Macroeconomic factors have stirred up some turbulence, but investors remain relatively optimistic about the forecast for the $4.1 trillion healthcare industry in 2022. At the same time, investors are assessing the fundamental changes in the landscape that surrounds U.S. healthcare.
In terms of macroeconomics, there’s last year’s seven percent rise in inflation — the highest uptick since 1982. Meanwhile, the Fed is planning higher interest rates, while tapering to an earlier than expected end of bond purchases.
Stock prices are high. Treasurys are still offering negative real yields, and there are insufficient returns on many corporate bonds given the risks. Investors need opportunities that can hedge against inflation and provide attractive ROIs while minimizing risk.
Healthcare remains active
This year looks to be strong for healthcare investment, following the ongoing trend of activity. Healthcare services deals in the last five years represented 70 percent of U.S. private equity (PE) healthcare buyouts and one-tenth of all U.S. PE buyouts, according to PitchBook. But opportunities aren’t guaranteed. Investors need deeper insights, especially given the increasing power of consumers, who have thus far been largely insulated from healthcare costs.
“That’s changing thanks to high-deductible health plans and the direct-to-consumer virtual care models that promise patients a path of less resistance between themselves and their care providers,” said Don McDaniel, CEO of Canton & Company, in an interview with PitchBook for its Q3 2021 US PE Middle Market Report. However, as he also noted, the value levers are opaque, and the industry fails to function like a typical market because of cost and quality variation, lack of cost transparency, and irrational pricing.
Investment opportunities with caveats
Healthcare offers both hedging and growth opportunities for private equity funds. Healthcare-focused 302 venture funds raised $82.9 billion in the first five months of 2021 — a record amount. PE activity in healthcare also charted a record as PE deals were up 50 percent in value over 2020.
And yet, there are three major factors that will come into play noticeably in 2022: rising healthcare costs; deal multiples; and the growing force of consumers.
1. Healthcare expenditures have slipped under the radar because of the COVID distraction, but the lull won’t last
The usual focus on national healthcare spending has taken something of a backseat to concerns about the pandemic, but the pendulum will swing back as stakeholders take note of the steep curve once again. Per capital health expenditures reached $12,530 in 2020, according to the Centers for Medicare & Medicaid Services. That 9.7 percent increase represents a level not seen since the early 2000s.
Stakeholders see healthcare as an essential need, but such spending jumps when overall inflation is taking so much out of consumers’ pockets make costs difficult to swallow. That leads to any number of negative results from patients skipping care to program cutbacks to providers shuttering.
“The higher-cost institutions cannot sustain their margins, especially in light of the pandemic’s effects, and care is moving farther into the community,” McDaniel said in the report. “So, service providers need to determine how to provide high-quality care that meets patient expectations, all while dramatically reducing overhead.”
That will mean moving care out of hospitals and into less expensive facilities in the community while also using technology to deliver care safely and effectively in the home.
2. Elevated deal multiples are intensifying the need to drive earnings growth among portfolio companies
As with any investment category that becomes hot, healthcare’s increased flow of money has pushed acquisition prices upward. Private equity and venture funds alike are competing for worthwhile targets with promising futures.
Tech-enabled healthcare companies have been drawing average valuations of 17.1 times earnings with the overall industry average sitting at 14.9 times earnings. PE deal activity in the sector hit a high in Q3 2021, as values were up 50 percent year over year, and dividend recapitalization debt at $58.5 billion was higher than in 2019 and 2020 together.
Recent exits from healthcare companies have hit impressive highs. Consider this: The 2019 acquisition of athenahealth by Veritas Capital and Evergreen Coast Capital drew a multiple in the low teens. But the $17 billion acquisition of athenahealth by Hellman & Friedman and Bain Capital announced in late 2021 saw a 21 times multiple. Exits for some well-managed healthcare tech companies have reached 23 to 25 times EBITDA.
As PitchBook noted, high deal multiples make urgent the need to produce significant earnings growth to make the arithmetic work for investors. Operational and clinical efficiencies, including a smart approach to technology and data use that supports value-based models, will be of the utmost importance.
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3. Consumers are increasingly figuring in as an influential market force
Consumers are starting to demand the type of seamless convenience that they get from other interactions in their lives. Those that offer positive, consumer-centric experiences will become the providers of choice.
“Any healthcare investment must have sightlines into consumer preferences, whether your portfolio company is in the direct care business or not. It’s going to permeate every interaction,” said McDaniel. And well-known retail giants are ready to wrest revenue away from healthcare’s traditional players. “There are insurgent disrupters in the market — the Amazons, Walmarts, and Best Buys of the world — that leverage their consumer success and apply it to healthcare,” he added.
For example, Amazon has expanded its Amazon Care telehealth, now offering it to its employees in all 50 states. But that’s not the endpoint. Jumping ahead, the company started offering Amazon Care to large employers nationwide and has already inked major deals.
“Meanwhile, healthcare’s incumbents are trying to innovate either to maintain revenue or to slice business away from their competitors. In the case of hospital institutions, they’re doing so while carrying the burden of massive capital expenditures,” McDaniel said.
These three factors alone are examples of the complexities in healthcare. Any institution looking to invest across the sector should carefully consider a strategy backed by market data and expert advice to maximize success.
Canton & Company helps PE investors and their portfolio companies gain insight and execute proven strategies that create value. Our team of experienced healthcare economists, clinical leaders, operational experts, and health tech specialists have the real-world perspective that accelerates your growth trajectory throughout the investment lifecycle. Contact us here.