During the past five years, healthcare stakeholders’ expectations of sources of industry growth and profits have shifted toward alternative subsegments. For example, healthcare services and technology (HST) subsegments, which represented about $65 billion in earnings in 2023, will experience an estimated 9 percent CAGR during the next five years.1 By comparison, payer profit pools (about $55 billion in 2023) will have an estimated 7 percent CAGR during the same period.2 This implies that by 2028, HST profit pools may be nearly double the size of payer profit pools today.
Companies across the healthcare value chain, especially incumbents with substantial stakes in lower-growth or shrinking profit pools, are looking for opportunities to unlock incremental value by expanding their participation in attractive new subsegments (frequently those that are adjacent to their core businesses). Transact-to-build M&A—the programmatic acquisition and scaling of assets with differentiated capabilities—can be an effective way for care delivery organizations (health systems and physician practices) and payers to rapidly launch, build, and grow new businesses; access diversified earnings; and reshape their core business models and earnings profiles, often while continuing to improve the US healthcare experience. This article examines the prevalence of transact-to-build M&A in healthcare, the benefits that accrue to organizations that successfully pursue it, the inherent challenges of doing so, and six actions to help organizations beat the odds and realize value from these deals.
A sizable share of healthcare M&A deals are now focused on building and scaling new capabilities
In 2021, the atypical combination of strong US equity performance, low interest rates, and increased credit availability propelled M&A activity to record highs.3 By 2022 and 2023, however, geopolitical uncertainty and challenging economic conditions—marked by repeated interest rate hikes, stock market volatility, stubborn inflation, and looming fears of recession— contributed to a drop in M&A activity across industries. Deal volume in healthcare declined by about 40 percent between 2021 and 2023.4
Prior to the current slowdown, however, dealmaking had steadily increased for more than a decade. From 2010 to the peak in 2021, Healthcare-specific deal activity grew by almost 45 percent (Exhibit 1).5 These figures highlight the critical role M&A continues to play in the healthcare industry, in particular as a catalyst for long-term value creation and new business models.
In 2023, about 40 to 50 percent of payer-led M&A deal volume and about 50 to 60 percent of hospital-led deal volume was in vertical rather than horizontal transact-to-build deals, as acquirers in both segments sought to extend their core businesses to access new value pools and enhance their ability to improve health outcomes.6 Hospital-led deal activity focused predominantly on physician services and nonacute and outpatient care delivery, reflecting the accelerating shift in consumers’ preferences for convenient, low-cost care settings and acquirers’ efforts to expand into adjacent service lines.
Among payers, about 15 to 20 percent of deal activity was focused on care-delivery segments (for example, physician services and postacute care); approximately 20 to 30 percent was focused on HST as payers looked to engage across a greater portion of their members’ care journeys and boost process efficiencies; and about 10 percent was focused on noncore segments (for example, medical products and pharmaceuticals).7
Transact-to-build M&A provides opportunities to optimize portfolios and operations
Many healthcare organizations believe transact-to-build M&A offers greater potential than alternative M&A opportunities to serve members and patients in new ways. Alternatives include “transact to transform” (catalyzing substantial performance improvement and capturing synergies to reinvest in transformative strategic and growth initiatives) and “transact to scale” (efficiently and programmatically “tucking in” smaller players, expanding existing business lines, entering new geographies, or unlocking scale economies in a roll-up strategy).
A substantial proportion of healthcare innovation today is driven by smaller, agile companies that are evolving care models and simplifying patient journeys, making them attractive targets for incumbents. High rates of investment by venture capital funds, which commonly use M&A as an exit point for their portfolio companies, may also accelerate M&A opportunities.8 Would-be acquirers can unlock deal value in three ways.
Accelerating and diversifying revenue growth
By entering HST markets, large healthcare incumbents can gain immediate access to faster-growing profit pools with the potential to substantially improve top-line growth. From 2023 to 2028, for example, healthcare data and analytics revenue alone is expected to grow at nearly four times the rate of payer revenue.9 When a large organization acquires an asset with this profile, it gains access to the new revenue stream immediately after the deal closes. In the longer term (the specific time frame varies based on the nature of the acquired asset and the relevant growth vectors), the parent company can scale the acquired asset more quickly than if it had remained independent; for example, through sales to the parent and partner organizations and accelerated investment in products that serve adjacent markets. In many instances, the acquirer’s ability to directly channel its business volume into the asset can be a prerequisite to catalyzing breakout growth for the asset scale and unlocking value.
Legacy payers in particular have been motivated to pursue transact-to-build transactions during the past five to ten years to improve overall financial performance as margins in their core businesses decline. By increasing the proportion of enterprise revenue and EBITDA attached to higher-growth value pools, acquirers can (in theory) benefit from higher EBITDA multiples, although realizing this value is highly dependent on successfully integrating and scaling the new asset.
Addressing margin pressure through new capabilities
Through transact-to-build M&A, payers and care delivery organizations may simultaneously change their business mix and realize cost savings through traditional synergy levers (for example, shared-services consolidation) to help address cost pressures prevalent across the industry. Some targets may have sophisticated capabilities that could be deployed within the acquirer’s organization to modernize core functions and unlock new value.
Consider a payer that acquires a company that provides differentiated capabilities in medical management for dual-eligible special needs plans—an area in which the payer has struggled historically. The payer could commercialize the target’s offering, thus gaining a new revenue stream, and simultaneously improve its health outcomes and costs by deploying the capabilities internally. Additionally, in some instances the combined entity could reduce administrative costs by rationalizing core systems (for example, enterprise resource planning and electronic health records).
Catalyzing innovation and revitalizing consumer relationships
Organizations building new, disruptive business models provide opportunities for legacy payers and care delivery organizations to evolve how they operate and engage with members, patients, and other healthcare stakeholders. Many of these smaller businesses—with their agile operations, cultural bias for innovation, and consumer focus—could unlock performance in an acquirer’s core business. For instance, a target may have best-in-class internal product development practices driven by rigorous data-backed, consumer insights; a legacy acquirer could benefit from infusing these methods of insight generation into its own product development practices without otherwise disrupting its existing processes.
Building deep, trust-based relationships with consumers remains a perennial struggle for healthcare incumbents (for example, tech companies have nearly double the customer satisfaction scores of commercial payers).10 Many HST entities serve consumers directly, often using technology, advanced data, and analytics. Acquiring such companies could allow legacy players to continue owning consumer relationships and mitigate the risk of disintermediation.
Acquirers can maximize their odds of M&A success with six actions
Transact-to-build M&A can help organizations achieve breakout growth. It is also hard. Inherent differences in business economics and operations make these transactions more difficult to execute and capture full value from. However, acquirers can identify, plan for, and address potential difficulties early in the deal cycle to increase their chances of long-term success. Six actions in particular have proved especially effective for incumbent purchasers.
Set and follow an ‘M&A blueprint’ and avoid reacting to market conditions
Rapid shifts in the healthcare industry can generate a robust pipeline of assets for sale at potentially inflated valuations. Even the most seasoned acquirer may succumb to “fear of missing out” in a deal-heavy market cycle, spending valuable resources on evaluating assets being pursued by their competitors without a clear, overarching vision for how the asset—and potentially even the segment in which it operates—fits in with its own strategy. Alternatively, would-be acquirers with funding available may pursue less-than-desirable assets that have become available due to difficult market conditions, without a clearly defined plan for how the would-be asset will deliver value.
Consider a payer with an existing portfolio of care-delivery assets whose interest is piqued by a pharmacy services asset that may be for sale. Although the asset may have best-in-class capabilities, the payer does not stand to gain strategic advantage by deploying these capabilities to its own care-delivery assets. In contrast, consider a health system with a healthy balance sheet and access to substantial capital that has an opportunity to acquire a skilled-nursing facility in another geography at a highly attractive valuation. Before moving forward, the health system will want to critically assess whether expanding to new geographies and postacute care settings aligns with its overall corporate strategy.
Companies can more readily identify these potentially distracting situations if they have an existing road map and a strategy to help them continually prioritize assets and activities. Well before assessing potential assets, high-performing acquirers take two important steps:
Develop an ‘M&A blueprint.’ The M&A blueprint clearly articulates how a potential subsector or theme, such as provider-enablement solutions or postacute care delivery, fits into the overall strategy.11 The blueprint needn’t drill down to the asset level; rather, its purpose is to establish a business case for the innovation-focused play under consideration.
Follow a proactive deal-sourcing and outreach strategy. Building on the M&A blueprint, effective deal sourcing requires, at a minimum, a comprehensive view of the market asset landscape; a consistent, fact-based asset evaluation framework; and an outreach strategy that’s tailored to each target and has sufficient buy-in from the acquirer’s executive team.
Build a deal model and establish a target price based on a deep understanding of the asset’s business model
Deal pricing is tricky, and in most transactions it’s more art than science. The risk of mispricing an asset is magnified in transact-to-build deals because acquirers may be unfamiliar with the asset’s business and the critical underlying value drivers. For instance, a payer attuned to considering membership growth and managing total cost of care as the most critical value drivers for their business may overlook the importance of medical staff composition or referral patterns for a chain of outpatient clinics. Unfamiliarity with these metrics may lead the payer to accept the management case “as is”; however, these cases often reflect an inherent bias for aspirational, best-case outcomes. Best-in-class acquirers revise the management case based on a detailed assessment of the current state and risks associated with the distinct value drivers in the asset’s business model. Additionally, a best-fit deal model accounts for how the acquiring company will distinctively channel its business volume to rapidly grow the asset. The outsize potential for value creation the acquirer may bring as the “best owner” can make deal pricing challenging. On the other hand, this would also serve as a unique justification for any markup to the asset valuation that the acquirer may be willing to pay. These assumptions rely on specific interactions between the acquirer’s and target’s business models that are unlikely to be reflected in a generic management case.
To maximize the likelihood of unlocking incremental value from a transaction, successful acquirers build their own deal models, grounded in realistic assumptions about the value drivers of both the target and the acquirer and a shared vision for the future combined organization. They also evaluate a range of outcomes and only proceed with the transaction if they feel reasonably confident in their ability to navigate worst-case outcomes.
Define the end-state operating model early and use it to guide integration, building, and scaling decisions
Organizations undertaking an M&A transaction often underestimate the need to articulate the end-state operating model for the combined businesses. The best acquirers define this no later than the diligence phase to assess its feasibility. They then work backward to design specific timelines and activities for business build and scaling, using the operating model as a guidepost for the rest of the transaction (Exhibit 2).
This is critical to maximizing potential value from the deal and mitigating business build and business continuity issues. A failure to enter the planning phase for the business build with a clear end-state vision—and use it to guide business decisions—incurs risks, including the following:
- depressed revenue growth due to lack of focus on operationalizing a combined go-to-market strategy
- dis-synergies from choosing to complete the asset’s “business transformation” or “performance improvement plan” before pursuing integration and further business building together with the parent, which often results in duplicative functions, potential overinvestment in areas that are not crucial to the future company, and underinvestments in areas that are crucial
- failure to capture cost synergies due to lack of alignment on functional combinations
Consider the case of an ambulatory surgery center (ASC) in the process of transitioning to a new electronic-health-record (EHR) system when it is acquired by a hospital system. Having two separate, disjointed EHR systems prevents either company from delivering a seamless patient experience or improving health outcomes with a more complete patient profile. In this case, the acquirer would be wise to consider halting the ASC’s ongoing EHR transition and instead transitioning to the parent system’s EHR.
Plan to invest beyond the purchase price to fully unlock value
While most executives recognize that achieving combinatorial cost synergies requires a one-time, sometimes substantial, up-front investment, even seasoned acquirers often don’t appreciate that unlocking incremental revenue growth from M&A requires further investment in financial and human resources.
Consider a payer that acquires a chronic-condition-management platform with the aspiration of cross-selling an existing offering to the acquirer’s customer base. The target’s existing platform would likely require substantial investment to withstand the strain posed by onboarding a large volume of new customers all at once. Although it will cost more in the first year or two, investing in a robust, scalable platform capable of supporting the combined organization’s growth aspirations will likely reap more benefits in the long run.
Growth seldom comes for free. It’s important to understand the magnitude of investment that will be required to realize profitable growth for each value-creating opportunity incorporated in the deal model. For acquirers pursuing a programmatic strategy (that is, carefully choreographing a series of deals around a specific business case or M&A theme, which we have found creates the most value),12 investment across a series of deals may be required.
To evaluate targets and track performance, tailor metrics to the deal thesis
When evaluating a potential target, successful acquirers focus on the financial metrics that make the most sense for the strategic outcomes they are seeking.13 This will often require the acquirer to take a different approach than when evaluating its own financial performance. For example, using ROIC or ROE in the short term to assess the attractiveness of a potential target or the early-stage performance of an acquisition might preclude an organization from pursuing attractive, high-growth, early-stage companies, which typically require a longer period to demonstrate attractive ROIC or ROE and, hence, may be better evaluated via metrics such as revenue growth in the near term. In short, acquirers that consider a broad spectrum of metrics and allow for flexibility in metric-related boundary conditions to account for strategic intent will be less likely to pass over potentially attractive opportunities.
For instance, a payer acquiring a high-growth digital consumer engagement platform that is unlikely to be profitable in the short term may initially witness enterprise margin dilution after an acquisition. Focusing on earnings per share or ROIC for such an asset in the first year could erroneously prompt the acquirer to cease making the sustained investments required to fuel further innovation and unlock growth, irrevocably derailing the asset’s growth trajectory. Instead, in the short term, such an asset can more accurately be evaluated on membership and revenue growth, gross margin performance, and ability to achieve near-term integration milestones (for example, full integration of IT systems) to reach future profitability.
To avoid losing momentum or getting distracted by less appropriate metrics, successful executives determine up-front the appropriate metrics for measuring a specific asset’s ability to contribute to the M&A strategy and transparently manage the expectations of board members, investors, and internal skeptics about any potential short-term negative impact.
Dedicate meaningful time to cultural and organizational change efforts
McKinsey research shows that companies that effectively manage culture during integration planning are more likely to capture cost and revenue synergies; about 75 percent of companies that effectively manage culture report meeting or exceeding cost and synergy targets compared with only about 45 percent of companies that report ineffectively managing culture.14 Working norms at a large corporate acquirer could be detrimental to the asset, compromising its ability to deliver expected growth margins. For instance, a large for-profit payer may have formal, centrally managed hiring processes tied to its annual budget cycles. These hiring processes may be entirely unsuitable for a recently acquired high-growth asset that has thrived with a decentralized, “just in time” hiring process, allowing it to rapidly adapt and compete in a fast-shifting market. In the same case, as a publicly listed entity, the acquirer may have a higher degree of transparency in its budgeting and target-setting processes than the target is accustomed to. Intentionally acknowledging these differences in working norms could help the respective teams collaborate effectively and reduce friction that could increase employee turnover, impede value capture, or slow growth.
To avoid the unintended consequences of failing to address culture, successful acquirers take a tailored approach to understanding the nonnegotiables that drive value in each company and make informed decisions about which of these to retain, integrate, or wholly redesign for the future. These decisions should be aligned with the end-state operating model; an acquired company that will continue to operate as a stand-alone business unit can retain more of its culture than a company that will be subsumed into the acquirer’s existing functions.
To operate from a place of strength, successful acquirers begin any cultural work by focusing on the two organizations’ similarities. In cases that require a degree of cultural integration, recognizing that talent and culture are the responsibility of leadership—not HR—is crucial. Tracking and measuring culture initiatives with the same level of rigor as value capture initiatives can lead to more successful change management.
The fundamental shift in sources of innovation and growth in healthcare creates challenges and opportunities for companies across the ecosystem. Organizations are increasingly pursuing transact-to-build M&A to tap into new sources of innovation, accelerate revenue growth, alleviate margin pressures, and radically transform how they drive health outcomes for their customers. However, acquirers undertaking such transactions are also prone to common pitfalls, such as overreacting to market conditions, missing the mark in asset valuation, failing to define the end-state operating model, underestimating the investments needed to fully unlock value, obsessing over the wrong success metrics, and presuming that cultural and organizational change will occur organically. Organizations that successfully forestall the common pitfalls in such transactions will be best positioned to thrive in the next era of healthcare transformation.
