“Whenever you have an environment where the credit markets are not as aggressive as they once were, that’s going to impact valuations and ultimately the activity in the M&A market,” explained Parris Boyd, partner, Firmament. “With that said, the big slow-down has been mostly for larger deals. The direct lending market for core mid-market and lower-mid-market deals is still active with a lot of dry powder. Direct lenders have raised a record amount of capital over the past few years. As a result, we’re still seeing good deal flow in the lower-mid-market, particularly for healthcare deals which are largely recession-proof.”
As part of our ongoing series on healthcare private equity investors, Boyd spoke to PE Hub and shared his insights on a wide range of topics, including rising interest rates, returns, debt-to-equity ratios, exit opportunities and the role of Amazon and UnitedHealthcare as dealmakers.
9x return a “nice win”
“Our first investment was a provider of durable medical equipment to patients that are homebound,” he said, referring to AdaptHealth, which the firm backed in 2014. It went public in 2019 through a merger with DFB Healthcare Acquisitions, a SPAC sponsored by Deerfield Management, and Firmament exited the investment in 2021.
“The industry was undergoing a change in reimbursement to reduce costs and increase transparency in fees,” he recalled. “To date, this has been our most successful investment, as we generated an approximate return of 9x on total invested capital. This was a nice win but is also illustrative of a bread-and-butter transaction for us; we made a structured equity and debt investment in a healthcare sub-sector that was undergoing change, requiring deep industry knowledge to navigate. Deals with nuance that require extra diligence on the front-end are right in our wheelhouse.”
The firm has a flexible approach to investing across the balance sheet, primarily in structured equity and unitranche debt, according to Boyd.
“We facilitate control equity deals through one-stop buyouts and growth investments utilizing minority equity and debt,” he said. “A typical deal for us is a business generating between $5 million and $7 million of EBITDA that is looking for growth capital. In these situations, we are more than likely the senior lender via a unitranche loan and the controlling or minority shareholder through a redeemable preferred equity investment with upside through common equity ownership.”
Firmament has also done deals with debt and structured equity that generate a return through a liquidation preference schedule to get the firm a 2x+ total return and 3x+ return on equity.
“In these situations, minimizing dilution was important to the owners of the businesses,” he said. “We focus on upside but also on downside protection. The debt portion of our investment provides current income to our investors, shortening the J curve and providing downside protection. The J curve for a typical PE fund can be 5 to 7 years; whereas our J curve is typically 1 to 2 years.”
“Our debt-to-equity ratio really hasn’t changed that much, despite the rise in interest rates, because we’re not aggressive on leverage,” he said. “For us, it’s about what levers we can pull post-closing, instead of financial engineering through high leverage. An increase in interest rates when you have conservative leverage is not really going to move the needle on the company’s cash flow coverage. We usually have somewhere between 1.5x and 2x interest coverage for most of our deals.”
What makes Firmament different?
“The way we’ve historically differentiated ourselves is through our ability to invest across the capital structure and provide all the capital necessary to close a transaction, our focus on the lower-mid-market, and our knowledge of healthcare,” said Boyd. “Because we’ve spent a significant amount of time in healthcare, we’re able to quickly assess ways we can add value and avoid risks. In a lot of our investments, we’re providing guidance and assistance on several fronts, including filling holes on the executive teams, establishing the appropriate key performance indicators and organic growth plan, developing the regulatory and information technology infrastructure, optimizing the capital structure, and structuring and executing tuck-in acquisitions. As the businesses get larger, our investments benefit from a lower-beta business profile and multiple arbitrage upon exit.”
“I think optimizing the timing of our exits is one of the most important things we do,” said Boyd. “We start the process of thinking about our exit plan before we invest, recognizing it is a combination of art and science. A large portion of our investment process is developing a value creation plan, with a timetable and goals to measure our success, and a path to monetize our investment.”
Boyd added that Firmament tracks these plans monthly, and once the plan has been achieved, the next question is what else can be done with this business and what’s the market environment for buyers of this type of asset.
“I think the average hold time has been shorter for several industries, not just healthcare,” he said. “We’ve experienced an aggressive credit and valuation environment for several years, which has led to shorter hold times by investors. When you layer on top of this an aging population, as well as other trends in healthcare, the result is strong growth in certain areas of healthcare and a very active M&A market. Historically, we’ve held things on average for three to five years. Given the large growth we’ve experienced in some of our investments, we’ve recently considered exiting a few investments after a couple years.
“Once we get to a point where we feel like we’ve pulled all of the levers that were in our plan, and a few other ones that we feel like we can execute on, depending on the market environment, we look to exit,” he said. “The ideal buyer, either strategic or financial, typically depends on the asset; our goal is to put the business in the best position to succeed in the long term and maximize value to our investors. Historically, we have sold businesses to both financial and strategic buyers.”
Amazon, UnitedHealthcare and more
In healthcare practice management services, Boyd expects to see more strategic buyers as the industry consolidates and value-based care becomes a larger part of the healthcare landscape.
“Hospitals and insurance companies (e.g., UnitedHealthcare) have been acquiring physician practices for years and this trend will continue,” he said.
Amazon, which announced in July that it is buying US healthcare provider One Medical for $3.9 billion in an all-cash deal, “is a very strategic and sophisticated investor, and this move tells me that their research suggests primary care is the best place to start in the process of consolidation,” Boyd observed. “The move by Amazon signals the attractive nature of the healthcare market from an investment perspective. It is too early to tell if the Amazon deal is good or bad for the healthcare industry, but it is something we are watching closely.”
In terms of the current market, if you were looking to go public as an exit, your plans are on hold as the IPO market is shut down due to the state of the economy. Boyd said that the broadly syndicated bank market for large loans is pretty much frozen, and large direct lenders have been picking up credit assets at a discount in the secondary market.
Healthcare and technology
“Clinicians are slow to adopt technology and change their behavior, but I think they will be forced to change, due to shifts in regulation, labor shortages, and greater demand from consumers for transparency regarding fees,” Boyd said.
Firmament has spent a lot of time on the services side of healthcare in the past, but now, the firm is focusing on the technology side to take advantage of what Boyd predicts will be a big wave of change in the coming years.
“We recently invested in a technology company called Panacea that provides price transparency, revenue integrity and compliance software to healthcare companies,” said Boyd. “Panacea, which is a merger of three businesses, provides software and consulting services to more than 600 hospitals, health systems, physician practices and accountable care organizations across the US. In an era when consumers are increasingly demanding transparency with healthcare costs and 95 percent of provider revenue is driven by accurate coding and defensible pricing, we believe providers like Panacea are critical to the operations and success of healthcare service providers.”
Cutting costs and fixing labor shortages
“Our current investment themes are primarily focused on businesses that eliminate costs from the healthcare system and the labor shortage that exists in several areas,” said Boyd. “This would include businesses that are moving surgical procedures and other services from higher-cost settings, such as hospitals, to lower-cost environments, such as ambulatory surgery centers. Two segments that come to mind are orthopedics, with certain hip and knee replacement surgeries recently being approved by Centers for Medicare and Medicaid Services to be performed at an outpatient ambulatory surgery center, and skilled home health. We are also spending time on investment opportunities that focus on value-based care.”
The firm closed an investment last year in an orthopedic management services company, M2Orthopedics.
“The initial platform practice that our management services organization partnered with was founded in 1941 and is focused on joint replacements,” he said. “This subsector benefits from an aging population and CMS’s recent approval of reimbursement for hip and knee joint replacement surgeries performed in an outpatient ambulatory surgery center. The practice did not own a surgery center, and the physicians were performing the majority of their joint replacement surgeries at the local hospital. We partnered with management and the physicians to construct an outpatient surgery center, which will more than double the size of the business and eliminate costs from the healthcare system.”
Labor shortages continue to plague the healthcare system.
“We invested in a nurse staffing business called PRN Healthcare that has benefited from this trend,” said Boyd. “The shortage of nurses is created at the education level, as the current nursing education system is not producing enough nurses to offset retiring nurses. The rate of nurses retiring also increased during covid and exacerbated the shortage of nurses. Since our investment, the business has grown by more than 75 percent.”
Founded in 2012 and based in New York, Firmament is a structured equity capital provider to small- and medium-sized enterprises. In January, the firm announced the final close of its third investment vehicle, Firmament – Structure III, at $475 million. In antiquity, the term “firmament” represented the mystical arch that held the stars, protecting the earth from above.
In 2021, Firmament sold GPS Dental to Main Post Partners. Also in 2021, Firmament exited AdaptHealth, which had gone public through a merger with a SPAC in 2019.
In 2021, Firmament invested in PRN Health Services, M2 Orthopedic Partners, DxTx Pain & Spine and Panorama Eye Care (see below for more info).
Firmament’s healthcare portfolio highlights
(Dates refer to initial investment)
DxTx Pain & Spine: An intervention pain management MSO in the Midwest. (March 2021)
e4 Services: A healthcare consulting and professional services firm that provides operational, IT, and strategic advisory services to US hospital & health systems. (July 2020)
GPS Dental: A dental practice MSO with practices in AR and the southern United States. (December 2020)
M2 Orthopedic Partners: An orthopedic MSO that is comprised of orthopedic practices in the mid-Atlantic. (July 2021)
Panorama Eye Care: A vertically integrated ophthalmology MSO with practices in Colorado and Wyoming. (February 2021)
PRN Health Services: A tech-enabled medical staffing business which provides registered nurses, licensed practical nurses, and certified nursing assistants to hospitals and long-term care facilities across the US. (September 2021)
Vision Integrated Partners: An MSO headquartered in St. Louis, Missouri, that manages eye care practices across the United States. (September 2019)