This article originally appeared on Forbes.com.
The biggest challenge facing private equity investors for several years running has been finding attractive investment opportunities. Amid high prices and stiff competition, overall deal count has dropped 19% since 2014, the high-water mark for deal activity in the current economic cycle.
Yet one sector, retail healthcare, has been conspicuous in its growth. From 2012 to 2017, the number of deals involving retail health companies—those that operate freestanding health-related outlets like dental clinics or urgent care facilities—has soared, increasing at a compound annual rate of 34% in the North American market.
What’s the attraction? As discussed in Bain & Company’s recently released Global Private Equity Report 2018, retail health is a fragmented, high-margin sector with strong growth characteristics. In a sea of high prices, it still offers targets at reasonable multiples and many opportunities to unlock substantial value.
The playing field includes a wide range of health services, from urgent care and dental to physical therapy and dermatology. The sector has been growing at a steady 3%–4% clip annually, and individual retail health clinics typically enjoy strong earnings before interest, taxes, depreciation and amortization (EBITDA), with margins of around 25% and often much more. The sector is benefiting from healthcare trends that encourage cost management and greater patient choice. It also plays to the needs of an aging population, and as with many health-related businesses, growth is likely to be recession-resistant.
For PE buyers, the sector is especially attractive because it offers many opportunities to quickly help retail health businesses perform even better. Boosting organic growth by adding outlets, for instance, can deliver a very high return on invested capital. Similarly, a buy-and-build strategy gives PE investors the chance to arbitrage multiples that historically have expanded with a company’s growing scale and clout. While retail health businesses with fewer than 10 outlets have been commanding multiples of around four to seven times EBITDA, those with 10 to 50 clinics are selling for seven to nine times, and some marquee assets with more than 50 clinics are trading in the low teens.
This calculus was at the forefront of Harvest Partners’ 2014 recapitalization of Athletico Management Holdings, a chain of physical therapy and rehabilitation outlets. The company had consistent performance, a favorable mix of payers, strong cash flow and a management team focused heavily on clinical excellence. What it didn’t have was M&A expertise or capital to ramp up expansion. Harvest brought both when it invested an estimated $400 million in the company.
Harvest’s vision was to build Athletico from a Chicago-focused PT provider into a superregional platform. It created a dedicated team to quadruple the number of new outlets opening annually. It also solidified the operating model and infrastructure needed to support a larger organization. Within six months of the original investment, Athletico acquired rival Accelerated Rehabilitation Centers from OMERS Private Equity, more than doubling the size of the business and expanding its scope throughout the Midwest. That set the stage for a quick exit: In December 2016, Harvest sold the company to Chicago-based BDT Capital Management, collecting a strong return on its original investment.
Investing in the retail health sector, of course, carries its own set of risks. As demand increases, asset prices will inevitably rise, making it essential to go in with a clear value-creation plan. We find that the best playbooks are a careful blend of retail and healthcare best practices. Retail investors bring expertise in real estate management, site selection, branding and marketing. They use a consumer mindset to home in on target customers and best meet their needs. Healthcare specialists tend to attack the operations side of the business by improving clinical workflow, optimizing billing practices and improving negotiating power with payers and suppliers. They also understand how potential changes to the reimbursement or regulatory scheme might affect margins or the size of the addressable market. The ability to run plays from both directions can be a meaningful advantage in assessing and realizing potential.
Success also hinges on clinician buy-in. Physicians and other clinicians play a major role in the management of these companies and add significant value. People who have devoted their careers to a practice need to know that a PE playbook isn’t focused solely on financial performance, but also on delivering better outcomes for patients. This likely will include a plan for improving the patient experience and quality of care. It might involve strategies for bringing in new talent or increasing both professional and office staff to handle new volume without bottlenecks.
None of that is easy, and careful due diligence is essential to finding the right targets. But at a time when PE funds are awash with capital but lacking appealing targets, a sector as vibrant as retail health is worth a close look.
Nirad Jain and Kara Murphy are partners in Bain & Company’s Healthcare and Private Equity practices and are based, respectively, in New York and Boston. Jeremy Martin is a Bain principal based in Atlanta.