In recent years, the healthcare sector has seen profound changes, with a focus on new modes of delivery, new technologies and new shifts in the payment environment. The COVID-19 pandemic accelerated many of these changes, as solutions such as telemedicine and remote monitoring became more prevalent, and pandemic-related initiatives drove many decisions on resourcing and priorities. However, existing challenges remain, and a new political landscape means uncertainty about the regulatory environment will continue to impact the investment environment.
How are private equity (PE) investors reacting to these major shifts in the healthcare landscape? And where do they see opportunities over the next several years? To find out, McDermott Will & Emery collaborated with WSJ Intelligence, which supports The Wall Street Journal | Barron’s Group with research for its advertising division, to engage with a global cohort of PE investors, including managing directors, chief investment officers and partners of PE firms, the majority of whom are employed by firms with $10 billion-$100 billion in assets under management.
Q: Which of the following healthcare subsectors will attract the most attention from PE investors in the next three years? Please select up to four. Total respondents n=150
Among the key findings:
Almost three-quarters of respondents (74%) strongly or somewhat agree that “the healthcare sector was ripe for structural change prior to the onset of the pandemic, which has accelerated opportunities for investing in new modes of healthcare delivery.”
Health IT and telehealth stands out as the subsector that will attract the most attention from PE investors over the next three years, followed closely by large health systems (Figure 1), though there are prioritization differences between leaders2 and others (Figure 4).
Leaders (40%) see broad upside opportunities from their investments in physician practice management due to optimizing effciencies driving lower costs and greater convenience.
Executives from firrms rated as earnings leaders hold strong views on privacy and security, with more than half (53%) pointing to regulations on interoperability as the most impactful government intervention affecting historical and current investments.
A majority of respondents say PE has driven interest in biopharma investments that support the creation of COVID-19 vaccines and therapies (62%) and helped fill the gap between in-hospital and out-of-hospital care (59%).
One issue that nearly all respondents agree on: No matter how the healthcare environment changes, there are major opportunities to improve the way healthcare is delivered and create new benefits for providers, payors and patients. As Ira Coleman, chairman of McDermott Will & Emery, says, “It’s incredibly rewarding to partner with the private equity industry to address really tough, long-standing challenges in U.S. healthcare. Private equity has already made such a positive impact, and I think we’re going to see even more meaningful change moving forward.”
WHAT INVESTORS ARE PRIORITIZING NOW
“There’s tremendous dispersion going on in healthcare, and being able to enable innovation and reduce inefficiencies in the $4 trillion system that is U.S. healthcare is really to everybody’s advantage.” — IRA COLEMAN, CHAIRMAN, McDERMOTT WILL & EMERY
PE investors have long considered industry inefficiencies the most important investment driver, and our survey confirms that regardless of changes driven by the pandemic or shifting government regulations, this remains unchanged. Among both leaders and others, a focus on healthcare industry inefficiencies is the leading factor driving investments over the next three years (figure 2).
Additionally, fund managers who rate their firm as an industry leader in terms of returns are more likely than other respondents to name efficiency gains, value-based payment models and cost reduction as the most important drivers. They are also less likely to point to increasing regulation as a growing issue affecting future investments (figure 2). “The overall government influence and availability of healthcare is going to grow,” says Rob Wolfson, executive managing director at H.I.G. Capital. “We have to prove that we add value in this ecosystem. And I’m very comfortable with the value proposition we present because I know the quality of businesses that we are building, the quality of care we deliver and the cost that we’re able to do it in.”
Q: Which of the following PE drivers will have the greatest impact on overall PE investment in healthcare in the next three years? Please select up to two. Total respondents n=150, leaders n=57, others n=93.
The prioritization of cost reduction through efficiency gains as an investment criteria varies, however, across sectors. While it’s the most important driver of emerging opportunities for investors in large health systems and ambulatory urgency centers, it’s less important for investors in pharmaceuticals, biotechnology and device manufacturers. This fits with investment patterns across those industries, as large health systems and ambulatory surgery centers are typically more mature enterprises, and therefore present greater opportunities for efficiency and optimization.
Investors in biotech, pharmaceuticals and devices see the growing revenue stream from payors as a key rationale for investing in those sectors. This isn’t surprising given that U.S. per capita pharmaceutical spending grew from less than $900 a year in 2006 to over $1,200 in 2019,3 well before global vaccine initiatives pushed spending to record levels, according to Organisation for Economic Co-operation and Development (OECD) data.
The expansion of value-based payment models and demands for cost reduction are also key investment drivers, ranking second across the board. With value-based care a priority for the Centers for Medicare & Medicaid Services (CMS), which oversees healthcare reimbursement for over 100 million Americans, this will likely remain a strong opportunity for investors, and one where the investment community and government agencies may share common ground.
For investors in physician practice management, lowering costs to patients is the top driver of emerging opportunities. Value-based purchasing led the field in health IT and telehealth.
While each subsector has unique characteristics, the survey findings reveal broad trends in how investments in healthcare innovations are generating value. Drivers listed below (figure 3) are among the top that respondents selected for at least one of the 12 subsectors included in the survey
Q: Which of the following factors is the most important driver of [x]? Total respondents n=150
WHERE INVESTORS ARE PLACING THEIR BETS
Leaders see physician practice management as the sector that will attract the most investment over the next three years, followed by large health systems (figure 4). One clear reason these sectors appeal more to leaders than to smaller firms is their complexity, which means investors need to commit more time and resources to ensure successful outcomes.
PE investments in large health systems, according to McDermott, include investments focusing on parts of the business (e.g., specific service lines, cardiology, emergency room, lab, P.T. and others) as either a platform or portfolio company, or engaging in other kinds of joint ventures or in for-profit hospitals. “There’s an opportunity for private equity strategy and capital to help the health system improve on these different lines of operation,” Sokol says.
Q: Which of the following healthcare subsectors will attract the most attention from PE investors in the next three years? Please select up to four. Total respondents n=150, leaders n=57, others n=93. Health IT captures a wide range of technology tools used in healthcare, ranging from electronic medical records to scheduling systems, which are aimed at supporting the delivery, payment and other administrative aspects of healthcare.
Earnings leaders also see broad upside opportunities from their investments in physician practice management, driven largely by the idea that consolidating these practices will increase patient demand and revenue, thanks to lower costs and greater convenience. “There are just so many aspects to the business that can be improved by more sophisticated and strategic management, which ultimately helps physicians maximize their time with patients,” says Jerry Sokol, chair of McDermott’s national Health Transactions Group. “There’s ancillary services, managed care contracting, group purchasing and leveraging professional management.”
Among the full cohort of survey respondents, health IT and telehealth stands out as the subsector that will attract the most attention from PE investors over the next three years, followed closely by large health systems.
The majority of investments, according to respondents, are in new platform companies, such as rollups of physician practices into a new entity. This is followed by partnerships with nonprofits, reflecting a growing trend in healthcare investments: working with nonprofit hospitals that are looking to improve efficiency and reach broader communities of patients (figure 5).
Motivations driving investment models differ significantly. Growth opportunities are regarded as most important for platform companies (59%), while partnerships with nonprofits comes in second (52%). Better risk management and a better public profile are significant drivers for both investment types.
Q: Which of the following business models will attract the most attention from PE investors in the next three years? Total respondents n=150.
“Data and analytics are essential to better care delivery. In almost every one of our health businesses we have data specialists utilizing data to look at efficiencies and quality of care, identify trends and find ways we can leverage data to think about things differently and deliver better and more consistent care.” — ROB WOLFSON, EXECUTIVE MANAGING DIRECTOR, H.I.G. CAPITAL
THE ACCELERATION OF CHANGE
The coronavirus pandemic has accelerated the pace of structural change as healthcare evolves toward the “next normal,” creating substantial opportunities for new investments, mergers, partnerships and delivery models (figure 6).
Perhaps the most obvious shift has been the rise of telehealth and health IT, the sector the largest group of survey respondents cited as being of interest to them over the next three years. Prior to the pandemic, according to the U.S. Centers for Disease Control and Prevention, just 43% of health centers were capable of providing telemedicine services. By November 2020, that had risen to 95%. While telehealth visits by patients began to decline in late 2020 compared to earlier in the pandemic, they still represented nearly a third of all health visits.5
The question for investors now is how a blended model of care will play out in each of the various care options. “COVID-19 certainly accelerated the concept of telemedicine. Many healthcare businesses were actually completely saved because of telemedicine,” McDermott’s Sokol says. “Now, as we emerge from the pandemic, the question is going to be, what areas of healthcare are still going to use virtual healthcare and telemedicine versus going back to traditional practice?” Sokol cites areas such as behavioral health, which don’t require a physical examination, as being ripe for long-term growth in their use of telemedicine.
Demand for COVID-19 vaccines and therapies also drove broader interest in biopharma investments in areas such as cell and gene therapy, according to survey respondents. While the billions spent on vaccines and treatments may have triggered that interest, long-term investments are based on the potential upside of new treatments well beyond the pandemic. Solutions such as mRNA-based treatments, for example, have been in development for over a decade and show promise for use in a wide range of illnesses, including some hard-to-treat cancers.6
Q: To what extent do you agree or disagree with the following statements regarding the impact of the COVID-19 pandemic on healthcare PE investment? Total respondents n=150.
“The pandemic created opportunity, but it also exposed weaknesses. Telemedicine, risk-based contracting, the movement to outpatient, all saw significant growth. The question is going to be, as we emerge from the pandemic, what changes are going to be lasting?” — JERRY SOKOL, CHAIR NATIONAL HEALTH TRANSACTIONS GROUP, McDERMOTT WILL & EMERY
The majority of respondents also agree that PE helped fill the gap between in-hospital and out-of-hospital care during the pandemic, as outpatient care became an even more important part of the overall treatment landscape. “It’s been understood that outpatient can be a more comfortable, convenient and cost-effective setting for certain procedures previously done in a hospital,” says Alina DiDonato, senior managing director, Farragut Square Group. “As a result of the pandemic, where the hospitals needed to be at the ready to handle COVID-19 patients, the outpatient trend accelerated as more and more procedures migrated at a rapid clip to the outpatient setting.”
THE NEW REGULATORY ENVIRONMENT
If there’s one thing that gives investors pause about opportunities over the next several years, it’s the regulatory environment — both in terms of current regulations and the uncertainty that surrounds the new administration in Washington, as well as other governmental shifts. Although these regulatory shifts give pause, they also create great opportunity. Nearly 1 in 3 (29%) respondents cite increasing regulation as one of the top two PE drivers.
In the existing landscape, 44% of respondents name privacy and security regulations on interoperability as most important, followed by prohibitions against self-referral and health technology regulations. Investors from firms rated as earnings leaders hold somewhat stronger views on privacy, with more than half (53%) pointing to privacy and security regulations on interoperability as the most impactful government intervention (figure 7).
Q: Which of the following types of government regulation have had the greatest impact on your organization’s healthcare investment plans? Please select up to two. Total respondents n=150, leaders n=57, others n=93.
The biggest regulatory impact on investors, according to survey respondents, comes in the area of patient reach, followed by limitations on innovation opportunities. These two issues dominate the concerns of respondents across all regulatory issues, from privacy to interoperability to technology. “In the space of health technology, the government playing catch up. It can’t catch up fast enough,” McDermott partner Monica Wallace says. “That’s uncertainty that has to be dealt with.”
It’s easy to see why investors are concerned about privacy, security and technology regulations, which have become increasingly intertwined in the era of telemedicine, medical devices and apps — not to mention regulations that can differ significantly from state to state. As Wallace says, “It’s a minefield of different regulations that need to be monitored and tracked given the constant change in this space. When we conduct our due diligence reviews, we focus on applicable federal and state laws which, in the healthcare technology space, may require an assessment of all 50 states, each of which has their own regime. There are so many different aspects that tie into this concept of privacy and security and regulatory oversight, for example, services conducted through apps, information that is tracked, patient disclosure requirements, and how you keep up with it.”
The challenge of complying with regulations across jurisdictions has already impacted areas like telemedicine, where providers were shielded from potential penalties for certain HIPAA violations during the pandemic, as long as they exercised good faith efforts to preserve patient privacy.7 That didn’t stop some providers from adding disclaimers letting patients know that they’re only authorized to log in from certain states, in an attempt to avoid liability under regulations in states with stricter privacy regulations.
As healthcare moves to a post-pandemic environment, uncertainty about what’s next on the regulatory front continues to affect the industry. “Are regulations going to stay the same? Are those going to go away? Are they going to be modified?” asks Wallace. “And what new regulations are going to come down the pipeline, given some of the changes that we’ve seen throughout the pandemic?”
Looking forward to emerging areas of government regulations, PE executives predict regulations governing the individual insurance market to have the greatest effect on healthcare investment plans (43%), closely followed by alternative pricing methods (39%) and drug pricing (31%) (figure 8).
Investor concern about the future regulatory environment when it comes to insurance and payment scenarios comes on the heels of a period of continued change and uncertainty around government policies on payment, at least in the U.S. While the healthcare industry has largely adjusted to the changes brought on by the passage of the Affordable Care Act a decade ago, changes in the scope and enforcement of that law have resulted in a need to constantly reassess the regulatory and payment landscape. With the Biden administration looking to expand Medicaid and make permanent certain subsidies and tax credits introduced during the pandemic, uncertainty will remain for the foreseeable future
Q: Which of the following emerging areas of government regulation do you expect to have the greatest impact on your organization’s healthcare investment plans in the next three years? Please select up to two. Total respondents n=150.
In addition, uncertainty over new regulations on drug pricing is also likely to continue to weigh on investors, particularly since reducing drug prices has become a bipartisan issue, albeit one where the two parties remain far apart on both policy options and how to pay for any price relief.
“Some see constant conflict between the rapid nature of health technology innovation and the methodical, often slow grind of government regulation. PE investment is about moving business and the larger industry forward, but regulation does not have to be the enemy of innovation. Successful navigation of the health technology regulatory environment offers a lot of upside to investors.” — KRISTIAN WERLING, PARTNER, McDERMOTT WILL & EMERY
There are significant opportunities for investors based on the changed — and changing — environment. The pandemic exposed the broader public to inefficiencies in healthcare that the PE community had been aware of for some time. The resulting shift to telemedicine and other technological solutions has created new opportunities for investors, as evidenced by the interest in the sector shown in this study. As the market continues to evolve in the post-pandemic world, it’s clear that a broader focus on more efficient and cost-effective solutions will create further opportunities for investment.
“Enabling innovation and reducing inefficiencies in the system gives patients higher levels of satisfaction,” McDermott’s Coleman says. “People will want to invest in companies that are able to enhance care and lower expenses — bending the cost curve in the right direction and providing better services.”
1 Health IT captures a wide range of technology tools used in healthcare, ranging from electronic medical records to scheduling systems, which are aimed at supporting the delivery, payment and other administrative aspects of healthcare.
2 “Leadership” segment defined as respondents who self-reported their organization’s performance as leading in either modified internal rate of return (MIRR) or multiple of money invested (MoM).
3 “Pharmaceutical spending,” Total, US dollars/capita, 2003-2019, OECD
4 Health IT captures a wide range of technology tools used in healthcare, ranging from electronic medical records to scheduling systems, which are aimed at supporting the delivery, payment and other administrative aspects of healthcare.
5 “Trends in Use of Telehealth Among Health Centers During the COVID-19 Pandemic—United States, June 26-November 6, 2020,” CDC Morbidity and Mortality Weekly Report, February 19, 2021.
6 “Analyzing Tumor RNA May Help Match Patients With Most Effective Cancer Treatments,” National Cancer Institute, March 19, 2020
7 FAQs on Telehealth and HIPAA during the COVID-19 nationwide public health emergency, U.S. Department of Health and Human Services