Faced with intense competition and rising valuation multiples to acquire high-quality healthcare platforms, healthcare private equity firms need to step up their diligence and expand their value creation playbooks to reduce risk and continue to generate growth relative to other industries and the public market. excess return.
During the pandemic, some long-term and short-term trends have converged that have driven steady growth in healthcare PE. The large amount of dry powder waiting to be deployed, along with cheap and accessible financing, has played a key role in driving transaction volumes and valuation multiples higher in most healthcare services industries.
Additionally, while the pandemic has disrupted demand for certain healthcare industries, it has also accelerated innovation and adoption curves across multiple sectors. Technology platforms such as virtual and home care services, as well as telehealth and home hospitals, were forced to scale up overnight to replace traditional clinics and facility care environments that closed early in the pandemic.
In addition, the marked increase in the incidence of anxiety and depression during the pandemic, coupled with growing societal awareness and acceptance of mental health issues, reinforces the need for scalable, high-quality behavioral health and substance use disorder care models . The same is true of value-based care, which has seen unprecedented activity in primary care, high-spending medical and surgical specialties, and acute and end-of-life care.
Collectively, these forces have achieved notable success in rising transaction volumes and asset values, and have broad appeal across most healthcare sectors.
The impact of increased physical activity
In this environment, due diligence has become more important than ever. As acquisition prices rise, investors face higher barriers to generating targeted returns, so the depth and type of due diligence on potential assets must increase accordingly.
Just knowing and feeling good about the macro forces is no longer enough. Given that healthcare is still localized, it is critical that investors understand and feel comfortable with where a particular target is positioned in their local market. This means understanding the target versus local health system environment, regional payer and reimbursement trends, existing provider referral channels, regional demographics and consumer preferences, and employer landscape.
Additionally, this often means a deeper look “behind the scenes” during due diligence to assess the platform’s true ability to execute and grow. This includes paying close attention not only to the target’s organic growth rate, but also to the persistence of existing volumes and revenue streams, given the ongoing impact of the pandemic and rapidly evolving local competitive trends.
Due diligence also includes examining the platform’s track record of achieving growth after adjusting for the past to assess readiness and maturity for continued inorganic expansion. It also includes identifying significant variability in quality results and performance between sites, which may indicate a lack of consistency among suppliers or poorly developed operational or management processes.
As such, expect a greater separation between platforms that are truly differentiated and integrated and platforms that are just average or below average.
Create the next generation of playbooks
As acquisition prices have risen, the first-order synergies and value-creation strategies that investors have historically relied on are now increasingly incorporated into acquisition prices. Realizing returns from this higher basis point will require more intensive and ongoing value creation efforts, including revenue and expense optimization.
On the revenue side, the pandemic has reminded healthcare platform leaders that their focus must go beyond simply generating growth rates high enough to ensure that growth is sustainable and diversified. Partnerships with in-market health systems are an example of how provider platforms are trying to increase volume and revenue stability.
Historically, many PE-backed platforms have attempted to earn a portion of referrals from all providers in the market. With local networks and referral channels tightening in many regions, continued adoption of the “Swiss strategy” may reduce future volume and revenue predictability. As a result, platforms are increasingly seeing the value in establishing priority relationships with regional health systems through a range of operational arrangements as a means of securing and expanding access to key patient populations.
In addition, sustainability and diversification of platform revenues must include a clear strategy to expand or in some cases initiate value-based care engagement. Given the unique capabilities and potential revenue disruption associated with value-based care, next-generation value creation programs must chart a clear path for filling and expanding critical capability gaps and transition economies associated with migration.
In terms of fees, investors need to move beyond the 1.0 playbook, which primarily includes back-office synergy implementation, revenue cycle management optimization, and management team specialization. Platforms now need to do all of these things while also focusing on optimizing the point of care — working with clinicians around their practice.
This is especially important in a value-based care model. Here, executive capacity will be driven by the ability to align and adhere to clinical pathways and engage effectively with patients to influence behaviors that improve health and reduce spending.
Working with providers to standardize and optimize clinical practice and point-of-care performance requires a different set of value-creation strategies and skills. This differs from the historical requirements of executing a more traditional back-office-focused synergy realization and scale readiness program.
A more nuanced approach to integration planning is also needed. This requires the creation of operational processes and structures to balance local needs around consumerism, provider engagement, care management, marketing and patient acquisition, and other activities, as well as greater opportunities for centralization and standardization.
Driving value across the entire healthcare investment lifecycle
As the healthcare private equity market continues to face intense competition for leading assets and changing market conditions in many industries, traditional transactional due diligence and value creation approaches are necessary but not sufficient. Transaction due diligence must be enhanced through a more sophisticated assessment of local market and competitive dynamics and risks.
The value creation plan must show the way for sustainable and diversified revenue growth. These growth plans must be coupled with a more sophisticated, broader approach to cost optimization—one that goes beyond the typical back-office integration and into clinical practice.
As procurement valuations and market complexity increase, they need a stronger approach to unlocking the full potential of cost synergies and growth plans. Investors and portfolio companies creating next-generation playbooks will gain an edge as they seek to drive value across the entire healthcare investment lifecycle.
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