On October 21, we attended McDermott Will & Emery’s HPE New York event for a morning of panel discussions and networking. Much of the focus was on private equity’s healthcare M&A strategy amid higher interest rates, a pricing disconnect between buyers and sellers, and other headwinds in the industry.
Right off the bat, the first panel posed a question to the audience asking what was causing a drop in deal activity. Quite clearly, the top two answers were, “frozen credit markets” and “pricing too high,” with “wage inflation” another major factor in how buyers approached potential deals. Higher wages may very well keep some PE firms from buying service-intensive healthcare businesses because the future of wage inflation is still a major unknown. The data have yet to reveal a flight from service business acquisitions. However, LevinPro HC statistics show the monthly share of service acquisitions is staying remarkably consistent around 73% each month from July to the first three weeks of October.
As far as financing deals in this environment, we may see more PE firms with copious “dry powder” self-finance with cash for the time being, until the debt markets become more favorable to them. Not all buyers have that ability, so we may see the share of PE firms as buyers inch up. PE firms already accounted for 39% of buyers in all third-quarter deals, according to statistics from LevinPro HC, and have consistently accounted for similar percentages in the last 12 months of M&A activity.
In a buyer’s market, and with lenders/buyers much more cautious in evaluating acquisition opportunities and their future earnings, valuations will likely come down for almost all healthcare targets, services and tech businesses alike. One panelist has observed valuations in digital health pull back by almost 20% in some cases, and service businesses were likely hit with a similar valuation reduction. What could halt many transactions is whether the sellers will agree with those lower valuations. Owners without a specific investment horizon or real financial need to divest will be able to afford to wait for their desired value. When that will come, who knows? And when a number of limited partners need their capital back, continuation funds are a growing option for underperforming portfolio investments and even well-performing ones.
Buyers and their capital providers will have to scrutinize deals much more carefully, and with a less active bidding environment, they have more room to do so. The relationship between capital providers and sponsors will also likely change, with more sponsor oversight from the capital providers and some hard decisions to come for non-performing partnerships. But buyer discipline is good for the healthcare industry, as it will lead to fewer bad investments and potentially fewer negative headlines in the media regarding private equity’s takeover of the healthcare industry.
