‘Difficult meeting of the minds between acquirer and target’ says SVB healthcare banker

'You need an established bottom in order to figure out valuations, and I don’t think we have hit that point yet,' said Jonathan Norris.

Valuations are proving challenging in the healthcare sector, as they are throughout M&A today. PE Hub talked with Jonathan Norris, managing director for business development in Silicon Valley Bank’s healthcare practice, about what he has been hearing and seeing in the space. Norris oversees business development efforts for banking and lending opportunities as well as spearheading strategic relationships with many healthcare venture capital firms. He also helps SVB Capital through sourcing and advising on limited partnership allocations.

What does the current exit environment look like?

When I think about exits, I put them into two different categories: the IPO world (including reverse mergers and SPACs) and private M&A.

On the public side, I think it’s going to be a hard slog. From 2019-2020 we saw many IPOs shoot up in share price but have since come down quite a bit. In the last 12 months, many are down 50 to 60 percent or more from what their IPO price was over the last two years. So, for new companies looking to go public, it’s really hard to assign a value.

In previous years, you would speak about valuation by saying, “this company is like this well-performing IPO or long-standing public company,” but even long-standing public companies have suffered market cap erosion. I think there’s a question about why you would bring a company public right now. I think IPOs are going to be really difficult as we’re still trying to find a bottom on valuations of healthcare companies, across all sectors. You need an established bottom in order to figure out valuations, and I don’t think we have hit that point yet.

How about on the other side of the coin, the buy side?

The M&A side is in a similar state, as the M&A values are, a lot of the time, based on comps in the public market and those public companies have been hit a little bit. When you combine what you would consider a valuation on the frothier side for private companies that have raised private rounds over the last couple of years and you look at valuations of public comps coming down, it’s a difficult meeting of the minds between acquirer and target. We’ve seen significantly less M&A activity this year.

For the deals that we did see, while the exit value might seem large, if you peel back the onion for the later-stage investors in these rounds the multiple is between 1x to 2x, which is not typically what they’re expecting. It was not that big of a step up from where they were valued at the last private financing. I think that’s what’s available right now. For the early-stage investors, which can still be a good investment, they can still get good returns, because they’re in at a much lower valuation. They are getting exits but maybe not as big a multiple as they were hoping. However, we are starting to see some more private/private M&A activity happening, especially in health tech, with a little momentum there.

The fundamental problem is that you have robust private valuations that these companies have to catch up to which I don’t think has happened yet. For this year, I think we’ll continue to see compressed multiples in M&A overall. If companies think this is the right acquirer, even though they’re not excited about the price, they may pull the trigger. Others may hunker down, really try and grow the company and earn the 2019-2020 valuations through product development and/or revenue ramp. I think M&A is going to be a little bit of a tough sell in the rest of the second half of this year. Additionally, M&A is always available at good multiples when you have high-performing companies that have multiple acquirers interested – that part of the equation is still there, we just expect reduced activity.

What are your thoughts on the recent mega deal of Amazon acquiring One Medical?

Well, one note about this is that it is a public-to-public M&A. This is also happening quite a bit in biotech because you saw a lot of these biotech companies go public really early in their development progress. A lot of preclinical, Phase I and Phrase II companies that went public are now really interesting acquisition targets. Instead of the private companies – which once you get valued in a financing that value is static until you raise it again – public companies change value every day, and a lot of these companies are off of where they were trading at 12 to 18 months ago. So, acquirers are getting these companies at a discount (sometimes very significant discount) from where they were valued a few years ago. This feels like a more reasonable acquisition target for the big players. And target companies realize that this is a premium to where they’re trading right now in an uncertain market. Whereas these private companies at high valuations can’t reprice unless they actually do a financing round, so they’re somewhat stuck. That’s really where the struggle is in the private market. I think you’re going to see a lot of intriguing M&A opportunities in the public market. In health tech, you also have a lot of really large financings in the private market over the last two years, with many of these private companies rich with cash.

Why are US PE firms partnering with European VC life sciences firms?

Jonathan Norris, Silicon Valley Bank

We’ve certainly seen some examples of PE firms partnering with VC firms over the last year. I would say that right now is a very interesting point in time for these collaborations. This collaboration really allows for venture firms to multiply their dry powder. The good news is that most venture funds have raised new funds recently, so they have new funds to deploy. I think they’ve done a decent job of keeping their dry powder, but nobody could have really forecast what we’d be seeing now in mid-2022. I think there’s a premium to having additional dry powder to be able to support your existing portfolio, as well as additional capital to think about add-on acquisitions or roll-up strategies. In the end, cash is king for these companies, but it’s also the same for VCs, because they have to be able to support their existing portfolio companies, even through tough financings. We all know that some of the biggest and best exits that we’ve seen in the venture world have had hiccups along the way. Some of those hiccups are company induced, but some of those hiccups are financial market, macro-economic factors. To be able to support those companies through thick and thin is so important, and is the thesis of the venture capital world. If they have additional capital to do that, I think that can be hugely helpful.

What else are you seeing out there?

Healthcare venture fundraising, which does include some PE and growth funds like Tiger Global, Lead Edge and Alpha Wave, has really been incredible in 1H 2022. We are actually on a rate to beat last year’s record-breaking fundraising number, which was $28 billion, as we are at $15.8 billion midway through this year. It means we’re so well-capitalized in the market, which is great. I think that is such a huge difference from 2008 when we were really having a really tough time in financial markets and globally. Many of those funds in 2008 did not have newly closed funds under their belt to weather the storm. We are seeing an unprecedented amount of capital now and, in order to raise, investors must believe that they can deploy that in a way to generate great returns, and LPs, who actually give investors this money, must believe that to be true. Obviously, financial markets are not changing the fact that technology in healthcare continues to accelerate. The question now is, how do you tinker with valuations that have been a little heady over the last couple of years and make sure it’s balanced with where the market is now? Investors continue to make bets on new technologies. There’s no doubt about that. So that’s an interesting part of the story to see where 2H 2022 and 2023 takes us.