Healthcare Pain Brings Private Equity Gain

The US healthcare industry is going through invasive surgery, with private equity firms wielding the sharpest scalpels and expecting big paydays.

The US healthcare industry is weighed down by unwieldy legacy business practices and outdated technology, and in need of revitalized business strategies and tactics.

This lethargic state of affairs is increasingly attracting the attention of private equity firms, the best of which have not only capital, but an entire surgeon’s toolkit for turning ponderous healthcare companies into fleet-footed competitors.

A recent study from Bain & Co. found that while overall private equity dealmaking was flat from 2013 to 2014, healthcare PE deals grew significantly in value. Indeed, one by one, major private equity firms are adding or beefing up healthcare investment platforms. In March, buyout giant Clayton, Dubilier & Rice added star J.P. Morgan banker Ravi Sachdev to its leadership team investing in healthcare. Hedge fund firm Visium reportedly will branch out into private equity with a dedicated, $500 million healthcare vehicle.

TPG has reportedly scored one of its biggest-ever exits – a $5 billion profit – from the agreed sale of Par Pharmaceuticals. Last year, TPG co-founder David Coultersaid he viewed healthcare as the best industry for private equity investment.

The anecdotal evidence of outperformance is backed up by data: Of all private equity deals exited since 2000, the average gross returns have been 2.4 times capital invested, according to analytics firm PERACS. But healthcare exits over the same time period have generated an average 2.5x performance, and with a lower risk profile than deals in many other industries like industrials, IT and consumer.

Indeed, US healthcare has many attributes that make the sector attractive to private equity investors, among them:

• The healthcare spending is expected to grow significantly faster than GDP – a nice tailwind to have when trying to build a company.
• Healthcare is currently experiencing booming merger and acquisition activity, most notably the announced $41 billion Teva-Allergan deal, the $37 billion Humana-Aetna deal, and the potential $30 billion merger of Shire and Baxalta. Mergers of all sizes tend to produce division spin-outs – the kind of corporate-orphan opportunities that private equity investors love.
• The internet, mobile technology and other tech breakthroughs hold forth the promise of transformative value-creation in medical fields that have been slow to embrace innovation. Private equity investors see an opportunity to infuse legacy players with a shot of technology.
• While mega-corporate M&A activity makes headlines, broad swaths of the healthcare landscape remain highly fragmented, offering the best PE firms a chance pursue buy-and-build
• Among many other changes, the Affordable Health Act vastly expands the market for behavioral health services, addressing issues such as substance abuse and mental illness. Many private equity firms are already backing business plans that will deliver these services in innovative ways.

Private equity firms largely draw capital from institutional investors, and where returns seem promising, institutional capital is sure to form. These investors are increasingly enthused about the growth and structural changes that they see in the healthcare space. Where there is investor interest, private equity fundraising is sure to follow.

With a healthcare industry badly in need of transformative capital, a frothy M&A market expected to produce a slew of spin-outs and keen interest from institutional investors, look for private equity to become a larger and larger force in US healthcare.

Don’t miss Privcap Media’s Healthcare Game Change conference, a gathering of private equity investors and healthcare innovators to be held November 18 in New York City.