Grégoire Andrieux, Paris partner, and Eleanor West, London partner, McDermott Will & Emery look at recent trends in healthcare M&A and what they mean for dealmaking in 2024
It has been a challenging 12 months for private equity dealmakers, and while the healthcare sector has proved more resilient than many, it has not been immune from a slowdown in transactions.
A choppy transaction climate
Investment bankers attending McDermott Will & Emery’s annual Healthcare Private Equity (HPE) conference in September highlighted the change in buyer appetite for healthcare assets that has occurred in the past few years.
Three years ago the spotlight was on healthcare services deals with a focus on consolidating fragmented markets, but the environment today is different with much more demand for strong organic growth in well-integrated, high-quality assets. Distribution deals, dental laboratories and national champions were among the examples given of attractive targets in the current climate.
What we are seeing is a bifurcation of deal activity with a real disparity in demand between Tier A and Tier B assets. Lots of people want to buy fast-growth, high-margin businesses, and those assets are going to sell whatever the market is doing. But for other types of asset, buyers are a lot more reticent, there is more of a bid-ask spread issue, and more concern about how the exit maths will work.
This year, European private equity firms are trying to get increased exposure to growth through innovation and it is likely that will continue to be a theme. At the same time, there is an expanding number of distressed transactions coming to market, creating a barbell effect where the most healthy and the most troubled deals are getting done, but with less activity in the centre.
Negotiating the market
For sellers, the advice is not to try and time the market in anticipation of a rush of deals in Q1 2024, but to instead focus on managing a business, its milestones and its operational trajectory. Where assets do not fall into that Tier A category in terms of margins and growth, sellers will likely have to accept a valuation discount that might not have applied a few years ago.
The good news is that bankers report a strong pipeline of deals ready to transact in 2024. Some banks are saying that pipeline is now at record levels, but whether that activity will start to unlock in the first, second or third quarter of next year remains to be seen.
Sellers are being told to start sale preparations early in order to identify issues that need to be addressed and start to solve for them, because meantime sponsors continue to fundraise and stand ready to deploy in what could be a busy climate ahead.
The segments of the healthcare industry where panellists at HPE expected things to be busy moving forward include those implementing AI, software-as-a-service and other technologies. Strategic buyers have been important in many processes in the past 12 months and have represented a larger proportion of the buyer universe than was previously the case, but the expectation is that private equity funds sitting on dry powder will return to the market as interest rates stabilise.
Strategies for closing deals
Given the pervasive mismatch between buyers and sellers when it comes to pricing, structuring to bridge the gap has become a much more common feature in healthcare transactions today. While sub-segments that still exhibit strong growth, such as medtech, continue to attract high multiples, elsewhere it is assets requiring buy-and-build strategies that rely on financing that are harder to get across the line.
Bridging that valuation gap at a time of sparse credit availability is particularly difficult where sellers are private equity firms under pressure to return capital, so more deals are getting done for family-owned businesses that have more appetite for structuring solutions such as earn-outs, reinvestments and vendor notes.
At the same time, the tight M&A environment and depressed public markets are driving well-capitalised buyers to look at take-privates, carve-outs, club deals and minority deals as an alternative source of targets at a time when sellers are withdrawing or delaying processes if they can.
We have seen some public-to-privates getting done recently in healthcare, because valuations in the equity markets are depressed and there is room to be opportunistic. But those deals are difficult for private equity to execute and, given the premium those assets typically go for and the challenges in the financing market, we may not see a lot more of them.
Carve-outs are another space where sponsors are alive to opportunities, as strategic sellers hone in on their core businesses, but deals are not always easy to deliver.
A number of the panellists at HPE identified financing as more of a challenge to dealflow right now than the availability of targets, with the result that deals are being structured with more equity, lower leverage, higher pricing and tighter covenants. Another big theme has been the increased use of continuation funds by private equity owners looking to deliver liquidity to their investors while increasing their own time horizon to deliver the next phase of growth in an asset.
Overall, healthcare is still viewed as a safe harbour for both investors and lenders during a turbulent macro environment, so the speakers anticipated a busy year for deals in 2024, even if buyers might remain selective and processes will continue to take longer to execute.
Our view is that whenever the economic environment is difficult, investors tend to sharpen their focus on healthcare opportunities. Sponsors are more aligned with their lending partners than ever before and, in the more attractive parts of the industry, deals are still getting done. Our expectation is that even more transactions will come to market and get executed in 2024.