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7 questions on healthcare private equity deal environment!
A media department reached out this morning with questions about the current deal environment. My answers below:
1. What do private equity investors find attractive about the healthcare space?
- Most importantly, it’s a profitable market driven by underlying regulatory barriers to competition. That’s why dental practices rarely fail, while retail stores fail all the time.
- In addition, you have a third party payment mechanism that separates the decision maker from the payer, resulting in healthcare spending that persistently grows at a faster rate than the overall economy.
- Finally, you have economic inefficiencies all over in healthcare, so there are lots of economic rewards for those who can fix problems in the current system.
2. What are the drawbacks and risks of investing in healthcare right now?
- The biggest issue *right now* is that there is regulatory and payment uncertainty given some of the statements and predictions that have been made about the DOGE effort and its potential impact on Medicaid and Medicare. That uncertainty is having a chilling effect on investment activity.
- More generally, healthcare investors must always be careful with any impact they are having on patient outcomes and wellbeing. Otherwise you risk causing real harm to people (not to mention the headline risk and bottom line impacts that follow). Healthcare solutions that aren't well thought-through can have unintended consequences that are bad for everyone, especially the customer.
3. How is the Trump administration, and the sweeping changes they have already begun to make, expected to impact this sector, if at all?
- Nobody knows for sure, but there is talk about significant cuts to fraud, waste, and abuse in Medicaid and potentially Medicare. The numbers that are being mentioned are large enough to suggest that “waste” might be interpreted broadly. And regardless of the type of cuts or how warranted they may be, that is potentially substantial industry revenue that might get pulled from the sector, which will have an impact.
- In addition, there have been talks of potential healthcare regulatory changes such as PBM reform, FDA reform and/or resource availability, and potential restrictions on DTC pharma advertising, all of which would impact current business models.
- On top of that you have other potential broader policy changes such as increased tariffs (which impact med tech, equipment and supplies companies, but also impact healthcare providers’ supplies costs), M&A regulations, immigration (which may impact staffing), and M&A regulations.
4. What do valuation multiples for healthcare deals look like? And how has that changed/is it expected to change?
- Valuation multiples range widely right now – we’ve seen multiples in the single digits for either lower-quality or retail-heavy assets, and multiples in the 20’s for high-quality assets. There has been more of a focus on high-quality assets on the part of buyers, so that middle-tier and lower-quality assets aren’t getting as high multiples now as they did a few years ago, while the highest quality assets are trading at very high prices.
5. What does the opportunity set look like in the middle-market specifically?
- The middle-market’s relationship to the top end of the market is similar to previous years, except that you are seeing more middle market investors emerge and more middle-market investors are showing a willingness to extend down into the lower end of the market in their search for deals.
6. There is a huge backlog of deals that has resulted from the dearth of M&A activity in recent years. Will healthcare deals comprise a significant number of the M&A deals expected to come to market?
- Investment bankers are predicting that it will. And even though I don’t think I’ve ever heard an investment banker forecast that the deal market is not going to be stronger next quarter than the current quarter, I suspect they are correct. Certainly there are a lot of healthcare assets in portfolio companies that need to be sold, and LPs are asking for their money to be returned before investing in a new fund, all of which suggests that deals are going to heat up compared to recent levels. We have also seen a lot of requests for sellside work, which suggests a good number of assets coming to market later this year.
7. What is the impact of AI on the healthcare sector and is it changing the way PE firms look at companies in this space?
- So far it is mostly a “future” thing, though we have seen AI show up in tech-enabled services such as imaging/radiology and in helping data companies pull insights out of unstructured data such as physician notes and discussions. Increasingly it’s expected to play a bigger role in other tech-enabled services such as revenue cycle management and other business process automation.
- Down the road, there is potential for a significant impact in the healthcare software space, as software functionality becomes easier to copy and reverse engineer with AI developer tools, leading to a proliferation of software vendors, and driving downward pressure on both pricing and future development costs. Barriers to switching such as network effects, switching costs, and the mission-criticality of the software, along with barriers to functionality copying such as proprietary data and partnerships will protect against such effects, and we expect investors to increasingly focus on those attributes when evaluating healthcare IT opportunities as a result.
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