In the continuation of a trend this summer, population health management vendor Evolent Health acquired the majority of one of its competitors Valence Health, for $145 million. Valence Health has a broad suite of services including, value-based administration, population health and advisory services for mid-size provider organizations making the transition to value-based care. The acquisition fills a few gaps in Evolent’s current offering while concurrently providing Evolent an opportunity to serve a broader swath of the market.

Valence Health serves over 600,000 lives across 10 clients including the University of Chicago, Cincinnati Children’s and North Shore. This new combined entity is expected to serve more than 1.8M lives across 23 operating customers – about a 50% increase in lives from the 1.2M lives and a 77% increase from the 13 operating customers currently under Evolent.

The acquisition raises two broader questions about the current state of the PHM market in the U.S. The first is what is the rationale behind this deal:

Why was Valence Health sold?

• Not meeting aggressive growth targets: This answer to this question is fairly straight forward. Valence Health has underperformed expectations recently. The company was widely publicized as expecting to do $140-145 million of revenue in 2016 with an annual growth rate of 20-30%.

Evolent is only buying the part of Valence that focuses on provider-sponsored health plans. It supposedly was offered and did not want the legacy Cicerone business focused on insurance co-ops. Even if you assume the high end of the $80-85 million of revenue Evolent expects Valence to do this year and add $35 million for Cicerone, the combo is $20-25 million short of what was originally expected for 2016.

The majority of the revenue shortfall is likely to due to the Cicerone business, given that about half of the insurance co-ops have shut down and many others are struggling to stay in the black. However, the core Valence business that Evolent is buying does not seem to have very diverse growth among its existing client base or adding many new clients in 2016.

Why did Evolent Health make this deal?

• Profitable sooner: Due to the transaction, Evolent expects to achieve an adjusted EBITDA break-even earlier in 2017 by a quarter or two, which is important to investors and shareholders.

• Expanded service capability and expertise: Roughly 75% of Valence’s business is providing back-office technology/services needed to run health plans for provider organizations. Evolent currently outsources this function to UPMC for Medicaid lives and Evolent collects low-margin third party administrator (TPA) fees. We expect Evolent to transition those services from UPMC to Valence Health allowing Evolent to capture additional top-line profit on what was largely a pass-through cost to UPMC.

Valence could help Evolent be a very low cost provider of TPA services that it uses to leverage and win broader population health deals with health systems and IDNs or be used to provide TPA services for all the health plan lives (Medicaid, Medicare and Commercial) that a provider covers.

While there may be concern about this undermining Evolent’s relationship with UPMC, both parties have already accomplished the primary goal of this relationship (commercializing the UPMC population health platform via the creation and broader adoption of Evolent’s solutions) and UPMC has already embarked on ventures with other quasi-Evolent competitors in population health.

Evolent also acquires over 600+ outsourced case and care managers as part of the acquisition which will give them additional capacity to serve existing and new clients with their outsourced care management and care coordination offerings.

• Cross-selling opportunities: While 75% of the Valence business is TPA, the other 25% is estimated to be a split – 10% non-recurring implementation and consulting engagements and 15% recurring technology and consulting engagements that are focused on building and managing physician networks. Valence has 90+ customers that apparently do not use it for the core TPA services, but rather technology and consulting around population health.

This should create a foot in the door for Evolent to try to sell its broader platform and services including (e.g., pharmacy services, additional IT capabilities, etc.) into the Valence client base. Evolent would possibly transition clients onto its Identifi platform from Valence’s Vision solution, although that might just be the estimated 10-15 clients that are using analytics on top of the TPA services.

Evolent does not plan to market the Valence Vision platform as a standalone solution, but it would be surprising if it were shut down for software-only clients anytime soon. There may also be large parts of the Vision platform (specifically around pediatrics) that are re-written onto Identifi.

Aside from the 90+ non-TPA clients, it is worth noting that Valence signed a co-marketing agreement with Aon in January. It is expected Evolent would try to maintain this relationship given that Aon apparently advises 500+ hospitals on benefits for the employees they self-insure. That self-insured population is typically the first cohort of lives that Evolent takes on when engaging with a new provider client.

Broader implications for the PHM market

While there seems to be nearly an untapped potential in the PHM market, this deal should pose as a cautionary sign for vendors especially those that are promising their investors high double digit annual rates of return. While the long-term market opportunity may be huge, near-term it remains small with most HCOs dipping their toes into PHM. This may have contributed to Valence Health’s revenue hiccup this year and subsequent sale. Even Cerner, a company that has done a very good job of marketing and selling its Healthe Intent platform, admits that sales, while robust, by and large remain on the smaller side in terms of covered lives and revenue.

Which also highlights another risk Valence likely saw – the entry of larger, well-financed companies into the PHM market that have the resources to be both patient and gradually scale over time. The Valence acquisition and the Wellcentive-Philips deal that came after are both indicative of a market that is beginning to coalesce around a smaller number of vendors that have the scale and breadth of capabilities to enable a HCO’s PHM strategy.

It also shows that if vendors really want to be able to command a larger PPM fee (>$10M PPM) from their larger provider clients, they need to have a broad set of capabilities and solution offerings to serve different patient populations and meet the varied needs of their provider clients especially the growing Medicaid market.