Healthcare: A sector for all seasons

Private equity investment in healthcare fell in each successive quarter in 2022 and remained muted at the start of this year. After a record-breaking run in the wake of covid, geopolitical tensions, inflation, high interest rates and labor constraints led to a deal-making stalemate.

However, as some sense of stability returns to the market, there are already signs that a recovery is underway. “The theme in healthcare investing in 2023 is one of resilience. Private equity deals picked up materially in the second quarter even as transaction levels remained depressed in other sectors,” says Vincent Guillaumot, a managing partner at Archimed.

Private equity appetite for healthcare is buoyed by the sector’s fundamental resilience, of course, given the compelling megatrends that are driving demand. However, healthcare has undoubtedly been impacted by macro headwinds.

“The healthcare provider space, in particular, has been impacted by inflation. Labor costs represent the single largest line item in the P&L of these businesses and so a shortage of qualified labor and spiraling wage costs has impacted healthcare providers most severely,” says global co-head of healthcare at EQT, Michael Bauer.

Inflation also affects interactions with payors. Segments that are dependent on third-party reimbursement or are subject to a pricing umbrella are currently exposed, not to mention the sword of Damocles that currently hangs over the prescription drugs market given the US government’s new ability to negotiate lower prices under the Inflation Reduction Act.

Meanwhile, supply-chain issues caused by covid and geopolitical tensions have added a layer of unpredictability to what is typically a highly stable sector, according to Allen. “More than anything, however, there is a sense that healthcare trading patterns have been disrupted by all these shocks over the past few years and people are waiting for things to settle down. When we start to see more normal trading patterns return, I think that will help stimulate deal activity.”

What’s hot in healthcare

There are, of course, particular sub sectors within the healthcare space that are proving more popular than others. “We focus on the medtech, life sciences tools and diagnostic sectors where there is clear product differentiation through tech and innovation,” says Bauer. “That is where we are seeing the most attractive opportunities currently.”

Meanwhile, Raj Shah, head of healthcare at Nordic Capital, points to interesting opportunities within pharma, pharma services and healthcare IT, as well as areas within medtech.

“Deal-making in the North American healthcare market has been stronger than in Europe, where sellers have adopted a wait-and-see approach hoping for valuations to rebound”

Vincent Guillaumot
Archimed

“We continue to see strong appetite for businesses built around organic growth such as pharma, medical devices and outsourced providers enabling the life sciences industry,” says Allen. “Strategic buyers continue to be aggressive in areas such as life sciences tools, so that gives private equity investors confidence around exit as well.”

Guillaumot adds: “Among the current standouts are life sciences companies benefiting from artificial intelligence; cancer immunotherapy specialists with strong development pipelines, and many biopharma companies thanks to a new generation of regulatory approved products in areas such as metabolic medicine and cardiovascular devices.

“Healthcare services are also particularly attractive due to rising demand in developed countries, where the over-80 population should double in the next 15 years. Although buyers are starting to be more disciplined on entry prices, healthcare IT remains a highly attractive sector as well.”

Demand for consumer health has remained strong despite the cost of living crisis. “With an aging and more health-conscious global population, people want to proactively control their health,” Guillaumot says.

Meanwhile, as a growth capital investor, HealthQuest Capital favors care delivery companies that are able to show attractive unit economics. “This is a sub-sector where we can put equity to work to help the company expand organically, or through partnerships which we can help to facilitate,” says HealthQuest managing partner ­Garheng Kong. “The inorganic strategy is still happening, but interest rates are changing the economics for platform plays.”

HealthQuest is also actively exploring the use of AI within healthcare, particularly as it pertains to diagnostics. “While AI utilization in diagnostics is not a new concept, the scope and capabilities of AI have significantly expanded with advancements in technology and computing power, and particularly, the availability of large-scale healthcare datasets,” Kong explains.

The convergence of the technology and healthcare sectors is a compelling theme for EQT too. “Everyone is talking about the use of AI in drug research,” says Bauer. “The data suggests that applying AI could reduce the time to identify and validate a drug target by as much as 40-60 percent, so there are potentially massive efficiency gains to be achieved.”

Evolving dealflow

The nature of dealflow in the healthcare sector is also evolving. There has been a strong focus on take-privates over the past 12 months, given the fall in public market valuations. “Public markets corrected relatively quickly, creating a window of opportunity,” says Bauer, pointing to London-listed veterinary pharmaceuticals company Dechra, a deal announced by EQT this summer. “So far, we have seen very few private owners willing to bring ­companies to market although we expect that to change as we near the end of the year.”

“Carve-outs have represented around a quarter of deals in the first half of 2023 by our estimates, whilst public-to-private transactions have represented around half,” says Guillaumot, who points to Archimed’s acquisition of NASDAQ-listed Natus Medical.

Growth capital investment opportunities have also remained relatively strong. “In the growth landscape where we focus, companies may be near profitability but still need that additional capital to get them across the line to sustainable cashflows,” explains Kong. “With an IPO market that hasn’t rebounded, at least not for non-biotech healthcare, and strategic volumes off 20 percent compared to the same period last year, many of these companies are tapping private markets for another round. Compared to the high-point of 2021, terms are more favorable to investors, and it’s creating a more rationale environment overall.”

Nonetheless, valuations for healthcare businesses have generally remained robust. “Prices for good businesses are as strong as ever but the market has bifurcated into assets that still command strong competition and those that would find it hard to find a home,” says Shah. “Those weaker assets just aren’t coming to market.”

Indeed, according to Bauer, the medtech sector is trading in line with historic 10-year averages. “Of course, there was a bit of exuberance in the aftermath of covid with sectors such as pharma services and life sciences, but that has now corrected and we are back to long-term average levels,” he explains. “Life sciences tools are trading at around 20X EBITDA, as in the years before the pandemic, while medtech is averaging 17X. Certainly, we have not seen valuations come down significantly from their pre-covid levels. I think this reflects the market’s view that the long-term trends impacting healthcare are favorable.”

Guillaumot, meanwhile, explains that private equity investment into healthcare is globalizing, with regionally focused firms expanding into broader geographies. “This is notably increasing competition in the US and Europe, with Asia less affected. We have also seen some diversified asset managers with VC arms enter the space. Consequently, competition in healthcare private equity is higher than ever,” he says.

Hale the future

What is clear is that healthcare is becoming an increasingly dominant sector for the private equity industry. Given the macro fundamentals that govern the sector, that is unlikely to change.

“Healthcare spend represents around 20 percent of US GDP, which means we have a lot of white space in terms of innovation for cost savings. This will continue to be a key area for investing because the cost is only compounding as the population ages into costlier brackets at a more rapid rate,” says Kong. “On the innovation side, meanwhile, we’re really excited about new models of care that emerged as a result of the pandemic. We’re in the early innings of understanding what that looks like at scale.”

Allen, meanwhile, points to the future dealflow and exit opportunities that will emerge as pharmaceutical companies re-evaluate their businesses as pattern expiries proliferate over the next few years. “That will impact what those large corporates are selling. It will also impact what they are looking to buy as they rebuild their revenue bases,” he says.

“Healthcare will continue to command a larger and larger share of global spend, given the demographic and consumption trends that we are seeing,” adds Shah. “I think those trends will now continue to accelerate, including outside the core European and US markets. As consumption increases, there will also be enhanced focus on efficiency in healthcare delivery, which will fuel further innovation. This is a sector that will continue to grow.”

Alternate timelines

The speed of recovery varies depending on geography.

“Deal-making in the North American healthcare market has been stronger than in Europe, where sellers have adopted a wait-and-see approach hoping for valuations to rebound,” says Archimed managing partner Vincent Guillaumot.

However, European investment bankers are busy lining up processes for early 2024, and market participants are optimistic that the sector has turned a corner, globally. “Dealflow was considerably slower in the first half of the year, with the macro weighing heavily on some of our target companies,” says Raj Shah, head of healthcare at Nordic Capital.

“Geopolitical risks and ongoing supply-chain issues, together with the inflation and interest rate environment, impacted dealflow significantly. But over the past couple of months, we have started to see a notable lightening of mood.”

Tom Allen, managing director at Advent International, adds: “Overall, deal activity has clearly been down. Sellers have been tentative about bringing assets to market in 2023, preferring to hold and continue to build value while they wait for interest rates to peak and confidence to be restored to the buyside. We are seeing an interesting pipeline start to build for next year, however, and we expect activity to pick up soon.”