High valuations may curb healthcare M&A appetite of private equity groups

Healthcare M&A has been heating up for years, but sky-high valuations and rising competition may be causing some private equity (PE) buyers to walk away from the table.

Still, attractive margins continue to be a top factor driving M&A activity and bringing in potential buyers, according to a recent report from management and technology consulting firm West Monroe Partners and Mergermarket.

The report was compiled based on survey responses from 100 market practitioners on the drivers and challenges for healthcare acquirers.

PE interest

The healthcare space has seen an influx of new buyers from PE groups in the last several years. These buyers, in particular, look for ways to leverage technology and innovation to lower overall care costs and purchase value-add assets and operations.

However, the competition for assets is also limiting the market, the report found. A shortage of attractive targets was cited by 25 percent of respondents as the top financial or market barrier to acquisitions. Finding assets around or below $100 million have proven to be the most difficult, according to the report.

“Excessive competition for targets means that a lot of attention is being concentrated on fewer companies,” a director of acquisitions and development at a skilled nursing care facilities company said in the report. “These high-quality targets get noticed and acquired in the market much sooner than others.”

Market challenges

The lack of asset supply has led some private equity groups to make bigger purchases, such as the recent acquisitions of hospice provider Curo Health Services for $1.4 billion and home health company Kindred Healthcare for $4 billion. Across the industry, the competition has led to higher valuations that make it more challenging to complete a deal.

“Valuations are a big concern in the current market,” an operating partner at a PE firm based on the East Coast that specializes in life sciences and healthcare said in the report. “Businesses that have matured over time have accumulated assets that have increased in value. With affordable valuations being a criteria of attractive targets, the number has fallen considerably.”

For a lot of private equity buyers, federal reimbursement for Medicare and Medicaid services represents a significant risk and also impacts M&A.

“In working with PE sponsors, the biggest risk we see is the level of reimbursement from the government,” Brad Haller, a director in West Monroe Partners’ M&A practice who focuses on healthcare deals, said in the report. “They want to keep that as low as possible, and will even step back from the brink of a deal and walk away if a final analysis shows a large portion of government reimbursement in their finances.”

The median multiple for U.S. healthcare transactions was 13.8x EBITDA (earnings before interest, taxes, depreciation and amortization) in 2017 and 14.5x EBITDA in 2016, compared to 10.5x in 2015, according to the report.

Almost three-quarters of respondents—73 percent—said they had walked away from a potential healthcare deal, citing financial and/or tax issues as the reason.