EQT’s Eric Liu predicts continued recovery in dealflow for healthcare sector

'Interest rates are still high, but we can feel the system starting to move again.'

Higher interest rates and a difficult exit environment have had a significant impact on dealmaking activity in the healthcare sector. To find out how private equity firms that invest in the sector are handling the challenges, PE Hub spoke with Eric Liu, partner, head of North American private equity and global co-head of healthcare at Stockholm-based EQT. The interview is part of PE Hub’s ongoing Q&A series with high-profile dealmakers.

What are the challenges of investing in the healthcare sector?

First, healthcare is an odd animal, a bit like the education sector. It is an industry delivering an inherently critical service to society. Depending on who you ask, people can have mixed views as to whether companies should be making money in the healthcare sector. As a result, investments in the healthcare sector are inherently more prone to both regulatory and media scrutiny. So, EQT avoids certain types of companies even if the underlying business fundamentals might be attractive, and we try to focus our efforts on companies that are providing a very clear and differentiated benefit to society.

Second, in the US, the government is frequently a large customer, as well as the main regulator, so they set prices and change rules at their sole discretion. This degree of customer concentration can be manageable for a while, until it’s not. That is why it is difficult to dabble in the sector. The most successful healthcare investors are consistently active in the market, nimble, and aware of where the risks tend to be higher.

And third, there are large segments of the sector that were temporarily boosted by covid. Sometimes it’s obvious – if you are evaluating a clinical lab, you can identify which revenue came from covid tests. But it’s not always that obvious since some sectors were boosted in a secondary way. Additionally, when trying to invest in a company where temporarily elevated revenue is falling, it is hard to know when it will bottom out, and how long it will take to return to run-rate trend.

What opportunities is EQT pursuing in the healthcare sector?

We try to pursue opportunities where we have a specific value creation plan and thus believe that we can be distinctly better owners than the average firm.

We have been focused on the same sub-sectors for the last six to eight years: medical devices, life science tools, healthcare IT and pharmaceutical services. These are the sub-sectors within healthcare where we have much deeper expertise and have external advisors that can add meaningful value.

Even within these sectors, we try to pick our spots. We are much less prolific than other private equity firms. EQT’s large-cap private equity funds tend to be fairly concentrated and have historically had approximately 15 platform investments globally across all sectors, so we can be highly selective within US healthcare. Right now, EQT’s private equity funds only have two US-based portfolio companies in the healthcare sector, after having sold five companies in the last few years.

How has covid affected your dealmaking?

What was surprising and unusual during covid was how productive people were able to remain while working from home, particularly in an industry where relationships are important. Zoom is a very good technology, which enabled people to maintain existing relationships and interact in a transactional way. In my particular situation, most of my partner colleagues are based in Europe, so I was ironically relatively better off during covid than pre-covid because everyone was forced to interact by Zoom, whereas previously my European colleagues saw each other more often than I saw them.

During covid, we had to be very selective around which investments could be made in a remote environment. For example, the EQT IX fund’s $8.5 billion acquisition of Parexel signed in summer of 2021, when we were still working from home. We were comfortable making that investment because we had so many existing relevant relationships and touchpoints with the company. First, it was a well-known company, having been publicly traded for several decades. Secondly, we had completed thorough due diligence on the company in 2017 before its take-private. Thirdly, we knew the CEO [Jamie Macdonald] well because he was our original chairman at EQT’s other US healthcare portfolio company, Certara. And lastly, I had been friends for many years with my partner counterpart at our co-investor Goldman Sachs.

Now that most of the industry is functioning as it was prior to covid, people are able to start developing new relationships again, and do not need to continue drawing down on their inventory of pre-covid relationships. And that expands the scope of people we’re willing to work with, and also the scope of companies in which we are comfortable investing.

What differentiates EQT’s healthcare strategy from other PE firms?

First, and this is not specific to healthcare, is our corporate governance model. We do not populate company boards with EQT investment professionals. Our boards are comprised of majority independent directors, including the chairperson. These board members are typically former CEOs and CFOs with relevant industry experience who are not employed by EQT.

Second, and this is healthcare-specific, is that part of EQT’s strategy in the private equity business is to avoid healthcare service providers. This is a highly unusual approach for a private equity firm investing in the healthcare sector, particularly in the US. By deselecting provider deals, we are ignoring almost 50 percent of all dealflow in our market. This strategy works for EQT because these types of for-profit provider businesses do not tend to exist in the same way in Europe as they do in the US.

The third thing that makes us different relative to other large, diversified, multi-sector firms is that healthcare is disproportionately important for EQT. Forty to fifty percent of the capital deployed globally in the last few private equity funds has been in the sector. This activity level provides us with a broad network of relevant relationships and more experience generally.

How has EQT’s North American healthcare investing strategy evolved?

I joined EQT in 2014 as the first US hire in the private equity business. I had joined from another firm that was a very successful and prolific investor in the healthcare industry. At my prior firm, we submitted first-round bids fairly often because it gave us the opportunity to meet management, conduct due diligence, and make investment decisions on a more informed basis after we had done our work. And investment banks benefited from having us in their sellside processes because of our reputation.

When I joined EQT, it was more difficult generating dealflow than I had expected, because the market had evolved to narrow processes where bankers would only make outbound calls to six to eight parties. While I had good relationships with bankers, no one in the US knew who EQT was, so it was difficult for bankers to justify to their client why to include us in their processes. We had to be extremely selective about which assets to target and had to do a lot of preemptive work well in advance of a sale process to justify our inclusion. And then we had to bid with conviction and make sure that our conversion rate was high. We were forced to operate in this manner for our first few years in the US in order to survive and build our reputation. But even now, when we are better known and could in theory operate differently, we have found that this approach works well and is also good for internal morale, since we avoid wasting time on opportunities that everyone knows will not end up happening.

What’s your forecast for dealflow this fall?

There was a nine-month period between July of 2022 and March of 2023 where there were essentially no large-cap private equity deals announced in the healthcare sector by any major PE firms. Starting in April 2023, there were a few new investments announced and then a few more thereafter. Interest rates are still high, but we can feel the system starting to move again.

Sellers have not capitulated on valuation expectations, and buyers have realized they cannot wait for a correction in expectations before starting to invest again, because they might be waiting for a long time. Thus, PE firms are deploying selectively in situations where they think they can be good owners.

Heading into the post-Labor Day period, I think the market will continue to thaw. Although interest rates are higher than they have been in the past few years, the near-zero interest rate environment was also a historical anomaly. I think we will see a continued recovery in dealflow through the end of this year and into next year.

For more on EQT’s healthcare strategy, see our previous profile. And for more perspectives on dealflow for the remainder of 2023, see our interviews with Blackstone’s Martin Brand, Sperry Mitchell’s Beatrice Mitchell and Churchill’s Anne Philpott.