It was a tale of two halves. 2022 began at the same white-hot pace where 2021 left off as healthcare private equity (HCPE) sponsors were armed with dry powder and optimism coming out of the industry’s best year on record.

Then the world changed.

Russia invaded Ukraine, energy prices skyrocketed, and inflation reached multi-decade highs. As central banks around the world hiked rates, public listings sank and credit markets dried up. This shift shook private equity activity globally, with healthcare no exception. Additionally, pressure from a tight labor market hit healthcare particularly hard. Buyout volume fell by more than 35% in the second half of 2022 compared with the first half of the year, and the fourth quarter had the lowest quarterly HCPE deal activity since 2017.

Yet even with the slowdown in the second half, 2022 was still the second-best year on record for healthcare private equity by many measures. Total disclosed deal value reached around $90 billion, down from $151 billion in 2021 but still over $10 billion more than the next-closest year. Deal volume in North America and Europe was the second highest on record. Asia-Pacific reached new heights for disclosed deal values, despite the slowdown in China.

Navigating continued uncertainty

The uncertainty from these macroeconomic and geopolitical dynamics—and now mounting turbulence in the banking sector—is far from resolved, but rising asset valuations and scale corporate merger and acquisition (M&A) deals late in 2022 suggest continued faith in healthcare investments. The S&P 500 healthcare index recovered in the fourth quarter and closed 2022 down only 4% from where it ended in 2021. Amgen’s $28 billion acquisition of Horizon Therapeutics and CVS Health’s $8 billion acquisition of Signify Health highlight impressive enterprise values of 20 to 30 times EBITDA. Did these green shoots portend a recovery in healthcare deal activity, or were they a false sign of spring? Time will tell.

Consistent with private equity writ large, the recovery of healthcare private equity activity hinges in part on the credit market. High rates aside, banks need some predictability of where the overnight rate will settle before they feel comfortable extending credit, especially for deals over $1 billion.

Meanwhile, we expect private equity sponsors to flock to a subset of investment strategies in 2023 as they continue to adapt to macroeconomic challenges:

• Find creative ways to get deals done. Some funds will look for ways to engineer the leverage they need for large deals. Others will pivot toward smaller deals where securing financing or writing larger equity checks may be more plausible. Still other funds are likely to build public-to-private pipelines to take advantage of depressed valuations. Sponsors with strong corporate relationships and exceptional operational due-diligence capabilities may consider carve-outs. Corporate partnerships may provide private equity sponsors both access to capital and a potential path to exit. Recapitalizations may be popular ways to provide exits for current limited partners.
• Pick category leaders with defendable moats. While it is hard to time markets, it is easier to bet on a company that will remain strong through bad markets. Category leaders have historically delivered higher profitability and are better able to withstand downturns. Factors to look for include category-leading operations, proprietary intellectual property, unmatched technical capabilities, or differentiated customer advocacy.
• Build scale in existing assets. As investors look inward to drive value in their existing portfolios, 2023 may be the year of tuck-in acquisitions. Add-ons in categories with known cash-flow potential may help funds secure financing or may be small enough for funds to finance without credit. Operational due diligence and clear integration theses will be increasingly important in these deals.
• Identify margin improvement opportunities. Historically, revenue growth and multiple expansion have been so strong in healthcare that funds have not had to focus on operations as much. Margin improvement contributed only 2% to healthcare deal returns between 2010 and 2021. Funds that identify the right operational levers early and execute their margin improvement playbooks will achieve the full potential of their assets.

Private equity funds may also use this moment of disruption to revisit their fund strategies and reconsider the subsectors they focus on and the investment themes they plan to prioritize.

Reasons for long-term optimism

Economies move in cycles, but the long-term growth of healthcare is powered by several immutable trends, such as aging populations and the rise of chronic diseases. Funds with conviction in this space, the ability to identify highly differentiated assets, and the expertise to develop a plan for operational excellence will find themselves ahead when favorable economic conditions return.

Beyond the familiar benchmarks we use to measure healthcare private equity activity, this year’s report takes a close look at several other long-term trends: the continued rise of the biopharma and life sciences tools sectors, the shift to value-based care models as the payer and provider spaces blur, and a spotlight on successful strategies for scaling provider IT platforms.

As always, we hope you enjoy our report on private equity and M&A in the healthcare sector. We look forward to continuing our dialogue with investors and stakeholders around the world.