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The Urge to Merge

March 1, 1998
by Jeffrey Elliott
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SWELLED WITH MERGERS, acquisitions and alliances, healthcare IT continues as a volatile industry. While M&A activity increased 30 percent in 1997, consolidation ruled the talk of the sector, says industry expert Kenneth Brown, chairman of the Joint Healthcare Information Technology Alliance. Large healthcare IT companies are chief beneficiaries, pulling away from the rest of the pack by substantially increasing revenue, profits and marketshare with every acquisition.

Last year HBO & Company, Atlanta, became the first healthcare IT company to break the billion-dollar barrier with 1997 revenues of $1.2 billion, raising eyebrows throughout the investment community. Standard and Poor’s Financial Information Services added HBOC to its popular S&P 500 Index of widely-traded common stocks in October. HBOC’s 1997 revenue increased 27 percent and net income rose 61 percent from the previous year. Its growth can be attributed to a flurry of acquisitions in 1997 (AMISYS Managed Care Systems, Inc., Enterprise Systems, Inc., HPR Inc. and National Health Enhancement Systems, Inc.) and plenty of new contracts. HBOC had $150 million in sales during the fourth quarter alone.

Another industry leader, SMS, Malvern, Pa., posted consistent revenue gains through the third quarter of 1997, up 12.4 percent over the first three quarters of 1996. Known as a company with more conservative growth strategy, analysts are still projecting SMS to achieve a billion dollars in revenue in 1998. SMS’ recent buyout of the remaining 50 percent of Delta Health Systems, Altoona, Pa., it did not already own and acquisition of German software firm Data-Plan Software GmbH will play a large part in its continued growth.

The United Kingdom’s largest independent software vendor, Misys Plc, propelled itself into healthcare IT in 1997, buying up the fourth largest vendor, Raleigh, N.C.-based Medic Computer Systems for $923 million in cash. Misys answered Medic’s call for a large suitor that showed interest in aggressively growing the healthcare IT firm. Analysts believe this mega-deal may trigger other large IT firms’ entry into a potentially lucrative marketplace.

Room for the rest
Don’t count out the rest of the healthcare IT players just yet. Small to mid-sized companies continue to show relative success in niche markets, using size to their advantage, says Brown. "Smaller companies are quicker on their feet." New technologies and nifty enhancements to available technologies--along with efficient installation and customer support--often come from the smaller firms that are not bogged down in corporate bureaucracy.

Their success depends in large part on venture capitalists who are plugging more of their money into the healthcare IT industry. According to Price Waterhouse, 1997 saw 84 venture capital placements worth $200 million in healthcare IT companies.

Financiers will admit the rapid pay-back period most technology investments provide makes it an attractive industry, but there are drawbacks. "This has not been an easy area to invest," says Thomas Stephenson, general partner with Sequoia Capital in Menlo Park, Calif. "We’re dealing with cash-strapped customers." In healthcare, Stephenson says, the technology is less important than meeting the customer’s needs; therefore, the critical issue in financing IT developers is timing. Stephenson admits his firm was too early in financing an electronic medical record company that provided lackluster returns.

Wary Wall Street
Healthcare IT reaffirmed itself to stock market investors in 1997. "The rebound we’ve seen in the last eight months is indicative of investors’ confidence that these companies will continue to grow," says Ray Falci, Bear Stearns managing director covering healthcare IT. Amid a number of missed quarterly earnings by healthcare IT companies, the industry’s market value began spiraling downward in mid-1996 as investors and analysts abandoned healthcare IT stocks under fears of inflated valuations. However, after the industry bottomed out on the market in mid-April of 1997, stocks reversed course and began making up the lost ground.

Although shy of the 1995-1996 valuations, healthcare IT companies have continually shown earnings stability and strong investment returns. In the past, says Falci, investors have allowed poor performance from one company, such as missed quarterly earnings, to negatively affect the stocks throughout the industry. Now, he says, investors do not regard individual company performance as an industry benchmark. "Wall Street is now taking each stock on its own merits."

The same in ’98?
Analysts are painting a positive, yet competitive picture for healthcare information system companies this year. "A vast majority of healthcare providers are increasing their IT spending in 1998," says Ann C. Gallo, principal for BT Alex.Brown, a Boston investment bank. In general, she says, the larger healthcare IT vendors have the advantage over smaller vendors because of the trend toward one-stop shopping. "(Providers) are looking at the full-solution vendor approach to IT." Large vendors with applications--particularly human resources and accounting--that cover the healthcare enterprise should see the greatest returns.

Also, look for another year with plenty of consolidation activity. Gallo expects IDX to step up with some crucial growth-related announcements--not to be left in HBOC’s or SMS’s wake. Medic Computer Systems, with a supply of capital from its new parent company should be busy playing the M&A game also.

Fiscal Report

A look at 1997 financial statements from some of the leading healthcare IT vendors

Cerner Corp., Kansas City, Mo., finished 1997 with stellar fourth quarter revenues ($69.8 million), up 50 percent over the same quarter last year. For the year ended January 3, 1998, Cerner reported $245.1 million in revenue, up 30 percent from $189.1 in 1996. Net earnings were up 82 percent to $15.1 million.

MEDITECH, the privately-held software developer based in Westwood, Mass. posted fourth quarter 1997 revenues sharply down from the same period last year, but closed the 1997 books with $193.8 million in revenue, up from $168 million in 1996. The company signed 180 new contracts in 1997.

Daou Systems, the San Diego-based healthcare networking company increased revenues 47 percent over 1996 to $41.7 million. Along with its largest fourth quarter performance--up 60 percent from last year--Daou’s earnings per share during the same period rose 67 percent from 1996.

IDX Systems Corp., Burlington, Vt., reported strong 1997 fourth quarter results of $69.8 million in revenues, up from $54.8 million during the fourth quarter of the previous year. The company posted year-end results of $251.4 million, a 21.5 percent increase over 1996 figures. Net income for the year was up $6.4 million to $23.1 million.

Transition Systems, Inc., Boston, ended its fiscal year 1997 on September 30, 1997, with $44.6 million in revenues, a 30 percent increase over 1996. The company acquired Vital Software Inc. in September for approximately $6.3 million--$3.6 million in cash and 252,003 shares of common stock.

Jeffrey Elliott is business editor at Healthcare Informatics.

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