of an interim payment system, or IPS, in 1998. Congress mandated the IPS be implemented until the PPS was fully developed and implemented in 2000. Among the many impacts of this change in reimbursement methodology, total payments for Medicare home health care services declined from approximately $16.4 billion in 1997 to $7.5 billion in 2000, or 54%. The dramatic decrease in reimbursement dollars drove the number of home health care agencies down by approximately 35%. Agencies went out of business, stopped providing Medicare-reimbursed home health care, or merged with other agencies.
On October 1, 2000, HCFA implemented PPS for Medicare home health care. With this stable regulatory framework in place for a decade, the home health care industry enjoyed a period of strong growth – the number of agencies increased to pre-BBA97 levels – and margin expansion. On March 23, 2010, President Obama signed into law The Patient Protection and Affordable Care Act, which had the net effect of only modestly reducing the payments for Medicare home health care visits.
So, since the introduction of the PPS mandated by BBA97, the home health care industry has been operating in a fairly benign environment. That came to a screeching halt effective January 1, 2020 as a result of the implementation by CMS of a new prospective payment system for payment of Medicare home health services. This new reimbursement methodology was created by CMS in response to The Bipartisan Budget Act of 2018 (“BBA 2018”), which was signed into law on February 9, 2018 by President Trump.
BBA 2018 mandated that CMS revise its existing reimbursement scheme to provide for reimbursement based on increased clinical specificity. This new system is referred to as the Patient Driven Groupings Model, or PDGM, and it, among other things, increases the number of possible patient classifications from 153 clinical groupings to 432. PDGM is intended to be revenue neutral to the federal budget.
In implementing PDGM, CMS also incorporated a number of other important changes:
Taken together, the implemented (and soon to be implemented) changes to CMS’s reimbursement methodology for home health care has the potential to create significant chaos and disruption in the home health care sector, potentially on par with what was seen after BBA97.
A couple of factors can mitigate against such a downside scenario. First, there is significant, bipartisan interest in both the House of Representatives and the Senate to fix through legislation CMS’s reduction in reimbursement rates based on future changes in home health care agency behavior which CMS attributes to the agencies’ responses to PDGM. The argument here is that the behavioral changes have not actually been observed, so CMS is not making assumptions based on facts. If Congress does make a change, and bills have been introduced in both the House of Representatives and the Senate, it is likely that the behavioral-related decrease will be limited to something around 2% per year and will be based upon observed behavior.
Second, more sophisticated industry players have the data and analytical tools to help them optimize their operations to survive and, hopefully, thrive under PDGM. By focusing on different levers like patient mix, utilization and intensity of services, coding optimization, and labor mix and cost, they can reduce the hit from PDGM, and possibly, even benefit from it.
Third, given that PDGM is intended to be a revenue neutral initiative, there will be winners and losers. Those agencies with limited exposure to clinical groupings that historically have required a higher utilization of therapy visits (multiple sclerosis rehabilitation, neurological rehabilitation, etc.) are likely to benefit from the new payment system.
The combination of increased technology requirements needed to manage through PDGM, the payment rate decreases and also, importantly, the cash flow impact of rising DSO’s as a result of the RAP elimination, will likely cause many smaller and less sophisticated agencies to go out of business, exit the Medicare home health care business, or merge with another agency with the financial wherewithal and systems to survive. The salutary effect of this for the sophisticated players is that they will be able to acquire additional home health care assets at reduced valuations or capture market share from shuttered businesses.
It will be interesting to look back in a few years to see if we’ve entered another “golden age” of Medicare home health care similar to the 2001 to 2010 time period (and even to 2019, if you include the somewhat modest changes ACA made) OR if we’ve set back the cause of home health care by squeezing providers so hard that they choose not to participate, leaving patients without adequate home health care provider resources. If the latter is the case, look for costs elsewhere in the system to balloon as ER visits, hospital admissions, and SNF utilization all increase.
In any event, as with any major reimbursement or regulatory changes, the more sophisticated home health care companies are likely to thrive and continue to consolidate the highly fragmented market, as the ever-increasing demand for home health care services is not going to diminish.
Merger and Acquisition (M&A) activity among food & beverage (F&B) industry participants in North America maintained a reasonably robust pace in 2019 with over 300 completed transactions, achieving a level roughly in line with 2018 performance. At the same time, the aggregate value of deals closed in 2019 dropped significantly to just over $14 billion, as compared to just over $35 billion in 2018 and approximately twice that amount in 2017. This follows a trend of fewer blockbuster transactions in which mega strategics traditionally pursued competing and/or complimentary product lines aimed at consolidation, expanding category market share, and dominating retailers’ shelf space.
For many of the large consolidators of years past, the current focus has shifted from market share expansion to optimizing previous acquisitions and pursuing investments in legacy brands and on-trend alternatives (e.g., better-for-you foods). These better-for-you foods are generally natural/organic, minimally processed, and plant-based with a focus on the consumer that is pursuing a healthier, more active lifestyle. M&A activity within the F&B industry is increasingly attributable to several prevailing themes, including (i) divestitures of non-core brands and product lines in order to reshape portfolios and focus resources on traditional core competencies, and (ii) pursuit of disruptive acquisitions in areas that appeal to growing consumer preference for healthy beverages, snacks and meals that fall within the better-for-you category. Significant divestiture transactions in 2019 included (i) Kellogg’s sale of its cookies and fruit snacks business to Ferrero International (makers of Nutella) in July, 2019 for approximately $1.3 billion, and (ii) the sale by Campbell Soup of its Arnott’s Biscuits division to financial buyer KKR in August, 2019 for $2.2 billion. As for transactions of a more niche variety that fit the healthy, better-for-you description, there were numerous
examples, with healthy snacks and beverages accounting for the majority. Examples included (i) PepsiCo’s announced acquisition of BFY (Better For You Brands), maker of PopCorners and Rice Rounds, in December, 2019, (ii) Hostess Brands’ announced acquisition of Voortman Cookies in December, 2019 for $320 million, (iii) Hershey’s acquisition in September, 2019 of ONE brands (nutrition bar maker) for just under $400 million, (iv) Atkins Nutritionals acquisition of nutritional snack company Quest Nutrition for $1.0 billion in August, 2019, and (v) Coca Cola’s September, 2019 acquisition of Italian mineral water and sparkling beverage company Lurisia for $97 million.
So, does an environment in which larger strategic acquirers are more focused on rebalancing current portfolios and less on growth via acquisition equate to a softer market for potential sellers of F&B companies? The answer is generally “no”. Whatever pull back occurred among strategic buyers in 2019 was effectively offset by an escalation in transaction demand on the part of financial sponsors (e.g., private equity funds), which represent a massive and growing pool of investable liquidity. KKR’s $2.2 billion acquisition of Arnott’s Biscuits from Campbell Soup, mentioned previously, is a prime example of private equity’s interest in the F&B sector. Investor interest in F&B targets in 2019 was enhanced by dynamics that included (i) less competition from more internally focused traditional strategic buyers, and (ii) given concerns about a potential economic slowdown, the desire to invest in more defensive, less cyclical industries such as F&B. With relative economic stability, receptive capital markets and early signals of lessening trade tensions as we head into 2020, we anticipate that the drivers of M&A activity in the F&B industry in 2019 will continue to support a robust deal pace in the coming year.
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Despite continued trade tensions, geopolitical unrest, and weakness in global demand, the U.S. economy entered its 126th consecutive month of economic expansion – the longest in U.S. history.
Strong performance across numerous key market indicators, including a low interest rate environment and unemployment at the lowest levels in nearly 50 years (3.6% as of October 2019), is creating strong tailwinds for the building products sector. Strength in the housing market is evidenced by leading indicators, including an increase in home starts, rising home ownership, and robust home remodeling activity, all pointing to continued economic strength and market demand.
Demographic trends, particularly those driven by millennials will likely also fuel opportunities for the building products sector. In pursuit of better wages and conveniences of urban living, millennials are increasingly drawn to urban areas and are creating an increased need for multi-family units, where demand continues to outpace available supply.
With economic growth promoting activity across both residential and commercial construction, lack of housing inventory, affordability, and increasing construction & material costs create headwinds impeding higher growth. Access to skilled labor within a tight worker pool also remains one of the most consistent challenges.
M&A activity in 2019 was influenced by the cyclical nature of the sector. The market experienced a modest pull-back in 2019 with 131 M&A transactions, as compared to 184 deals in 2018.
We expect acquisitions to remain a key part of a successful growth strategy for companies operating in this sector. Middle market-sized deals continue to be an area of focus, with strategic buyers making a series of smaller acquisitions to consolidate a highly fragmented market. Particularly of interest are companies that offer emerging technologies such as integrated building solutions to provide an entrance into the intelligent building and Internet of Things (IoT) sector, as well as those technologies that drive cost and energy efficiencies.
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We are now into a new decade and 2020 arrived seemingly way too soon. From what we hear throughout the supply base, it will probably be a decade that presents serious challenges for companies that supply automotive OEMs. Advanced technology, such as electrification and autonomous mobility, is – and will continue to be – disruptive to existing business models.
The internal combustion engine is not going away, but there will be a continuing shift to electrification. There will be 125 million vehicles on the road by 20301 and the resulting technology and related manufacturing restructuring, along with decisions to be made in resourcing, will be greatly impacted as budgets are aligned with the new technology. Mercedes and Audi both recently announced layoffs due to the dramatic shift in their portfolios from combustion power to electric vehicles and their combined reduction-in-force in the next year is anticipated to be approximately 20,000 workers. This shift to electrification is already having a significant impact on Germany’s economy, which is expected to continue.2
Currently, vehicles powered by electric technology are generally more expensive to produce. Suppliers of powertrain components will have to shift part of their product offering(s) to electric componentry and must have the available capital and resources to do so. Over the last 24 months, our experience at Amherst has shown us that few suppliers have been able to invest the necessary capital for the required capital expenditures for their current production, let alone investing in new technology for their products and manufacturing.
Critics of electric vehicles are claiming that electric vehicles are killing employment in the auto industry. Unfortunately, it’s not that simple. Electric vehicle sales have not yet caused a sales decline of individual vehicles and they seem to be the OEMs’ key hope in complying with CAFÉ standards in the United States and the new regulations in both Europe and China. If these new standards are not met globally, the fines associated with them may reach several hundred million dollars.
The major impacts over an as yet unknown time period for auto industry employment and suppliers will be to the unit supply volumes of individual components in the vehicles, engines, and drivetrains. The causal factors for these decreases will be the replacement of piston driven engines by electric motors and the corresponding decrease in the numbers of parts required in the drivetrain.
The days where the OEMs could simply roll out the next generation of vehicles, with some alteration utilizing tooling and factories that were amortized long before this next decade begins, is long gone. The challenge for the OEMs and their suppliers is to innovate quickly with safe and reliable products that can eventually be afforded by the masses. This is, and will continue to be, an expensive and difficult challenge.
We would be pleased to provide you with a more in-depth presentation on these trends or help answer any specific questions you might have in this area.
Please contact us if we can help you or your clients prepare for this impending shift in the industry’s future.
Sheldon Stone, Partner
Restructuring Practice Leader
Bruce Goldstein, Managing Director
Restructuring Advisory Services
1 CNBC, May 2019
2 New York Times, “Electric Cars Threaten the Heart of Germany’s Economy,” December 2019
The behavioral health industry focuses on treating people with a variety of conditions including anxiety, ADHD, bipolar disorders, eating disorders, PTSD and substance abuse disorders. The market for mental health and substance abuse treatment is expected to reach $23 billion in 2019 and is projected to grow 7% per year through 2024.
Despite the expanding market, there is still a significant clinical unmet need as many potential beneficiaries do not seek treatment, cannot afford it, or treatment options are limited. At the same time, the worsening opioid crisis, the continued de-stigmatization of mental illness and the enhanced focus on behavioral health from Capitol Hill has increased the number of people who are seeking and receiving treatment. That trend is likely to continue as payers and providers shift their focus to treating the whole patient, including mental health, as part of the overall continuum of care.
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Uncertainty is a proven deterrent to deal-making activity, and that has certainly been evidenced in the automotive sector as we approach the end of 2019. According to Thompson Reuters, through the first 9 months of 2019, the number of deals completed among global automotive companies totaled just under 200. This level of activity represents a drop of almost 25% compared to the same period in 2018. In what might be considered another indicator of risk averse behavior, the average deal size for transactions completed in 2019 through September also declined considerably, just over 30%, from the same period one year earlier. So, following a particularly robust level of deal activity in 2018, why the apparent pull-back in 2019?
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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.
Partner and Co-Founder
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.
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:
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.
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.
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.
Sheldon Stone, Partner
Restructuring Practice Leader
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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