Happy Fri-yay, Hubsters! Aaron here, winding down the week with the Wire.
Healthcare Heartbeat. I’ve been taking the opportunity of writing the Wire every Friday to include insights from sources throughout my reporting on PE-backed healthcare deals. For this edition of Healthcare Heartbeat, Robb Vorhoff, managing director and global head of healthcare at General Atlantic, shared his thoughts with me via email.
In terms of valuations, he noted that we have yet to see a correction in the private deal market commensurate with the decline in public market valuations, noting that private markets usually lag public markets by six to nine months.
“There was a huge amount of capital raised (at inflated valuations) over the last few years,” he said. “Many companies don’t need capital yet and are rightly focused on expense management to extend their cash runways, given the current market environment. The ultimate need for capital will be the catalyst to drive a private market correction.”
He also said he has not seen “many down rounds yet.”
“But we are seeing companies that need capital today acknowledging that their last round valuation may not be consistent with the market today (i.e., they are not demanding an up round). Many companies are exploring venture debt as an alternative source of capital,” Vorhoff explained. “The healthy part of all of this is companies are focusing more on proving out and enhancing unit economics vs. growth at all costs. The best companies, those that have always been focused on unit economics and disciplined growth, are looking for ways to play offense. The best entrepreneurs are playing long ball and focused on optimal partner selection when raising capital (vs. pushing headline value at all costs).”
When asked specifically about what the healthcare M&A landscape currently looks like, he noted that large strategic acquirors are getting more active.
“Horizontal consolidation is getting harder for health plans and health systems, so we are seeing an increased focus on vertical integration and strategic expansions of their business models,” he said. “We’re also seeing increased activity from large technology and retail companies looking to enter/expand in healthcare.”
He also added that earlier stage companies are looking to accelerate the path to scale and profitability, as the market for acquisitions and investment is prioritizing profitable growth over hyper growth with significant losses.
“Many sectors (such as virtual care) will see significant consolidation with the best companies looking to acquire other strong players and expand their offerings,” Vorhoff said. “Competitive intensity is increasing in a lot of sectors, and in many cases, there are far too many subscale companies that aren’t going to make it if they can’t find the right partner.”
When asked where he sees the most opportunity in the healthcare sector, he named a very popular trend that won’t be going away anytime soon – value-based care.
“We continue to see great opportunity in value-based care, particularly those companies focused on innovation in care delivery that deliver better clinical outcomes and a superior patient experience at a lower cost to the system,” he said. “We believe we are in the early innings of this massive shift (from FFS to VBC) across the US healthcare.”
To learn more about GA’s investment strategy, see the profile I wrote earlier this year for PE Hub’s healthcare spotlight series.
Employee ownership programs. My colleague Carmela Mendoza from Private Equity International just published a piece about how employee ownership programs – which seek to build wealth among company workers and are gaining traction in the private equity industry – may affect returns for LPs.
The story starts off by an event that took place back in May, When KKR’s co-head of Americas private equity, Pete Stavros, a long-time champion of employee ownership, had some news for staff at CHI Overhead Doors: on the headquarters’ factory floor, Stavros informed them that their pay-outs from an employee ownership program they had joined seven years prior would range from 1.5 to 6.5 times their individual annual salaries.
The story goes on to ask: How does the dilution of investor’s shares affect fund returns?
When it comes to public companies, there is evidence that employee ownership can lead to better corporate performance, Carmela reports. For example: Over the last 15 years, shares in employee-owned businesses in the UK, such as retailer John Lewis and design and engineering company Arup Group, have outperformed those in the FTSE All-Share Index, according to the UK Employee Ownership Index, which measures listed companies with more than 10 percent ownership by ordinary employees.
But when it comes to privately owned companies, there’s little evidence of how corporate performance is affected. Carmela spoke to several academics who focus on finance and private equity for her report; all of them noted the area has not been well researched, being too recent for anything systematic, especially in private equity-backed companies.
Employee ownership programs cost money, “but people may be working harder,” said Ludovic Phalippou, a professor of financial economics at the University of Oxford’s Saïd Business School. “So [it’s] unclear what [the] net effect is.”
Allyson Tucker, chief executive of Washington State’s $152 billion pension fund, which is also an investor in KKR’s North America funds, said that the employee ownership model will benefit both management and workers in a way that will yield strong long-term returns for investors.
But she noted that it’s too soon to know with certainty what the qualitative and quantitative outcomes will be. “We will evaluate this question as the programme gains acceptance and momentum.”
ICYMI. Last week, another co-worker of mine over at Private Equity International, Adam Le, wrote about why rising interest rates may not mean lower returns on new deals.
The industry appears to believe that muted returns will be temporary and that its ability to generate alpha in the long run is rooted in its ability to act as canny operators. Claire Chabrier, president of French private equity association France Invest and associate director at Amundi Private Equity Funds, told PEI that around two-thirds of returns in the French PE market are driven by value creation coming from sales and profitability growth in portfolio companies, Adam wrote.
“It’s not leverage, it’s not multiple increase, it’s really that companies are growing when they are backed by private equity investors,” Chabrier said. “Two-thirds of the value creation comes from all the day-to-day jobs we make in a company, helping them to transform, to grow, to build up.”
Indeed, a rising interest rate environment could even fuel a boon for asset classes outside of private equity.
“There seems to be a very significant inflow of interest from the companies to finance themselves in private markets, which I would say is very accretive to the private debt funds overall,” said Olga Kosters, managing director for credit at Apollo Global Management.
That’s it for this edition of the Wire. Wishing everyone a happy weekend. I will be kicking it in Jersey, playing basketball and going to the Yankees game on Sunday, so here’s hoping Aaron Judge (great first name, even better baseball player) does not hit No. 62 until I am in the building!
MK Flynn will be back with the Wire on Monday.
Have a great weekend,