Private Equity Spotlight: The current state of the health care private equity market

This episode features a panel discussion on the current state of the health care private equity market, comparing it to previous years and exploring how the industry has adapted, and continues to adapt, to remain competitive.

The panel was moderated by Chris Sheaffer, global vice-chair of Private Equity at Reed Smith, and Nicole Aiken-Shaban, Life Sciences & Health Care partner at Reed Smith. Panelists included Tony Crisman, managing director and head of Healthcare IB at Stout; Daniel Schultz, managing director of BD at Webster Equity; Kevin Reilly, managing director at Ally Bridge; Brandon Cohen, principal at H.I.G. Capital; and Brian Bewley, Life Sciences & Health Care partner at Reed Smith.

Transcript:

Intro: Hello, welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content through this series, please contact our speakers. 

Chris: Welcome to the panel. Appreciate you guys taking part in this kind of state of the healthcare healthcare market panel as part of our private equity healthcare forum being hosted in the New York office today. We've got a great panel together. Maybe before we start, we'll kind of kick things off with introductions. My name is Chris Sheaffer. I'm vice chair of Reed Smith's private equity group. 

Nicole: Nicole Aiken-Shaban. I'm a partner in Reed Smith's Philadelphia office with a focus in healthcare regulatory and transactional work, and particularly in the private equity space. 

Tony: Tony Crisman, Managing Director, Head of Healthcare Investment Banking at Stout, 25-year healthcare investment banker. I was at Lincoln for 15 years before that and started out at an old name firm, Dain Rauscher Wessels. 

Brandon: Brandon Cohen, I'm a principal at HIG Capital based out of Miami. I spend all my time in healthcare. 

Daniel: My name is Dan Schultz. I'm a Managing Director at Webster and I manage all of our business development. 

Kevin: And I'm Kevin Riley. I'm Managing Director at Ally Bridge Group. We're a life sciences-focused healthcare investor, predominantly in biotech and medtech, mainly focused on growth stage transactions. 

Brian: Good afternoon. My name is Brian Bewley. I'm in our life sciences and health industry group like Nicole and heavily focused on private equity transactions. 

Chris: So let's just dig into it. I mean, private equity investing in healthcare has been a very hot topic over the last couple of years. You know, the market generally between interest rates, you know, macro events, obviously an upcoming election. There's been a lot of focus on the regulatory side recently. Look, Tony, you're sitting closest to me. I mean, look, on the investment banking side, you guys obviously see quite a lot. I mean, how has 2023 been? How's the first ’24 been? How's the first half of the year? 

Tony: It's been an interesting start to the year. I think that there was a lot of pent up demand, an interesting thing that I always think about. The beginning of my career, capital was the scarcity and assets were the commodity, and we're completely upside down. And we were trending that way over the last 20, 25 years. But I think a lot of people were really hoping for a tidal wave of transaction activity to start ’23, or start ’24. And I think for the most part, what we've seen coming to market are a lot of assets that bankers and private equity have been kind of holding on to maybe late ’22, ’23 might have been their initial timing. But just looking at the overall market dynamics and things of that nature, they were kind of held. So it really started to perk up in late March. And I do think that the regulatory dynamics, they always drive deal activity within healthcare, which is why it's technically attractive. And so you do see a lot of portfolio adjustments through COVID and into the current day in terms of where healthcare investors are looking to deploy capital, not just recession resistant, but pandemic resistance. 

Chris: Brandon, what are you guys seeing on the sponsor side? I mean, have you guys been hearing from your LPs a little bit more? I mean, how are things going with HIG? 

Brandon: Yeah, I'd echo some of the comments. It felt like the first month or two of the year were a little bit slower than expected. I was actually looking back at some data. Our healthcare deal volume is probably up 30%, 40% in 24 year-to-date versus the same period in ’22, ’23, still off of the 2021 peak. The interesting thing that we've seen is just the quality of the assets. You mentioned in, people holding things back. And we've seen, it feels like the number of deals getting done are far fewer than that 2021 level, despite the volume being fairly close. And it feels like buyers are still pretty cautious, right? We've seen a lot of instances where a banker tells me, hey, got a dozen IOIs or multiple turns higher than you. And weeks later, that deal kind of falls apart. And on the sell side, we've seen several processes where buyers kind of complete most of their work and don't show up at the end. And, you know, I don't know that that's healthcare specific, but it just feels like buyers are fairly cautious and, you know, sellers don't necessarily want to take a discount to 2021 levels. 

Chris: Yeah. I mean, I think that extends well beyond healthcare. We're seeing the same thing regardless of market and sector. It just seems like the valuation still needs to be bridged a little bit, both healthcare and otherwise, but hopefully, you know, we're optimistic for the back end of the year here. 

Nicole: Brian, this one's for you. Chris did mention some of the recent changes in the healthcare industry that have been happening recently. Could you give a brief overview of those to the participants here today and thoughts on what investors should be thinking about on the horizon when they're looking to invest in the healthcare space? 

Brian: Thanks, Nicole. I actually printed off something because this is a year where there's quite a bit of activity, so it's unusual. There's been a lot of developments on both the state and federal level. I'm sure most of you have been following it. At the state level, several laws have been passed. There's some laws that are pending. Really around, I think approximately 13 states now have promulgated or adopted essentially many HSR laws requiring notice and at times approval by the state governments for private equity transactions. There are some states that are, for lack of a better way of saying it, worse than others, more restrictive. California, Illinois, Minnesota, and New York are the four that I wrote down that are incredibly restrictive because they require pre-merger notification requirements and then also approval of the transaction. At the federal level, similarly, there's been quite a bit of activity from the antitrust side. And I'm not an antitrust attorney, but because I do a lot of of work in this space. It's obviously on the top of minds of us as counsel, but also our clients. The first thing, FTC, DOJ, and HHS issued a joint request for information in March of this year to examine private equity's role in healthcare consolidation. They actually extended the deadline for responses to June 5th, which has already passed. Obviously, we don't know the outcome of that RFI and what they're ultimately going to do with it. But I assume that probably by the end of the year, we'll see some activity resulting from that RFI that the government issued. And as you all probably know, because you've gone through deals that require these HSR filings, but FTC has proposed changing to the filing requirements that would increase the disclosure obligations for healthcare deals. Usually I'm generally reluctant to talk about proposed legislation because it's just proposed and you don't know for sure if it's going to come to fruition, if it will ultimately result in some sort of law that's promulgated. But I think it was about four weeks ago, Senators Warren and Markey proposed, and this is the exact title of it, Health Over Wealth Act. There's a lot of different things that it requires. If it's successful, it will require private equity firms to obtain licenses from the Department of of Health and Human Services to invest in health care entities. And if you fail to qualify or obtain a license, you would be restricted from doing deals in the health care space and potentially would have to divest portfolio companies. This would also allow HHS to block deals pending their review, and then it would also require that the PE firms disclose financial and operational data, including debt levels, political spending, what wages are going to be, and what facilities are going to be utilized and not utilized. And then the last thing that would be required, again, if this is successful, is that there would have to be an escrow account. You'd have to establish an escrow account to cover all health services costs for five years should there be facility closures. Now, again, this is their proposal. I think there's quite a bit. I don't know if it will be successful. And frankly, even if it is, I think it's going to be challenged because of how restrictive this law would be. And frankly, it's anti-capitalistic. And so I'm not sure how much legs or how if it will actually get legs but it is certainly something that we should all be paying attention to and then I guess the last thing and this is more of a general theme and some of you are probably members with like the American investment council but a lot of the activity that we're seeing at the state and federal level you know is the result of really one-sided narratives that are being pushed about private equities role and and health care transactions and obviously at the FTC level even at the congressional level and I would even say the Department of Health and Human Services, some of you may know, I was a former government attorney well over a decade ago, both with the Department of Justice and with the Office of Counsel to the Inspector General for HHS. And private equity was a thing back then, and there was some talk about it, but it's taken well over a decade to see what we're now seeing both at the state and federal level. And I think, unfortunately that is part of that is the result of private equity not having the same same type of representation from a lobbying perspective within the gov you know within the government and I think that's now changing and so I what I do expect and what I do anticipate I know many of you the private equity firms are part of this you know whether it's AIC or other industry associations I do expect that counter narratives are going to start being popping up and being presented because there's obviously a really good story and narrative that private equity needs to put out there. Namely, if private equity is not funding technological advances or advances in patient care, where's the money going to come from? Because we know the government is not going to fund these things. So I do think that we're going to see changes in how this narrative is being presented, But it largely is going to be driven by private equity firms and cooperation with industry associations and law firms. 

Chris: Yeah. And just picking up on those last points, if anybody's listened to the webinars that have been put out there as part of the FAQs of the government, they are very anti-private equity, to the point they're completely one-sided. Maybe I'll throw this to Dan and Kevin. What has been, I guess, your respective firm's reaction to some of this regulation? Are you looking at it both in terms of investment and PR? I mean, how are you guys kind of thinking about it more broadly? Because there's just such a spotlight on the sector right now. 

Daniel: Yeah, I mean, for us, it's not necessarily outward PR, but more with our LPs and trying to position to them sort of where patient care meets what we're doing to give them their returns. And so for us, it's internally thinking about within ESG, within some of these other initiatives that we have is how do we message that to LPs and other groups that we work with that what we're doing is actually a benefit to the community. 

Chris: Kevin? 

Kevin: Yeah, I mean, I think the increased scrutiny in this entire space just coming from a place of regulators trying to understand everything that's going on, right? Trying to digest the effects of consolidation within the healthcare industry and how does a traditional private equity flip and strip transaction affect jobs? How do physician roll-ups affect the space? How do these new value-based care platforms and startups affect the market? So honestly, I get the focus on it. It's something as healthcare investors need to be constantly thinking about. I've spent my whole entire career in healthcare and I don't understand the intricacies between all these different subsectors within healthcare. So why do we expect the regulators to, right? So I think the intent might be well warranted. I think the problem is, in reality, I think consolidation that's causing a lot of issues in the healthcare world is less so by private equity-backed businesses and more so by corporate giants amongst the payers and PBMs, et cetera. So it keeps me up at night. It's top of mind for us on all the HSR issues that was just touched on. And I think the problem is, is we're investing in companies, particularly in biotech and medtech, oftentimes this increased scrutiny is preventing additional innovation in the category, right? So again, it's top of mind for us and very similar to what was just described over here. It's something we need to constantly be educating our LPs on too. 

Nicole: Yeah and I think it's a good point to make that the scrutiny at the government level is not just on private equity, although that's obviously one of the big talking points that we see in the press and in the proposed legislation that Brian was talking about as well. But we also see it with sort of that consolidation more broadly with vertical integration with some of these payer organizations. So I think there's going to continue to be that government activity as we move forward into 2024 and 2025. A question for you, Brandon, on your end, when you're thinking about the government's role in healthcare investing going forward, let's say in the next six to 12 months, what do you think that role is going to look like and its impact on the investments that you're looking at doing? 

Brandon: Yeah, obviously don't have a crystal ball. And Brian, one more quick answer to that question. Look, I think we're obviously focused on the areas that you brought up from a regulatory or approval standpoint from an FTC perspective, corporate practice of medicine at the state level is something we're very focused on. Obviously, it depends on who wins the election and what that does to regulation. But as I think a lot of folks have touched on, we've always been focused on, compliance and quality on outcomes, as I'm sure most investors are. And demonstrating that value proposition has become a bigger topic to us, getting involved in those lobbyist groups and showing that, hey, we are creating jobs, we are driving, you know, better quality, better outcomes, and, you know, kind of setting that up, regardless of what the government decides to do with some of their proposed and pending regulation. 

Nicole: And Kevin, feel free to weigh in more broadly on what you think the government's role would be, but maybe more specifically, thinking ahead to the election, which is, you know, coming up in a few months, you know, what do you think the outcome of that election one way or the other might have on the healthcare investing sort of in that period of time right after the election finally, the dust settles, let's say, and we know who the next president's going to be. 

Kevin: Yeah, I mean, on the first part, I think the cardinal rule in healthcare is things always take more time, more money, just because everything is incredibly regulated, right? I think on the product side that we're investing in, again, drugs, medical technologies, et cetera, FDA has done a great job of pushing drugs and technologies to approvals. I think they're at all-time highs, which is great. Reimbursement has become more and more of a slog for investing in commercial stage opportunity, just getting an approval means nothing nowadays. Now you have to go out and get reimbursement coverage. And we're seeing that across our portfolio. It's getting more and more difficult, even though we're picking companies that have an incredibly robust amount of clinical evidence that shows good clinical outcomes. And also, you're actually saving the healthcare system money. I think back to the HSR side, it's cloudy our investment thesis if we think it's going to be a difficult ultimate exit down the road, if a strategic is thinking about how this affects you know antitrust issues right we were we we led this series seeing a company called GRAIL if you guys probably know that was sold to Illumina that just had to be forced to divest that business actually yesterday and spun it out so it's just it's all very top of mind to us on the question around election I i'm not going to pretend to be a political analyst here obviously there's always critical matters at stake I looking back at the data over the last four or five election cycles, so-called the last 20 years, I think we've seen Republicans sweep, Dems sweep, split government and if you look at all the data, there's always volatility in and around the time of the election, but the healthcare market generally performs well right after the election. And I think this year specifically, I actually think healthcare is a little bit less in the limelight than just other broader geopolitical issues and things that we're all well aware of. So versus elections in years past, I'm actually less concerned about who wins the house and how that affects our investment philosophy. 

Chris: Maybe I'll throw this to you, Tony. We've started this panel about everybody expecting to be this massive waves of assets, of quality assets that have been building up and building up. We heard from Brandon, obviously, though, that sale processes are taking longer, people are being a lot more deliberate. I commented about valuations maybe not yet being there. We've also talked about the increased regulation. How is all of this coming together? Where are we heading for the next six months? Where are we heading next year? Are people less inclined because of some of this regulatory focus to be in the market? What's your view in terms of what things look like going forward? 

Tony: Yeah. No, there's going to be activity. I think post-Labor Day, we're going to see, as I mentioned, I think a lot of what's been coming out are things that I'll say bankers have been holding back, rightfully bankers and their owners saying, hey, it's not the right time until we got some normalization of the debt markets. We're just accepting what the debt markets are, I guess is what it really is. But the thing now, I think we're going to start seeing that pitch velocity for the assets that are going to be coming out. What's interesting, I do still think there's been a quality of asset. I said, I mean, I'm a banker, so every B and C asset's an A, don't worry about it. But I think we have seen more of the Bs and Cs where we are getting the canaries in the coal mine, like those A assets in certain segments that everybody else is watching to see if it transacts and happens. And that gives people the confidence that, hey, the values are out there, right? I mean, hey, we can put five and a half times leverage on this. Great. At that interest rate, we've got handcuffs with those. So how do we manage through that and things of that nature? One of the things, and I think, Brandon, you said a couple of things that are very important, and it's something I'm talking to everybody within our team, but also across the bank, about is process design matters. I'm hearing a lot of frustration from private equity players that bankers are still trying to run processes like it's 2021. Now, we know banking is a young person's game. We haven't had a down market for 15 years. So a lot of folks who've only really seen an up market and how you market in an up market. My reality is I think some bankers are still over pitching valuations because in a down market, you got to get what you can get. Problem is if you go out and try and mark that in the market, you end up with issues of, and we give a lot of advice to buyers looking at assets. We're like, look, this is a 10 to 12 times business all day long. We think you got bid 14 to get in. And there are groups bidding the book. And what's happening is you're ending up with attrition immediately post-MP and losing parties, losing competitive tension, and ending up with hung transactions. The secondary thing is if you're running your process too fast. Private equity is in the conundrum right now. They have to do twice as much diligence. It's half because of lenders, but it's half because, hey, I'm willing to get to your premium value. I've got the capital. I've got to put it to work. I need it to diligence out clean. So stop telling me it's speed, certainty, terms, and value all day long. You're going to have to start giving people exclusivity. It was the anomaly was 2020, late 2020 to late 22. too. That was the anomaly, not the norm. And I think people are still trying to run processes through that. And it's creating a lot of challenge for buyers and you're seeing attrition. So I'm telling our team, we're running processes proper. We're not telling clients we can get you everything all the time. And it says, by the way, I don't like hung deals. And then finally, bring in some of your hard bidders. If you've got bidders at 14X, bring in your hard 12, because I guarantee you that 14 is going to turn into an 11 and the hard 12s are going to say, you're an idiot. And by the way, that's good for your fee overall, but bring in some of those players that are cuspy. You can go ahead and keep your message to the market that, hey, it's 14X to get in and just tell the player that's a hard 12. Hey, I know you can play up, you know, play into that. And that's why we're seeing far more transaction activity than we're seeing transaction closings. 

Chris: I mean, Dan, you're on the other side of that. You're getting the books, you're looking at everything, you're acting with Stout and the banks. I mean, what's your reaction to what Tony did? 

Daniel: I think first, you still have a very, very wide range of expectations, right? Buyers have one expectation that we're in the credit market. Sellers have the other expectation that we're two years back and we're still trying to look back in the 2021, 2022 timeframe. From where I sit in sourcing deals as my primary job, deals between zero and 15 million to be able to have still been in the market in healthcare services. We're seeing those deals. There's good quality deals. The ones that are larger than that, bankers are really having to have tough conversations. We've been sitting on this deal for the last six months, nine months, 12 months, is now the right time to pull the trigger. Good assets still get premiums and are still getting valuations that we expect. We're still buying deals that we're getting on good multiples. I'll say where the add-ons come into play is a little different. They're not getting the same multiples today that they were getting two years ago, which were consistent with what we were playing for platforms. So you're seeing the change as we do our buy and build strategy within healthcare services. The add-ons are not as rich of a multiple as we had been. Going forward, I think that you're probably gonna see deal flow kind of stay the same within that lower middle market, you're going to have some of those larger deals come to market. But really, I think 2025 is going to be when more of the floodgates open and people get a little more comfortable with the market. 

Nicole: We've heard a little bit about the changes on the horizon from a regulatory perspective, the financial outlook, and the markets generally. This is going to be the lightning round for the entire panel. And I'll start with Tony, since you're right on my right. I know you get to go first. Just a one-minute view on what you expect the outlook for healthcare investing to be for the rest of 2024. 

Tony: Yeah, I think for the remainder of 2024, we are going to continue to see increased activity month over month. I do also think you're going to start to have those conversations happening in Q4 for Q1 launches, because I do think 2025 is setting up to be a year of necessity of going to market in transaction velocity. You know, hopefully we can get to a point where we're seeing transaction closings matching what's in market. But I do think that's getting to that alignment that Dan was talking about. So I would anticipate seeing increasing deal flow, increasing direct discussions with some of those assets, maybe you've been knocking on doors of where they're getting serious and saying, all right, now's the time to go make it happen. So through the remainder of the year, I think I'm optimistic. I've never been a great wave person. Like, hey, there's going to be a wave of deals. I do think ’25 is going to be better, but I think each month is going to tick up. And I think investors are finding the right seams where they want to go target. We have seen increased interest in life sciences and diversifying some of those healthcare services plays. But we saw that starting kind of back in ’21 having to do with that pandemic resistance dynamic overall. So I would anticipate seeing more in med tech, seeing more in outsourced pharma services, areas like that where there's a little bit more insular budgets and better regulatory dynamics where, hey, we're actually getting FDA approval. So that's great, as opposed to, hey, everything's a problem and a little bit murky and opaque. 

Nicole: Yeah, go ahead, Brandon. We'll go down the line. 

Brandon: Yeah, I'd echo a lot of that. I think we've still seen those A-plus, A-deals getting done, not just the ones that Tony are telling us are A-deals. To Dan's point, I do think you see more activity in 2025. But I think, and you asked the question earlier, I didn't answer it. Look, we're fortunate to be a big firm and not have a ton of LP pressure, but you're going to see more and more LP pressure. I'm not sure you talked to our investor relations teams and they're telling you, you know, LPs are very focused on return of capital. I think on top of that, you're going to see lender pressure as well, right? Those companies that should have sold in 2022, it's now 24, you know, they gave you kind of a year or two. At some point, they're like, look, guys, we want to get out of this. And I think you'll start to see sponsors where, you know, hey, you were hoping this was a two, three times return. turn. But if you have a path to getting an acceptable outcome, whether it's your LPs or your lenders, you're going to be pushed. So I think from a deal activity standpoint, I think we'll expect to see volume increase. And I think you'll start to see that close rate increase as well. 

Daniel: Yeah. So I think the activity is still going to happen. I mean, right now we have in healthcare services, two deals under LOI. So in the summer months, hopefully those two will close, but I think you'll start to see some of those middle market deals actually get closed. One thing that we didn't mention is that I see approval too, is becoming harder to get with a lot of these companies. So I think that, you know, there are certain markets within healthcare services that are favorable and some that are unfavorable. So some of those favorable markets, deals are continuing to get done. The unfavorable ones, it's going to be cyclical. And once kind of the market knows and the perception changes, I think you'll start to see more activity there. But I think it's, as I mentioned earlier, I don't think it's going to be until 2025 that we really see the market come back to where we had seen it before. 

Kevin: First of all, I feel very good now that I know the playbook on how to sell a company, from Tony. But yeah, I think a little bit of what Brandon said too, I think just across the board for private equity firms, regardless of the subsector in healthcare, DPI is low in funds that were raised in 2018 through 2022. So I think you're just going to see more and more deal volume have to pick up from that perspective. On the product side and in biotech and medtech, we're seeing a lot more activity now. I think we did in medtech, for example, we did two investments in 2022, 2022 and 2023, we're doing four, about to be five over the next month and a half. So I think that's an effect of finally post the COVID kind of bubble era companies or high quality companies are finally willing to kind of take their medicine a little bit on valuation. So I think every single one of the deals we're doing right now are at significant down rounds or with heavy structure, which I think is just, you know, taking the dose of reality where the public markets are. In biotech, we've seen very high-quality companies be able to get public, and the highest-quality ones trade well. I think medtech and other areas like Digital Health will lag the biotech market, but I do expect IPO activity to pick up later this year and early next. And that's a little bit of a lag as well because M&A volume has picked up from strategics as they've sorted through their own balance sheet issues and on portfolio construction issues. So overall, I think activity will continue to pick up and I'm actually pretty bullish on 2025. 

Brandon: It's one thing that you touched on an interesting point, just like the need for creativity, whether it's through structure, or getting a little bit more scrappy on how to get a deal across the finish line. We've seen the founder led deals where they're not focused on last dollar, people feel are willing to maybe roll a little bit more and increasing corporate carve outs. So I think part of it to your point too, is not running the same playbook from the private equity guys and being a little bit more relaxed, I roll up your sleeves, do a little bit more work, incorporate structure. 

Brian: Yeah so notwithstanding what I said at the beginning at my talking points uh i'm incredibly optimistic uh I've been doing this for 20 years, eight years at a high level in the federal government and I've seen cycles where the rhetoric is really aggressive you know it was for several years it was targeted in the life sciences space with drug manufacturers med device manufacturers. You know and then it moved into the not-for-profit space with hospitals and health health systems being non-compliant, especially when it comes to the Stark law, a lot of types of, you know, lots of regulatory activity. And now we're seeing it in the private equity space. And usually what happens is, you know, the rhetoric starts very aggressive. There's a lot of hyperbolic comments and statements at both the federal and the state government levels, but then it ultimately balances out. It always comes back down to a more even keeled, manageable perspective and view. So unfortunately, I think that's what we're seeing right now. But like I said, if you go back 10 years, you will see that there were the similar types of rhetoric and hyperbole was being pushed by government regulators, but focusing on different companies in the industry. So I'm optimistic because of that. And I know Carol, I've been doing this for 20 years. Carol's been doing this for longer. I'm sure she would agree. It does go in cycles. We just happen to be in one of those cycles, but it will certainly balance itself out. 

Chris: Well I’m glad we're ending on a high note in terms of optimism going forward. Obviously, that's better for everybody at this table. So thank you, everybody, for participating in the panel. Really appreciate the time. Definitely some valuable insights. Thanks, everybody. 

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