M&A Healthcare Advisors 2023 End Of Year Review

M&A Healthcare Advisors 2023 End of Year Review

A slower than average 2023 deal cycle for Private Equity Buyers.

Strongest M&A year for Strategics in recent memory.

The greater economy creating headwinds, due to inflation and high cost of capital.

Despite adverse economic trends, healthcare valuations remain at their peak.

The economic story of last year was headlined by historic inflation creating upward pressure on interest rates and cost of capital. In an interview with McKnight’s Home Care, we stated that a continued slowdown would occur in Private Equity acquisitions. At that time, we were concerned that insolvency (due to unrealized losses in government securities) across most regional banks would adversely effect financial buyer investments in small to medium size healthcare companies. Fortunately, through a mix of government bailout, loosening regulations, and more “easing” (QE) through bonds, the regional banks were spared. However, the cost of capital remains the highest it has ever been in the era of leveraged buyouts. Institutional lenders are requiring amortization of principal on already astronomical rates, making this impractical for acquisition debt.

In the face of these systemic issues, we have experienced continued interest in healthcare services. As, evidenced by the Optum acquisition of both LHC Group (finalized in Q2 2023) and Amedisys (expected to be approved and merged by Q1 of 2024), the demand for caregivers is at record levels. The buyers best suited for acquisitions this year have been strategic acquirers. Leading up to 2023, the M&A landscape had been dominated by Private Equity activity. In contrast, this past year, the majority of our buyers were larger corporate healthcare providers including LHC Group, CVS Health, and Intermountain Healthcare. The reasons are quite simple, strategic buyers have the free cash flow (FCFF) and are not beholden to the aggressive return on invested capital (ROIC) expectations of Private Equity sponsored buyers (GPs) and investors (LPs).

Despite these challenges, Private Equity has remained active through the purchase of bolt on acquisitions. Of our twelve current transactions in process, the majority of the counterparties consist of financial firms. In every case, these firms are out bidding strategic buyers and customizing transaction structures to satisfy the seller’s expectations. The main contributor of this could be the need to exit from these mature portfolios in the relative short term. Due to this pressure to satisfy investors rate of return, financial buyers are augmenting portfolio value in the most expeditious way by bolting on smaller synergistic and accreditive companies. The question remains, who is the buyer of the buyer of the portfolio upon exit? In a recent article from Pitchbook news, they show an uptick in Continuation Funds, in which Private Equity is essentially buying the portfolio back from themselves. This approach would suggest that lower middle market acquisitions will increase as financial buyers focus on improving their “continued” portfolios.

What was most unexpected in 2023, was the continuance of record high valuations from years prior. We have discussed the concept of outlier bids. In virtually all our transactions, we have been able to consistently drive at least one outlier bid. This trend was consistent last year. One theory for the above market offers (i.e. price considerations) in 2023 could be demand outweighing supply, less active buyers, but, proportionately, there were much fewer seller targets. What our internal analysis suggests is that at minimum, there is one healthcare buyer in market who will gain immediate growth and/or efficiency in our client’s business. That accretive value will encourage them to pay a premium compared to other buyers.

As we follow the end-of-year trendline and look ahead, our forecast suggests a strong 2024 for M&A transactions. Stay tuned for our coming outlook on the coming year.