Healthcare M&A: Are technology services firms consolidating fast enough ?

Healthcare M&A is dampening demand and squeezing margins for IT services firms in the short term. This requires tech services firms to respond in some way to the increased competitive pressures.

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The giant sucking sound you constantly hear nowadays is healthcare companies being swallowed up in an M&A frenzy.

Healthcare is consolidating. Here are some facts:

-- When the $ 37 billion Aetna/Humana deal and the $ 53 billion Anthem/Cigna deals are done, the payer market will see a trio of dominant players ( along with United Health ).  

-- The provider market has seen significant M&A activity in the past couple of years. Deal value for 2015 was over $ 90 billion

-  -Pharma/biotech had a record year in 2015 with over $ 300 billion in M&A activity. Despite the unraveling of the $ 160 billion mega-merger between Pfizer and Allergan this year, M & A activity continues to be brisk.

Driven by pharmaceutical M&A, deal making in the Healthcare sector totaled US$672.9 billion during 2015, according to Thomson Reuters. In a survey of healthcare providers by Health Leaders Media (HLM) earlier this year, over 75 % of respondents indicated they intend to pursue or complete deals in the pipeline over the next 18 months. M&A in healthcare shows no sign of slowing down.

The HLM survey respondents indicated that “supporting sustainability of their long-term mission is the primary reason” for pursuing M&A. Translation: M&A is about survival. Put another way; consolidation is about negotiating power in the market – payer vs. provider, pharma vs. govt, and so on.

Implications for the technology services sector

My firm’s research team recently analyzed the Q1 earnings releases of 5 major IT services firms that have a significant healthcare portfolio. The analysis showed signs of softness in demand and margin pressures, among other things ( you can download the report here). Healthcare IT services leader Cognizant has called out the dampening effect of healthcare M&A activity, specifically referring to the payer segment. Any slowdown in IT spending, either due to pending M&A activity or changing priorities post-merger, could have big implications for tech firms with exposure to healthcare.

This is already happening, as healthcare companies use their bulk and weight to negotiate harder with service providers. A fragmented service provider community can do little to resist the inevitable pricing pressure which comes from this.

The IT services sector seems to be going through a round of consolidation as well. Just as with healthcare enterprises, M&A within the tech sector is about “supporting sustainability of their long-term mission.” Large recent transactions include Cap Gemini’s acquisition of iGate last year; however there is a separate dynamic that seems to be at play.  Big technology firms are spinning off their services divisions to focus on the core technology business. Examples of this are Xerox’s sale of its ITO business to Atos, and more recently the sale of Dell Services to NTT, both of which had acquired their services businesses (ACS and Perot Systems respectively), a few years ago. HP just announced their decision to hive off HP Services (itself the result of the acquisition of EDS for 13.9 billion in 2008) in a deal with CSC week that will create a $ 26 billion IT services company. HP CEO Meg Whitman recognizes that It services firms will consolidate over time, and wanted to be ahead of the curve.

While HP, Xerox, and Dell go back to core technology businesses, these divestitures are an opportunity for firms like CSC to climb into the top tier of tech services companies. This also begs the question of whether consolidation is coming among the giants of offshoring – TCS, Wipro, Infosys.

In addition to consolidating within the sector, short-term options could be:

-- Get on the right side of consolidation: With healthcare enterprises consolidating, vendor consolidation is inevitable. Many incumbent vendors will get squeezed out, and the others will face pricing pressure. We had seen this happen when the big telecom mergers happened in the nineties.

-- Develop specialized competencies aligned to future investments, e.g., digital. A recent McKinsey paper suggests that more than 50 percent of strategic IT budgets in healthcare payers are earmarked for digital transformation initiatives. For mid-tier and smaller companies, this could be the ticket to remain relevant in the current wave of price competition and the dominance of larger IT services firms

-- Revamp the go to market strategy: With enterprises now operating in 2-speed and bi-modal structures, services firms need to align with an increasing range of stakeholders across the business for new opportunities. The role of the CIO – for long the primary target executive for IT services firms – is changing as well, sometimes resulting in lower levels of influence and budgets, especially for transformational initiatives. Tech firms have to restructure their sales organizations, revamp selling messages, and enter into strategic partnerships to enhance their value propositions.

Despite the short-term demand weakness and margin pressures, the current wave of healthcare enterprise consolidation may well be a huge opportunity for tech firms. However, to survive and thrive,  IT services firms will need to align with emerging IT priorities and stakeholder groups, and actively pursue consolidation through M&A strategies.  

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