Health Care Quiet As Reform Package Looms

The federal stimulus package promises both to bolster the fortunes of health-care portfolio companies and to generate deal flow in the months ahead. Unfortunately, uncertainty surrounding President Barack Obama’s push for health care reform, and the poor economy, have left dealmakers sitting in the waiting room.

Though the traditional view is that investors flock to health care during tough times, the percentage of health care LBOs relative to the broader market has actually declined in recent months. The number of health-care deals that closed in the first quarter of 2009 represented just 5.8 percent of all LBOs consummated by U.S. sponsors, down from 9.2 percent in the fourth quarter of 2008, according to data from Thomson Reuters, the publisher of Buyouts. Over the longer haul, health-care deals accounted for 6.5 percent of all U.S. sponsored LBOs in full-year 2008, down from 7.4 percent in full-year 2007.

“I think 2009 will be an assessment period for most people,” said Bob DeSutter, a managing director and co-head of the health care team at investment bank Piper Jaffray. “They’ll assess the benefits of stimulus and the concerns of reform, and act in 2010—presumably in a better lending environment.”

When President Obama signed the American Recovery and Reinvestment Act earlier this year, it paved the way for $787 billion in government stimulus money to be steamrolled into the economy, including 15 percent of that to health care. Subsectors earmarked for capital infusions include health care information technology, or HCIT, and laboratory services, neither of which is a stranger to sponsor-backed deals.

All told, the Recovery Act allocated $19 billion to HCIT—a niche that’s already seen LBO activity this year. In March, Greenwich, Conn.-based Ferrer Freeman & Co. teamed up with U.K. venture firm SV Life Sciences to acquire r3 Health Partners, a provider of health-care IT consulting services. That same month, Brookfield Asset Management penned a deal to acquire all of the outstanding common shares in MediSolution Ltd. that it did not already own for C$19 million ($14.95 million). MediSolution provides health-care planning and blood bank management software.

The government’s objective in allocating dollars to HCIT is to save money by replacing disparate and decentralized paper-based systems with a unified, centralized electronic format. For some, however, it’s still too soon to place their bets alongside the government.

“The problem in the healthcare IT space is that there are no standards right now,” said Russell Carson, co-founder and general partner of Welsh Carson Anderson & Stowe, which in May wrapped up its eleventh fund, WCAS XI, with $3.7 billion in commitments.“If you invest now, you might have a product that will be left out once the standards are made.”

In the past 12 months, Welsh Carson Anderson & Stowe closed only one health-care deal, investing $100 million to acquire GeoDigm Corp., a provider of computer imaging technology to the dental industry, which Carson noted has very limited exposure to Medicare reimbursement.

Elsewhere in the stimulus package, the National Institutes of Health was presented with $10.4 billion in additional funding through September 2010. Jennifer Mulloy, a director out of TA Associate’s Menlo Park, Calif., offices said some of that money will probably trickle down to contract research organizations and other outsourced service and device providers to the clinical laboratory industry. TA Associates is currently raising its eleventh flagship fund, TA XI LP, with a $3.6 billion target, as well as a third mezz fund.

The largest chunk of health-care targeted Recovery Act funds, $87 billion through 2010, has been allocated to Medicaid, the state-run program that subsidizes health care for low income families and individuals. Through Medicaid, that money should help stabilize the revenues of portfolio companies that depend on the program for reimbursement.

Under The Knife

Buyout shops have plenty of dry powder for health care deals. Since 2006, at least $58.2 billion in new capital commitments has been raised by health care-focused buyout shops, defined as firms with at least 60 percent of their known investments in health care, according to Thomson Reuters.

And prices have become more attractive. Piper Jaffray’s DeSutter said that health care companies today are consistently trading at multiples below 10x EBITDA, sometimes reaching as low as 6x to 8x. Traditionally, health-care companies sell at multiples that are several turns higher than for companies in other industries. When traditional LBOs were trading at 9x and 10x during the previous peak, health-care companies were going for 13x and 14x, DeSutter noted.

Lester Knight, a founding partner at Roundtable Healthcare Partners, believes that now is a great time to buy businesses. With the closure of six recent add-on acquisitions, the Lake Forest, Ill-based firm has put more money to work in the last six months than it has over the last couple of years. On May 1, the firm announced its most recent deal, the acquisition of NGInstruments Inc., a maker of surgical cutting tools, by portfolio company Avalign Technologies Inc.

Even high-profile deals are being consummated at what seem to be depressed multiples. Pharmaceutical giant Pfizer’s $68 billion purchase of competitor Wyeth was agreed to at a multiple of just 8.7x EBITDA, while the historic norm for pharmaceutical purchase price multiples has been well into the double digits.

Nevertheless, industry pros expect the overall health-care deal market to remain anemic. The big reason: Sponsors have yet to learn the shape of President Obama’s promised regulatory overhaul, which could cut health care spending by $1 trillion over the next decade.

Nobody can be certain what President Obama’s effort to extend health insurance to 46 million uninsured Americans will look like in its final product. To make the endeavor fiscally possible, his administration has identified $950 billion in spending cuts and tax increases. At least $300 million of these savings will come from spending cuts to Medicare, which provides health-care subsidies to people aged 65 years or older, and Medicaid—two programs President Obama said “contribute to yawning deficits” that cannot be controlled. In 2008, the government spent $396 billion on Medicare alone.

The search for savings will also include a $1.1 billion “comparative effectiveness research” program funded by the Recovery Act. The purposes is to identify the best and most cost-effective health-care practices across the country, then roll them out across the United Startes.

“There is a good chance we will see more reform and more change than any other time in the last 25 years,” said Knight of Roundtable Healthcare Partners, which is investing out of its vintage 2005, $500 million second fund.

The Obama Administration hopes that the savings it has identified will serve as sign posts for Congress as it attempts to draft a cohesive health-care reform bill. But several health care bills and memos are floating around the House and Senate. And while expanding insurance coverage to the uninsured is a hallmark of all of them, few agree on how it will be paid for. “In health care, the devil is always in the details,” said Wyatt Ritchie, a Jeffries & Co. Inc. managing director who works in the investment bank’s health care group.

Should President Obama succeed in cutting Medicare and Medicaid, expect to see a broad-based wave of consolidation hit the health care market as companies that depend on those programs struggle to survive. This could be especially true in the health-care provider sector, a fragmented population that includes hospitals, nursing homes, and rehabilitation centers.

“Health care was 6 percent of GNP in 1965, and its 17 percent today,” Carson of Welsh Carson Anderson & Stowe said. “Before long it will be at 20 percent if nothing is done. We need to get health care on track with the general growth of the economy. There are a lot of opportunities out there, but there are also a lot of land mines as we try to get the industry to operate more efficiently.”