This article is part of Bain’s 2019 Global Healthcare Private Equity and Corporate M&A Report. Explore the contents of the report here or download the PDF to read the full report.

Competition for healthcare assets has intensified in recent years among both financial sponsors and corporate acquirers, driving average deal values higher. Despite a record number of assets trading in 2018, funds still could not deploy as much capital as they would have liked. Competition is likely to intensify, as dry powder has reached historic levels and investors view healthcare as a safe haven in an economic downturn.

The crowded deal market has prompted investors to explore more creative deal approaches, such as:

• partnering;
• looking to public markets;
• moving beyond the traditional leveraged buyout; and
• expanding value-creation theses.

Let’s look at each tactic.

Partnering

With strong demand for high-quality assets driving up valuations, investors have joined other financial sponsors or corporate acquirers in order to access transactions they could not execute on their own or to gain a proprietary angle. Partnerships also help funds to diversify portfolios or team up with an experienced operating partner with the requisite know-how.

Consortiums continue to represent a significant portion of megadeals. Indeed, 7 of the 18 deals with a value greater than $1 billion were acquired by financial sponsor consortiums, representing more than 30% of total disclosed deal value. Investors were also able to acquire assets at a discount to public market valuations. In one such example, CVC Capital partnered with PSP Investments and StepStone Group to acquire Italian pharmaceutical company Recordati at a 20% discount for $7.4 billion. This included a roughly 52% majority stake in the company and the obligation to launch a mandatory takeover offer for the remaining 48% stake, which completed in February 2019 with minimal take-up.

Funds turned to corporate partners for similar reasons. Joining corporates can give a fund credibility with the target firm and potentially unlock synergies, which could make the difference in being picked as the winning bidder or opening up a proprietary process. The 18 corporate partnership deals announced in 2018 accounted for $7.9 billion, or 12.5% of disclosed value, as several of the largest deals of the year involved a strategic partner. In one example, a Summit Partners–led group teamed up with OptumHealth to acquire a controlling interest in Sound Inpatient Physicians for $2.2 billion. Teaming with Optum creates expansion opportunities in services and geographies for Sound Inpatient Physicians that might not have been possible had Summit invested on its own.

In an example spanning both consortium investing and corporate partnerships, TPG and Welsh, Carson, Anderson & Stowe teamed with Humana to acquire Curo Health Services for $1.4 billion. The consortium plans to combine Curo with the hospice business of Kindred, which the same consortium purchased in late 2017, to create the largest hospice provider in the US.

Looking to public markets

Heightened competition for private healthcare assets has also prompted investors to seek more opportunities in public markets (see Figure 4). Despite healthy public valuations prior to the fourth quarter of the year, public assets still represented an attractive alternative to the private market in many instances. The four largest deals of 2018, totaling $27.1 billion in deal value, involved taking public companies private, including the largest deal of the year, KKR’s $9.9 billion acquisition of Envision Healthcare, a physician practice management (PPM) group. The deal value represented a roughly 30% premium to Envision’s volume-weighted average share price prior to initial reports of negotiations. In the case of athenahealth, after activist hedge fund Elliott Management put pressure on the public board, Veritas Capital and Elliott’s Evergreen Coast Capital acquired the company for $5.7 billion.

Figure 4

Other opportunities emerged in carving out noncore businesses of large healthcare companies undervalued by public markets. Some large biopharma and medtech companies, for instance, have sharpened their focus on core businesses and divested noncore assets. Three of the top 18 deals were carve-outs from larger parents, including the largest medtech buyout of the year, Platinum’s $2.1 billion carve-out of LifeScan from Johnson & Johnson.

Finally, funds have been taking minority stakes in public assets, which provides exposure without having to finance the entire company or pay a steep control premium to buy out shareholders. Buyout firms made these investments across a wide range of deal sizes. For instance, on the larger side, a Carlyle-led partnership invested to become the single-largest shareholder in Adicon Holding Limited, a network of independent clinical laboratory companies in China. And on a smaller scale, HgCapital made a $13 million investment in Orion Health Group, an Australian population health management platform.

Moving beyond the traditional leveraged buyout

As competition has increased, funds have increasingly sought to broaden the aperture on asset classes and investment profiles, both to put more money to work in healthcare and to diversify the potential pool of assets. Firms are exploring a wide spectrum of assets from lower-risk core assets to early-stage growth assets in hopes of finding appropriate risk-adjusted returns.

Investors executed long-hold investments with an eye toward maintaining ownership in high-quality core assets through an economic downturn. Several large investors, such as KKR, Carlyle and Blackstone, have launched long-hold funds in recent years to gain flexibility in holding assets longer than a traditional 10-year closed-end fund. Given the platform economics and continued buy-and-build potential, larger retail health platforms established through buy-and-build strategies can represent attractive long-term investment opportunities. In one example, KKR acquired a majority stake in Heartland Dental, a leading dental support organization serving 840 dentist offices in the US at the time of acquisition, for an undisclosed value through its core investment fund, with an expected holding period of at least 15 years. Buyout firms that historically employed a long-term strategy have also gotten active in healthcare. Cranemere, a private holding company with long-term investment horizons, acquired a majority stake in NorthStar Anesthesia, a US provider of outsourced anesthesia services.

Investors have also stepped up investments in earlier rounds and minority investments in private companies. This includes both outright acquisitions of early-stage assets and investing in seed funding rounds. For example, KKR made a $57 million Series B investment through its Health Care Strategic Growth Fund in data analytics company Clarify Health Solutions, and Abu Dhabi Investment Authority led a $500 million Series G round in Moderna Therapeutics. KKR established its growth equity platform in 2014 and now has 12 healthcare growth investments.

Alternative healthcare–focused vehicles are on the rise, including sector-specific funds to chase nontraditional buyout assets. Several large funds have taken on clinical-stage risk within the life sciences industry through special investment vehicles. Bain Capital raised a $720 million life sciences fund in 2017 to make investments in medical device, specialty pharmaceutical and biotech companies, while Blackstone acquired a life sciences investment firm to act as its new Blackstone Life Sciences division. In addition to the potential returns for the new platforms, there are potential synergies with the firms’ broader healthcare efforts.

Expanding value-creation theses

Creative deal strategies have proliferated as investors realize that they will not be able to rely on the same magnitude of multiple expansion for returns. More investors are starting with a thesis predicated on attaining regional or category leadership, or improving operations with a well-defined value-creation plan, and validating that thesis during due diligence vs. waiting to quantify it in post-acquisition value-creation planning.

We continue to see buy-and-build strategies employed in retail health globally, with a focus on segments such as dental and veterinary health. And although investors have been building such platforms in traditional retail health segments for a while, opportunities still exist to execute the strategy. For example, Nordic Capital acquired three dental groups and one large dental laboratory across Germany, Switzerland and the Netherlands.

Moreover, investors have started to roll out this strategy in other provider segments, such as behavioral health. For example, KKR developed the Blue Sprig Pediatrics platform for behavioral treatment services for children on the autism spectrum.

Funds also executed multiasset buy-and-merge strategies in order to grow scale quickly and develop a category leader with improved commercial effectiveness and general and administrative (G&A) cost efficiencies. GI Partners simultaneously acquired Cord Blood Registry for $530 million and California Cryobank for an undisclosed amount, combining the two companies into a leading provider of stem cell and reproductive tissue storage.

Investors have been increasingly interested in developing integrated, scaled platforms via M&A. For example, CD&R portfolio company Vets First Choice merged with Henry Schein’s animal health business to develop a publicly traded, multichannel veterinary services platform. CD&R will maintain its investment in the new publicly traded entity named Covetrus. Investors have also looked to leverage these scaled platforms to complete add-on investments. For example, Bain Capital established its current revenue cycle management (RCM) platform, Waystar, through the initial acquisition of Navicure in 2016, followed by the subsequent acquisitions of Zirmed in 2017 and Connance in 2018.

These asset combination strategies, such as buy and build or multiasset buy and merge, have the potential to deliver impressive returns, but they also come with more execution risk than other buyout strategies. Funds can improve their chances of success by ensuring that the initial platform has a stable core on which to build, putting a capable management team in place to drive growth from acquisitions, and buying add-ons that can lead to category or regional scale without losing sight of both revenue- and cost-based synergies.

Even when funds do not have the opportunity to outright acquire or build category leaders through serial acquisitions, they are increasingly investing in diligence to be able to underwrite operational improvements. Some spend more time on operational due diligence, aiming to underwrite improved commercial effectiveness and reduced costs. For sectors such as retail health, this is absolutely critical, as many platforms have struggled to strike the right balance between same-store performance and M&A growth.

What’s ahead

We expect competition for high-quality healthcare assets to remain strong in 2019, which will open the door to even more creative deal structures and strategies, as well as continued forays into public markets. Partnerships between financial sponsors and with corporates will help put capital to work and potentially create some unique angles. Investors may employ buy-and-build strategies beyond traditional retail health and look for opportunities in other physician sectors or deploy a similar approach in medtech via a series of acquisitions. And they will pursue carve-outs of noncore assets from large public companies, prospecting for niche category leadership opportunities that have been undervalued by the public markets or their corporate operators.