Amid questions about the direction of the global economy, investors doubled down on healthcare as a safe haven in 2016, driving up both deal count and deal value. Yet, with so much interest in overall healthcare assets, they faced intense competition for deals. This heated struggle bid up valuations and forced healthcare investors to get creative. Many funds took advantage of a disparity between public and private valuations for some healthcare assets, which prompted a surge in public-to-private transactions. The flip side of this trend was a falloff in the number of IPOs amid a modest decline in overall exit activity. These are the findings from Bain & Company's sixth Global Healthcare Private Equity and Corporate M&A Report.
In sharp contrast to the broader decline in PE deal-making, healthcare PE activity soared last year. Global healthcare disclosed deal value reached $36.4 billion in 2016 (excluding several large deals with undisclosed deal value), its highest level since 2007. That marked a nearly 60 percent increase from the total of $23.1 billion in 2015. Two megadeals -- the $7.5 billion investment in MultiPlan and the $6.1 billion acquisition of TeamHealth -- accounted for more than a third of the total deal value. Deal count also rose to 206 in 2016, up from 199 the year before.
"As a long-term bet, healthcare is hard to beat," said Kara Murphy, a partner in Bain's Global Healthcare and Private Equity Practices and co-author of the report. "Deal activity will continue to be high as more funds look to deploy capital into the sector. Given the intense competition, funds will need to be increasingly creative to get deals done."
The total value of corporate M&A in healthcare fell sharply in 2016, though it was still the third-highest year on record. Much of this slowdown was due to the dearth of megadeals, but activity stalled for deals of all sizes, including those in the 'sweet spot' range for larger PE funds between $500 million and $5 billion. This contributed to a slight decline in the pace of healthcare exits, which were down from 145 in 2015 -- a record-setting year -- to 126 last year. Sales to corporate buyers still made up the bulk of the exits, but their share of the overall pool fell to 50 percent in 2016 -- down from 57 percent in 2015. IPO activity also fell as a share of total exits, from 16 percent in 2015 to 8 percent in 2016. The bright spot for sellers in 2016 was the sponsor-to-sponsor channel, which grew in number and share from 28 percent to 42 percent of total exits. Despite the overall slow-down in exits, many funds were able to achieve significant exits at attractive multiples.
New Trends on the Horizon Dominated by P2P, Cross-border Investing, and Healthcare IT
While the U.S. stock market remained strong, healthcare assets were off slightly from their highs in 2014, which depressed public multiples for U.S.-listed healthcare companies. At the same time, heated competition for assets bid up multiples in the private market. The result was that some assets on the public market were trading at enough of a discount for PE firms to take them private.
According to Bain, three of the top four healthcare PE deals of 2016 were public-to-private (P2P) transactions involving U.S. companies, accounting for nearly 30 percent of total disclosed deal value. Looking ahead, funds will continue to hunt for P2P targets in the U.S. as well as other regions, especially Europe.
Many PE investors reached across borders in 2016. European investors likely looking to escape intense competition across the continent due to a small pool of investment targets and diversify their portfolios bought assets in the U.S. -- the world's largest healthcare market. Last year, nine of the top 10 global deals involved U.S. targets, but four of them were led by European buyers. That stands in sharp contrast to 2015, when half of the top 10 deals involved European targets, and none of the top 10 deals resulted from cross-border investments.
Cross-border investing was also active in Asia-Pacific in 2016. Chinese investors in particular looked outward, often buying overseas companies with services they hoped to bring to China. Developed market funds in the region also invested heavily in emerging economies.
From a sector perspective, high levels of uncertainty around future reimbursement and regulations in the healthcare industry, particularly in the U.S., led PE investors to "healthcare-light" sectors -- businesses that have some buffer against reimbursement risk, but benefit from positive secular and demographic trends. These frequently are the firms that supply information technology, staffing and other services to the core healthcare sectors, such as contract outsourcers and healthcare IT (HCIT) firms.
HCIT was an especially active segment last year. The total value of HCIT deals swelled to $15.5 billion -- four times larger than in the previous year -- centered on traditional technology companies as well as tech-enabled services firms that combine technology solutions with services offerings to meet the needs of their clients. The segment attracted both healthcare-focused funds as well as IT-oriented funds, driving up competition and valuations. Many funds sought category leaders with promising paths to expand into adjacencies, while others pursued assets with clear buy-and-build opportunities. Data and analytics, revenue cycle management, and IT solutions for alternate site providers such as behavioral health were leading themes in last year's deals.
What Does 2017 Have In Store?
"Investors can expect more volatility in 2017," said Nirad Jain, a partner in Bain's Global Healthcare and Private Equity Practices and the report's co-author. "As the turmoil continues, so too will the attractiveness of healthcare as a safe-haven investment. With an aging and ailing global population, demand for healthcare services will rise regardless of whether there are economic headwinds, tailwinds or crosswinds. But, that's not to say all healthcare investors will have smooth sailing -- sky-high valuations for healthcare assets mean that there are choppy waters to navigate."
In this environment, deal makers will need to continue to be creative and look harder to find targets that have the capacity to deliver meaningful returns.
Category leaders, which are often better positioned to weather an economic downturn, will continue to command a premium. Investors interested in pursuing buy-and-build strategies will prize these companies as those best situated to roll up smaller, weaker competitors.
Bain anticipates that more consortium arrangements are also likely. An increase in partnerships between PE funds and corporations will also emerge, particularly in the pharma and medtech sectors, which may be ripe for carve-outs after the wave of megamergers over the past several years.