Michael J. McGuinness and Aarthi Belani share how convergence transactions pose challenges such as distinct regulatory regimes, potentially incompatible corporate cultures, and differing expectations for executive compensation, while working out these alliances.
Michael J. McGuinness
When Amazon, Berkshire Hathaway, and JPMorgan Chase teamed up in 2018 to form a new company, they set out to provide more efficient, better-quality healthcare to their 1.2 million employees. The new company, Haven Health, would certainly seem to be the progeny of strange bedfellows.
But unusual as it may sound, partnerships of this sort are increasingly common in the healthcare industry, as disparate players converge in hopes of injecting innovation and efficiency into the medical system.
Microsoft, for example, has entered numerous collaborations with healthcare companies, focused on secure messaging, data sharing, and electronic health records. Johnson & Johnson has partnered with Apple on an Apple Watch app to monitor and study data on irregular heart rhythms in hopes of improving diagnosis and outcomes for people living with atrial fibrillation. In another example, the pharma giant Roche paid $1.9 billion to acquire Flatiron Health, a software start-up that mines oncology data from electronic health records to improve clinical trials.
Such combinations are known as “convergence transactions,” where potentially odd-bedfellows form unconventional partnerships to pursue unique efficiencies in the target market.
For M&A professionals who help broker these alliances, the partnerships pose challenges that include distinct regulatory regimes, potentially incompatible corporate cultures, and differing expectations for executive compensation. Successful deal making requires anticipating and then effectively navigating these issues.
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The Forces in Play
When Haven Health was formed, its founders said they would focus on streamlining health care by leveraging their collective experience with technology, supply chains, consumer experience, and data collection. Their initial goal for the independent, non-profit company was to improve the quality, service and, especially, costs of healthcare that had frustrated their employees and families.
Berkshire Hathaway’s Chairman and CEO, Warren Buffett, described those costs as a “hungry tapeworm on the American economy.” It seems clear that this deep-pocketed trio’s ambitions go well beyond their own companies’ health benefits. As JPMorgan CEO Jamie Dimon put it: “Our goal is to create solutions that benefit our U.S. employees, their families and, potentially, all Americans.”
The increase in convergence transactions is part of a larger trend of mergers and acquisitions in the health and technology sectors. 2018 saw a record number of healthcare transactions-1,794, according to S&P Capital IQ-and analysts predict this trend will continue through 2019. Many of these deals were conventional hospital and health plan mergers in both the for-profit and non-profit sectors.
But digital health deals have more than tripled in the last five years-to 56 in 2018, compared with 17 in 2013. The upturn reflects the healthcare industry’s increasing pursuit of technology to provide more efficient care and meet the demands of digital and personal health initiatives in the United States, Europe and Asia.
Several factors are driving the trend. Aging populations and unhealthy life styles in many of the world’s biggest economies are driving increasing chronic conditions requiring costly, complex care, placing various pressures on current healthcare systems and offerings. As governments around the globe revise their healthcare strategies and policies to improve efficiency and reduce costs, healthcare companies often find themselves having to accomplish more with fewer resources. Many pharmaceutical companies, facing significant patent expirations, are turning to acquisitions, licensing and collaboration deals to keep drug pipelines flowing as well as expanding their portfolios into new delivery systems and digital solutions. And personalized healthcare is becoming more viable, thanks to digital technology and AI-assisted data mining for genomic sequencing and identifying potential therapies.
With those various forces at work, convergence transactions between healthcare companies and technology players seem certain to continue.
Consumers are also driving the demand for more streamlined and efficient care. Tech-savvy consumers who are accustomed to the efficiency of digital retailers such as Amazon are looking for that same sort of smooth interaction with their health care providers. In fact, Amazon has entered the field, purchasing the mail-order drug and distribution company Pill Pack for almost $1 billion.
Consumer-centric care also creates a demand for more affordable care with transparent pricing, as does the increased focus on providing healthcare to underserved populations. New technologies are tracking health care habits and data on personal devices, and healthcare companies need to be able to integrate that data into patient care.
An Evolving Regulatory Environment
Convergence transactions raise complicated and often unfamiliar issues for dealmakers. One big question: Which regulator or regulators have oversight? Healthcare companies are highly regulated, of course. By contrast, despite the “techlash” clamor in Washington, so far software and digital companies outside of the healthcare space seldom find themselves subject to government regulation.
A key regulator, the U.S. Food and Drug Administration (FDA), is modernizing its approach to overseeing convergence product offerings, attempting to keep pace with developments in diagnostics, robotics, bioinformatics, and genomics. As the regulatory framework shifts, dealmakers will need to keep abreast of changes and understand the implications of evolving statutes, regulations, guidance documents, and precedents.
While federal US regulators, such as the Centers for Medicare and Medicaid Services (CMS), DEA and the Federal Trade Commission, have various roles in regulating healthcare payment for services to Medicare and Medicaid beneficiaries, drug prescribing, and general claims and collaborations regarding healthcare services, respectively, most regulation applicable to the delivery of healthcare services in the US is left to the states. Complicating the matter, most US states have specific and divergent requirements regarding who can provide healthcare services, how such services can be provided, and reporting obligations regarding the services. Increasing multi-jurisdictional offerings must evaluate and understand the unique requirements of each state to the applicable offering and consider methods for streamlining operations in a compliant manner across the jurisdictions.
Convergence transactions also typically raise data privacy and security considerations. Many of the collaborations involve personal health information and data, so it’s essential to understand any patient-privacy or consumer-privacy rules. In the U.S., that includes whether information and its uses are subject to the Health Insurance Portability and Accountability Act of 1996 (HIPAA), a variety of additional federal privacy/data protection statutes (e.g. Children’s Online Privacy Protection Act, Family Educational Rights and Privacy Act, Gramm Leach Biley Act), or state-specific health data privacy and medical records requirements, and if so, what disclosures, patient authorizations, security requirements, operating policies, and other considerations would be necessary for compliance. With data privacy a paramount consideration, dealmakers will need to review data security policies, cybersecurity of databases and medical technology, and other data security implications.
Of note, where data flows, operations, or users arise outside the US, different data privacy requirements may apply, such as the General Data Protection Regulation (GDPR) in Europe and the new Chinese national standard on personal information protection.
Divergent Approaches to Intellectual Property
Besides differing regulatory environments, dealmakers in convergence transactions must also reconcile strategies on intellectual property that are often at odds. Companies in the life sciences industry invest heavily in R&D. Bringing a new drug or device to market can have a decade-long runway. Additionally, healthcare companies often face low imitation costs by competitors, as new drugs can easily be reverse engineered.
Given the economics and competitive pressures of the industry, life sciences companies rely on patents to safeguard their investment and frequently pursue infringement actions against industry competitors. Cross-industry studies illustrate the extraordinary importance of patents to life sciences. One survey by the Licensing and Executive Society Foundation found that 89% of respondents in healthcare described patents as “extremely important” for “creating a competitive advantage for your organization,” compared to 73% of electronics and software respondents.
Patents play a similarly important role in the technology industry. However, while healthcare companies invest heavily in monetizing and protecting their intellectual property, technology firms tend to follow a different strategy. Tech companies increasingly employ a defensive approach to patents, whereby they amass large war chests of fairly narrow patents. Those armories of intellectual property are then used, not as ammunition against competitors Ã la life sciences, but rather as leverage to keep the peace. Technology firms thus rely on arsenals of patents to deter competitors from bringing infringement suits and take a defensive approach to enforcement themselves.
Brokering deals between companies from technology and life science industries will thus require dealmakers to acknowledge and reconcile divergent intellectual property strategies.
Cultural and Deal Structuring Considerations
Another question convergence transactions typically raise is how to structure payment of the aggregate purchase price. Healthcare and technology companies usually have different payment structures. In tech companies, the aggregate purchase price includes a cash payment but also typically includes restricted stock awards that become available at certain pre-agreed and specific times, through vesting. This can be seen, for example, in Twilio’s acquisition of SendGrid for $2 billion in stock.
In life science companies, on the other hand, the aggregate purchase price includes an up-front cash payment but also typically defers a portion of the purchase price until achievement of certain milestones. Examples include a deal between Affimed and Genentech that included $5 billion in payments based on specified development, regulatory, and commercial milestones. A collaboration deal between Nektar Therapeutics and Bristol Myers Squibb paid $1.0 billion and an equity investment of $850 million up front, with an additional $1.78 billion in milestones, of which $1.73 billion are development and regulatory benchmarks, and the remainder are based on sales figures.
Given the different cultures of the companies involved in convergence transactions, dealmakers will need to decide how the purchase price in M&A transactions is to be structured, considering approaches from both the technology and healthcare sectors. The myriad and complex issues surrounding convergence transactions will ultimately impact deal valuation, deal terms, and deal closings.
New practices and precedents will undoubtedly emerge as convergence transactions become less an anomaly, and more the norm.
Michael J. McGuinness and Aarthi Belani are partners in the mergers and acquisitions group at Jones Day law firm. This article represents the personal views and opinions of the authors and not necessarily those of the law firm with which they are associated. Michael Zaslow, Henrik Born, and Elliot Horlick contributed to this article, which was reviewed by John Beeson and Alexis Gilroy.