Industry professionals involved in healthcare M&A transactions saw a drastic decline in deal volume during the first month of 2023.
According to data captured in the LevinPro HC database, 210 transactions were reported in January. This represents a 30% decline compared to the 301 deals posted in January 2022.
A record 2,397 transactions were reported in 2022 following 2,218 deals in 2021.
There were 59 transactions in January 2022 with reported prices that totaled approximately $26.2 billion. The recently concluded month featured 36 deals with reported prices that totaled about $7.9 billion for a total price decline of 70%.
“No sector [including health care] has been immune to the capital markets volatility experienced last year and valuations will adjust accordingly,” said John Nero, senior managing director at Newmark Healthcare Capital Markets Group in New York.
The often-cited fears of a recession, an elevated pace of inflation and the increase in the cost of capital caused by the Federal Reserve’s campaign of raising interest rates to the highest level since 2007 all contribute to the conditions market participants are dealing with. But they are only part of the story.
“2022 was an outlier year for M&A activity across all strata of the market,” said Andre Ulloa, partner/executive advisor at M&A Healthcare Advisors in Los Angeles. “From a macro level, the increased cost of capital will impact enterprise values, which may cause sellers to wait until they can drive higher offers. If the cost of capital increase is coupled with uncertainty in regard to hyperinflation, or the potential of a major deleveraging of the market, investors will remain less acquisitive until there is more stability.”
The Fed’s rate-setting Federal Open Market Committee believes there is a need for “ongoing increases in” borrowing costs.
“We do expect a slowdown of M&A activity in [2023],” Ulloa said. “In the small/micro-cap sector, or lower middle market, our firm deals with founder operators who are assessing if organic growth will be more fruitful than scaling through a merger or acquisition with their equity participation.”
Ulloa also discussed the involvement of private equity (PE) in the healthcare M&A market. PE firms and their portfolio companies were involved in 137 deals in January 2022. A decline of 47% was experienced in January 2023 when 72 PE transactions were reported.
“Over the past six years, we were involved primarily with transactions in which the buyer/investor was private equity, or some form of financial firm,” Ulloa said. “Now we are seeing more strategic companies valuing the operations more than the profitability.
“We are seeing private equity lowering their valuations. That leaves lower-middle-market M&A in a place where ownership may determine that pricing isn’t high enough from strategic buyers for them to exit completely, and the offers from financial firms may not be attractive enough for them to remain involved in anticipation for a follow-on capital event.”
Numerous target sectors within health care experienced year-over-year declines in deal volume. eHealth, which had 54 deals in January 2022, fell 52% to 26 transactions in January 2023. Physician Medical Groups (PMG) posted 77 transactions in January 2022, but declined 34% to 51 deals in the first month of 2023.
“Nothing is recession-proof in an absolute sense,” said Kevin Moyer, practice lead, transaction strategy & transformation at Sax Capital Advisors in New York. “All markets will experience some level of tangential effect during a recession. But in today’s current environment, the medical office building market should see minimal material trickle-down from a macroeconomic perspective as there is an ever-present continued need for medical office space.”
Declines experienced within the acquirer sectors included eHealth, falling 46% from 37 deals in January 2022 to 20 transactions; PMG declining 38%, from 64 transactions to 40 deals in January 2023; and real estate investment firms dropping 26% from 19 deals in January 2022 to 14 transactions.
Despite a drop from seven Hospital target sector deals in January 2022 to only one transaction in the recently concluded month, Nero foresees notable activity in the sector during 2023.
“Independent hospitals will likely continue to consolidate with larger health systems,” Nero said. “Cost pressures and thinner margins on smaller community hospitals have motivated this alignment with larger systems. A similar trend is occurring for small to midsize physician group practices. We have observed health systems aligning with specialty operators in inpatient rehabilitation hospital and behavioral health sectors, which will create more joint venture and merger transactions.”
Ulloa identified the “outlier bid” as a bright spot in the healthcare M&A landscape.
“On average, EBITDA multiples have gone down,” Ulloa said. “Certain segments have been hit harder than others. However, we continue to receive outlier bids on our deals, which are at the height of the market. We continue to see one offer in every deal that greatly exceeds the average valuation. There is plenty of fear, uncertainty and doubt to go around. So far, we have been able to find at least one buyer that adds value to the seller’s company due to operational synergies, geography or accretive integration with their current service line.”
Despite the decline from 15 Behavioral Health Care target sector deals in January 2022 to nine transactions a year later, Ulloa remains bullish regarding the sector.
“There is a silver lining with treatment facilities, which are inpatient and in network,” Ulloa said. “We are seeing financial growth in treatment centers.”
A drop in deal volume has not dampened Nero’s optimism regarding 2023. He said Newmark expects an uptick in M&A activity this year as investors and targets have had an opportunity to adjust valuation expectations and prices in a “new normal” rate environment. Also mentioned was the market’s performance when the economy has been battered.
“As previously experienced in 2020 and 2008, healthcare facilities have been resilient and demonstrated stability in occupancy rates in economic downturns,” Nero said. “Healthcare expenditure is 18% of GDP and demand for healthcare services continues to grow with the aging senior population and growth in insured lives. In terms of macro indicators, multiple significant tailwinds will support M&A volume remaining strong in future years, particularly for services-oriented sectors.”
There is no question that investors and potential sellers in the healthcare space will have to adjust to the interest-rate environment that will exist when the Fed stops raising borrowing costs. Valuations will undoubtedly be impacted by the cost of capital and those looking to execute deals may need to work even harder and longer to find agreement where prices are concerned.
“ and other investors in the healthcare space will be looking to scale their physical asset footprint with strategic expansion, playing a big role in M&A deals,” said Moyer, who added that specialty provider practices make medical office buildings desirable as they are a high-value asset that offers exclusivity. “Medical office real estate companies will be looking to innovate in order to bridge pipeline gaps they may be experiencing. Inflation is playing a big role in today’s activity. Consumers are waiting for their desired price and are holding out to see if that is achievable.
“With interest rates maintaining their upward trajectory, managers will be looking to decrease the inherent negative arbitrage that may present itself via current market-level cap rates and their cost of capital through moderate, as opposed to maximum, leverage at the entry point of an acquisition.”
