Back to School: Bar rises for healthcare investors

Healthcare is poised to remain a safe-haven investment in 2017 as the sector’s long-term fundamentals remain positive, but the bar is rising as a growing number of funds disproportionately focus on the sector, according to Bain & Co Partner Kara Murphy.

“The reality is [that] in a world where it’s so hard to get deals done, the basic analysis that ‘this is a good market’ isn’t going to give you enough conviction to win,” said Murphy, who co-wrote Bain’s Global Healthcare Private Equity and Corporate M&A Report 2017. “You have to turn over more stones than you have historically if you actually want to own a company.”

Reflective of fierce competition, only 30 percent of large healthcare PE investors over the past five years have successfully sealed more than one deal valued between $500 million and $5 billion (or more) — the “sweet spot” for large financial deal makers, the firm’s April report found.

At the same time, total disclosed healthcare-PE-deal value spiked to $36.4 billion in 2016, the highest since 2007 and a 60 percent year-over-year increase, the report shows. Meanwhile, overall PE deal value fell.

An expensive and competitive climate has pushed buyers to get creative. Among other things, the valuation arbitrage between the public and private markets, if sustained, should support a continued surge in take-privates, Murphy said.

In 2016, the weighted average valuation multiple (EV-to-LTM EBITDA) for publicly traded healthcare companies was 11x against 13x for PE-relevant segments, Bain’s analysis shows. (Bain defined “relevant segments” as those in which PE is most active: provider and related services, payer and related services, HCIT and suppliers of services to pharma and medtech firms.)

Even if sponsors have to pay large premiums for public companies, $1 billion-plus assets with an edge or leading brand will create buzz, Murphy said. “There’s a ton of excitement around guys like Advisory Board.”

Advisory Board, a healthcare and higher-education consultant exploring strategic alternatives, is among public companies that could produce a transaction with one or more PE firms this year. Take-privates this year so far include American Securities’ $2.5 billion deal for medical-helicopter company Air Methods.

Three of the top four healthcare PE deals of 2016 were public-to-private transactions involving U.S. companies, the report says. Combined, TeamHealth’s $6.1 billion sale to Blackstone, Press Ganey’s $2.4 billion sale to EQT, and ExamWorks’ $2.2 billion sale to Leonard Green accounted for nearly 30 percent of total disclosed value, the report found.

Sponsors will continue to hunt opportunities in “healthcare-light” subsectors that are less vulnerable to potential Affordable Care Act modifications and other risks, according to Bain. Healthcare IT, retail health and contract services for drugmakers are all considered healthcare light.

Still, Murphy speculated that more funds may update their theses in the wake of intense competition and high prices. Investors may determine that the relative attractive multiples and EBITDA potential characterized by healthcare-heavy assets offset reimbursement and policy risks, Murphy said.

Creative deal structures — consortium arrangements, carveouts, cross-border partnerships and collaborations with strategic buyers — will increasingly be used to pursue opportunities in the pharma and medtech sectors, Murphy predicted.

For instance, New York buyout firm Clayton, Dublier & Rice less than a week ago teamed up with CareCapital Advisors, a platform of China-focused Hillhouse Capital, to acquire the digital dental equipment business of Onex Corp.’s Carestream. The unit was reportedly anticipated to fetch about $1 billion.

Also this month, Boston’s Bain Capital and London’s Cinven won the auction for Stada in a deal that valued the German drugmaker at about 5.3 billion euros ($5.6 billion).

“Not all funds are underwriting to the same level of return, and when we layer that on with where we are with healthcare reform, there’s more volatility,” Murphy said. “But that can also create opportunity. We expect that people recognize that the bar is rising.”

Action Item: Reach Bain’s Kara Murphy at kara.murphy@bain.com

Photo of Kara Murphy courtesy of Bain & Co.