More than a decade after the U.S. federal government enacted the Health Information Technology for Economic and Clinical Health Act (HITECH), hospitals, ambulatory centers, and physicians have largely adopted technology such as electronic health records (EHR) software in time to qualify for Medicare and Medicaid incentive payments, as well as revenue cycle management (RCM) software. Rapid market penetration has contributed to the HCIT industry's high growth and high margins--and low barriers to entry have encouraged a multitude of small companies to flourish. This has made the industry relatively fragmented, despite the rapid ascension of some large players, such as Epic and Cerner.

We expect the coming five years to be characterized by a few key trends:

• Continued mergers and acquisitions that enable players to provide more complete offerings with additional modules and capabilities, as well as contribute to emerging standards of care.
• A continued transition from license to subscription revenues.
• A fierce battle for customers as they upgrade from legacy software.
• Greater clinical usage and monetization of data.
• Providers increasingly consolidating the plethora of HCIT vendors, further accelerating the move to standard platforms.

Greater consolidation and very high acquisition multiples mean that the industry will likely be characterized by very high leverage over the near to intermediate term, which could translate to less investment in technology platforms or more equity to fund transactions. It also remains unclear at this time which players will emerge as the winners from this fragmented market.

An Increasingly Critical Function

HCIT software solutions play an essential role in health care providers' operations, storing and transmitting customers' proprietary information and protected health, financial, payment, and other personal patient information. Health care providers are often hesitant to switch software vendors due to the sensitive nature of the information.

The HCIT market serving providers is largely divided into two main groups: EHR providers and RCM companies, though the line between them has become blurred. The increasing array of software and services provided, such as patient engagement, practice management, eligibility, care coordination, coordination of benefits, and payment integrity, are now critical for health care providers to improve clinical performance, collections, operating margins, customer service, and--ultimately--health care quality.

EHRs hold all clinical data, and increasingly additional data, including payments, insurance, and social determinants of health (SDOH).   With cyber security and the risk of data breaches, accompanied by potential Health Insurance Portability and Accountability Act (HIPAA) violations, at the forefront of their concerns, health care providers are averse to switching from one EHR provider to another. Switching systems is also an expensive and time-consuming undertaking for providers. Nevertheless, hospitals or ambulatory care centers may switch to match larger health systems after they've been acquired. Additionally, health systems may change to a vendor with a more complete product offering. Epic, for example, has replaced Cerner in multiple health systems because Cerner's RCM product has underperformed.

RCM vendors are increasingly focused on managing all financial interactions with payers and patients.   In addition to collecting receivables, they offer multiple functionalities, such as eligibility, claims submission, denials, and appeals, as well as patient engagement tools, care management tools, and population health and analytics. While health systems have largely outsourced EHR functions to software vendors, less than 50% of the addressable RCM market is currently managed by end-to-end vendors. Nevertheless, providers rarely take advantage of all a vendor's functionalities, retaining many different legacy vendors or niche best-in-breed solutions.

HCIT companies' rapid recovery from the COVID-19 pandemic demonstrated the increasingly critical nature of the industry. The pandemic led patients to defer elective procedures, resulting in a lower transaction volume for expensive medical claims. With the revenue of many HCIT companies tied to a percentage of customers' collected bills, several had weak quarters in 2020. Additionally, new contracts took longer than usual to ramp up, with health care providers focusing on their current operations and deferring large spending decisions. Nevertheless, most HCIT companies recovered as transaction volumes returned and providers increased their HCIT budgets once again. Health care providers may also see IT investments as a way to increase volume and collections, for example through solutions that verify insurance coverage, remind patients to schedule and arrive to appointments, and shorten intake time.

From a credit perspective, though software markets generally have low barriers to entry, intellectual property rights, long-term contractual arrangements, client relationships, and high switching costs and cross-selling capabilities can serve as barriers to entry in the HCIT market. We consider large software companies that offer end-to-end solutions for both EHR and RCM, and those that have begun utilizing and monetizing data to provide additional analytics solutions, as significantly more competitive than their peers. Finally, we view the market share of software vendors as a competitive advantage in the market--certain software providers have large enough market presence that others are forced to make their offerings compatible with theirs.

Data Analytics: The Next Frontier

Until recently, gathering data and storing it so physicians and patients can access and share it seamlessly has been a goal on its own. Software providers have also looked for ways to cross-compare clinical outcomes or collection rates across health care systems or geographies. To advance the value of their products and embed them further in their customer's operations, we expect HCIT providers to race to find additional information the data provides when aggregated, find additional clinical uses, and monetize this treasure trove using intelligent automation to analyze the large volumes of medical records. Given the time it takes to develop new modules and the speed to market required in this competitive space, we expect HCIT companies to favor acquisitions of software modules that provide entry and competitive advantage in the data analytics market. As a result of active merger and acquisition (M&A) activity and high acquisition multiples, we expect leverage to remain elevated and cash flow constrained.

Population health management

These analytics are also essential in improving population health measures and helping the transition to value-based care from fee-for-service. We expect this transition could accelerate, partially due to the weaknesses in the health care system exposed by the pandemic. For example, adults with low incomes have a higher risk of serious illness if infected with coronavirus, as they are more likely to have chronic conditions. There has over the past several years been greater realization in both the public and private sectors that SDOH factors such as employment status, physical environment, and access to food and transportation contribute significantly to health outcomes. By adding SDOH information into the EHR, algorithms can identify primary care patients who may need additional services and allow care providers to make referrals and connect patients with community resources and social services that support health and wellbeing outside of hospital and clinic settings (see "Treating The Cause, Not The Symptoms: How Societal Factors Are Starting To Shape U.S. Health Care," published Aug. 5, 2020).

Chronic care management

To meaningfully improve the health of patients who regularly utilize significant medical resources, the Centers for Medicare and Medicaid Services is encouraging greater adoption of value-based and primary care-focused ways to improve care management (including a significant increase in reimbursement for chronic care management services). Providers are focusing their efforts on keeping people healthy and out of the hospital using new technology for remote patient monitoring and other ways to routinely check in with patients with chronic conditions. For example, Project Ruby (doing business as WellSky) recently announced it will work with The Ohio State University Wexner Medical Center to implement in-home heart failure care protocols intended to reduce hospital readmissions for patients discharged after admission for heart failure, a leading cause of hospital readmission in the U.S. The WellSky protocols leverage technology from Sensible Medical that allows clinicians to view the inside of the lungs of heart failure patients and quickly assess their lung fluid, enabling customized care interventions.

Suggested diagnostics

While technological challenges still exist, providers and researchers can now use machine learning software to mine the de-identified electronic health records of millions of patients and identify comorbidities, demographic variables, procedures, and medications that could be early predictors of future health issues. In the next five years, we expect EHR providers to increase their efforts in these mining and analysis capabilities, which could help influence patient care by assisting physicians in decision-making using all pertinent information available in the EHR. While the clinical community may take time to adjust to automated suggestions, EHRs will increasingly be able to offer prescriptive analytics, which could go beyond simple descriptive information and suggest diagnostics, patient clinical protocols, and patient follow-up treatments. Although software contributing to clinical decision-making could open the door to liability, we believe liability for software vendors will be limited. Vendors will offer suggestions only and doctors remain the ultimate decision-makers. This advanced software also has the potential for more timely disease recognition and ultimately more efficient and effective treatment.

Clinical trial optimization

The EHR contains data that can identify potential clinical trial participants, opening a new end market: life sciences and pharmaceutical companies. We expect EHRs to facilitate trial recruitment, aggregating and monetizing their existing data and potentially finding ways to incorporate additional data such as genomics, lifestyle, and behavior, as well as wearable device data, for clinical research and trials. EHRs can also take advantage of their interaction with health care professionals to suggest clinical trials for potentially qualifying patients.

Precision medicine

While the emerging field of clinical genomics is still in the early stages of clinical application, we expect EHRs to play a role in bridging genomic information with health care records. Specifically, clinical genomic data is expected to help diagnose patients and assist clinical decision-making, offering additional information to the clinician at the point of care. Nevertheless, because this requires significant investment and new complex data collection, we view this as farther off than the rest of the data advances we expect from EHR companies.

Favorable Business Prospects And Low Debt Costs Have Led To High M&A

Capital structures have become gradually more aggressive, with high debt-to-EBITDA ratios and very modest cash flow. Leverage has been increasing materially as financial sponsors pay high multiples for leveraged buyouts (LBO) of software companies. LBOs are often followed by a rush to acquire add-on modules and other analytics solutions to existing platforms that often produce little EBITDA at first. Software companies often seek to acquire targets that will add capabilities difficult to build organically, provide cross-selling opportunities, or gain exposure to fast-growing segments. These targets often have very high valuations and may contribute little profit or cash flow for several years.

One of the largest LBOs was private equity firms Bain Capital and Hellman & Friedman's January 2022 acquisition of EHR and RCM software-as-a-service (SaaS) software provider athenahealth Group Inc., one of the larger players in the industry, from Veritas Capital and Evergreen Coast Capital for about $17 billion. The announcement came nearly at the same time as Oracle announced an agreement to acquire Cerner Corp. for nearly $30 billion, International Business Machines Corp. announced plans to sell part of its IBM Watson Health business to private equity firm Francisco Partners, and Microsoft Corp. announced its intentions to acquire Nuance Communications Inc. While both EHR and RCM vendors have long acquired competitors or vendors with capabilities they've targeted, both may have become targets of new entrants into this attractive market. We believe M&A will continue to be a theme for this fragmented industry, especially as larger HCIT players and more established standards emerge.

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Leverage And Financial Policies Could Limit Upgrades For Rated HCIT Companies

Most HCIT companies are rated 'B-', which indicates that these companies operate with very high debt levels that push the limit of sustainability, but often have uniquely solidified competitive positions due to the essential roles they play for health care providers, unique intellectual property, high recurring revenue, high risk and costs associated with switching vendors, and low capital intensity.

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We have taken relatively few negative rating actions in the industry, reflecting the already-low ratings and our expectation that many companies have high recurring revenue sources that are resilient during downturns and that their offerings do not face significant technology transition risk. Recurring revenue and high retention rates provide strong visibility into future revenues, with large percentages of revenue under multiyear contracts. To add to that, low capital intensity allows for consistent cash flow production, even at very high leverage.

Additionally, many industry participants have largely evolved from license revenue to SaaS already, lowering their back-end costs and allowing them to manage hardware and maintenance more efficiently. The shift has also allowed customers to scale applications more easily across their health systems and get quicker access to the latest updates and modules, allowing software companies to quickly cross-sell acquired products to their existing customer bases and collect synergies from their investments.

Most of our rated companies are small participants in the highly fragmented HCIT market, which includes companies with significantly greater scale and financial resources. We expect continued consolidation among HCIT providers will further increase the scale and margins of some market participants, though often at the cost of a leveraged balance sheet. Our view of these companies' business risks is generally differentiated by scale, market share, capabilities, addressable markets, as well as operating efficiency and profitability levels. These competitive positions will be increasingly differentiated as M&A continues and the industry matures.

The debt of the HCIT companies we rate has been consistently increasing. This indicates they will have to pay higher interest in the future, which we expect will affect their cash flows and ability to compete in a rapidly changing environment, tying up significant cash flows for debt servicing.

Overall, leverage of private-equity-owned companies will likely continue increasing steadily as the still historically low borrowing costs incentivize companies to raise debt for investments. We expect excess cash will be diverted toward acquisitions, growth opportunities, or other shareholder-friendly activities, given the private equity ownership of most of these companies. Nevertheless, due in part to low capital intensity, we believe the HCIT sector is consistently able to produce free operating cash flow despite high leverage.

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Related Research

• Trouble Ahead: Higher Interest Expense Strains 'B-' Rated U.S. Health Care Credits, Sept. 29, 2022