Private equity investment in U.S. healthcare plays a formidable role today and, in all likelihood, even more tomorrow. In most cases, these investors are successful in exploiting weaknesses and opportunities relentlessly while profiting their limited partners. In so doing, they are fundamentally reshaping U.S. healthcare.
BACKGROUND
Private equity (PE) raises its capital from Limited Partners– pension funds, institutional investors, high net worth individuals and others– who entrust funds to their management. Investments range from $25 million up to hundreds of millions for companies poised for near-term growth or to facilitate their buy-outs of other companies.
PE does not invest in start-ups or early stage companies: that’s for venture capital investors recognizing that 70% of these never get out of the gate. Each PE fund has a unique portfolio based on its investment thesis. Some specialize in a sector or industry; others are more diversified. Some primarily focus on U.S. markets, others invest in global opportunities. Often, they partner with companies and other funds to acquire equity stakes in businesses; sometimes they go it alone.
Overall, PE funds raised $714 billion last year: the third biggest year on record. They have raised $3.7 trillion since 2014 and have $2 trillion on hand to invest (Preqin). As interest rates increase driving debt-costs higher, and as going public (45% fewer IPOs since the 90’s) becomes less attractive, organizations will look to PE as an option.
HEALTHCARE IS ATTRACTIVE TO PRIVATE EQUITY
In 2018, there were 715 private equity deals in healthcare for a combined value of $103.72 billion, up from 709 deals worth $88.87 billion, according to Forbes. Experts predict fewer deals that are bigger in 2019. Every sector in healthcare will be impacted.
There are three reasons PE is confident making bets in healthcare:
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Federal policy is favorable to private equity investment: The federal government directly controls more than 40% of total healthcare spending. Medicare, Medicaid and other government healthcare programs consume 29% of the total federal outlays and they’re expected to increase 5.4% annually thru 2026. Complicating matters, the trillion-dollar federal deficit from FY 2017 looms as an important campaign issue in 2020. Understandably, to reduce the deficit, the administration is pursuing strategies to lower spending in Medicare, Medicaid and other health programs. Key elements in these efforts are price transparency, value-based purchasing and alternative payment models, drug price containment and competition. These policies favor private solutions, industry consolidation and innovation over government-run healthcare thus favoring PE.
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Consumers are increasingly concerned about health costs and looking for solutions: It is well-documented that surprise medical bills and out of pocket costs for healthcare are major concerns to consumers. They think their health costs are too high and blame hospitals, doctors, insurers, drug companies and everyone but themselves. They want health that’s holistic, predictable prices, convenience and insurance that’s understandable and affordable. PE investments in these areas is significant and growing: there’s consensus in the investment community that the health system will be a B2C (Business to Consumer) industry for most transactions. For PE, the opportunity is to deploy capital in solutions that equip consumers to play a more direct role in their care.
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The wastefulness of the current system is an opportunity for PE: Up to 34% of the overall spend in the U.S. system is wasted due to duplicative services, unnecessary care, fraud and so on. Much of the horizontal consolidation among hospitals and other providers and business arrangements in the supply chain has resulted in higher costs. PE investments in core operating processes—revenue cycle management, supply chain, care coordination, drug discovery, insurance design, employee health benefits et al—focus on eliminating waste and fraud. Companies that offer scalable solutions that reduce health costs while improving user experiences are attractive to PE.
“In the current cycle, healthcare deals have returned $2.20 for every $1 of invested capital on a gross pooled basis, while technology deals have returned $2.10. Those multiples outshine valuations in every other sector. “(CEPRES). PE sees opportunity where others see uncertainty.
MY TAKE
The U.S. healthcare industry is being re-shaped by private equity investing. Healthcare is capital intense. The discovery of new therapies, integration of information technologies and analytics, expansion of services via digital and telehealth, direct to consumer retail health, customized health insurance, professional services (behavioral health, physicians, dentistry, et al) and development of hybrid of care delivery models require capital to compete. Operating margins alone are insufficient to fund growth in most healthcare sectors: they require the combination of debt and, in many cases, equity investments by PE.
For most healthcare organizations, the imperative is to increase both their scale of operations and scope of services. So, partnering with, or competing against private equity-backed ventures will be the norm.
There are three realities that must be understood as PE takes center stage:
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Private equity is opportunistic: Opportunities to improve the efficiency and effectiveness of U.S. healthcare are readily accessible to PE. That’s why more than half of the PE funds specialize in either healthcare or technology that offer strong growth, recession resistance and superior historical returns. But the prospect of an economic downturn in 2020 means PE will be more aggressive in its investments pursuing healthcare sectors where margins are thin, regulatory compliance is manageable, demand is strong and growing, incumbents are vulnerable and a scalable operating model is a strategic advantage.
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Private equity is powerful: Most PE firms prefer a low profile. They guard the identities of their investors and prefer the spotlight on their portfolio companies. Some are better known than others, but in healthcare, they’re powerful. Apollo, KKR, Goldman Sachs, Carlyle, Blackrock, Blackstone, TPG, Hellman and Friedman, General Atlantic, Welsh Carson and many others have deployed billions in healthcare.
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Private equity is competitive: PE looks for opportunities to deploy its capital efficiently. It is unafraid of crowded markets, avoids paying too much for an asset and expects an acceptable return on its capital in 3-7 years (the average is 4.5 years which includes selling to another PE-backed company). And some PE funds fail.
PE is a source of capital that’s re-shaping U.S. healthcare. Its expanding role and the implications for public policies and competition must be considered by every organization and in every sector.
Paul
FACT FILE: 10 BIGGEST PRIVATE EQUITY DEALS IN HEALTHCARE IN 2018 (Forbes)
1. Envision Healthcare; $9.9 billion (Kohlberg Kravis Roberts)
2. Athenahealth; $5.7 billion (Veritas Capital, Evergreen Coast Capital)
3. Brentwood, Tenn.-based LifePoint Health; $5.6 billion (Apollo Global Management, ATP Private Equity Partners, RCCH HealthCare Partners)
4. Kindred Healthcare; $4.1 billion (Welsh, Carson, Anderson & Stowe, TPG Capital, Humana)
5. American Medical Response; $2.4 billion (Air Medical Group Holdings, Kohlberg Kravis Roberts, Ardian, Koch Equity Development)
6. Sound Physicians; $2.15 billion (Revelstoke Capital Partners, Athyrium Capital Management, Summit Partners, Silversmith Capital Partners)
7. Lifescan; $2.1 billion (Platinum Equity)
8. Curo Health Services; $1.4 billion (TPG Capital, Welsh, Carson, Anderson & Stowe, Humana)
9. Juice Plus; $1.235 billion (Altamont Capital Partners)
10. Analogic; $1.1 billion (Altaris Capital Partners)
RESOURCES
Alex Kacik “Private equity infuses healthcare with $63B investment” Modern Healthcare April 18, 2019 www.modernhealthcare.com/finance/private-equity-infuses-healthcare-63b-investment
Healthcare Private Equity Association www.hcpea.org/
“Private Equity: Healthcare’s New Growth Accelerator” PWC 2019 www.pwc.com/us/en/industries/health-industries/top-health-industry-issues/pe-in-healthcare.html
Gondi et al “Potential Implications of Private Equity Investments in Health Care Delivery” JAMA. 2019;321(11):10471048.doi:10.1001/jama.2019.1077https://jamanetwork.com/journals/jama/article-abstract/2727259
“Private Equity is Piling into Health Care: High Prices and Stiff Competition mean investors must think creatively” The Economist July 2018 www.economist.com/finance-and-economics/2018/07/26/private-equity-is-piling-into-health-care
“Current Trends in Private Equity Investment in Ancillary Healthcare Providers” American Bar Association September 2018 www.americanbar.org/groups/health_law/publications/aba_health_esource/2016-2017/december2017/ancillaryhealth
Bain & Company 2019 Global Private Equity Report www.bain.com/insights/topics/global-private-equity-report/
