Market Update: Pent-Up Demand in Healthcare Services M&A

December 8, 2023

At McGuireWoods’ 16th annual Healthcare Finance & Growth (HCFG) Conference, panels of healthcare-focused investors and lenders provided insights about the healthcare M&A and debt markets.

The healthcare M&A panel included Vida Harvey, vice president and assistant general counsel of Novant Health; Vasanta Pundarika, managing director and head of healthcare investment banking at Matrix Capital Markets Group; Rich Searles, partner at Merritt Healthcare Advisors; and Matt Smith, principal at Source Capital.

The healthcare lending panel included Jackson Diaz-Cobo, executive director of healthcare services at JPMorgan; Craig Evans, national head of healthcare banking, corporate banking division at BankUnited; Barrett Polan, director of the healthcare investment team at Hayfin Capital Management; and Dan Storer, group head and senior managing director of corporate healthcare banking at Huntington National Bank.

Below are a few key takeaways from the panelists: 

There is enthusiasm in the market to get deals done, subject to greater scrutiny from investors. A panel of leaders from a large health system and from healthcare-focused private equity fund and investment banks provided a well-rounded provider- and investor-based perspective on the healthcare M&A market. The panel noted that there is great enthusiasm to get deals done. Opportunities in women’s health, behavioral health, home-based care, cardiology ancillaries and health technology are particularly exciting. However, many investors are being more patient to find the right targets with strong long-term growth prospects, while others are waiting on the sidelines due to higher debt costs. Across the board, investors are keeping a close eye on regulatory headwinds, specifically increased antitrust scrutiny in the healthcare space by the Federal Trade Commission.

The panel noted that investors are wary of margin compression due to higher operational costs largely attributable to inflation and a mass labor shortage that is pushing providers to utilize expensive contract labor. Targets with demonstrable revenue and volume drivers that bode well for long-term growth despite the current higher operational costs are still receiving strong valuations. The high-valuation frenzy of the pandemic era is a thing of the past, but sellers may be struggling to come to terms with that reality. Panelists noted that although both investors and sellers are willing to be creative when structuring a transaction to help bridge the valuation gap and related risks, the number of tools available to bridge that gap are relatively few and generally may carry some level of healthcare regulatory risk.

It is important that companies interested in an exit event do not rush to market. Advisers are encouraging companies to become attractive targets by conducting go-to-market diligence, including cleaning up legal and compliance issues, analyzing corporate and tax structure, consolidating/updating capitalization tables and addressing operational issues. Panelists shared in the sentiment that “time kills deals.” If there are fewer issues that need to be addressed in the buy-side diligence phase post-LOI, the deal is more likely to close.

Capital is available, but high rates may persist; borrowers should focus on regulatory diligence before underwriting. A panel representing both bank and private credit lenders with extensive experience in healthcare lending shared their perspective that there has been an influx of new business and an uptick in deal activity going into the fourth quarter of 2023. While the Federal Reserve may continue raising rates and rates may be higher for longer, a significant amount of capital is available to be deployed. From the panelists’ perspective, loan terms have been more lender-friendly in today’s environment. Providers, payors and life sciences companies (including pharma services and pharma-adjacent companies) tend to be easier to underwrite because they are tied to need-based consumerism. The panel noted that there is a robust pipeline of value-based care transactions and strong demand for credit in the cardiology and women’s health sectors, as well as an influx of opportunities in the med-spa space, but that some lenders may find it challenging to underwrite businesses that do not have clinician ownership.

The panelists noted that it is easier to extend credit to businesses that have spent time with counsel to conduct healthcare regulatory diligence and address risks that could have a financial impact. Specifically, lenders are concerned about borrowers being subject to government investigations and audits due to regulatory noncompliance that can be expensive to defend. Lenders also are looking for borrowers with strong IT infrastructure and sound privacy and security practices. Security incident response can be incredibly expensive and can significantly impact the borrower’s operations and finances.

Panelists also said they have observed a recent uptick in covenant violations by borrowers. Lenders are spending more time to fully understand the borrower’s platform and the sponsor backing the platform, so they can make sensible assumptions about the business and reduce the risk of covenant violations. Some of the panelists noted that they also are investing in AI-based products to better understand and assist in accelerating the borrower’s revenue cycle management and healthcare receivables.