Tackling healthcare in 2011

Healthcare exits should remain strong in the new year, but mid-market and lower mid-market funds have the advantage, writes Reeve Waud.

A lot of people who don’t invest in healthcare or who are just starting to invest in the space may think the demographics are in their favor just because of the aging population. If that’s the way you view the opportunity to invest in healthcare, you’ll have your head handed to you.

In the world of private equity, investing in healthcare successfully requires having a deep understanding of regulations, reimbursement and compliance. You need to have a laser-like focus on industry dynamics such as replicable models, strong management, 100-day plans, exceptional management talent, and 13-week rolling cash flow forecasts, among other aspects. You have to focus on saving people money and providing higher quality care.

In 2010, the need to be on the right side of the cost-containment curve became even more acute. It was a year to focus on cutting costs and gaining a better understanding of your operating metrics.

Uncertainty over the healthcare bill really provided some opportunities for those who had a vision and a strategy. If you don’t understand where the world is going you can become a little bit like a deer in the headlights. You wait until there’s clarity. Uncertainty provides opportunity, and clearly there’s been a lot of uncertainty in 2010.

Most private equity firms are cautious given the unknowns regarding the healthcare bill, so you have to have a very firm conviction when making an investment or you have to be providing a service which clearly will benefit from the overhaul. An example is a company in the revenue cycle management business that helps hospitals to collect money from  various payers. In a tougher economic environment there’s a real premium on being able to collect those dollars. That makes that service even more valuable.

The healthcare services segment lends itself to smaller firms with strong operational skills. There are very few middle market private equity firms that focus exclusively on healthcare services. You find a lot more of the lower mid-market funds which build companies for either strategic buyers or large private equity funds.

On the opposite end of the spectrum it’s very difficult to get deals done with a multi-billion dollar healthcare fund because they’re competing with large healthcare companies who are strategic buyers that have synergies. Many of those companies focused on cost control and managed their balance sheets in 2010 and, therefore, have a lot of cash on hand now.

One of the real concerns is that the pressure is not only on the federal government to rein in healthcare costs, but also on the states, whose massive budget deficits are unsustainable. Medicaid in any given state can tell you they’re going to pay you, and they do intend to pay you, but companies have to ask themselves if they can stay in business if they’re not going to get paid for 100 days. That’s an unfortunate situation facing lots of smaller companies right now.

If you look at the budget deficits in most of the states around the country, it’s only getting worse, and it’s getting worse quickly. While that may not slow the pace of investment, it’s another factor that you have to take into account.

In 2011, we’ll continue to see specialized funds and the acknowledgement that healthcare is not cyclical and can’t be outsourced. There will continue to be strong exit opportunities to strategic buyers in 2011, and in general the amount of exits should remain strong because there’s access to financing, both from the traditional bank market as well as the high yield market. 

There are significant opportunities to improve the cost effective delivery of healthcare, but the funds you’ll see focused on this will likely be in the middle and lower mid-market.

Reeve Waud is Managing Partner of Waud Capital Partners.