As private equity investors continue to queue up to invest in companies benefiting from the digitalisation of healthcare, a drop-off in valuations in the public markets could create new opportunities in a market that is short of assets.
Listed tech companies across a wide range of industry verticals have seen valuations fall in recent months, in a readjustment that could drive more take-privates for digital healthcare businesses, and cause some to put off planned listings and seek capital elsewhere.
Steven Dyson, partner in the healthcare team at Apax, says: “We are in very strange times. Three months ago, people were investing earlier and earlier, and we saw really high valuations, making it hard to see all those companies being successful but difficult to know which ones would do well. The change in the economy and the change in valuations that we have seen since then is pretty material, but it remains to be seen how that will flow through to the private markets.
“I cannot believe private market valuations will not reset down to some degree, though good companies that are growing fast and have a strong value proposition will continue to prosper.”
The pace of digital adoption across the healthcare industry is driving more and more investors into the space. “The healthcare sector is often one of the laggards when it comes to the adoption of new technologies, both because it is highly regulated and because of the risk profile associated with new technologies in patient care,” adds Dyson. “But over the last few years, the sector has picked up the pace of adoption and that new momentum shows no signs of slowing.”
Access to care
Paul Moskowitz, a principal in the healthcare private equity team at Bain Capital, says the scale of the opportunity for investors is compelling. “Healthcare as a vertical is catching up to the level of automation occurring in other segments of the economy, which is creating a real opportunity around healthcare marketplaces. At the same time, consumerisation of healthcare is creating an explosion of new technology use cases, as patients seek the means to access care online in the same way that they access other services.”
Moskowitz adds that there has been an evolution in the way private equity has been addressing healthcare IT in the past decade, as the most active investors have shifted from being funds focused on technology and software towards those with a significant understanding of both the healthcare end markets and disruptive technologies.
“Healthcare as a vertical is catching up to the level of automation occurring in other segments of the economy”
Bain Capital Private Equity
The complexity of the healthcare industry has required a whole new level of digital innovation, Moskowitz adds. “In other segments of the economy, horizontal application tools for customer relationship management, enterprise resource planning or supply-chain management have been sufficient. The needs of healthcare are so specific that they have required the development of new tools to address the needs of participants across the value chain.”
It is the mega-trends underpinning growth in both healthcare and technology that are attracting investors, with each considered attractive non-cyclical bets at a time of increased macroeconomic uncertainty.
Moskowitz says: “My sense is that historically healthcare has been one of the best performing areas of private equity, with very attractive fundamental growth characteristics, insulation from macroeconomic cycles, and compelling economics, particularly in medtech and biotech. All of that has contributed to stable and consistent returns. At the same time, technology has been the other really attractive area for investors, so when you combine the two it creates a really interesting constellation for both LPs and GPs.”
Private equity investors are keen to target established healthcare businesses that are applying digital capabilities to improve their offerings, and software companies creating digital technologies for application in the healthcare space. However, Eric Liu, co-head of the global healthcare sector team and head of the North American private equity team at EQT, says there are not enough assets to go around.
“The healthcare sector has become much more competitive in recent years, with a lot of new entrants,” says Liu. “The real economy is not able to create scaled healthcare assets at the same pace at which investors can raise capital, which has led to a supply/demand imbalance that has sustained private equity asset valuations for assets perceived to be high quality, despite the declines in public equity markets.
“The nature of competition in healthcare is different from in the TMT sector, which is also highly specialised and competitive. The healthcare sector is much smaller and there are not as many scale assets. There is an asset scarcity dynamic that drives PE buyer behaviour in the healthcare sector that does not exist in the same way in other sectors.”
Liu says investors need to narrow their focus – EQT has deselected half the industry by opting not to invest in healthcare service providers, and focuses instead on four main subsectors: medical devices, life sciences tools, pharmaceutical services and healthcare IT.
“One thing that makes healthcare a challenging sector for private equity investors is the underlying philosophical debate about whether it is a sector that should exist on a for-profit basis or be funded by governments,” he says. “That dynamic creates a constant level of scrutiny, from both the media and politicians, of the role that private equity plays in the sector, particularly as it relates to the direct provision of care.
“As an industry that is already heavily regulated, uncertainty around future regulation is always a concern”
“We prefer to invest in healthcare product and software companies where they are providing a clear benefit to patients or improving efficiency in the system. We avoid investing in healthcare service providers partly because of government reimbursement risk, and partly because of the enhanced PR risk associated with investing in businesses that treat patients who could have poor outcomes.”
Other obstacles make healthcare more challenging for investors. Jan Pomoell, co-head of the health team at Triton Partners, says: “As a result of the multi-stakeholder environment within the healthcare industry, conflicting incentives and misalignment between stakeholder groups pose a salient challenge.”
Regulation can create an additional layer of complexity, including the risk that rules can change overnight and significantly shift value propositions, according to Pomoell. “As an industry that is already heavily regulated, uncertainty around future regulation is always a concern. While a number of these regulations are necessary to ensure a safe environment for patients, many regulatory bodies fail to provide incentives that nurture innovation and encourage efficiency.”
George Moss, a partner in the investment team at growth-focused PE firm ECI Partners, says regulation can also make it difficult to scale these businesses: “Regulation and the construct of healthcare systems means that, particularly in Europe, it’s often a country-by-country market that you are looking at. A business model that works well in one country may need to be proven again in another country. The flipside to that is there are strong barriers to entry so once you have a strong position, it is hard for others to come in and compete.”
However, Moss says willingness on the part of regulators to embrace digitalisation – to drive down costs and improve patient outcomes – is also creating opportunities. “In the UK, data in healthcare has historically been quite siloed, but during covid the government waived some of the privacy restrictions to help hospitals get quicker access to patient records and unblock some of the challenges to the healthcare system that had been around for many years.
“Some of those relaxations of regulation are due to revert back to pre-covid standards, but that new outlook on data and more joined-up approach between primary and secondary care has the potential to unlock real innovation for patients.”
Moskowitz believes the biggest challenge is “making sure we are on the right side of the disruptive trends taking place in the subsectors we are focused on. In healthcare, sudden shifts in regulation can change the risk-reward profile, so we spend a lot of time identifying companies that play on the right side of healthcare regulation, which means a focus on enabling the shift to lower cost, higher quality care.”
While the universe of LPs seeking investments that capitalise on the digitalisation of healthcare continues to expand – including tech funds, healthcare funds, generalist growth funds and even strategics – a number of subsectors stand out for future growth.
Martin Calderbank, managing partner at Agilitas Private Equity, says: “The subsectors that stand out most to us are those where the dimension of competition is quality rather than price and, therefore, there is no compromise on the alignment of interests between investors and end-users. This is particularly the case with acute care services, as demonstrated by our investment in Exemplar Health Care, as well as in the equipment and medical device manufacturing sectors, where we have backed companies like Prodieco and Frontier Medical Group.”
Others point to opportunities to be had where technologies can improve payment processes, bring efficiencies to the supply chain, or help healthcare businesses address staffing challenges.
Moss at ECI says: “Data businesses, either in the pharmaceutical or the healthcare space, are interesting and are an area where we spend a lot of time hunting for opportunities, as well as other tech-enabled health or pharma services business models.”
“The pharma services subsector is particularly interesting right now,” agrees Pomoell. “It’s a rapidly growing, resilient and non-cyclical market where we are seeing attractive opportunities for us as investors. It is an exciting subsector that is at the forefront of the healthcare industry’s scientific revolution, with attractive trends in areas such as pharmacogenomics and rare diseases.
“Across all subsectors, we believe the most attractive companies are those that have a strong view towards digitalisation and technology, and which understand its power to transform businesses. We look at all our potential investments from a digital perspective and only invest in those companies where we can harness digitalisation as an opportunity.”
While it remains challenging to source deals in such a competitive environment, the fresh pace of digitalisation in the healthcare industry is creating opportunities aplenty.