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Are High Prices Testing Private Equity's Ability to Close Healthcare Deals? Print E-mail
Written by David H. Fater   
Thursday, 06 September 2018 11:37
Now that healthcare consumerism is replacing traditional retail storefronts with dental and urgent-care clinics, the sector has drawn ravenous interest from private equity funds. But are would-be buyers getting discouraged by increasingly high prices? In a recent survey of private equity funds and strategic buyers, the top challenge identified in completing healthcare mergers and acquisitions is a shortage of attractive targets. The biggest reason? The deals are getting too expensive.
Of the 579 deals for U.S. healthcare targets last year the median transaction value has increased substantially since 2015. It is what appears to be a perfect storm and the number of transactions was the second highest on record. The specific targets included healthcare providers like physician practices and health systems as well as healthcare IT companies and life sciences companies. This is a diverse mix of targets with each of them having their own unique valuation issues.

Health system deals tend to catch a lot of headlines primarily because of their size, but they actually represent a small proportion of overall healthcare acquisition transactions.  Midmarket transactions, especially among relatively small specialty practices, make up most of the deals taking place.

The problem is investment banks are overpricing the companies looking to sell, valuing them in some cases two or three points higher than just two years ago without much justification for it. It is an old story where companies that are essentially average in terms of their financial performance or operational capabilities are looking to demand a price that is in line with companies operating in the top quartile. Put differently, the sellers believe their streets are paved with gold rather than high class bricks.

Prices have risen on the provider side in a herd mentality because their peers are selling at premiums. Dental groups, for example, are attractive to private equity firms because insurers tend to reimburse them without much pushback, their patients return at regular intervals and their industry is fragmented, inviting firms to create services organizations to support them. It is the reason that physician practice management companies flourished in the late 1990’s and we all know where that ended up. However, it has not deterred private equity groups from looking at other specialty groups that have similar criteria such as dermatology, ophthalmology, plastic surgery and behavioral health.

Private equity's strong appetite for healthcare acquisitions was on full display in a recent regulatory filing that revealed nine such firms submitted offers to buy Nashville-based physician staffing company Envision Healthcare in February. In June, Envision announced private equity firm KKR would buy the company for $9.9 billion in cash and assumed debt. KKR submitted a bid for up to $46 per share, which came in less than other offers of up to $60 per share. We recently valued a specialty practice at $155 million and when the transaction closed it fetched very near that price.

As the acquisition trend plays out, a new difficulty for private equity is finding companies with the infrastructure to support the kind of growth they are targeting. Outside of hospitals and health insurers, the healthcare market is highly fragmented with many early stage companies. The targets tend to be one or two dominant players of size and then there is a significant drop-off in terms of size and sophistication.

Interestingly enough, 73% of respondents in a recent survey had walked away from a potential healthcare acquisition. The principal reason was what was discovered in extensive due diligence. Would-be acquirers walked away because of anticipated problems with reimbursement, technology integration and security and compliance. We have preached for years about the necessity of integrating the due diligence with the post-merger integration plan as the best way to determine if the deal is worth doing and at the target price.

A different firm’s view through the lens sees that 75% of what is out there still represent attractive targets. This is most evident in physical therapy, urgent care, dentistry and even veterinary practices. Bringing consumerism into the equation makes a transaction more attractive AND that is one of the things that is inherently wrong with our current healthcare system. The consumer is not really involved because of the way the system works. So, the more like a retail play the more attractive the business is.

Despite all of private equity's investment in specialty practices, several industry experts said firms haven't shown the same appetite for hospitals and health systems. Brick and mortar assets like hospitals are expensive, and the high degree of consolidation that has already taken place in the sector has made them even more so, not to mention buying health systems means improving patient care, paying for building upkeep and adding new technology. Also, the rapidly growing trend is to push more services out of the hospital and into free standing facilities which can help drive down cost to the system.

We believe the acquisition binge will continue for a period of time despite the valuation questions. There is value in scale in healthcare, especially in negotiating insurance contracts or directly contracting with large employers. As long as the economy continues to hum, deals will get done until the contraction takes place or the valuations become too high even for the private equity players

To explore ways in which we can provide assistance in assisting with your merger and acquisition activity, including valuation, in this evolving health care environment, please contact David H. Fater at or Richard M. Cohen at

Last Updated on Thursday, 06 September 2018 12:41

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