Credit Suisse https://www.credit-suisse.com published the follow-up note “Interesting Debates Emerge Post the Bloomberg Article” on January 26, 2022, with some emerging debates on the Optum and Change Healthcare (CHNG) merger.
Credit Suisse analysts expected CHNG shares to respond positively to the news of the company reportedly exploring the sale of their PI business in light of the UNH merger.
However, several antitrust developments overshadowed the report. One example being the DOJ’s new antitrust head, Jonathan Kanter, making comments that he will seek to block deals that are “likely to lessen competition” rather than pursuing complex settlements.
In another development, the FTC blocked Lockheed Martin’s proposed acquisition of Aerojet. As for CHNG, Mr. Kanter’s comments in combination with recent action by the FTC and the entire administration on large corporate mergers have caused more skepticism on whether the UNCH/CHNG transaction will close.
With a ~3% decline on Tuesday, CHNG shares are now trading at ~33% deal spread. Assuming a “no deal” price of $18, shares are now implying a probability of just 18% on the deal going through. Credit Suisse analysts have had discussions with several investors and industry experts throughout the day and have highlighted and addressed some of the key interesting questions and takeaways as listed below:
- Several investors and industry stakeholders believe that CHNG/Optum putting together the divestiture package is not necessarily driven by DOJ’s request/recommendation. In fact, an argument is being made that the two companies want to be ready with remedies already in place in case the DOJ approves the deal, which will likely come with some divestiture requirements. Starting a sale process post, the DOJ decision would likely need the extension of the merger agreement beyond April 5th (which comes with its own caveats, as addressed below). However, analysts believe it is fair to assume that CHNG/Optum’s decision to explore the asset sale is likely influenced by the back and forth between CHNG/Optum, the DOJ, and where DOJ’s focus has been
- The PI business is one of the “crown jewels” of CHNG and there is no reason to believe that this business would get a multiple below mid-teens EV/EBITDA. However, any deal related to a divestiture package is essentially a “fire sale” and is likely to carry a discount to traditional valuation multiples. This a 7-8x EV/EBITDA isn’t a surprise to the analysts and is likely to garner enough interest
- Interestingly, some investors and industry experts noted that the DOJ is likely reviewing this deal on both horizontal market overlap concerns (areas where both CHNG and Optum have a presence such as PI, medical networks, risk adjustment, etc.) and vertical market overlap concerns (such as an insurer, UNH in this case, owning CHNG’s Clinical Decision Support business -InterQual, which has 60-65% market share). Given the anti-trust environment, some believe that the DOJ might push for divestitures in pretty much every such area. If PI alone is worth $350 min of revenue, a divestiture package addressing both horizontal and vertical anti-trust concerns would be well in excess of $650 min (the “burdensome clause” as per the merger agreement). Some argue that this could result in UNH walking away from the deal or pushing for a lower purchase price (which UNH could do if the merger agreement needs to be extended beyond April 5th). Credit Suisse Analysts expect UNH to push for the merger as long as it makes financial and strategic sense. However, the analysts do not expect the CHNG management team and shareholders to agree for a lower purchase price. Notably, any material change in the merger agreement will require the two companies to refile the agreement and obtain shareholder approval. With CHNG’s fundamentals remaining stable and the company on track to meet or exceed their LT targets, analysts see the company walking away from the deal (even if that means putting a relationship with one of their key clients, UNH, at jeopardy.
- If the UNH merger doesn’t go through, the analysts see CHNG focusing on the company’s core operations and delivering on their objectives as an independent company. Recall, the merger negotiation/discussion between CHNG and UNH was pretty much an exclusive process and did not involve any other parties. CHNG doesn’t fit into the strategic focus and objectives of other insurers as much as they fit within UNH, given their strong services business, Optum. With Cerner now in a pending merger with Oracle, any potential combination with Cerner is also off the table. With CHNG’s leverage being at ~4x (on the analysts CY 22 EBITDA, a private equity transaction also seems unlikely. However, similar to Oracle buying Cerner, CHNG could garner interest from one of the large tach companies, albeit any such deal announcement in the near to intermediate term will be highly unlikely.
- Since the deal announcement, CHNG’s results have been largely stable. The company is on track to exceed its FY22 adjusted EBITDA merger proxy projection of $1,051 min. Management has also notes that any operational impact from the deal overhang has been immaterial thus far. However, if the approval process continues to drag on, analysts would not be surprised to see some near term operational disruptions and slowdown in the company’s business pipeline. Longer term, however, analysts remain confident on the company’s ability to exceed their LT annual revenue growth target of 4-6% and EBITDA growth target of 6-8%. One interesting argument has been made around the competitive disadvantage CHNG might find itself in if the company opens up their books to competitors (while exploring these divestitures), but ends up staying an independent company
- As analysts have noted in the past (evident from the current ownership), CHNG shares have recently attracted interest from fundamental investors, (the majority of them had owned CHNG in the past and followed the story closely). However, with the DOJ’s decision now looming on or around February 22nd, even fundamental investors are now hesitant to step in. With respect to risk-arb investors, given the current anti-trust environment, most see the DOJ suing the merger. If that happens (and UNH/CHNG decides to challenge), it could mean the process drags on for another 8-9 months which is not an ideal scenario, even from the point of view of fundamental investors.
For more information on the follow-up note by Credit Suisse analysts titled “Interesting Debates Emerge Post the Bloomberg Article” concerning the CHNG Deal weighing sale of ClaimsXten, ask questions, provide feedback, or news, email Jailendra Singh at jailendra.singh@credit-suisse.com or call 212-325-8121.