D. Scott Mackesy is a managing partner and member of the management committee at Welsh, Carson, Anderson & Stowe. Mackesy in 1998 joined WCAS, which invests in growth-oriented healthcare and technology businesses.
PE Hub “sat down” virtually with Mackesy recently to discuss everything from the dealmaking environment through the global health crisis to 2020 highlights for WCAS and what keeps the investor up at night.
How would you characterize 2020 and how did WCAS navigate through the challenges of the pandemic year?
The term I’d use in describing 2020 for the firm is incongruous, which gets to a very difficult year in a number of respects – the pandemic and just dealing with all the issues related to it.
The firm, in terms of the portfolio and our results for the year, experienced one of the best years it’s ever had. That incongruity is such a stark contrast.
Given the healthcare exposure we have in the fund, the biggest focus and challenge we had immediately was keeping our frontline workers and our healthcare employees safe – and that led initially to a lot of PPE. That was an enormous undertaking as the pandemic set in.
Once we got that settled, there was a lot of focus on the healthcare portfolio in terms of shoring up liquidity. We saw volumes at some of our portfolio companies down 50 percent to 60 percent, so it was really traumatic.
And then you have an incongruous portfolio when you compare that to the tech side. The tech portfolio was really resilient, which reflects our focus on critical business applications in the information technology space that are largely recurring revenue, SaaS-based businesses.
How was 2020 the best year ever for WCAS?
One, the health of our team at Welsh Carson. Individually, WCAS has managed the pandemic very well in terms of the physical health of the firm and all of our associates. Keeping our teammates healthy and engaged is something we’re proud of.
And then, the numbers were just great. Fund XII (2015 vintage year) is a 29 percent net IRR fund and about a 1 times distribution to paid in capital, which is top decile performance, and we retain 13 of 16 portfolio companies representing significant future value creation.
We’ve had distributions in the year of about $1.6 billion, and we invested about $1.5 billion. We were really active on monetizations and we were also successful in new capital deployment. We completed five new transactions in 2020, all of which WCAS was uniquely positioned to consummate on the basis of existing relationships.
Despite having such a great year at WCAS, what keeps you up at night?
I have two worries. No. 1, I worry about work-life balance and the sustainability of the work-life balance.
That’s where we’re trying to be a little more disciplined. We’re trying not to have Zoom calls on weekends and just give people personal space.
The workload balancing that needs to happen when you’re in a remote world is not as apparent. The most practical way to do that is on a deal-to-deal basis. After you’ve worked on a deal – for let’s say, a couple months – we’re making sure we’re cognizant of that and making sure you don’t get staffed on the next one that comes in the next day.
It’s hard to stay engaged on a Zoom call for hours on end, so I think we’ve become a little more efficient in getting to the point in those discussions. I wouldn’t equate efficiency with effectiveness, however.
We have a lot of momentum at the firm which has created a lot of positive energy and that’s just fun to be around. It’s unfortunate, candidly, to be in a remote work environment with all that good stuff.
No. 2, longer term, I worry about the impact of this work environment on culture at the organization and sourcing and process to invest.
What are the requirements to invest in a company that you haven’t met in person before? That’s something everyone wrestles with a little bit. What risk are you willing to take in terms of the old traditional way of doing business, versus the world that we’re currently in?
We all benefited – including WCAS – from a lot of work we’d done over the last few years in 2020. We had long-established relationships and we were in front of deals working on them long before they were consummated.
If the pandemic persists for a long time, I really worry about new deal activity and relationship development, which is the core of our sourcing in this world.
I personally don’t think it will, but if this were to continue for another year or two years, you’d be challenged with a different environment in terms of your underwriting policies as it relates to new capital deployment.
Did any unforeseen opportunities emerge within the portfolio in light of the environment?
No. 1, Clearwater. We did a recap at the end of the third quarter that was facilitated by the resilience of that business model and its value proposition in the marketplace. [Covid] continued demand for really high-quality scaled SaaS businesses. Clearwater is an industry leading, integrated data and SaaS solution for investment portfolio accounting, reporting and analytics.
InnovAge was again very resilient in 2020. We recapped that business in the second quarter in a very successful transaction, and in spite of the pandemic and in spite of all the issues in healthcare.
InnovAge is indexed against an end market – the dual eligible market – that is very powerful. At its core, it keeps Medicare and Medicaid eligible patients out of nursing homes. It keeps you aging in place in the home. That theme is obviously even more powerful today then maybe a couple years ago when we invested in it.
The market conditions were such that we were able to transact and recap both in 2020 at very meaningful IRRs and ROIs for WCAS XII. Clearwater’s [transaction value] was done at over 3x our money, and InnovAge was done at over 6x our money.
What has surprised you most about the PE environment through the crisis? Any past deals you regret passing on given what the market looks like today?
People have looked through near-term potential weakness in any company’s performance and transacted on the basis of long-term growth prospects. That activity continues to surprise us, and I think it reflects the fact that there’s a lot of capital out there and people need to put it to work.
Scale, high-quality assets received premium valuations. That’s a lot of the activity that you saw driving the markets. That theme will continue to resonate. If you have a questionable economic and global backdrop, paying up for quality assets has never been a bad idea. You might have a slightly lower return at the end of the day, but you’re not going to get in trouble doing that.
We had a chance to invest in Moderna maybe seven, eight years ago, and passed on that. To be honest, it’s a little bit out of our area of expertise – betting on a new unproven molecule and delivery mechanism. So really not in our power alley, but at the same time, it would have been nice to do that deal.
Moderna is so unique, and it was a unique relationship, a unique time, and it had just so much promise. We challenged ourselves to try to get there but didn’t at the end of the day.
We’ve seen joint-ownership and partnership deals grow increasingly popular. This has long been part of the WCAS playbook. Why are more firms catching on?
Anytime you see successful deals being done, mimicking is the greatest form of flattery. We don’t have an exclusive lock on that. There are firms that are more inclined or better positioned to do those deals and I think we’ve certainly been a leader in that regard. I think you’ll see more of it.
That whole partnership theme is something we focus on a lot at the firm. Look at Concentra-Select Medical, Kindred-Humana, Shields-Walgreens, Identifix-SRS.
That can be partnerships with founders, where we’ve done a ton of deals on the tech side. Partnership relates to corporates, where we’ve done corporate carve-outs. Partnership relates to other corporates where we’ve partnered with them to buy [other businesses].
Out of WCAS XIII, which is 60 percent committed across eight companies, more than half of those are partnership deals.
What investment opportunities are you most excited about today, and how does covid and a new political landscape play into that?
Covid has exacerbated trends that were already in place. If you think of the growth of home care, telehealth and remote healthcare and monitoring – any of those trends just got an enormous boost.
On the healthcare side, it will be interesting to see how people’s engagement and interaction with the healthcare system changes as a result of covid. Are they more reluctant to go to an acute care hospital setting? Would they prefer to go to outpatient settings? We think so.
Maybe it gets accelerated but it hasn’t changed the underlying secular trends that we’ve been investing in for a long time. We’re indexed toward outpatient and lower cost settings and healthcare businesses that bend the cost curve.
On the technology side, the same thing is true. We are very focused on software solutions that are business critical with high-end NPS (net promoter scores), good economic profiles, recurring revenue streams and contracts. That doesn’t change.
It’s more of a price discussion. Are the value propositions of these businesses enduring, and if so, how do we price in covid and covid-related risk?
The themes that we’re investing behind in healthcare are bipartisan in nature. The fact that there’s a little change in Washington doesn’t change how we’re approaching the marketplace.