We recently reached out to Nirad Jain, a partner in Bain & Company’s New York office, to get his thoughts on the private equity and healthcare sectors, his two areas of expertise. He co-leads the firm’s healthcare diligence advisory capabilities and co-authored Bain’s latest Global Healthcare Private Equity Report, a valuable guide to a rapidly evolving industry.
For PE in the U.S. healthcare sector, we’re seeing more add-on activity, both in absolute terms and in proportion to all majority investments in the industry (add-ons now make up about ~70% of all buyouts compared to less than 50% pre-crisis). Is this a reflection of PE firms pursuing depth rather than breadth, as you pointed out in a recent interview?
Absolutely. PE investors have long understood the value of having the leadership position in a market. Some funds pay up for the leading asset in a market. Others are willing to buy follower assets and use tuck-in acquisitions to grow their scale, either challenging the existing market leader or carving out a market niche where they can lead.
Bain & Company, through our extensive work in healthcare private equity, sees the pace of add-ons as another sign of the fragmentation that still exists in many healthcare sub-sectors. Many of these—dental clinics, physical therapy and behavioral health, to name a few –still have significant room for consolidation.
It is important to remember that inorganic growth is not necessarily better than organic growth. Bain’s research and experience shows that most winning strategies involve a combination of organic and inorganic moves. In addition, some strategies may require businesses to shed non-core portions of the organization so that both company resources and management attention can stay laser-focused on the core growth engine of an asset.
How is PE activity shaping up in U.S. healthcare this year?
This year has been busy so far. According to Bain’s research, deal count through April is tracking with 2014, and we’re seeing activity across a variety of healthcare sub-sectors, including dental services, behavioral health, payer services, provider services and alternate care sites.
Some argue that the Affordable Care Act has catalyzed PE investment because more Americans are insured and more healthcare spending is coming out of consumers’ pockets. What’s your take on this line of reasoning?
At Bain, we think the ACA has accelerated the rise of new payment models and new approaches to care delivery. To date, much of this activity manifested in M&A and partnerships among corporate payers and providers. In the PE space, we are seeing an uptick in activity from these trends, primarily in the earlier stage health IT (HIT) and services businesses. We think this activity will likely grow over time but, for now, there are few scale assets available to PE buyers.
Looking ahead, we see expanded insurance coverage in particular fueling a lot of PE investment—for example, in the behavioral health sub-sector. The ACA built on the Mental Health Parity and Addiction Equity Act of 2008 by expanding coverage for mental health and substance-use disorder services. The result is heightened interest from investors in the behavioral health assets that have become available over the last few years. We believe this interest will continue, especially as “next-generation” behavioral health assets, which have more of a role in managing their patient populations, form.
Where are PE firms finding the most value (or most investment opportunities) in U.S. healthcare? Specifically wondering about segments (middle or lower-middle markets, for example) and sub-sectors like services, staffing, technology, etc.
The good news for PE firms is that investors can find value in many different sub-sectors and at many different check sizes. There were a lot of great exits last year, and a lot of attractive assets came to market.
Looking back at historical returns, Bain found that the pharma sector has been the star of the show, delivering high returns. This is partly because corporate buyers are such a strong exit channel for these assets.
There are also great opportunities in the provider, medtech, services and technology spaces. In particular, we are seeing a lot of interest in medtech carve-outs, next generation behavioral health (as previously mentioned), retail health (including veterinary and dental clinics), physical therapy, provider assets in emerging countries, services firms focused on pharma and medtech customers (e.g., CROs) and OTC manufacturers. Additionally, we think interest and activity will continue in early-stage assets related to population health management as new approaches, potential platform assets and strong management teams emerge.
One thing PE firms should keep in mind is that, in many cases, the quality of the asset is more important than the underlying market fundamentals. Bain has done analysis on public companies that have achieved sustained value creation and found that more sustained value creators exist among companies that are leaders in markets with weaker fundamentals, compared to those companies that are followers in stronger markets. With this in mind, the biggest takeaway for PE firms is this: Don’t overlook less attractive markets where you may be able to find valuable assets with leadership positions or leadership potential.
Strategics have been trumping PE bids for a while thanks to synergies and tax inversion strategies. Do you expect this trend to continue in 2015 and perhaps beyond? How much runway is left for strategic M&A activity?
Bain anticipates strategic bidders will continue to be active acquirers in the deal sizes and sub-sectors that are attractive to PE buyers. Fueling this trend is a trifecta of demand for continued growth, availability of large cash reserves, and strong financial markets. Some of this activity will be opportunistic, but we expect that a meaningful amount will be driven by strategic buyers re-balancing their portfolios, particularly after the recent M&A bonanza. This re-balancing will include both acquiring assets to build out leadership positions in core businesses and shedding assets in non-core businesses, which will create opportunities for PE firms to carve-out assets and bring together assets that will fill holes in strategic portfolios.
The ACA has been in effect for several years now—have you noticed anything in the healthcare M&A or PE markets that surprised you that resulted from regulatory changes?
As expected, the overall pace of developing new payment models and care delivery approaches, spurred by both M&A and partnerships, has been brisk. What has been somewhat surprising is the significant impact that local market conditions—including patient characteristics, provider infrastructure, physician dynamics and payer landscape—have had on success of these changes. It is clearer than ever that care delivery is a local market game, and what works in one market will not necessarily work in another. As a result, Bain is seeing local markets evolve at very different paces and in very different directions. This phenomenon is incredibly important for PE firms as well as strategic buyers to understand, as it affects how quickly assets related to payment models and care delivery can scale up. Further, it means that the commercial model for companies serving the payer and provider spaces must evolve.
Nirad Jain is a partner in Bain & Company’s New York office. He is an expert in the firm’s Private Equity andHealthcare practices, and he co-leads Bain’s healthcare diligence advisory capabilities. He has led more than 100 client cases across the healthcare value chain, including diligence, corporate M&A, transformation/performance improvement and strategy work in the services, payer, provider and medical device sectors.
He holds an MBA from The Wharton School, a Master of Science from Stanford University and a Bachelor of Science with honors from Columbia University in operations research and economics.
Featured image courtesy of Wikimedia user Electrodrive.