Healthcare Private Equity: COVID’s Boon or Bane

The Healthcare industry has always been difficult to understand which makes it hard to identify good assets which was the major reason why private equity investors were hesitant to invest in it. But in recent years, there has been a transition. The outlook that healthcare is a complex and boring industry has been changed by COVID. It did what Lewis Ranieri did for the banking industry. But, the real question is this, Is this change in outlook profitable to all or not? By Aniket Kumar

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Private Equity: Origin & Meaning

Let’s go back a century, Investors have been acquiring businesses and making minority investments in privately held companies since the dawn of the industrial revolution. Merchant bankers in London and Paris financed industrial concerns in the 1850s. Private equity in the first half of the 20th century was the domain of wealthy individuals and families. The Vanderbilts, Whitneys, Rockefellers, and Warburgs were notable investors in private companies in the first half of the century.

The history of modern private equity can be traced back to 1901, when J.P. Morgan--the man, not the institution--purchased Carnegie Steel Co. from Andrew Carnegie and Henry Phipps for $480 million. Phipps took his share and created, in essence, a private equity fund called the Bessemer Trust. Today the Bessemer Trust is more a private bank than a private equity firm.

It was not until after World War II that what is considered today to be true private equity investments began to emerge marked by the founding of the first two venture capital firms in 1946: American Research and Development Corporation (ARDC) and J.H. Whitney & Company.

Until now private equity was an investment class known to just the elites, but with innovation and an increase in demand for almost everything after World War II, an opportunity was seen by financial institutions, bankers, & private institutions. They knew that government alone could not cater to such huge demand, so they all chipped in and started investing in startups, traditional companies & financial institutions. The idea was simple, providing capital to companies that are in need of it and taking a chunk of ownership in return. It was indeed a risky business, if you lose, you lose big but if you win, then the capital you invested looks like chump change in comparison to the returns. Just have a look at these historical private equity investments and their returns,

• ARDC struck gold with its $70,000 investment in Digital Equipment. When Digital Equipment went public 11 years later, ARDC's share was worth $355 million, an annualized return on capital of 101%.

• In 2005, the Glazers saw the cash-generating power of European soccer before even Europeans recognized it. They loaded Manchester United’s balance sheet with $660 million to acquire an asset that has subsequently been valued at over $2 billion.

• Five private equity firms, led by KKR and Bain Capital, in 2006 paid $8.2 billion for an 80% stake in the chip maker. In NXPs IPO last year, the companies made back their money up to four- or five-fold.

• KKR, Goldman Sachs, and other investors bought the discount retailer in 2007 for $6.9 billion. Profits grew under the investor's watch, and the company went public again in late 2009. Dollar General now has a market value of nearly $11.8 billion.

As we can see from the above examples that private equity firms look for profitable investments. A lousy 10% return every year is not going to cut it from them. They need high ROI’s on their investments as they take huge risks on betting on corporations about which no one has ever even heard of.

Now, as the faith in the public health infrastructure dwindles due to COVID. It has given a golden opportunity to the private sector to step in and revolutionize the healthcare sector which can be done with the support of private equity firms.

As of late, Private Equity firms are investing heavily in the healthcare sector. The pandemic has shaken virtually every industry, none more than healthcare. Yet $151 billion of private equity capital surged into healthcare globally in 2021, more than double the prior year, and the number of deals soared 36% to 515.

According to Bain & Company’s research paper, the record number of deals stemmed partly from a pandemic-induced backlog of parked deals, as well as the revival of megadeals headlined by the $34 billion Medline deal and the $17 billion acquisition of Athenahealth.

The Covid-19 pandemic not surprisingly was the foremost driver of healthcare deals, but a range of other factors also contributed significantly to the record levels. Several structural trends continued to benefit healthcare companies. An aging population, the rising incidence of chronic illness, rising income levels and healthcare access in emerging markets, and digital innovations in treatment and operational processes combined to boost underlying demand for an array of healthcare goods and services,

Private Equity & Healthcare

We have already established that private equity firms are looking for profit-churning corporations but there is a huge contradiction between the goals of the healthcare sector and private equity. The Healthcare sector’s priority should always be patient’s well being and safety but when there is an added responsibility of generating profits. It could lead to a change in priorities.

Let me describe to you what happens when a private equity firm buys struggling health systems or hospitals.

Strategies these firms use include:

• merging multiple healthcare practices

• reducing staff

• closing down portions of a hospital or healthcare practice’s operations

• focusing on growing a specific aspect of a healthcare practice’s offerings

• renegotiating reimbursement rates with insurers

The effects of private equity deals on people vary greatly. While no conclusive data shows whether it typically improves or damages care, many people worry it may place profits ahead of patients. In some cases, a constant drive to generate profits can damage care quality. A 2021 working paper found that nursing homes owned by private equity firms have 10% higher death rates among patients on Medicare. It also showed a decline in time spent with residents, less staff, and lower quality and training of staff. Despite this lower quality of care, these nursing homes were associated with an increase in taxpayer-funded Medicare spending. However, supporters of private equity in healthcare argue that streamlining processes and increasing profits can encourage investment in new technologies. This could boost innovation, potentially improving patient outcomes.

The specific impact of a private equity deal depends on the business it buys, the changes it makes, and more.

Some potential benefits of private equity in healthcare include:

• profit for investors

• better management

• closely following hospital guidelines

• better insurance reimbursement rates

Some potential drawbacks include:

• a decline in patient care

• cost increases for both taxpayers and patients

• staffing shortages

• the possibility for upcoding — when a person is recorded as being sicker than they are

• job loss for some healthcare workers

• possibly placing a strain on medical ethics

From the above arguments, you might think that private equity is the last thing that the healthcare sector needs But there is a subsector that is in dire need of investment and it just might be the thing to revolutionize this sector. I am talking about “Healthcare Technology”.

Healthcare Technology: A beacon of Hope

At its core, healthcare tech refers to technology-enabled products and services in healthcare. Distinct from medical devices and diagnostics, healthcare tech focuses on facilitating and enabling healthcare functions. Healthcare tech is a vast, hyper-fragmented field. Individual companies may serve a specific vertical, such as pharmaceuticals, medical technology, providers, or regulators, in a portion of that vertical’s value chain. In that context, individual companies usually fulfill a specific need—for example, digitizing core processes or providing digital health solutions. Healthcare tech companies can provide or facilitate anything from electronic medical records to clinical-trial management software.

Healthcare technology companies have historically gotten less attention from private equity (PE) investors than they might warrant. Admittedly, healthcare tech is complex, making it difficult to understand the industry and identify good assets.

Despite these challenges, maturing healthcare tech companies can be good targets for PE firms ready to apply rigorous analysis and invest in growing companies in US and European markets. Healthcare companies with a strong technology component are valued, on average, at 17.1 times earnings, compared with 14.9 times average across the industry, with lower multiples for companies without strong technological components; for example, pharmaceuticals average 15.1 times, and healthcare providers average 11.4 times. In recent years, well-managed healthcare tech companies have performed even better, with some exits at 23 to 25 times EBITDA.

Covid-19 greatly accelerated the adoption of virtual interactions between patients and healthcare staff. Companies rushed to digitalize many other manual processes as well, from drug clinical trials to medical records to revenue cycle management. The fallout from the disease exposed the creakiness of older IT systems, causing many providers and payers to realize they needed top-notch vendors to help upgrade their systems. And the widespread shutdowns exposed vulnerabilities in the medical supply chain so that the previously below-the-radar distribution of medical products suddenly drew outsize attention. This is where Healthcare Tech steps in and brings stability to a chaotic sector.

Conclusion

Healthcare is enduring a period of discontinuity on several fronts. Most obviously, the Covid-19 pandemic continues to stress the supply chain, wrench forward the previously gradual progress of digital care, and stretch many sectors thin with labor shortages. In addition, strains on the healthcare market are likely to intensify following the invasion of Ukraine. Apart from the pandemic and fallout from the Ukraine conflict, structural changes are washing through healthcare systems globally that give a reason for optimism. One positive shift is that technological innovations—including digital tools that redefine how patients interact with care, the use of artificial intelligence in drug discovery, and software that enables value-based care—are helping companies build new business models.

European and US PE firms have a significant opportunity to capture value from strategic healthcare-tech investments. Investors that take decisive action while focusing on targets with growing businesses that compete in attractive markets, with strong prospects for growth, can benefit most. PE firms’ trademark investment, expertise, and pursuit for continuous improvement in healthcare tech can generate investor returns while helping create better outcomes in healthcare.

The best kind of investment is the one that leads to innovation, welfare, and revenue. These three parameters need to be achieved while investing anywhere. If you have to let go of any of these parameters, then that investment does not lead to the development of society. On that principle, I think private equity firms need to understand the fact that the best investment in the healthcare sector is in healthcare tech rather than healthcare services or providers.

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