The number of private equity (PE) investment firms has grown over the past decade, and those investors have become quite active in the healthcare sector. And with good reason. Healthcare offers the right mix of opportunity and resilience that attracts PE interest.

While firms are certainly focused on realizing an ultimate return on their healthcare investments, they also bring their portfolio companies access to the capital that’s needed to fund business growth. Examples might include expanding into geographic markets, adding new clinical capabilities, or acquiring competitors. Growing businesses in turn help the firms profit from their investments.

Today, PE firms manage $4.4 trillion in investor capital in the U.S. Because they’re facing increasing competition, these firms must not only create value, but they must be able to differentiate themselves with expertise in a specific market, such as healthcare.

In 2019, PE firms announced 313 healthcare transactions with disclosed deal value reaching a record high of $78.9 billion, according to Bain & Company. What does that say about the healthcare market? Investors are optimistic.

Even if the immediate effects of the COVID-19 pandemic are unclear, the near-term and long-term prospects are attractive enough to justify investment. They see more reward than risk.

Why private equity invests in healthcare

Healthcare outranks plenty of other industries when it comes to PE interest of late, including real estate, energy, and communications. Here are five key reasons why healthcare makes sense for private equity firms.

1. High demand for services

Recent year-over-year growth in health services spending has hovered around 5 percent. However, 2020 was an anomaly with spending growth mellowing and actually dropping to negative growth in the second quarter of the year.

To put it into perspective, consider that the one-time, one-quarter drop is the only negative growth the healthcare sector has seen in the 60 years since this type of data has been reliably collected. All other quarters in all other years show nothing but an upward curve.

And healthcare is clearly rising out of the pandemic with service demand creeping back up again. In-person outpatient visits began to recover in August. With COVID-19 vaccines in full production and the promise of greater immunity, consumers are returning to their doctor appointments.

It’s no surprise PE investors find this longstanding growth trajectory attractive. Forecasts project that U.S. industry profit pools will grow by 5 percent annually over the next five years.

2. Opportunity for a digital revolution

Health IT is clearly an area ripe with opportunity. The machinery of healthcare service delivery truly needs better solutions to address system inefficiencies, the logistics of value-based payment models, and realistic cost reduction.

In December 2020, for example, a PE-backed technology firm that provides Medicaid information systems purchased a publicly traded data-analytics and patient-engagement solution provider for approximately $3.4 billion. The size of this deal alone indicates the appetite PE firms have for tech-enabled healthcare assets.

Undoubtedly, the digital revolution is changing business models, and no healthcare organization can expect to compete without substantial data to inform daily operations, care decisions, and future strategies. Data is also the basis for value-based reimbursement, so collecting, analyzing, and reporting data has become a revenue-generating business imperative.

And yet, the investments in health IT overall represent a broad universe with dozens of investors and deals across several categories. While many flocked to telehealth in early 2020 — counting on it to experience major growth during the pandemic — diversification is the prevailing trend.

Funding in healthcare innovation surged for much of the year, which is especially telling when considering the financial backdrop. Markets in general signaled a recession, but healthcare continued to produce returns.

3. Resilience

Everyone who follows the industry knows that healthcare is exceptionally resilient. In fact, it rarely follows typical market behavior.

Bain & Company noted that PE investments in healthcare during previous recession years produced a multiple on invested capital nearly 50 percent higher than other sectors. The industry’s track record speaks for itself.

Job growth is another indicator of the industry’s performance. The Department of Labor finds healthcare jobs are projected to grow 15 percent from 2019 to 2029, adding about 2.4 million new jobs to meet the growing demand for services.

But thus far, consumers have been largely insulated from the true costs of obtaining those services. That means they’ll seek care without much regard for price. As efforts to control spending accelerate, consumers are becoming slightly more sensitive to price, but generally not enough to substantially affect healthcare’s so-called “recession-proof” reputation.

4. Strong local markets

When making decisions about acquiring an asset, PE firms look at everything from the balance sheet to the board members to referral sources. Some of the most desirable investment opportunities are those with a strong foothold in their markets.

Recognizable category leaders and entities with good local relationships have the advantage as far as PE is concerned. Even with greater adoption of telehealth that offers consumers far-reaching access, healthcare is still local.

Value-based payment agreements for providers have also started transforming the delivery of health services into a local ecosystem. Providers are starting to work together for the common good of the community, and incentives are emerging to drive that dynamic.

5. Potential for add-on investments

When PE firms acquire an initial asset in healthcare or in a specific subsector of healthcare, one of the next moves is to buy and merge additional assets, rolling them up together in the portfolio. This often creates economies of scale and efficiencies through operational consolidation.

With so many facets of health and so many moving parts in the delivery system, portfolios might also acquire additional assets for the purpose of building out a continuum of care. This is often the case in behavioral health. An initial platform investment of a residential addiction treatment center, for example, might be followed by another transaction to purchase an outpatient center, followed by a business that offers sober living facilities.

Outside of pure clinical care, data analytics is a capability that has enormous value. Secondary add-on investments might include assets that can churn big data into actionable intelligence. Where health IT was once synonymous with electronic medical records, it’s matured into a landscape covered with tools that have the potential to influence revenue.

Our take: PE firms have discovered the charms of healthcare. They’re providing capital that can certainly lead toward a smarter health market. As they find fewer attractive investment opportunities, their challenge will be to find new methods of value creation and a vision for transforming healthcare in ways that benefit the patient as well as payers and providers.

Ready to accelerate the growth of your healthcare portfolio companies? The Canton & Company team of experts can unlock the value you need in today’s rapidly changing healthcare market. Contact us today!