While the US healthcare industry has historically been stable throughout economic cycles, it has a large consumer retail component to it, and “foot traffic” has been meaningfully reduced as a result of the coronavirus.
As such, many sectors within healthcare have been materially impacted.
The more discretionary the service, the more the sector has been hit – with some sectors down over 80 per cent. This trend has been mitigated somewhat by the growth in some sectors like telehealth, but overall, healthcare volumes are down substantially. There are signs over the past two weeks though, that volumes have been creeping back up.
These strange dynamics perpetuated by Covid-19 are having a derivative effect while PE groups sit on the sidelines, waiting to see what the valuation profile will look like once the US begins to move out of lockdown. Not only has the virus impacted GP surgeries and hospitals – with people choosing not to go to A&E – it has impacted inter-related healthcare businesses such as medical devices.
Telehealth trend accelerating
Yet at the same time, telemedicine is emerging as an area of investment interest.
“The trends we saw leading up to the Covid-19 outbreak in telemedicine, use of technology…anything that makes the healthcare sector more efficient and reduces costs, were already developing but they are accelerating now,” comments Kevin Rinker, Co-Chair of the Mergers & Acquisitions Group at Debevoise & Plimpton.
Some of the relaxation in regulations around the use of telemedicine may stay in place, in a way that will favour companies who utilise that technology, and as Rinker adds: “We are also seeing clients who weren’t historically active in those areas accelerating their interest and looking for acquisition targets.
“I think we’ll continue to see that trend.”
Working alongside Kevin is Andrew Bab, Partner and Co-Head of the Healthcare & Life Sciences Group.
He says that with regards to telehealth, one of the hurdles it had to jump was resistance among patients and physicians. While some remain sceptical: “The dam has now broken. Patients can see that this is a perfectly efficient and workable system that offers all sorts of benefits. The regulations allow physicians providing telehealth needs to practice across state borders. My view is that telehealth will be a clear winner, post-Covid 19,” says Bab.
In terms of healthcare providers benefiting from elective surgeries and other ordinary course care, who have been hit hard by the pandemic, the big question is, ‘Will there be a release of pent-up demand when the skies clear, or will some of those elective surgeries disappear for one reason or another?’
“With the economy taking a hit, the elective surgery that might have looked attractive a few months ago may not be going forward. Will there be some loss of revenue, or can it be made up for?” posits Rinker.
No step change in valuations
US healthcare deal flow might be lower at present, but there are still deals being done and while valuations on the margins might fall a bit, overall valuation levels are likely to remain robust. “I don’t think we are going to see a step change,” says one US-based healthcare investor, who asks not to be named.
Just recently, Clayton, Dubilier & Rice announced its acquisition of Huntsworth plc, a leading provider of specialty services that help pharmaceutical and biotech companies commercialise new therapies. The transaction was valued at GBP577 million.
Continuing my discussion with the PE group, they point out that given the sudden reduction in patient volumes, “We initially thought there would be a large number of healthcare companies looking for rescue capital. But for the first two months of the pandemic, most companies were able to weather the storm via managing overhead, drawing on revolvers, etc. However, more recently we are starting to receive requests for capital.
“The US healthcare sector will likely continue to support robust valuations post Covid-19. Perhaps at a slightly lower level from a few months ago, but not by much.”
On the valuation picture, Rinker agrees they will likely remain robust. Obviously, the metrics one might use to value a healthcare company have been impacted, such as EBITDA or discounted cash flows, but in Rinker’s view, the fact that multiples aren’t falling is encouraging.
“Once the revenues of US healthcare companies stabilise, I don’t think there will be much degradation in value, as is the case in other industries such as travel and entertainment, which may be impacted long-term as people adjust to doing things differently,” comments Rinker.
“In healthcare, it doesn’t seem like there will be any negative lasting impacts and there will be a number of opportunities for people who continue to be creative around cost cutting and increasing efficiencies in the delivery of and payment for healthcare.”
As it currently stands, the lockdown means that few new, non-distressed deals are coming to market. This is because financing levels are lower and more expensive than a few months ago, and it is very difficult for prospective buyers to meet management teams in person.
“The very few deals we have seen in the market tend to have robust growth prospects as well as an appetite for structure, including seller paper,” says the healthcare investor.
“We are talking to larger corporations about selling non-core assets, we are reaching out to investment bankers and lenders about companies that might need equity, and we are continuing to talk to companies we’ve met in the past who might want partial liquidity and equity financing. One has to be creative and keep those relationships warm. Once the virus is contained and the deal market turns back on, M&A volumes should pick up relatively fast.”
PIPE transactions
Over the near-term, one area of financing activity that could appeal to PE groups looking for a creative solution, is Private Investment in Public Equity (PIPE) transactions.
This is where a financial sponsor comes in and takes a minority stake in a public company, usually through some form of preferred security, to help provide liquidity to that company on a pretty quick timeline (compared to using traditional capital markets).
“Since those transactions don’t require leverage, the choppiness in the debt markets isn’t as much of an impediment to getting these deals done, so it’s a nice way for PE to deploy capital in this environment.
“We are working on five or six of these PIPE transactions right now, across various industry sectors. It’s a very active area in terms of financing/M&A activity,” confirms Rinker.
For US healthcare investors, telemedicine is likely to become a bigger area of focus, possibly more so for those looking for growth capital deal opportunities. And while more traditional, discretionary healthcare businesses have been disrupted, the long-term impact on their valuations is unlikely to be terminal.
One final pause for consideration, however, is how Covid-19 might impact those looking at cross-border deals.
As Bab concludes: “FDI rules and practice in Europe have begun to tighten significantly during this period and people are nervous about how this might affect pending and future deals with a healthcare – and particularly Covid-19 -–focus.
“There’s increasing concern over FDI-related regulatory developments and you might see a material drag on cross-border deals when the benefits are particularly important, like Covid-19 testing. We might see some surprising rulings on deals that previously might not have raised too many eyebrows.”
