With 17 announced transactions, the fourth quarter of 2022 was one of the most active quarters we have seen since the COVID-19 pandemic began near the end of Q1 2020. Four of the 17 announced transactions met our definition of “mega merger,” in which the smaller party has annual revenues in excess of $1 billion, and a fifth had a smaller party with revenues in the $500 million to $1 billion range. This was the third consecutive quarter in 2022 in which the average size of the smaller party across all announced transactions exceeded $800 million. As a result, the average smaller party size for the entire year reached an historic high of $852 million, well above 2021’s then-record size of $619 million.
Highlights of announced transactions in 2022 include the following:
· The 53 total announced transactions for 2022 moved up from 2021’s recent historic low of 49 announced transactions.
· The average profile of the smaller party in announced transactions remained strong. Smaller party annual revenues exceeded $1 billion in more than 15% of the transactions, just below last year’s historic high of 16.3%. More than 15% of smaller parties had a credit rating of A- or higher, consistent with a trend toward stronger credit ratings noted in 2020 and 2021 and significantly surpassing those historically high watermarks.
· The high percentage of mega mergers and other significant transactions over the course of 2022 resulted in an historically high average smaller party size by annual revenue of $852 million, more than $200 million higher than last year’s historic high of $619 million. The compound annual growth rate (CAGR) of the average smaller party size over the past 10 years approached 12%, up from 8% in 2021.
· While the number of announced transactions increased year over year, it remained below pre-pandemic activity levels. Nonetheless, the combined revenues of the parties in this year’s announced transactions resulted in more than $45 billion in total transacted revenue for the year, surpassing 2017’s recent historic high of $44 billion despite recording less than half of the total transaction volume.
· Despite the financial difficulties that many hospitals and health systems encountered in 2022, the percentage of financially distressed sellers, at 15%, was slightly below the 16% level observed in 2020 and 2021.
· Activity by not-for-profit hospitals and health systems as both acquirers and sellers continued to increase, growing from 81% of total transactions in 2020 to 87% in 2021 to 91% in 2022.
While the total number of transactions remained below pre-pandemic levels in 2022, there were clear signs that M&A activity was beginning to regain momentum, and we expect that momentum to continue into 2023. This expectation is informed by several factors.
The need to transform healthcare. As our colleague and firm chair Ken Kaufman noted in a recent blog, “this is a transformative period in American healthcare, when hospital organizations are faced with the need to fundamentally reinvent themselves both financially and clinically.” The high level of transformative transactions that we witnessed in 2022, culminating in Q4, is evidence that health systems are recognizing and responding to this need.
Severe financial pressures. As detailed throughout 2022 in our National Hospital Flash Reports, the past year was extremely challenging for many hospitals and health systems across the U.S. Organizations that were able to amass strong balance sheets have had some cushion against these financial pressures, although that cushion is getting thinner as resources are used to offset operating losses and financial markets exhibit continued challenges. Smaller organizations and organizations that did not have balance sheet strength may soon have to look for alternatives, including stronger partners that can help them stabilize financially.
Moving past the pandemic. COVID-19 is still with us, but the worst strains of the pandemic seem to be moving behind us. Strategic discussions that were put on “pause” during the height of the pandemic are occurring, including conversations on how to find the next level of intellectual and capital capabilities required to remain competitive in a rapidly evolving healthcare marketplace.
Some market forces present challenging headwinds to transaction activity, including a higher interest rate environment that is raising the cost of capital as well as heightened regulatory scrutiny of M&A activity across multiple industries, including healthcare. We believe, however, that these tactical factors are overshadowed by an increasingly important strategic rationale for providers to form partnerships. In our conversations with clients, one of the questions we hear most frequently is “What are our strategic options going forward?” For many organizations, the answer to at least part of that question will be a partnership or transaction that provides the resources needed to pursue their post-pandemic strategies.