It’s deal time! The 2016 JP Morgan Healthcare Conference has set the tone for another successful year for healthcare investing. A company’s financial health is a key factor in the underwriting process for any type of loan and, in the healthcare space, savvy investors also conduct through healthcare regulatory diligence. Sophisticated investors, however, go beyond a “check the box” review of a company’s regulatory compliance and ask “what does this mean” to the company’s overall and long term financial health.
Healthcare regulatory diligence and risk underwriting should go hand-in-hand. Changing regulatory scenarios can have a significant financial impact on a company’s Earnings Before Deductions for Interest, Taxes, Depreciation and Amortization (EBITDA), a key factor in the calculation of net-debt-to-EBITDA ratio in the leveraged loan market or impact the quality of secured accounts receivables in the asset based loan market. Just a few examples of areas where regulatory reviews should be incorporated into the financial underwriting process include:
- Pharmaceutical Drug Pricing and Competition: branded pharmaceuticals facing near term generic competition, significant patent litigation, Federal Trade Commission (FTC) or other significant government investigations related to drug pricing can have significant impact on future sales and market share. The same is true for generic manufacturers filing drug applications and considering market entry.
- Reimbursement Changes: payment policy changes and reimbursement cuts can have a significant impact on companies that derive a large proportion of revenue from certain procedures or codes. Underwriting scenarios should model how decreased reimbursement may impact cash flow from accounts receivable over time.
- Regulatory Approval and Coverage: failure to receive anticipated reimbursement coverage or regulatory approval for an innovative pharmaceutical, medical device, laboratory or other test or product can have serious financial implications if companies are forced to consider expenses related to unexpected product changes or reduced market share due to the inability to obtain reimbursement coverage.
- Government Investigations: healthcare companies are frequent targets of government investigations and False Claims Act litigation. Understanding the stage of the investigation and the type of claims at issue can often help underwriters “box in” a range of potential financial outcomes.
Take these scenarios to the next step and consider how the outcome of regulatory diligence should be incorporated into specific healthcare language in the credit agreement, such as representations and warrantees, notice or default provisions.
When conducting any type of healthcare regulatory diligence prior to making an investment, don’t forget to ask “what does this mean?” Carefully considering the outcome of healthcare regulatory diligence on a company’s financial strength will go a long way in protecting the long term value of your investment dollars.
Kate Waters Hardey is a partner in the Healthcare Group of McGuireWoods.