Hospital bed and medical supplier Hill-Rom Holdings hit an unexpected obstacle in its path from hospital bed-maker to digital medical device and analytics company.
The Delaware Court of Chancery won't let Chicago-based Hill-Rom, which now goes by Hillrom, out of its $375 million deal to buy Bardy Diagnostics, despite Medicare's decision to significantly cut payments for Bardy's wearable cardiac monitor.
Hillrom intends to appeal the ruling, but the episode underscores the perils of acquisitions in an industry that's heavily dependent on the public and private insurers that pay for medical products and services in the U.S. And it comes at a pivotal time in the company's digital transformation.
The Bardy acquisition was supposed to advance CEO John Groetelaars' strategy for rekindling growth after years of sluggish sales in Hillrom's largest business unit, which includes hospital beds. Aside from a one-time bump during the depths of the COVID-19 pandemic last year, demand for beds slowed as hospitals provided more services on an outpatient basis. As a result, Hillrom's revenue grew just 2 percent to $2.9 billion in 2019.
Traditional equipment sales are expected to resume their pre-COVID trajectory as the pandemic ebbs. To compensate, Hillrom continues to add more digital capabilities, including smart products that collect and transmit patient information.
"In the med-tech world you're valued based upon the growth rate of your company," says KeyBanc Capital Markets analyst Matthew Mishan. "With its new product portfolio and acquisitions, [Hillrom] is attempting to improve and sustain a more durable level of revenue growth."
Hillrom's third-quarter earnings report due July 30 will give a clearer picture of the company's post-pandemic growth prospects. Investors are bracing for a slowdown from third-quarter 2020 revenues, which included roughly $130 million in one-time COVID-related sales.
More telling will be results from Hillrom's newer business lines. Strong sales of advanced products and services have helped drive Hillrom shares up 17 percent to $115.20 year to date. Groetelaars has predicted more of the same.
"Despite a tougher comparison in our third quarter, we are on track to exceed our objective of $620 million in new-product revenue for the fiscal year," Groetelaars said during the latest earnings call, noting that the company planned to launch 10 new products in 2021.
Revenue from new products, like a digital device that helps clinicians diagnose ear and eye conditions, grew 20 percent to $160 million in the second quarter. Connected care and digital products account for nearly one-third of the business today, Groetelaars says in an interview.
This isn't the first time Hillrom, which spun off from Hillenbrand Corp. in 2008, has reinvented itself. The company started to shift beyond hospital equipment when it bought point-of-care diagnostics company Welch Allyn for $2 billion in 2015. It looked to further shed its reputation as a health care furniture maker in 2019 when it divested a host of "noncore assets," including its German hospital bed business, and rebranded with the tagline "advancing connected care."
The diversification "became even more relevant when the pandemic hit, [highlighting] the importance of connectivity, virtual interactions and using technology to elevate traditional medical devices," Groetelaars says.
As part of its strategy to "advance connected care," Hillrom in January agreed to pay $375 million for Bardy and its Carnation Ambulatory Monitor, which was priced at $365 per patch. In a statement announcing the deal, Groetelaars said the acquisition would provide "an attractive recurring, high-growth revenue stream and gross margin profile."
That was before a Medicare contractor cut the price it pays for the device by 64 percent. The cut sent Bardy's first-quarter revenue down 11 percent.
Hillrom went to court, arguing the change constitutes a "material adverse effect," entitling it to cancel the acquisition. The judge disagreed, finding the cut doesn't have a "materially disproportionate impact" on the company compared with its rivals.
Additionally, Hillrom acknowledged the reimbursement rate risk when it structured the deal to include a risk-shifting earnout with a lower upfront purchase price, down from an earlier offer of $450 million, the ruling said.
"There's going to be a lot of lobbying by [extended home-care monitoring] companies to try and get the payment back up, but that's a couple years away and it's unclear if it will happen," says Needham analyst Mike Matson.
Groetelaars says the Medicare reimbursement change, which isn't expected to influence rates paid by commercial payers in the short term, affects about one-third of Bardy's revenue.
"For Hillrom, the amount of our revenue that's actually exposed to reimbursement from commercial payers or Medicare is relatively low — it's less than 10 percent of our total revenue," Groetelaars says. "But having an expert network and having a very clear working knowledge of the process around establishing reimbursement and sustaining reimbursement is really important. We do have those capabilities."
Hillrom has been focused on buying high-growth businesses like Bardy that can increase total revenue by 1 or 2 percentage points, analysts say.
Even though Bardy is a relatively small deal overall, it "could be a headwind now if they have to move forward with it," Matson says.
Still, Hillrom's connected-care portfolio is on track to represent roughly 30 percent of total revenue this year, or nearly $1 billion, Groetelaars says, noting that devices that collect and transmit patient data are the company's fastest-growing products.
Growth stalled during the early days of the pandemic as doctors postponed nonemergency visits and people avoided medical care, but the segment is recovering quickly.
"Now we're refining our strategy and making sure we're clearly pointed to where the public is going in the future and that we're positioned to come out even stronger than we came into the pandemic," Groetelaars says.