Private equity investors are drawn to industries experiencing sweeping transformations, and few industries are being more buffeted by change than healthcare. Whipsawed between surging demand and systemic reforms to contain runaway costs, the industry's profit pool of between $500 billion and $550 billion is shifting across established categories, such as medical technology and pharmaceuticals, and among emerging ones, such as behavioral health services and specialty benefits management.
These disruptive dynamics have certainly piqued PE interest. Capital flowing into the industry worldwide doubled to some $30 billion in 2011, and buyouts of healthcare companies accounted for nearly two-thirds of the value of the top-10 global PE deals last year. There is plenty of momentum behind those numbers. Bain & Company forecasts that industry profits will grow solidly over the coming decade – to as much as $750 billion globally by 2020.
Several investment themes are poised to present attractive opportunities for PE investors. Within the medical technology sector, many categories that have historically been attractive have matured, leaving little scope to rapidly increase revenue. Instead, acquirers will be looking to rein in costs and bring better account management skills to bear. Commodity or mainstream plays will require paying closer attention to performance improvement and more sophisticated account management and go-to-market models than have been required. Many service-based investment opportunities, such as contract manufacturing and research, have not yet reached maturity and can provide attractive inroads to strategic partnerships.
In pharmaceuticals, service firms such as contract research organizations will remain at the top of the list of acquisition targets as drug companies look to reformulate business models. More broadly, there are opportunities in the services sector that could allow for outsized profit margins, particularly in spaces like pharmaceutical compounding and specialty pharmacy products (although the latter has high reimbursement risk). As different types of pharma service firms pursue more cost-effective approaches, investors may find rewards in helping redesign business models.
On the product side, the specialty pharmaceutical market will continue to be an area of keen investment focus as strategic buyers fiercely compete and carve-outs demand an above-average degree of complexity. With reimbursement levels tenuous, categories less reliant on third-party payment, like animal health and aesthetics, will hold new appeal.
Finally, healthcare providers and services – the sector that generated the highest deal volume in 2011 – will be even more significant for PE investors, particularly in the areas of physician practice management, specialty benefits management, diagnostic labs and retail healthcare. Although valuations are high, pockets of opportunity may exist within healthcare IT, including areas such as advanced analytics and informatics and payment integrity. Managed-care investments are riskier, but returns may become attractive as governments lean more heavily on the private sector to manage Medicaid and Medicare members. The rising role of the consumer could create strong potential for concierge medicine, and the intensifying focus on efficient care delivery will expand opportunities for innovative home-care and primary-care models. PE funds' investment themes will revolve around market leaders that show potential for cost improvements, have a path to consolidation or have room to expand customer sales.
But with big opportunities come big challenges. Competition to land assets at reasonable valuations is intense. PE fund coffers are loaded with $1 trillion in dry powder, which general partners are itching to put to work. Increasingly, they find themselves competing against strategic acquirers maneuvering to restructure their business portfolios as they position themselves to compete in a new regulatory environment.
Many PE investors have made and will continue to make good returns in this large and attractive industry. However, the battle to land top-quality assets at a time when sellers' price expectations are high is driving up acquisition multiples, leaving little room for PE owners to count on the traditional sources of market beta – gross domestic product growth, leverage and expanding equity values – to boost returns. Looking ahead, investment success will hinge more than ever on their ability to foster greater efficiency in the healthcare system and improve patient outcomes.
Kara Murphy is a partner with Bain & Co., where she is a member of the firm's global PE and healthcare practices. Partner Tim Van Biesen leads the firm's healthcare practice for the Americas.