The high price paid for Medical Director may not be a good thing for the future of the company
Sold to private equity for $155m, currently making close to $20m a year on a 50% profit margin, and without Telstra by it’s side, Medical Director, the patient management software on half our desks today, might struggle to survive the march of digital disruption
Asian private equity group Affinity Equity Partners’ agreement to pay $155 million to Primary Health Care for Medical Director begs a few questions on behalf of the users of the GP software system after which the company is named.
Previously called Health Communication Network, Medical Director includes a string of other businesses including a health information service and some back-office GP software. But the key profit maker and key product is the Medical Director software, which sits on half of all GP desktops in Australia.
The price (the deal has yet to be fully consummated) is about eight times the current earnings (profit) before you deduct interest, tax, depreciation and amortisation (EBITDA). As far as the sale of similar companies go, that isn’t out of the park by any means. You can pay up to 20 times for digital-darling type companies like Xero, but Medical Director isn’t one of those.
Medical Director, the software, not the company, might be described as internet 1.0 and we are probably up to about internet 3.0 in terms of the web now. Its base software technology is more than 15 years old and it is not architected for today’s web, like say Xero’s cloud based accounting software is. That doesn’t make it a bad bit of software, but it does offer some challenges for the buyers, and potentially in the near future for the users, if the new owners aren’t either smart and focused – or lucky.
So what issues face Medical Director ? And what elements of Medical Director, as a business, exist that give it a chance of succeeding and maintaining at least its approximate 50% market share of GP use and selling in five years or less for a much higher price?
Issue 1: 50% profit margin, high price
Private equity general operates on three simple principles. Buy low , change things to either make the profit much better so if you resell at the same multiple you get a lot more ,or ,transform the proposition of the company to make the profit (EBITA) multiple (currently 8 times), much higher (like say 15 times) because the company has a changed future for the better. Ideally they’ll do both of the latter – and sell very high.
There are a few issues here for Medical Director. Affinity didn’t buy that low according to most analysts. But let’s say they did. Medical Director today has a profit of nearly $20m at a margin of 50%. That sort of margin is unheard of in most businesses and generally very hard to maintain.
The only route for Afffinity given these the options of buy low and improve the profit are out or unlikely, is to transform the value proposition of company. The possible issue with that is that in the not too distant future Medical Director is likely to face stiff competition from digital disruptors using cloud technology, just as Xero used the cloud to disrupt MYOB. To stave off these wantabee future market leaders Affinity will need to invest and they need to do it almost immediately. After that they are going to need to perform a rarely seen miracle: transformation of a long time highly profitable and dominant incumbent. Alternatively they are going to need to cosy up to one of the newcomers who are ahead of them in designing for today’s cloud and eventually buy or merge with one. Either way they are going to need to stump up a lot more money not that long after they just paid a price that most analysts feel is at the top end of the scale.
But try and keep throwing off $20m each year at a 50% margin while investing and transforming your company and keeping staff and your PE bosses happy. At least they aren’t public anymore so they don’t need to worry so much about the financial press and public perception, but it’s not going to be easy.
Issue 2: Synergy
Telstra was in the market for Medical Director, but pulled out at the last minute due to senior management not backing the deal (see Telstra story on page 16). Telstra had a lot of clout and synergy to bring to Medical Director, which is probably why Primary was rumoured to be strongly supportive of the Telstra offer even though at $50 million for 50% it was a lot lower than $155 million for the lot. Industry insiders even say that Primary preferred the Telstra offer because they saw the value of joining with Telstra and expanding the Medical Director brand using Telstra Health, Telstra network services and the Telstra brand. Telstra and Primary would have offered quite a bit in the way of supporting assets for Medical Director to make the leap it probably needs to survive and thrive.
With Telstra out Primary had to drop the idea of holding on to at least of half the asset and building it along with Telstra. There were no ‘strategic buyers’ left who could help a lot. The $155 million for 100% must have been very tempting, especially given that when Primary tried to sell the Medical Director business two years ago, it’s rumoured they struggled to get offers above $100 million.
So what does Affinity bring in synergy? Compared to Telstra, very little. They say they have software development experience, but medical software is complex, fickle and very localised.
Issue 3: The ‘network effect’
If you’re not on the cloud, you’re not connected. Though the cloud has its scares and issues, it is secure and it does work. It’s the emerging infrastructure of nearly all smart companies. Even the small group that pumps out Medical Republic has all it’s systems on the cloud. And as to the matter of trust, just ask Amazon, Xero, or any big four bank if they think the cloud today is insecure.
A true cloud patient management system will let you connect to other doctors in your surgery, in other surgeries, to your patients, your service providers, the government ,specialists and more. It’s cheap to install and run, it’s device agnostic it’s fully mobile. And here’s the prize if you’re first in and good enough. Soon all these groups will start to become interdependent on your connecting infrastructure. For one group to efficiently talk to another in the network they’ll need to change to the standardised network (your network). You might even find patients start demanding it, like they are doing with Uber and other cloud disruptors who are making things easier and more efficient for pesky consumers.
As this interdependency grows, you get what is termed a ‘network effect’, which is when groups increasingly rely on each other and the network provider becomes stronger and stronger . Eventually the network is an ecosystem that you can’t afford not to be on. If a cloud competitor gets to that before Medical Director, then Medical Director will be in big trouble. So will Best Practice and all the others for that matter. Modern examples of network cloud based businesses that wiped out predecessors include Google, Facebook and eBay. If you’re a little bit older you will remember how Microsoft Office wiped out Wordperfect, Lotus and a few others by packaging their product and making businesses dependent on being able to talk the same language for word processing and spreadsheets.
Issue 4: Being incumbent
No matter where you look, if you are a leading incumbent company and making a lot of profit, as Medical Director is, it’s very hard to make the changes needed to compete with nimble digital and cloud-based competitors. You have to meet profit expectations while turning your company upside down and bucking multiple belief systems. Head of Telstra’s digital transformation, Gerd Shenkel told TMR ,” if you aren’t in front of that curve today, you are already probably already dead in the water. We wake up paranoid every morning and know we are the fight of our lives here to even keep our heads above water.”
Upside 1: Good brand, Share and history
OK, it’s definitely not all doom and gloom here. Medical Director possibly remains the pre-eminent GP brand in patient management. It’s a toss-up between them and Best Practice. The management team is reasonably stable and there is good corporate memory. Senior managers are confirmed as coming with the acquisition, providing continuity and therefore a platform for building and change. In addition they have a lot of market share – probably as much as 50%. That is going to buy them some leverage with their customers while they try to change.
Upside 2: Private Equity usually isn’t dumb
Despite what you see in the movies, when you’re inside private equity (which I have been), you’d be amazed at how smart and focused they can be – they love money yes but in the journey to making it they surprise you with how subtle and clever they can be on that journey. They certainly aren’t dumb. And they usually don’t go into a deal like this one without additional capital and a good plan. This combination can often set a company free that was stuck in a company that could not or would not allow it to realise its potential.
Affinity want to make a company they can sell for a minimum of about $500 million in five years or less. For that much money something usually has to be really flying or be in a position to fly. That’s what Affinity will be trying for and you can be sure they didn’t pay that much money without deeply thinking about what ‘flying’ would look like and what they’d need to do to get there. They might get there.
Upside 3: STILL time to change
If you’re a Medical Director user, don’t worry too much just yet. This saga has a long way to go. The cloud-based groups trying to compete with Medical Director, Best Practice, Genie and all the others are in their infancy. And analysts’ best guess is they will need a good year or two to make an impact on the incumbents. At that point, either the incumbents will buy one of the newcomers or they will have performed the rarely seen incumbent-company transformation.
If they don’t do either they will end up like Kodak, which developed the first digital camera but failed to see this future and act on it. They will become victims of digital disruption. Even then, you’ll have a couple of years to change over. But change over – to a modern cloud system – you eventually will.
Disclaimer: Jeremy Knibbs who is the TMR publisher, owns 0.8% of MediRecords which is a cloud-based patient management system company. He has also worked with Medical Director off and on since 1989.