As private equity (PE) firms continue to revise their investment strategies, one pattern seems to be emerging: Many are playing the long game in the healthcare market. And healthcare has some unique features that naturally lend themselves to the long game.
For one, healthcare is notoriously recession-proof. Even under the strains of the global pandemic, service levels are beginning to recover, bringing a slow-but-sure revenue outlook.
Additionally, healthcare is a huge segment with many tentacles that reach across social, financial, and political waters. Any investment with such broad impact warrants the patience to really understand it before deciding exactly how to time the ultimate exit.
PE holding periods have shifted
Dating back to the 1980s, the holding period for PE across all industries averaged three to five years, gradually leaning toward the higher end of that range over time. In April 2020, the median investment holding period rose to 5.43 years, up 9 percent over 2019.
But strategies vary, of course. There are plenty of investment candidates for which shorter or longer hold periods prove to be pretty successful. A firm could hold an asset for just a few days or for 20 years or more if it makes financial sense to do so. Here are a few reasons why investment houses might opt for longer holding periods in healthcare.
It pays to be flexible
Limited partners want more flexibility these days because selling too soon might mean they’re leaving money on the table. As healthcare bounces back from the COVID-19 pandemic, most agree that the market still has more growth to capture.
National health service expenditures dipped in the spring of 2020, but summer and fall trendlines demonstrated obvious recovery. Home health led the segment with 14 percent positive growth between February and October. Because vaccines promise the return of healthcare business as usual (for the most part), investors are willing to wait it out.
And fundraising certainly hasn’t slowed, which indicates steady optimism. In fact, PitchBook predicts overall PE fundraising in the United States will reach a new high in 2021, surpassing the previous record of $316.9 billion set in 2019.
As they wait out the recovery phase, fund managers have doubled down on creating value through making improvements at the operational level and fortifying their healthcare portfolio companies rather than relying on consolidation or quick exits. We’re seeing evidence of this play out in the rising number of assets PE houses currently have under management.
It will be important to examine working capital, potential restructuring, healthcare industry benchmarking, and go-to-market strategies. Building value in portfolio companies is one way to adapt to the new paradigms created by PE’s changing customer base.
COVID-19 has skewed valuations
COVID-19 is a non-recurring event in the larger market landscape. Not to say that it’s insignificant — it’s obviously had real impact on margins — but investors know the pandemic era is an extraordinary circumstance that’s not indicative of a business’s baseline performance.
Even so, the uncertainty still makes it difficult to complete due diligence and sift out a realistic valuation for a potential asset. Now past the one-year milestone from when COVID-19 was declared a pandemic, private buyers are willing to allow for reasonable adjustments to EBITDA, crediting some months of early 2020 or late 2019 as they look at performance in a big-picture context.
Competition for quality assets in the healthcare space remains tight so PE firms are open to higher multiples in spite of COVID-19. As a result, they might need a longer post-transaction holding period to make a reasonable gain on the capital invested.
Healthcare is complex, and while the market has embraced innovation faster in recent years, it still takes time to build a business. It can be difficult to summon the expected transformative change in a market as large as healthcare — with its $3.8 trillion in annual spending — and even more so when it’s deeply influenced by something as unpredictable as a global pandemic.
Whether they aim to correct for a skewed valuation or to mitigate pandemic-related losses, PE partners seem prepared to hold their healthcare portfolio companies longer. The equity stories they laid out in early 2020 are likely not the same tales they can tell now.
Our take: The global pandemic has been the asterisk on every financial forecast for the past year. Even growth-oriented segments like healthcare give investors pause. In chilling times, the less risky move is to focus on what you already own and help it prosper by investing in market research that will inform growth strategies, operational moves that will align your portfolio companies with new value-based payment models, and tactical marketing that will enhance your exit value.
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!