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Private equity: Why the healthcare sector appeals to private equity so strongly

healthcare, private equity, Health and medicine providers can bring tangible benefits to portfolios’ ESG scores. That’s one reason private equity deals are rife in the sector, writes Laraib Shahid.

The healthcare sector acts like a self-fulfilling prophecy: the increased lifespan of the world population is a key driver for investment, and the better healthcare that results from this investment increases lifespans. The sector remains attractive as the world’s population ages, creating a need for better healthcare, while the private sector and private markets are important for meeting demand.

Studies suggest that healthcare was the best-performing asset class in private equity (PE) between 2015-2021 in terms of internal rate of return (IRR), a popular metric used to forecast growth in PE. A counter-cyclical sector, healthcare provided a safe “port in a storm”, according to Justin Crowther, head of healthcare, UK, at PE and banking firm Alantra.

In public markets, healthcare stocks offered relative stability in 2022. The economic headwinds and geopolitical crises that can plague business activity had less effect on a sector that sees more or less constant demand.

Since the volume of PE healthcare deals reached record levels during the Covid-19 pandemic (see box, page 13), attractive returns and reduced volatility have encouraged European limited partners to allocate a greater share of their funds to the sector, in line with global trends, statistics from management consulting firm Bain & Company suggest.

With its academic and scientific talent and infrastructure, Europe persists in producing many innovative therapeutic and life-sciences companies. Investment in recent years has followed three themes: over-the-counter and generic medicine manufacturing; contract-development and manufacturing organisations; and clinical lab service providers.

Deals in the medtech sector returned to a more normal level in 2021 after the pandemic-dampened volumes in 2020. Eight healthcare IT deals closed during 2021, compared with five in 2020. Covid-19 accelerated the adoption of digital interfaces between caregivers and patients to enhance productivity.

So, what of 2022?

In 2022, private healthcare equity remained strong amid growing geopolitical tensions, high inflation, slumping stock markets and spiking interest rates. The year 2022 was the second-highest on record in terms of deal flow: the first six months maintained the record-setting pace of 2021, and a strong first-quarter pipeline persisted into the second quarter.

That said, the geopolitical crisis in Ukraine and high inflation changed the trajectory for the rest of the year. Funds started to become more selective, seeking pockets of opportunity in choice sectors, subsectors and geographies, according to the Bain report.

Life sciences continued to attract interest from buyout funds – that is, funds that look to purchase controlling stakes in companies and sell out for profit. The market has also witnessed a shift in activity towards healthcare information technology. In 2022, there was special interest in buyouts for firms that help to optimise business operations, especially given the possibility of a recession and the need to maintain cost controls and efficiencies.

As credit availability tightened, the size of the average buyout deal fell globally in Q3, particularly in Europe.

Lee Brown, global sector lead for healthcare at research and data provider Third Bridge, says companies with the most diversified portfolio of attractive assets and growth will remain more interesting to investors than those with more concentrated assets or with slower growth profiles.

Yann Mauron, thematic private equity manager at Pictet Alternative Advisors, says a key area with solid potential for growth is therapeutics, as biotechnology is witnessing healthy growth. This is reflected in Bain & Company’s statistics.

Another significant area witnessing growth is diagnostics, according to Paul Major, fund manager at Bellevue Healthcare Trust. Ailments such as cancer, diabetes and heart disease are affecting a growing portion of the world’s population as it ages, and early diagnostics can enhance the odds of a positive outcome.

Taking care of ‘social’

At a time when ESG investing is seen as a priority, healthcare companies’ ability to strengthen ‘social’ criteria has assumed major importance.

“When it comes to ESG investments, the ‘S’ is often the neglected component,” says Mauron.

Investment in private healthcare can increase the social factor within ESG investing, “whether it’s funding the development of new cell therapies to target solid tumours, leveraging advanced data analytics to optimise the design of clinical trials, or improving care for the elderly, investment in healthcare naturally contributes to us living longer, healthier lives”, he adds.

Since privately owned healthcare companies far outnumber publicly traded ones, private markets offer an eminently suitable place in which to fund innovations. In the biotech sector, 85% of companies in the US and 94% in Europe are private, according to Mauron. Also, private companies’ contribution to innovation is greater – a key factor in making a social impact, he adds.

Digital health is another key to serving poorer and harder-to-reach areas, a crucial part of the UN’s Sustainable Development Goals. At the same time, care providers have a critical role to play as the population ages; Mauron points to innovation in this sector, such as improving safety and efficiency with the help of technology and artificial intelligence.

According to Alantra’s Crowther, ESG needs to be at the forefront of strategic planning and board agendas: “Healthcare companies, whether they care home providers, pharmaceutical companies or medtech/medical device companies, have always had the ‘S’ of ESG at the core of what they do, treating patients, creating new drugs.” However, the ‘E’ and the ‘G’ are becoming more important, he says.

Healthcare companies face a growing number of ESG reporting requirements in the form of annual audits, regulatory issues and global standards such as B Corp Certification, issued by the non-profit organisation B Corp. Many large healthcare companies, including some of the largest European care service businesses, are moving towards certification, says Crowther.

“However, the benefits to healthcare companies of embedding ESG go beyond simply being awarded certification. A business can benefit in so many ways. Examples include increased positive feedback from current and future customers, greater brand awareness, more efficient supply chains and making it easier to attract capital,” he adds.

Increasingly, financial lenders are inclined to reduce lending costs for healthcare companies that employ strong ESG policies. When considering new care home developments, says Crowther, many lenders in the UK insist on certain ESG characteristics in the operator’s business.

Meanwhile, challenges remain. Healthcare businesses are undergoing staff shortages, especially in care services across Europe, which distracts from strategic medium-term goals – including ESG – and diverts attention towards short-term operational issues, Crowther notes.

Positive indicators

As a major global sector, healthcare accounts for roughly 10% of GDP in most European economies. Despite short-term recessionary pressures, the ageing population is a strong structural dynamic. Crowther says that the increased prevalence of chronic conditions as populations age, coupled with a growing focus on preventative measures, is likely to lead to increased spending on healthcare by governments, corporations and businesses.

But despite its safe-haven image, the sector is not immune to challenges that grip the economy, such as inflation, the increased cost of borrowing and the effects of Russia’s invasion of Ukraine.

“The start of 2023, however, has seen some more positive economic indicators,” says Crowther. “This will benefit the healthcare sector as much, if not more, than other sectors.” In the months to come, he adds, deal flow may return to the mid-market – and if debt financing returns for more significant transactions, the second half of the year could see a large upturn in activity.

With high expectations of recession in 2023, Brown at Third Bridge says larger-cap companies with diversified assets and healthy balance sheets could prove attractive to investors. “Depending on how you think the economy will proceed, throughout 2023 is going to largely dictate how individual sectors within healthcare perform,” he adds.

Whatever happens, there will always be a demand for healthcare. As a result, Brown says, investors will “gravitate” to pharmaceuticals, as they will continue to “hide out in safe havens”.

At the same time, because of the rising cost of capital, small and mid-cap companies with limited liquidity runways will continue to struggle this year.

A healthy year

In 2021 – the second year of the Covid-19 pandemic – private equity healthcare deal volume was down by 23% as a share of global private equity activity. However, healthcare deal volume still posted a record year.

According to Bain & Company, the private equity market closed deals worth more than $150 billion in the global healthcare sector. The average disclosed deal value soared 134%, mainly because of five buyouts greater than $5 billion, compared with just one in 2020. About 36% more deals were recorded in 2021 – a total of 515, compared to 380 the year before.

Valuations in 2021 also reached a record high, doubling to $151 billion from $66 billion in 2020, according to disclosed information collated by Bain. The number of deals over $1 billion in Europe almost doubled. The Asia-Pacific region also saw deal volumes and disclosed values increase.

Biopharma and life-sciences tools, along with diagnostics, accounted for 74% of disclosed deal value in Europe, rising to $19.3 billion in 2021 from $4.1 billion in 2020.

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