The challenge of creating value through M&A: An examination of UHG’s acquisition strategy
Will Bacic, Principal, M&A Practice
UHG Group’s (UHG) Optum business unit recently agreed to buy health technology company Change Healthcare for $13 billion ($8 billion valuation plus $5 billion in debt), paying a 41% premium over Change Healthcare’s closing price, with the deal expected to close in the second half of 2021. This acquisition is one of many that UHG has made over the past ten years, demonstrating a very active approach to M&A. Against the backdrop of consistent case studies showing the difficulty in capturing enough value in synergies to justify acquisition premiums paid, we took a deeper look at what’s driving UHG’s M&A strategy and what competitors can take away from it.
M&A history is littered with failures
Executing a successful M&A transaction while creating enough value to justify the acquisition premium paid is a difficult proposition. Lofty synergies are often promised as part of many M&A deal announcements, yet studies have shown that 40% of M&A deals don’t achieve cost synergy targets – decreased fixed and variable costs through shared resources, eliminating redundancy, etc. Revenue synergies, such as access to new markets, cross-selling, and increased pricing power, are even more difficult to achieve with studies showing 70% of M&A deals don’t achieve revenue synergy targets. In fact, the average merging company loses between 2-5% of its combined customers following a merger. Since successful M&A transactions are difficult to come by, it’s especially important to have a well-considered M&A strategy driving every move from M&A market scanning for target companies to deal valuation and negotiation through successful integration planning and execution.
A brief history of Optum
Understanding the hurdles M&A transactions present, let’s take a closer look at UHG’s approach to acquisitions over the past 10 years to see what lessons we can learn. UHG’s revenue is split between its health insurance business (United Healthcare, often referred to as UHC) and Optum to the tune of 63% to 37%. Three main business lines are housed under the Optum brand:
OptumRX: pharmacy benefit management
OptumHealth: care delivery, care management, behavioral health, consumer offerings
OptumInsight: technology services, health care operations, data and analytics
The announced plan for the Change Healthcare deal is to merge it into OptumInsight, the technology division, to enhance revenue cycle management and clinical information exchange solutions, streamlining clinical, administrative, and payment processes, driving quicker and more accurate claims processing, and simplifying financial interactions between providers and payers. OptumInsight is the smallest business unit by revenue in the Optum family, yet it has the highest operating margin at over 20% in each of the last three years.
Optum has seen significant growth over the past 10 years growing at a 5x multiple over that period with very similar growth in each of the three Optum business lines (ranging from 5x to 7x growth). Notable Optum acquisitions during this time period include CatamaranRx (pharmacy benefit management), MedExpress (urgent care and preventative services), Advisory Board (consulting), Surgical Care Affiliates (ambulatory surgery centers), Rally Health (digital health and well-being tools), PatientsLikeMe (online patient portal), Equian (payment processing services for payers and providers), and Davita Medical Group (provider group). While these acquisitions span the healthcare spectrum, UHG has stated that its strategy is to have every business segment of Optum drive down the medical loss ratio for United Healthcare. A United member can have an Optum care physician, receive medications from OptumRx, while analytics are done on care gaps by OptumInsights, with the goal of lowering the cost of care.
UHG’s stated strategy is to meet patients where they are by deploying more ambulatory and preventative care services through Optum, which works in concert with United Healthcare’s goal of reducing high-cost, unnecessary care services. UHG’s acquisition strategy has resulted in some of the best returns in the industry and has been emulated in part by CVS Health’s merger with Aetna and Cigna’s acquisition of Express Scripts.
Under the hood – revenue synergies are questionable
As well-considered as this strategy may be, we need to take a closer look at UHG’s financials to see what insights we can gain beyond just looking at UHG or Optum’s overall revenue growth. Optum has continued to grow at a rapid pace over the past several years, and the percentage of Optum’s revenue that has come directly from United Healthcare has decreased from 77% in 2011 to 57% in 2019 (see Exhibit 1 below).
Optum generating nearly 60% of its total revenue from United Healthcare is a very significant amount. The fact that Optum has virtually every payer as its customer (over 300 health plans) should mean that there are more and more outlets for its business outside of United Healthcare. Has it materialized?
Consider that the biggest change in Optum’s non-UnitedHealthcare business came right at the acquisition of Catamaran – with Catamaran’s existing customers simply shifting to Optum’s ‘paper’. Since then, however, the portion of Optum’s revenue outside of UnitedHealthcare has remained stagnant. Taking into account further acquisitions and typical customer churn, one could infer that these acquisitions have resulted in little to no true synergies.
Since there are only so many synergies available between United Healthcare and Optum’s growing business lines, we must consider some other reasons why UHG has been interested in so many acquisition opportunities. One driver appears to be a diversification and risk-mitigation strategy, the idea being that entering the healthcare services market can help offset the stagnant insurance business, a hedge against changes to the healthcare insurance landscape (e.g. US political changes to health insurance). This diversification and risk-mitigation strategy also helps keep UHG a step ahead of current and future competitors who might attempt to dramatically disrupt the healthcare market in the near future through a form of vertical integration (e.g. the oft discussed “Amazon effect”).
Another driver of UHG’s acquisitions appears to be a pure financial play, dramatically increasing revenue while striving to generate significant EPS returns from its acquisitions. While difficult to achieve, research studies have shown that some of the best diversified public corporations and financial buyers have been able to generate upwards of 35% returns per year by making non-synergistic acquisitions. They have done this through a combination of innovative operating strategies, clear and significant incentives for top-level executives based on aggressive financial targets, and pushing a fast pace of change. To be successful with this non-synergistic acquisition strategy, acquirers need the right leadership team, an aggressive execution plan, and ideally an eye for an under-valued asset, as it becomes increasingly difficult to create value if an acquirer overpays.
Bringing it back to Change Healthcare
Which brings us back to UHG’s acquisition of Change Healthcare for a 41% premium. On average, in successful deals, the acquiring company gives one-third of estimated synergies to the target company as an acquisition premium and leaves itself two-thirds of the estimated synergies to provide enough buffer to realize value on the deal. The acquirer should reap twice the synergy value since it assumes the risk of realizing the synergies while the seller collects its share at closing with no risk. In paying a 41% premium to Change Healthcare, UHG is signaling that it views Change Healthcare as a significant asset for its portfolio.
Between estimated synergies among its current business units and other opportunities to run the Change Healthcare business more efficiently, UHG must believe there is significant value that can be created to make this deal a good investment. UHG certainly has its work cut out for them, though they are no stranger to the challenge ahead.
UnitedHealth Group's acquisition strategy over the past 10 years has clearly and repeatedly demonstrated its ability to create shareholder value.
The impact on healthcare delivery, business model disruption and revenue synergies is questionable.