Taking temperatures

Some US healthcare-focused private equity investors are reevaluating their portfolios and approaching investment targets with extra caution amid an uncertain regulatory environment. A change in administrations come November could hamper some niche healthcare investment sectors.

General partners across the  US will be increasingly dividing their attention between balance sheets and poll numbers in the next few months, as a host of issues affecting the industry may hinge on Pennsylvania Avenue’s next resident.
 
Limitations on bank ownership, changes in capital gains duties and a steep tax hike on carried interest are just some of the policy issues that are expected to come into play after a new US president and Congress are elected this fall.
 

We're concerned that there may be some changes that reduce revenues.

Richard Tadler

Private equity healthcare investors have been keeping a particularly watchful eye on Washington, as a slew of potential regulatory changes being debated on the campaign trail could roil a previously successful portfolio.
 
The uncertain regulatory environment has also caused some firms to slow down their healthcare deal pace, as GPs proceed with redoubled caution when evaluating acquisition targets. 
 
“We’re cautious on companies that show continued growth in the future at past growth rates,” Richard Tadler, head of growth equity specialist TA Associates' healthcare division, told PEO. “We’re concerned that there may be some changes that would reduce revenues.”
 
Although radical changes like the implementation of universal healthcare are unlikely, one legislative issue looms that could carry major implications throughout the sector.

Medicare Advantage, a federally-funded programme that offers enrollees the choice of receiving traditional Medicare benefits from private health insurance plans, has proved a boon to several private equity investors active in the healthcare payer and provider space. Medicare is the federally funded health insurance program for the elderly. 
 
The programme provides private insurance providers with government subsidies to enroll Medicare

Nobody is buying Medicare advantage probably. I think they're tip-toeing around it.

Joseph Ibrahim

recipients, has come under severe criticism from Democrats as a handout to the much-demonised US health insurance industry.
 
Since gaining control of Congress in 2006, the Democratic majority has floated several major alterations to the program, but a complete revamp may only come after the November election. Although it is unclear what exact form that revamp will take, it will at the very least be a reduction in the program, if not its dismantlement entirely.
 
Since Medicare Advantage’s launch in 2003, several private equity firms have invested in health management operators and other healthcare providers which receive significant support from the programme, or have bought into other healthcare companies which would be adversely affected by the programme’s discontinuation.
 
“There have been a lot of investments in both companies that provide Medicare advantage plans and to companies that have benefited from supplying to those plans, so it has generated new areas to invest,” said Tadler.
 
Dedicated health specialist Ferrer Freeman & Company’s Preferred Care Partners and Pharos Capital’s Windsor Health Group are just two examples of healthcare providers owned by private equity firms that could be hurt by a drawback in the program.
 
The political rhetoric surrounding Medicare Advantage has caused firms to drop the niche healthcare sector from their investment radar.
 
“Nobody is buying Medicare advantage probably,” Joseph Ibrahim, healthcare investing principal at middle market specialists The Riverside Company, told PEO. “I think they’re tip-toeing around it.”
 
Beyond the fate of Medicare Advantage, private equity firms are also paying close attention to potential changes in Medicaid, the joint federal and state health insurance program for low-income individuals and children.
 
Investors are concerned that potential alterations or cutbacks in Medicaid’s reimbursement schedule, caused by deficit-plagued state budgets, could threaten skilled nursing facilities, hospitals and other recipients of Medicaid patients.
 
“I think Medicaid is another animal,” said Ibrahim. “That’s a state by state issue, and 32 out of the 50 states have serious funding issues, state funding deficits. So I think Medicaid is going to continue to receive pressure.”
 
The Carlyle Group-owned Manor Care and Fillmore Capital-backed Beverly Enterprises are just two skilled nursing facilities that could be adversely affected by cutbacks.

However, as state governments mull their budget options, Ibrahim points out that they may be more inclined to keep Medicaid as fully funded as possible, as state contributions are usually matched by federal dollars.

Whatever the fates of Medicaid and Medicare Advantage, health investors will likely be navigating a far different landscape than the one they have so profitably grown familiar with the last four years.