Congress Approves CHIP Reauthorization

Transcription

1 BMO Sponsor Finance Q1 218 Transaction Trends Transaction Trends provides private equity sponsors with middle-market transaction information and insights compiled by the BMO Sponsor Finance group information that helps sponsors better understand the current financing climate in the middle market. Congress Approves CHIP Reauthorization Many families were bracing for the potential loss of pediatric health insurance coverage, given the legislative uncertainty surrounding the Children s Health Insurance Program (CHIP). With the program s federal funding in flux, healthcare providers treating CHIP beneficiaries were left to consider potential impacts to reimbursement rates and coverage. Created in 1997 through bipartisan legislation, CHIP is a federal health insurance program designed to cover uninsured children in families that cannot afford or access private coverage but earn too much to qualify for Medicaid. CHIP is paid for with state and federal funds and may be administered by a state Medicaid agency or as a separate program. All states have expanded children s coverage significantly through their CHIP programs, with nearly every state providing coverage for children up to at least 2 percent of the federal poverty level. 1 In 216, CHIP cost $13.6 billion 2 and covered 8.9 million 1 children, representing approximately 12 percent of total Medicaid enrollees. CHIP funding expired on Sept. 3, 217, as legislators could not agree on how to fund the program based on preliminary Congressional Budget Office (CBO) estimates that an extension would cost the federal government $8.2 billion over 1 years. 3 States continued to operate programs using leftover funds from prior years until Congress approved $2.85 billion 4 of short-term CHIP funding in December in hopes of keeping the program afloat through March 218. With expected budget shortfalls in the event CHIP was not renewed, a number of states planned enrollment freezes and discontinuation of coverage. Aside from the ethical consequences of children losing their health insurance coverage, the effects would have spanned beyond families to healthcare providers. Failure to reauthorize CHIP s federal grants would have squeezed state budgets, resulting in more uninsured individuals where coverage is discontinued or lower reimbursement rates where states might have continued covering CHIP children absent federal aid. Many sponsor-owned providers that receive CHIP reimbursement likely receive a mix of commercial, Medicare and general Medicaid funding too, which would have partially mitigated the impact of more unfavorable rates and coverage. While some families may have the ability to pay out of pocket for pediatric procedures, this practice would have proved unsustainable for many of those affected if the program were not reauthorized. By March 218, an estimated 24 states would have exhausted guaranteed federal funding and may have resorted to accessing the government s limited redistribution funds. 4 Then, somewhat unexpectedly, following passage of the Tax Cuts and Jobs Act of 217, the CBO cut its cost estimate for CHIP reauthorization to just $8 million over the next 1 years, noting the program would decrease the federal deficit by $6 billion over that period. 3 The CBO estimated that the December 217 tax bill s elimination of the ACA s individual mandate will drive up premiums in the individual market. Those higher premiums, in turn, will increase federal subsidies for those with qualifying incomes. As a result, if kids were to lose CHIP coverage and go onto the individual exchanges instead, the federal premium subsidies would cost more than CHIP coverage. Though the political environment remains volatile, after a brief partial shutdown of the federal government, bipartisan support for the program continued and CHIP was reauthorized for six years as part of the continuing resolution that temporarily reopened the government. Medicaid/CHIP Enrollment (MMs) CHIP Children Medicaid Adult Medicaid Continued

2 U.S. Growth: What Tax Cuts Giveth, Will Fed and Inflation Taketh Away? President Donald Trump signed the Tax Cuts and Jobs Act of 217 into law on Dec. 22. The bill that emerged from the congressional conference committee wasn t what most had anticipated. The difference wasn t so much in the size of the cumulative tax cut and deficit increase, since the latter was capped at $1.5 trillion. The $1.65 trillion in tax cuts over the coming decade ended up increasing the 1-year deficit by $1.45 trillion, after accounting for spending reductions (mostly savings from not having to subsidize the previously mandated health insurance purchases of poor Americans). The difference was in the timing of the tax cuts, which were now more front-loaded. According to CBO estimates from Dec. 15, revenue will decrease by $212 billion in calendar 218 (1.1 percent of GDP) and by an additional $56 billion to $268 billion in 219. The revenue reductions subsequently start ebbing, with a big jump in 225 when the personal tax cuts expire. For 218, this generates a.4 percentage point boost to real GDP (employing a.4 multiplier), leading us to raise our forecast for U.S. economic growth from 2.4 percent to 2.6 percent (annual average). Previously, we had incorporated up to.2 percentage points of fiscal stimulus. This also leads us to pull forward the timing of Fed rate hikes in 218 and raise the net risk of more than three moves. Previously, we looked for a quarterly rate hike cadence to resume in June 218, following a six-month pause after December s rate hike (there was also a six-month pause after June 217 s rate hike). The downshifted cadence reflected increased Fed caution concerning: (1) running two policy normalization programs (rates and balance sheet) in tandem, particularly at the outset of the latter, and (2) uncertainty about inflation s recent underperformance and whether the idiosyncratic factors that dampened inflation this spring would wash out next spring. However, we now look for a March- June-December sequence, identical to 217 s pattern, with significant net risk of a September move. The more aggressive Fed posture reflects two factors. First, the unintended consequences of balance sheet shrinkage seem to be less of a Fed concern with the economy and financial markets buoyed by tax cuts. Indeed, the FOMC removed all references to balance sheet normalization in the Dec. 13 policy statement. We remain skeptical about a benign normalization process, particularly once assets start shrinking as much as $5 billion per month by next October. Second, upside inflation risks elicited by an economy growing at an even greater above-potential pace with no output gap (it closed in Q3 217 according to the CBO) and essentially at full employment likely ameliorate some of the Fed s inflation uncertainties. Interestingly, in the latest Summary of Economic Projections, the FOMC s median forecast for real GDP growth in 218 was revised up by a hefty.4 percent to 2.5 percent, factoring in fiscal stimulus along with stronger momentum heading into the year. The out-years also saw upgrades of a tenth or two of 1 percent. However, the inflation profile remained unchanged. It appears the Fed is betting that current secular disinflationary trends (owing to the likes of technology-enabled disruption and globalization) can continue countering cyclical inflation pressures and, perhaps, that tax cuts will spur more capacity growth. (Excerpted from BMO Capital Markets Economic Focus bmocapitalmarkets.com/economics/focus/recent/171222doc.pdf ) Potential Impact on Middle Market Businesses and Sponsors All signs currently point to higher and more frequent interest rate hikes in 218. The New Year will also usher in a new tax code which outlines a lower corporate rate and limitation on interest deductibility. For sponsor backed businesses benefiting from tax shields, the overall tax effect will likely be minimal. However, more deeply levered, full tax paying borrowers may feel the effect of the new limit on interest deductibility, especially as interest rates rise. Many sponsors have recently looked to interest rate hedging products to better manage this new dynamic. In the fourth quarter of 217, this drove an increase in private equity backed borrowers seeking interest rate protection in the form of swaps and locking into longer term LIBOR contracts for normal course borrowings. Sponsor 217 Hedging Strategies 1% 8% 6% 4% 2% % Swap 67% 33% Q1 Q2 Q3 Q4 Cap 73% 27% 73% 27% 36% 64% The changing financial landscape has and will continue to cause uncertainty in short-term interest rates. Transaction Trends 2

3 Market/Portfolio Trends Buoyed by solid market conditions, BMO closed approximately 9 new financings year to date, acting as the lead agent for roughly 75 percent, including LBOs, acquisition financings and dividend recap/financings. Average Pricing Spread over Libor for senior secured financings has remained in the 4.75 to 5 percent range as deeper senior leverage points have offset the flood of capital into the asset class in 217. The line between senior stretch and unitranche financings is blurring as senior stretch structures push deeper into the capital structure, resulting in a wider range of potential pricing from 5 to 6.5 percent. Leverage Leverage for senior/junior debt structures in aggregate remained range-bound in 217 with premium assets garnering higher leverage. BMO continues to support marque businesses with full leverage. The chart below reflects average leverage based on wide-ranging deal types completed by BMO, including various EBITDA sizes, industry verticals and other leverage-impacting details. LIBOR + Spread 5.1% 5.% 4.9% 4.8% 4.7% 4.6% 4.94% 4.75% 4.83% 4.87% X 3.58X 5.21X 3.76X 4.4X 3.33X 5.21X 3.59X 4.5% Q1 17 Q2 17 Q3 17 Q4 17 Q1 17 Q2 17 Q3 17 Q4 17 Senior Leverage Junior Leverage Purchase Price Multiples Healthy valuations are supported with full leverage structures and equity investments that rarely touch the minimum equity threshold. While all valuations have experienced an uplift in 217, a moderate separation has occurred as premium assets have seen a notable increase. Transaction Type The competitive nature of the market increased focus on add-on acquisitions with financings to support this activity up 27 percent in 217. The window for opportunistic financings remains open into Q Number of Observations X 6.X 7.X 8.X 9.X 1.X 11.X 12.X 13.X 14.X Purchase Price Multiple Add-On Acquisition...35% LBO...32% Refinance... 15% Dividend Recap... 11% Recapitalization...5% Other...2% Transaction Trends 3

4 Transaction Trends Food & Consumer Better-For-You Category Remains Popular with Strategics While the presence of strategic buyers within the food industry s better-for-you (BFY) segment is nothing new, financial buyers noticed an uptick in LBO auction competition in 217 for quality assets. As large consumer packaged goods companies (CPGs) scramble to find growth and reformulate their products with clean ingredients, they re paying sizeable premiums (upward of 2x EBITDA) for startup BFY brands popular with millennials. CPG brand executives acknowledge that small, niche brands have outmaneuvered them in innovation, marketing, speed to market and adaptability. Rather than develop new brands internally, these strategic buyers have targeted smaller, higher growth BFY companies to broaden their product portfolios and drive growth. Some large CPG brands have even set up their own venture capital arms to find and back the next growth concept adjacent to their existing core focus. Recent examples include Tyson Foods investment in Beyond Meat (a plant-based protein producer) and Nestle s acquisition of both Blue Bottle Coffee (a specialty coffee roaster and retailer) and Sweet Earth Foods (a plant-based food manufacturer) in late 217. Similarly, sponsors are setting up their own platforms to invest in these brands, but the competition remains steep even for early stage companies. The federal tax overhaul is expected to yield greater cash flows for corporations in 218, leading industry experts to believe that M&A volumes will remain robust within the BFY category. Where Has All the Data Gone? In its simplest form, e-discovery is the collection, processing, and hosting of electronically stored information (ESI) for legal proceedings, such as litigation and government investigations. The proliferation of devices (such as phones, laptops and tablets) continues to increase the amount of ESI, creating the need for an efficient solution to cull the relevant data for litigation matters. The e-discovery industry, estimated at approximately $4 billion, has experienced rapid expansion since 213 with annual growth of over 11 percent. It is expected that this level of growth will continue or even accelerate as the number of electronic communications and devices grows. Over the last three years, this hot segment has attracted significant private equity interest, given the inherent growth and potential for consolidation. Most notably in 216, sponsor-backed DTI merged with Epiq, the only public company in the sector. In 217, a number of providers came to market, each possessing a unique mix of services, technology and industry specialization. There are a few key areas to consider when reviewing these opportunities: Concentrations. Emerging litigation trends can impact the mix and volume of matters. Margin compression. Potential for increasing commoditization of hosting services. Service mix. Valuation and margin profile are impacted by mix of services, including managed review and legal process outsourcing. Customer mix. Paradigm shift to corporations procuring services directly instead of through law firms. Differentiation. Industry participants compete through service offerings and technology. Investment in the ediscovery industry is expected to continue with differentiated platforms of scale fetching double-digit multiples. Notable Better-For-You M&A Transactions Date Target Acquirer EV/Sales EV/EBITDA Jan 18 n/a n/a Dec x 21.2x Dec x 18.2x Nov 17 ~1.6x n/a Oct 17 ~12.x ~3.x Sep x n/a Aug 17 2.x 9.6x Jul x n.a Jul x ~2.x Jul x 21.2x Source: SDC for Food & Beverage; multiples per BMO estimates, press releases and filings. Specialty Chemical Sector Update The near-term outlook for the $55 billion global specialty chemical sector remains positive, with growth expected to largely track global GDP. Producers have benefited from low commodity prices in recent years, and overall efforts to rationalize operating footprints and refocus R&D efforts have enhanced margin profiles across the sector. The Asia-Pacific region has remained the primary driver of industry growth, which has been further augmented by a resurgence in North America and Europe. Megatrends such as global population growth, a rising middle class in emerging markets, energy efficiency and increasing digitization continue to represent core growth themes across many subsectors. These positive industry tailwinds, together with healthy valuations in the public markets and ample opportunities for consolidation, play across industries, and the supply chain drove M&A activity in the middle market in 217. BMO saw no shortage of add-on acquisitions, a handful of exits to strategics and a number of new platforms investments across its specialty chemicals portfolio in the past year. Specialty Chemicals Portfolio Data LTM Revenue Growth 14% LTM EBITDA Growth 1% Average EBITDA Margin 22% Average EBITDA Average Total Net Leverage 4.9x Maximum Total Net Leverage 6.5x $35 million Transaction Trends 4

5 About us Consistency, speed and surety of close are crucial when it comes to serving the needs of middle-market private equity firms. Whether it s providing capital for mergers and acquisitions, leveraged buyouts, recapitalizations or growth capital, BMO Sponsor Finance group works with you from initial review to ongoing portfolio management for reliable execution and follow-through with no handoffs. Let s connect Timothy Dana timothy.dana@bmo.com Aleen Hartje aleen.hartje@bmo.com Stephen Isaacs Head of Sponsor Finance stephen.isaacs@bmo.com Jennifer Kloud jennifer.kloud@bmo.com Adam Lively adam.lively@bmo.com Craig Munro craig.munro@bmo.com To sign up for current industry, economic, and business strategy content, visit our subscription center at bmoharris.com/subscribe 1 The Henry J. Kaiser Family Foundation, Extending Federal Funding for CHIP: What is at Stake 2 The Washington Post, 9 Million Kids Get Health Insurance under CHIP. Congress Just Let it Expire 3 Axios, Funding CHIP Would Save the Government Money, CBO Says 4 Georgetown University Health Policy Institute: Center for Children and Families, When Will States Run Out of Federal CHIP Funds? (January 218 Update) 5 The Henry J. Kaiser Family Foundation, Total Monthly Medicaid and CHIP Enrollment The opinions, estimates and projections, if any, contained in Transaction Trends are those of BMO Sponsor Finance as of the date hereof, and are subject to change without notice. BMO Sponsor Finance endeavors to ensure that the contents herein have been compiled or derived from sources that it believes to be reliable and which it believes contain information and opinions which are accurate and complete. However, BMO Sponsor Finance makes no representation or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions which may be contained herein and accepts no liability whatsoever for any loss (whether direct or consequential) arising from any use of or reliance on this report or its contents. Information may be available to BMO Sponsor Finance and its affiliates which is not reflected herein. This report is for informational purposes only, is not investment advice and is not to be used as a basis for any investment decision. This report is not to be construed as an offer or solicitation to buy or sell any security. BMO Sponsor Finance is a brand name used by Bank of Montreal and its subsidiaries. 218 BMO Financial Group (1/18) bmosponsorfinance.com