Braff Group: DRA Could Spike M&A Activity

PITTSBURGH–The Deficit Reduction Act’s 36-month cap on Medicare
home oxygen equipment could drastically alter the HME merger and
acquisition climate, according to a report released last week by
The Braff Group.

In the past, after reimbursement cuts, the most attractive
sellers have refocused their efforts on re-engineering their
businesses instead of fleeing the market, the 2005 M&A report
explained.

“However, this time, we sense that the 36-month oxygen cap may,
in fact, drive more non-fringe, i.e. quality providers, to the
market, changing the supply and demand dynamics to one that may
begin to favor buyers,” the report stated. “The big difference this
time around is that unlike other past changes in reimbursement, the
36-month O2 cap has no immediate financial impact that a
prospective seller has to recover from in order to capture a
valuation comparatively consistent with the recent past.
Accordingly, while risk has gone up–creating motivation to
consider a sale–revenues and earnings remain unchanged … for
now.”

Previously, the most important factor to sustain and spike the
values of HME companies in an “extremely risky” environment has
been the imbalance of supply and demand. “While many of the names
have changed over time, the sector has been in a sustained period
in which the number of aggressive buyers has exceeded the supply of
attractive acquisition candidates,” the report said.

Surprisingly, Wall Street’s reaction to the DRA’s 36-month
oxygen rental cap did not have immediate financial impact on the
respiratory sector, TBG said.

“The day after the Deficit Reduction Act was signed, the mean
decline in the publicly traded HME firms was only 1.4 percent,” the
report stated. “So while the oxygen cap may have sent shock waves
throughout the industry, the reaction from the Street was one of
decidedly less concern.”

However, the Act “has spiked the sector’s risk by providing
Congress with yet another mechanism to reduce reimbursement in the
future.”

The report, which called 2005 a “bellwether year” for HME, said
for the first time in five years, transaction volume in the
industry declined.

“While 87 deals completed in 2005 was the second highest total
recorded over the past five years, it is the first time during the
period that transaction volume has declined–a 10.3 percent
fall-off from the record 97 deals posted in 2004,” the report said.
“Given two consecutive years of significant reimbursement pressure,
such a slowdown was likely inevitable.”

After a “remarkable rebound” in 2004, the HME sector started out
strong in the first quarter of 2005 but then fell victim to cuts in
oxygen reimbursement tied to Federal Employee Health Benefit Plans,
soaring gas prices and cuts in nebulizer dispensing fees.

With three major transactions during the year involving firms
that specialize in diabetic supplies, wound care, urologicals,
respiratory supplies and other disposables (Warburg Pincus’
acquisition of CCS Medical and MP Total Care, and Owens and Minor’s
acquisition of Access Diabetic Supply), The Braff Group said it
expects further activity in this niche.