In late March, a three-way merger seemed like an excellent prescription for a trio of health-care companies seeking critical mass. The deal was intended to combine Neoforma.com Inc., a Web-based hospital-equipment and medical-industry supply company, with Eclipsys Corp., a health-care-industry computer software firm with real revenues, and Healthvision Inc., an Internet health-care firm.
Moreover, these three were forming a 10-year strategic alliance with Novation LLC (itself owned by two health-care co-op businesses), the contract negotiator for about one-third of the nation’s hospitals. All parties would have received stock in Neoforma.com.
Before the merger became a fait accompli, however, the stock market suffered a sharp setback. Fledgling E-commerce companies took the brunt, sending nervous entrepreneurs scrambling for deal preservers to keep their plans afloat. A three-way merger was especially vulnerable in the downdraft, as stock prices fell out of anticipated ranges.
“The market’s reaction epitomized the E-world,” says attorney Nancy Lieberman, a partner with Skadden, Arps, Slate, Meagher & Flom LLP, who represents the majority partner of Novation. First, according to Lieberman, market analysts suggested that Neoforma.com would lose its E-commerce luster because it would instantly have real revenues, thanks to its new partners. That drove the stock price from the $30s to $16 a share. Days later, when the market dipped, “Neoforma was tarred as an Internet company,” says Lieberman, pushing the company’s stock price below $10. In addition, shareholder suits against Eclipsys added a further complication.
In the wake of these events, Frederick Ruegsegger, CFO of Neoforma.com, became convinced that the deal would not work as originally envisioned. But he was not ready to abandon it, either. He arranged a four-party meeting–his firm, Novation, Eclipsys, and Healthvision–to look at potential alternatives, which included restructuring and simply unwinding. “As much as investors did not like the deal, all of our customers did,” says Ruegsegger.
By attempting to revive a deal instead of scuttling it, Ruegsegger, Lieberman, and their colleagues joined a growing list of stubborn deal-makers. For the 12-month period through mid-February, Thomson Financial Securities Data (TFSD) counted 39 deals in which prices were negotiated downward after the announcement date. Market turmoil in March put additional deals in jeopardy. While the dollar volume of announced deals dropped by 27 percent from the previous quarter, TFSD reports, the number of deals being renegotiated jumped comparably. Says Peter Simor, a partner with the M&A group at New York law firm Brown & Wood LLP, who served as merger counsel to Merrill Lynch & Co. in advising Healtheon/WebMD’s renegotiated purchase of Medical Manager, “A significant number of deals have been renegotiated recently.”
A Soft Touch Needed
The critical question for saving a floundering deal is whether the underlying economics make sense. But even if those factors are not in dispute, salvage operations still require a more deft touch than at the outset. It is natural, for example, to have wished the first round worked, with at least one party preferring the original pricing. Equally natural is the resistance to accepting the market’s or the regulators’ verdict that a deal might not sail. “Businessmen sometimes have to recognize ‘that dog won’t hunt,'” quips Lieberman.
And sometimes, it is essential to find some sweetener for the party that looks to have lost ground from the original agreement. In February, for example, Bell Canada Enterprises Inc., the Canadian telecommunications giant, had offered to buy the 77 percent of Teleglobe Inc. that BCE didn’t already own. That deal was valued at $6.7 billion (U.S.). An international carrier, Teleglobe had the Canadian monopoly on overseas calling until 1999. Since losing that, the company has been adding to its infrastructure to capture Internet and data traffic, a process that BCE was eager to accelerate.
But a first-quarter loss of $47.8 million was “very disappointing” for Teleglobe, according to a company spokesperson, especially compared with its $26.5 million profit in 1999’s first quarter. The initial transaction had been structured to be tax-free to U.S. shareholders of both entities, with a vague closing date of late 2000 or early 2001. In renegotiations– which occurred between BCE and an independent committee of Teleglobe’s board (because BCE already had three seats on that board)– Teleglobe accepted $400 million (Canadian) less in the purchase price. In return, BCE extended an additional $100 million (U.S.) loan to fund the infrastructure build-out, as well as a mid-October deadline for the closing, and a fixed ratio on the exchange of shares, now 0.91, regardless of BCE’s share price.
One reason for the prevalence of renegotiating is the decline of “lock and load” features in merger agreements. Until last year, such provisions, which were prevalent among high-tech firms, committed both sides to the purchase price regardless of a market shift. Originally designed to reflect the reality that “there was no accounting for extreme movements of pricing,” explains attorney Simor of Brown & Wood, this feature fell out of favor in mid-1999 when prices for high-tech stocks were rising so precipitously; Nasdaq gained 86 percent during 1999. But that also helped to tune in M&A professionals to the art of renegotiating.
In addition to the relatively recent absence of lock- and-load terms, Simor points to the greater rarity of both “collars” (changing the parameters of the exchange ratio if a stock price changes) and “walk-aways” (the provisions that establish when a given party can walk away from a deal). “Collars used to be reasonable for, say, a 15 percent change in a stock price, but since we’ve seen fluctuations exceed that by a long shot,” says Simor, such limits no longer make sense.
In Neoforma’s Case
Instead of walking away, CFO Ruegsegger was convinced that the preservation of the 10-year alliance between Neoforma.com and Novation was worth salvaging. About 30 percent of the nation’s hospital spending is channeled through Novation and its member organizations. The core relationship in the deal represents the chance to aggregate that demand, the supply-chain relationship, through these two parties.
To support that central idea, Neoforma.com reached an operating agreement with Healthvision, which gives Neoforma access to the latter’s technology and field resources. “We are using those resources to do our technical integration,” explains Ruegsegger.
As for Novation, there were two equally important aspects of the relationship that needed to be reworked. First, Novation’s outsourcing and commercial relationships. In short, its customers had to be brought on board. Second, its equity partners: 80 percent of Novation is owned by VHA Inc. (which also happens to be a significant stakeholder in Healthvision) and 20 percent by University HealthSystem Consortium (UHC). VHA is a national network of 1,900 hospitals and affiliated physicians; UHC is an alliance of 70 percent of U.S. teaching hospitals. “We ended up giving each of these parties more equity than in the original deal,” reports Ruegsegger, “but there is much more at risk now. They have to earn their warrants.”
Under the structure of the new agreement, Neoforma.com’s equity finds its way to the actual health- care organizations that are party to Novation. But those hospitals have to use Neoforma.com’s electronic marketplace. “There’s a tremendous incentive to gain traction in this deal,” says Ruegsegger.
Neoforma.com not only offered stock to VHA and UHC–a 36 percent and a 9 percent stake, respectively– but also the chance to earn up to 30.8 million (another 23 percent) and 7.5 million (5.8 percent) additional Neoforma.com shares, respectively, over a four-year period by meeting certain performance targets. “This equity at risk helps in talking to other shareholders and Wall Street analysts,” explains Ruegsegger.
Renegotiating a deal is nobody’s favorite pastime. It is clearly a feasible enterprise, however, given solid fundamentals and a hefty quotient of perseverance. And while these three companies were able to reach another agreement, many do not. The art of walking away is just as refined, and just as critical to master.