Our Hot Topics in the Middle Market roundtable brought together a panel of business and investment experts to provide their views on the healthcare M&A landscape. The panel featured Jessie Collins of athenahealth, Claudine Cohen of CohnReznick, Bill Gerard of SV Health Investors, Trey Marinello of Houlihan Lokey, Chris McKelvy of K. Ventures, and Michael Papile of Covington Associates, and was moderated by Nixon Peabody corporate partners Philip Taub and Gregory O’Shaughnessy. Our panelists shared a wealth of predictions impacting healthcare in the coming year.
Macro Trends in the Healthcare Sector
Healthcare, like many industries, has been in a peak, growth-oriented market for over a decade. During that stretch, investors have prioritized acquisitions at all costs—oftentimes at bloated valuations that were disconnected from a target’s fundamentals. In light of the recent pullback over the last twelve months, however, the importance of profitability has reentered the spotlight. Now, investors are prioritizing near-term earnings and revenue visibility. They are expecting their targets to understand key financial metrics and core competencies, such as the costs to deliver client care and customer acquisition rates. In other words, buyers are no longer “buying the forecast,” they are “buying the actual.” These recent corrections have put the healthcare market into its first adjustment period in years, introducing uncertainty for both buyers and sellers.
Our panel suspects that many healthcare businesses are still considering going to market, but may wait multiple quarters for a more favorable transaction environment. EBITDA valuations for middle-market healthcare companies have decreased by 2 -3 turns, unicorn financing has dried up, SPAC activity has come to a screeching halt, and the IPO landscape remains flat, all of which are forcing many potential sellers to enter “wait-and-see” mode.
The panelists also expect that increased governmental oversight will continue in the near term. In particular, the federal government has increased its focus on Hart-Scott-Rodino (HSR) scrutiny, as well as on data protection/privacy, foreign investment, and CFIUS concerns with respect to healthcare targets. Increased regulatory scrutiny means longer approval timelines, which means longer transaction timelines, which means increased transaction risk.
Strategics Gain an Edge
Strategic buyers are expected to be in a strong position in the near term. Strategics have been building up cash reserves for years but have been unable to deploy them because they have been outbid by private equity buyers flush with low-cost debt. Now, with interest rates rising and credit markets shrinking, strategics should be well positioned to capture opportunities. Of course, it will take time for healthcare industry sellers to accept that market dynamics will result in smaller valuations than they have become accustomed to in recent years.
The panel also discussed recent changes to M&A due diligence, and how strategics can use those changes to gain an edge. Advancements in technology have granted buyers powerful tools to dig deeper into a target’s diligence than ever before. But, reliance on technology and remote work constraints have also diminished the amount of contact between buyers and a target’s executive team, often resulting in a lack of fundamental relationship building that has historically been an M&A hallmark. Strategics will have a leg up on management diligence going forward, as they will have a more acute understanding of a target’s typical operations and organization, and can leverage that knowledge to accelerate relationship building in our increasingly virtual world.
COVID’s Legacy on Healthcare M&A
The COVID pandemic spurred a number of new (and, according to our panel, enduring) changes to the healthcare M&A landscape. Perhaps most apparent, COVID accelerated the acceptance of telehealth platforms and technology. The dramatic uptick in development and utilization of telehealth platforms will surely pique buyers’ interest in the coming years, and will become a mainstay throughout the healthcare sector.
The panel is also cognizant that federal dollars provided under the PPP loan and employee retention credit (“ERC”) programs are drying up. During the COVID years, many healthcare businesses had their balance sheets saved by PPP loans and ERCs. Without those cash infusions, many businesses may struggle or fail in the short term.
What to Watch For
Our panel has a focus on the following healthcare sectors: telehealth, value-based care, innovative approaches for senior care (such as isolation prevention and Programs of All-Inclusive Care for the Elderly, or “PACE”), and managed care. They are also keeping a pulse on the effects that will stem from the upcoming end of the COVID public health emergency on May 11, which will bring the end of certain free drug and drug testing programs, as well as the removal of certain limits on what pharmaceutical companies can charge for COVID-adjacent drugs.