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For healthcare investors, differentiation is crucial: ACG panelists

For healthcare-focused private equity groups, specialization is more important than ever, panelists at ACG InterGrowth 2017 in Las Vegas emphasized this week.

Opportunistically pursuing an asset at a below-market value is a strategy that no longer exists, especially as bulge-bracket firms increasingly compete for sub-$5-million EBITDA assets, said Enhanced Equity Funds principal Matthew Thompson on a panel discussion at the Aria Resort and Casino.

“We’re starting to see bulge-bracket firms who develop unique specializations within their very broad industry practice [pursue] these deals,” Thompson said on a panel called Health Care Trends: Where You See Pockets of Opportunity. “Quite honestly, that’s where a lot of the value lies — in smaller deals — where you can pay a slightly below-market multiple to get juice on typical organic and non-organic strategies.”

Healthcare-focused Enhanced Equity, for instance, recently competed with a large sponsor for an ophthalmology company generating just $4 million EBITDA, Thompson said.

That’s not surprising given the volume of PE deals in the vision space this year so far. Earlier this month, for example, global PE firm H.I.G Capital scooped up SouthWestern Eye and Barnet Dulaney Perkins to create a regional platform based in Arizona. SouthWestern founder Lotharie Bluth told Buyouts that he’d held previous talks with a number of PE groups including Waud Capital Partners and Excellere Partners.

Amid significant uncertainty about how healthcare will be regulated or administered, Thompson said Enhanced is focused on discovering differentiated operating models. That could mean figuring out how to have a “better mouse trap” in the physician-practice-management space, a market that will be increasingly challenged as valuations rise in the face of payment pressure, he said. Other opportunities might fall in ancillary services and technology, he added.

“That’s where we spend a lot of time: building that vision [around] where healthcare is going to be in five years, but also, what’s the core operating model today that we think can survive,” Thompson said.

While a herd mentality is reflected as PE buyers flush with cash continue to chase hot subsectors — oftentimes retail-oriented models — Raymond James Managing Director Burk Lindsey, another panelist, also emphasized the value that lies in niche segments.

Sponsors have flocked to retail-oriented models amid concern about the future of Medicare- and Medicaid- dependent companies, which are viewed as more vulnerable to potential changes to the Affordable Care Act. While these companies continue to come to market and command big multiples, some retail-oriented models have proven more challenged.

“The challenge with some of these retail-oriented models is there’s so much hunger to get into new sectors and new areas and try to find the next new idea. And that’s where we’re beginning to see some fracture lines because a lot of these aren’t tested.”

For instance, the urgent-care sector ran parallel to the freestanding-emergency-room sector up until a few months ago, Lindsey said.

Adeptus Health, backed by Deerfield Management, represents the largest freestanding-emergency-room network in the country. The money-losing company on April 19 filed for Chapter 11 bankruptcy protection.

While there’s a lot of interest in Adeptus and several comparable companies, the market’s view over the past 12 to 18 months has evolved, Lindsey said: “There’s a view now that these things don’t make sense particularly on a stand-alone basis. But if you’re [joint venturing] with hospitals who want to push some of that volume out, then there’s a business there that’s sustainable.”

The same can be said for other hot segments like mental health, and especially inpatient or residential substance-abuse treatment, Lindsey said.

A number of these models have traded for significant multiples because they’ve got great growth and phenomenal cash-flow margins, “but those cash-flow rates and margins are driven by out-of-network reimbursement, which we’ve seen over and over again in a number of healthcare sectors isn’t sustainable over the intermediate to longer term,” Lindsey said.

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