Despite high barriers to entry and the need for extensive due diligence, health care remains an attractive industry for private capital investors.
The U.S. health care market received $83 billion in PE investment in 2017, up from $72 billion the year before, according to the American Investment Council. Seattle-based Frazier Healthcare Partners is among the active firms in the industry. Over its 27-year history, it has developed specialized expertise to capitalize on the industry’s transformation.
“First and foremost, this is a complex and evolving marketplace,” says Managing Partner Nader Naini. “Frazier places a premium on seasoned executives who have a proven track record and are considered specialists in their sectors of focus.”
Frazier approaches investing by identifying long-term trends and searching for companies that can solve a fundamental problem within their markets—such as access to care or high-quality service to ensure the best patient outcomes.
Rising Costs in a Shifting Market
With its emphasis on experience, it’s no surprise Frazier partnered with audit, tax and consulting firm Plante Moran, which has more than 50 years expertise in the health care industry. Plante Moran’s experience allows its professionals to understand issues impacting clients across the entire health care continuum and help them balance risk. They adopt a broad perspective, helping clients envision what their organizations and the health care landscape will look like in the years ahead. That experience is critical, especially as traditional business models undergo significant change.
New payment models—such as bundled payments and capitation, in which a provider is paid a fixed rate per patient—are disrupting the traditional fee-for-service model health care providers have relied on for decades. Companies that can move toward new payment models will be well-positioned for growth, says Duane Fitch, a Plante Moran partner who focuses on the health care industry.
A shift in patient attitudes is also changing the market. With increasing costs, patients are rewarding value over volume. They want better care, not just more care, and the industry is responding. Companies can increase value by focusing on treating patients in the lowest appropriate cost setting, Fitch says. Services such as dental, home care, pet care, pharmaceuticals and vision are becoming more retail-focused to treat patients like valued customers.
“Typical danger spots for health care deals are reimbursement, compliance, technology, people, etc., and we’re constantly figuring out ways to mitigate the risks associated with those.”
Managing Partner, Frazier Healthcare Partners
Technology Lowers Costs, Raises Value
While some health care providers struggle with shifting revenue streams and providing quality care, both can be improved by adopting technology.
According to Naini, the health care industry has dramatically underinvested in technology—spending only 1 to 2 percent of its revenue on improvements. Compare that to financial service companies, which spend about 10 to 12 percent.
“Technology is critical not only to successfully run business operations—such as ERP and sales management—but also to enable value-based care,” Naini says. “Without access to good data and analytics, making appropriate risk-taking decisions can be difficult and financially catastrophic.”
Technology can be used to automate processes, such as contract adjudication, cash posting, credit extension, billing and collection follow-up, and to provide patient analytics—an area where Frazier helped two of its portfolio companies, Southside Pharmacy and TCGRx.
Technical improvements can have a positive effect when the time comes to sell. Companies that focus on technology will be valued at premium multiples, especially those with big data and analytics expertise, Naini says.
‘Dry Powder’ Opportunity Meets Regulatory Risks
Valuations for health care providers continue to be high, and even organizations that operate on a fee-for-service model are attracting buyers, Naini says. “There’s lots of dry powder, which makes it a good time to sell.”
PE firms are particularly interested in providers within certain subsectors, such as dentistry and dermatology, specialty pharmacy and outsourced pharma services.
However, licensing and regulatory requirements, complex reimbursement and complicated multi-party contracts remain formidable barriers to entry. “Health care is one of—if not the most—politicized and regulated sector of the economy,” Naini says.
This heightens “stroke of the pen” risk and makes it harder for generalist investors to be successful. Private equity firms need to fully understand risk-based care models and exercise stringent due diligence and underwriting. Providers must focus on diversification of revenue streams and payer sources to avoid risk concentration, Fitch says.
In addition, accounts receivable is often misstated in the valuation process, which can lead to large write-offs and professional liability. Other exposure levels require specialized legal analysis that may not be part of a typical due diligence process. Meanwhile, reimbursement uncertainty remains a significant concern in the U.S. health care market, namely the transition from the Affordable Care Act to its ultimate replacement.
To succeed in this industry, investors must understand its challenges and take a strategic approach when choosing their partners. As a partner, Plante Moran provides thoughtful guidance throughout the private equity life cycle—from due diligence to post-transaction integration and exit.
“Typical danger spots for health care deals are reimbursement, compliance, technology, people, etc., and we’re constantly figuring out ways to mitigate the risks associated with those,” Naini says. “What I’ve learned over the last 27 years is it all comes back to the people.”
Benjamin Glick is ACG Global’s marketing and communications associate.