By Costanza Bassano and Francesco Tenti
“Ten years ago only a few private-equity houses had dedicated health-care teams,” says Dmitry Podpolny of McKinsey. “Today nearly everyone does.”
According to PitchBook, 715 private equity deals in 2018 had closed as of mid-December for a combined value of $103.72 billion, which represents a considerable increase, in terms of overall monetary worth, compared to the three years prior at $88.87 billion, $70.5 billion and $31.52 billion respectively.
Healthcare stocks were among the best performers of 2018, attracting not only private-equity funds but also institutional investors, asset managers, tech-focused funds and corporate buyers. On February 25, Roche, the Swiss drug group and a market leader, announced its recent acquisition of Sparks Therapeutics for $4.8 billion, paying a shocking premium to get its hands on a promising biotechnology company demonstrating the positive outlook of the market on the healthcare industry.
Regarding PE firms specifically, 2018’s 3 biggest deals according to PitchBook were:
- Envision Healthcare; $9.9 billion; KKR:
Envision Healthcare Corporation is a leading provider of physician-led services, post-acute care and ambulatory surgery services. As a result of the completion of the merger, Envision has become a wholly owned subsidiary of funds affiliated with KKR, and Envision stockholders received an amount in cash equal to $46 per share of Envision common stock, representing a 32% premium.
- Athenahealth; $5.7 billion; Veritas Capital, Evergreen Coast Capital:
Athenahealth is a leading provider of network-enabled services for hospital and ambulatory customers in the United States. Private equity firms Veritas Capital and Evergreen Coast Capital, the private equity subsidiary of Elliott Management, acquired Athenahealth for approximately $5.7 billion in cash at $135 per share, a premium of 12.2%. In February 2019 Veritas and Evergreen combined Athenahealth with Virence Health. “This combination creates an industry leader poised to drive the future of healthcare IT”, says Isaac Kim, Evergreen Managing Director.
- LifePoint Health; $5.6 billion; Apollo Global Management, ATP Private Equity Partners, RCCH HealthCare Partners:
LifePoint Health is a leading healthcare company based in Tennessee which is dedicated to Making Communities Healthier. It is an organization of affiliated entities that own and operate hospitals and other healthcare providers in more than 70 communities. LifePoint Health merged with RCCH HealthCare Partners which is owned by certain funds managed by affiliates of Apollo Global Management. As a result of the merger, LifePoint’s shareholders received $65 per share in cash for each share they owned. This represented a premium of approximately 36% to LifePoint’s closing share price on July 20, 2018.
Below there is a Pie Chart representing the percentage of the total combined value in 2018 (103.72 billion) related to the 3 major deals.
The impact of downturns on PE healthcare’s investors
The growing interest in this industry is mainly driven by its economic performance over the past years. America’s healthcare market has grown faster than GDP during the last decades and annual spending on it is now around $3.5 trillion. In periods of economic uncertainty, investors see holdings in healthcare businesses as an effective defence. Looking at funds in the ten-year period following the financial crisis of 2008, the best performing specialist funds were those that primarily invested in the biotech and the healthcare sector.
In light of concerns regarding a slowdown in the economy, firms have been focusing their diligence on downside scenarios, especially on what holds up well through the cycle. Healthcare covers a wide range of businesses. Therefore despite it being a sector that is generally viewed as recession resistant, there were sub-sector differences in performance that investors would have to be aware of. For instance, some businesses provide services to hospitals and physicians, to insurers, and to drug companies; others supply products such as pharmaceuticals, medical technologies, and biotechnologies. Naturally, profit pools, margins, and growth rates vary widely among these sub-sectors, reflecting the variety in the risk-return profiles. According to CEPRES, healthcare support services produced multiples greater than two times invested capital, whereas healthcare equipment, facilities and pharmaceuticals produced multiples of 1.0 to 1.5 times invested capital (see figure below, Source: CEPRES PE.Analyzer).
An “easy” exit route for PE firms investing in Healthcare
The biggest challenge in 2018 for PE firms was finding the right asset at the right price due to an increasing dearth of targets, high multiples and harsh competition. Indeed, the industry has failed in reaching a larger share of the global market for mergers and acquisitions, especially because GPs are constantly facing aggressive corporate buyers willing to push up auction prices.
On the other side, the increasing presence of corporate buyers looking to realize synergies and to expand into new products or markets offer private-equity firms an “easy” exit route. In fact, a research conducted by Mckinsey confirms that exits to strategic buyers produce higher returns than sales to other private equity funds (see figure below. Source: PitchBook Data, Preqin, S&P Capital IQ).
Regarding holding periods, a number of high profile exits displayed enhanced returns due to compression. An analysis carried out by Results Healthcare, a corporate advisory firm focused on public and private healthcare companies, shows that private equity holding periods for outsourced pharmaceutical research businesses have decreased, finding that five deals (eResearch Technology, BioClinica, Phlexglobal, Synexus and InVentiv) were all exited from in less than four years. In the case of Synexus and InVentiv, the holding period was actually less than 18 months.
The fact that similar returns can be achieved even by shortening the traditional three to five year holding period makes the sector attractive to PE funds looking to deploy capital.
Can PE help improve the Health Care System?
While PE involvement is often looked upon negatively, third-party investment can bring both efficiency and provide a higher level of management knowledge and sophistication to these critical businesses. There is a debate on whether third-party investment in physician practices offers economies of scale that make healthcare more efficient, or just fosters monopoly control and price gouging. Indeed, PE funds are focusing more on pharmaceuticals rather than on healthcare providers because if they were willing to price to the limit of their monopoly power, they could make an exceptional amount of money. Obviously consumers are worried that the same thing could happen with providers as well. Nonetheless, PE firms have helped turn around several poorly run healthcare companies.
In conclusion, even if the positive effects of PE firms in this industry are not always clear and evident, it seems that PE investors are here to stay. Given the optimistic outlook of the market in the healthcare industry for the time being, PE firms are likely to increase their presence in this sector.
Editor: Stefan Larsen
Authors: Costanza Bassano, Francesco Tenti