Private Equity: Deal or No Deal?
July 30, 2019 Healthcare
Private equity is on the prowl for good deals in the healthcare space right now.
There’s a lot of competition and money searching for an investment opportunity. Sometimes, those opportunities involve public companies looking to go private.
Physician services provider Envision Healthcare Corp. went private through a deal last year, when it agreed to sell for $9.9 billion to a wholly owned subsidiary of KKR & Co; its stock price increased after the news. Also, private equity firm Apollo Global Management announced a deal to take rural hospital chain LifePoint Health private last year and merged it with RCCH HealthCare Partners. This article looks at some of the benefits and drawbacks of private equity deals.
Although PE firms have been active in healthcare services for many years, their participation in the space has grown significantly in the past five, according to the publisher Irving Levin Associates. Deal volume driven by these firms and their portfolio companies grew 450% between 2014 and 2018, reaching 369 transactions in 2018. PE firms’ share of the combined annual deal count in healthcare services increased to 46% in 2018, from just 14% five years earlier.
While healthcare-specific funds have been in the market for a while, private equity 10 years ago was more focused on biopharma and technology. “It used to be, ‘Let’s step over [healthcare] and hold our noses,’” says Lisa Phillips, editorial director for HealthcareMandA.com, which is published by Irving Levin. Now, PE is buying physician and other medical groups as well as hospice facilities.
Private equity has the enviable problem of too much money. Dry powder, or uncalled capital, has increased 64% during the last five years, according to the management consulting firm Bain & Co.
Given the influx of cash, private equity can look attractive to certain public healthcare companies as well. When Envision announced its deal last year, CEO Christopher Holden explained it to the publication Modern Healthcare this way: Going private protects the company from the sensitivities of Wall Street analysts who don’t appreciate investments that don’t result in a short-term payoff. What’s good for healthcare companies can be good for private equity.
“If you have a complicated story, you’re not really welcomed so much in the public market,” said Josh Harris, the cofounder of Apollo Global Management, according to the Bain & Co report. “That is creating a very fertile hunting ground for private equity, and we do see more opportunities here.”
Private equity leveraged buyouts often get a bad rap publicly, as was the case with Toys R Us and Payless ShoeSource. In Toys R Us case, about 30,000 people lost their jobs. Massachusetts Senator and Democratic presidential candidate Elizabeth Warren introduced the “Stop Wall Street Looting Act” in July to force private equity firms to take on the debt and pension obligations of the firms they buy. The bill would upend private equity as we know it, but it’s not clear what the measure’s chances are, given the uncertainty of the 2020 elections.
The argument in favor of private equity goes like this: PE firms often have the right experience and skills to really turn around an undervalued company, says Tatjana Paterno, an M&A attorney at Bass, Berry & Sims. “Some firms have excellent turnaround teams and they can add tremendous value. We have seen it play out with some of our clients, to the benefit of all stakeholders, including employees,” she says.
Another potential upside of this arrangement is the ability to make multiple acquisitions at attractive valuations without having to publicize purchase prices, which would be more challenging for a publicly traded company that needs to disclose all material events.
“An interesting strategy privately held buyers can deploy in certain emerging sectors is to rapidly acquire multiple smaller competitors at a discounted value before those targets learn about the consolidation in their industry and start demanding increased prices,” says Jonathan Bluth, the co-head of healthcare for Intrepid Investment Bankers LLC in Los Angeles.
But there are some things all executives should consider before doing a deal. Traditionally, private equity wants to exit a company after three to five years after making an investment. Some PE firms are beginning to do deals that take longer to mature, sometimes seven years or more.
Unsurprisingly, PE tends to look for deals that have a potential for high returns. Healthcare deals have returned $2.20 for every $1 of invested capital on a gross pooled basis, even more than other industries, according to Bain & Co. using CEPRES data.
But when it comes to numbers, it goes without saying that there’s lots of potential for miscommunication between healthcare staff and finance people. For example, doctors don’t necessarily care about EBITDA, Phillips says.
“It can be like herding cats,” she says.
Additionally, if your company is at the tail end of the lifecycle for a particular fund, you could face additional pressure to perform in a short time, Bluth says.
It’s not just the time-frame of private equity to be concerned about. Negotiating with private equity, and then handling all the due diligence, can be a real distraction for the executive team. Make sure the team is adequately prepared for an intense amount of work and has the resources and the support of experienced advisers, Paterno says.
“Importantly, don’t take your eye off the ball in terms of performance of the business,” she says. “This will help get the best possible value in a sale, and also minimize potential negative consequences if a sale does not materialize.”
As executives, you’ve probably already worked out contracts to make sure you won’t suffer a financial loss if you lose your job in a sale. That helps align your incentives with the interests of your employer during negotiations.
But a PE firm may want to keep you on board. In that case, annual bonuses and equity grants that are typical for public companies often go away under private equity ownership. They are replaced with payouts upon exit, potentially delaying your rewards for quite a few years. That aligns your interests with your new PE owners.
Whatever happens to the company, as a public entity, generally your main focus in negotiating a deal should be to obtain the best value reasonably available to shareholders, Paterno says.