Healthcare Finance: ROFO and ROFR Agreements in Acquisitions

1. Healthcare Finance:  ROFO and ROFR Agreements in Acquisitions Ashok Bhardwaj Abbott, Ph.D., Focus on Healthcare  Consulting  Seminar Series National Association of Certified Valuators and Analysts Thursday, December 6, 2012

2. Ashok B. Abbott is an Associate Professor of Finance at West Virginia University in Morgantown, West Virginia. Professor Abbott received his MBA in Finance at Virginia Polytechnic Institute and State University (VPI&SU) in 1984, followed by a Ph.D. in finance also at VPI&SU, in 1987. His Ph.D. dissertation title was "The valuation effects of tax legislation in corporate sell-offs".  He has published extensively in scholarly research journals and made presentations at national and international conferences. He serves on the editorial boards of The Business Valuation Review and The Value examiner. The Small Business administration recognized Professor Abbott as the Small Business Advocate-Journalist for the year 2002. His focus area of research and consulting in valuation is the level of price adjustments (discounts/premiums) appropriate for liquidity, marketability, and control attributes of the interests being appraised. Professor Abbott consults for valuation divisions of well-known firms, such as Standard & Poor's, Duff & Phelps, Willamette Management Associates, Houlihan Valuation Advisors, among others. He has served as an expert witness in the business valuation arena for 15 years. You can see his full CV at www.be.wvu.edu/faculty_staff/cv/ashok_abbott_cv.pdf.

3. Health Care Expenditure ( $ Billions)

4. Annualized Growth Rates

5. Health Care Utilization Evolution

6. Changing Utilization Patterns • Hospital admissions as a proportion of the population have declined. • Average length of hospital stay has declined. • Outpatient visits have more than doubled. • Physician offices are gatekeepers of hospital admissions.

7. Market Consolidation

8. Growth through acquisition • Physician practices are being acquired at a rapid clip by • hospitals, • private equity firms, • and health insurance companies. • Physician office consolidation is growing at rates approaching eight times the consolidation of healthcare facilities.

9. Consolidation Trends in Healthcare • Healthcare industry is moving towards an integrated model as a survival strategy. • Revenue squeeze is accompanied by cost escalation. • Economies of scale and scope are being explored aggressively.

10. Vertical Integration

11. Acquisition Déjà Vu • Is 2010 a repeat of 1990? • Not quite • Contractual problems were rampant in the HMO creation boom of 1990s. • Acquisitions in 2010s are being made with substantial contractual safeguards. • First purchase rights are being used increasingly in healthcare acquisition negotiations.

12. Health care acquisition landscape • Healthcare acquisitions are subject to considerable regulatory hurdles. • Anti-trust challenges are being used to block potential acquisitions. • Competing acquirers are using regulatory challenges to gain competitive advantage • Such actions increase transaction costs making acquisitions less profitable.

13. First Purchase Rights • Healthcare acquisitions are motivated by strategic considerations. • Wealth gains are expected as a result of the acquisition. • Value of anticipated gains from acquisition is incorporated in the acquisition negotiations. • First purchase rights are being acquired to gain competitive advantage.

14. Two forms of first purchase rights • First Purchase rights can take the form of • Right of first offer (ROFO) • Right of first refusal (ROFR) • These are rights to purchase the asset but do not obligate the holder to purchase the asset at the offering price. • ROFRs restrict marketability because they discourage third parties from engaging in the time, effort, and expense of due diligence regarding investment in the asset.

15. Right of first offer ( ROFO) • A right of first offer requires the owner of a property to let the right holder make a good faith offer to purchase the subject property; if the owner rejects that offer, the owner can sell the property to a third party only at a price above the one offered by the right holder. • ROFO right holder has the first mover advantage.

16. Strategic considerations in ROFO • Right holder gets to set the bar. • Right holder can set the minimum price payable by a potentially competitive acquirer. • If this price is set high enough it can preclude the competitor from making an offer • The owner of the asset has the ability to get a higher offer. • Right holder gets one shot.

17. Right of first refusal (ROFR) • A right of first refusal requires the owner of an asset to offer the property to the right holder on the same terms as those offered by a third party before the owner can sell the property to a third party. • ROFR right Holder has the last mover advantage.

18. Strategic considerations in ROFR • Right holder gets to see the bar and clear it. • Right holder can meet and marginally exceed the maximum price offered by a potentially competitive acquirer. • The existence of this second chance can preclude the competitor from making an offer • The owner’s ability to get a higher offer is restricted. • Right holder gets the final shot.

19. Comparing ROFO and ROFR • ROFO is exercised with limited information as the competing bid is unknown. • Right holder has to anticipate the highest competing bid and place a marginally higher bid on the block. • Competing bidder can outbid the opening bid marginally to win the transaction. • Owner of the asset can use ROFO as a bargaining chip. • ROFO has value , though limited, to the right holder.

20. Comparing ROFO and ROFR(contd.) • ROFR is exercised with full information as the competing bid is known. • Right holder has to place a marginally higher bid than the known, competing, bid on the block. • Competing bidder cannot outbid the closing ROFR bid to win the transaction. • Owner of the right can use ROFR as a bargaining chip. • ROFR has value to the right holder which is higher than the value derived from ROFO.

21. Pricing first purchase rights • First purchase rights are valuable. • Owner of the asset gives up an opportunity at an open auction restricting marketability. • Right holder is not obligated to make the highest possible offer. • Right holder has to only beat the next best offer.

22. Valuing first purchase rights • ROFO and ROFR are valuable. • ROFO allows the buyer to make a bid for the asset and can be valued as a simple call option. • ROFR allows the buyer to buy at the highest price achieved for the asset and can be valued as a look back put.

23. Valuing first purchase rights • First purchase rights are valuable when right holder is likely to value the asset more highly than a third party and/or a third party is likely to value it more highly than seller.

24. Option Model Implementation • The exchange option, first developed by Margrabe (1978), has proven to be an extremely powerful generalization of the Black-Scholes model. • ROFO and ROFR contracts can be modeled and priced using Margrabe equations.

25. Questions? Please do not hesitate to contact us for any clarifications. Ashok Bhardwaj Abbott Ph.D. MBA Email abbott.ashok@gmail.com Phone 304 692 1385