The State of Healthcare Private Equity
"Guarded optimism" is used to describe the HC PE landscape, as deal value picks up enormously from 2023. Let's dive into where opportunities lie for the future.
Overview:
When will the private equity industry regain its momentum? In order to predict future opportunities within the space, it’s important to see where we’re currently at. Overall, the healthcare PE market is one of “guarded optimism” in terms of deal value and volume. With pockets of light shining in North America, Japan, and India, shadows found in an uncertain macroeconomic backdrop and slowdowns in China are still prominent. With continued records amounts of dry powder and a lack of meaningful decreases in multiple expansion, the headwinds for HC PE have not fully passed. However, in North America, deal volume is expected to increase 20% from 2023, while deal value is expected to double. In just H1’24, the deal value of $36bn has already surpassed 2023, and this isn’t including mega deals such as R1’s $8.9bn sale to TowerBrook and CN&R. Zooming out, global deal volume is down, but value is up 25%, which somewhat contradicts the traditional trend of high volume with healthcare deals.
Something that I found interesting was comparing the size and number of deals in the healthcare space with other industries. Generally, deals tend to be smaller and occur more often than industries such as tech, but recently this has shifted towards more value and less volume, a trend found more in the tech space. With deals such as KKR’s acquisition of Cotiviti from Veritas, TowerBrook and CD&R’s purchase of R1, and EQT’s majority stake in CluePoints, we may be seeing an inflection point in healthcare private investments.
Where Are the Opportunities?
So far in H1’24, Healthcare IT has been a standout performer. With ~40 deals in the space (more than double of 2023 and 30 in pre-COVID H1’19), are we seeing sustainable long-term growth in this industry? As unstable regulatory environments leave private equity firms scrambling to diversify their healthcare portfolios from PPM platforms, companies are looking to expand into verticals with less exposure to regulatory scrutiny (HC IT, payor services, and pharma services). While provider IT has always been one of the larger players in investments, 75% of HC activity has been focused in this area. This includes electronic health record system management and revenue cycle management companies.
A.I. in Healthcare:
I’ll be honest, it’s hard for me to mention healthcare and tech in the same sentence and not discuss the implications of artificial intelligence in healthcare. While a lot of the investor sentiment is geared towards the future, there are short-term benefits. Before we have robots performing surgeries, companies have been learning how to use A.I. as a copilot technology, rather than the pilot. As I continue to learn more about the use of A.I. in healthcare, I will definitely follow-up with an entire post about this topic soon.
Geographic Hotspots:
Great, so now we know that HC IT and other lesser regulated sub-verticals are what’s getting investors excited in healthcare, what geographic locations are showing promising returns? Aside from North America, which has always been a large base of healthcare investments, there has been steady interest in Europe and Asia-Pacific regions. The rise of India has been exciting to follow with companies that used to be too small starting to fit into investment criteria. Another area of interest is Japan. With structural healthcare changes, an aging population, and conglomerate business structures with non-core businesses, we have seen an increase in corporate carve-outs. I think that KKR is at the forefront of investing in the Japanese market. With 39% of their $47bn APAC AUM, Japan is a vital region to help KKR meet their 5-year AUM growth plan.
Value Creation:
Okay, we’ve now identified sub-verticals and geographic hotspots in healthcare PE investing. Let’s talk about how these PE firms create value. As mentioned before, already high valuations prevent firms from riding the multiple expansion wave that they’ve been able to historically rely on. With revenue growth and multiple expansion making up most of the traditional path of value creation in historical PE trends, investors are limited to revenue growth as part of their core thesis. But how does this actually impact funds? The most tangible example is exit value maximization. With slowly recovering sponsor-to-sponsor exits and an unhealthy IPO market, PE firms need to start thinking about their exit even before they enter the investment. For example, if a PE firm was planning on selling the portfolio company to Lead Strategic A, would the strategy differ if they all of a sudden decided to Lead Strategic B? Would it be any different if the process was sponsor-to-sponsor? As we continue to look at the 7 characteristics of good LBO candidates (shoutout to all my IBW fellas), it seems to me that there may be a hidden 8th characteristic when looking at how private equity firms are thinking about exiting their investments.