Crafting the next-generation value creation playbook in healthcare private equity
Faced with intense competition and rising valuation multiples to acquire high-quality healthcare platforms, healthcare private equity firms need to enhance their diligence efforts and expand their value creation playbooks to mitigate risk and continue to yield outsized returns relative to other sectors and public markets.
During the pandemic, there’s been a convergence of several secular and short-term trends that have fueled steady growth in healthcare PE. The tremendous amount of dry powder awaiting deployment and the cheap and accessible financing have played a key part in driving deal volume and rising valuation multiples across most sectors of healthcare services.
Further, while the pandemic has disrupted demand for certain healthcare sectors, it has also accelerated the innovation and adoption curves across several domains. Virtual and home-based care delivery, along with technology platforms, like telehealth and hospital at home were forced to scale overnight to replace traditional clinic- and facility-based care settings that were shut down in the early days of the pandemic.
In addition, significant increases in incidence rates of anxiety and depression during the pandemic coupled with progress in societal recognition and acceptance of mental health issues have reinforced the need for scalable, high-quality models of behavioral health and substance use disorder care. The same is true of value-based care, which has seen unprecedented activity across primary care, high-spend medical and surgical specialties, and post-acute and end-of-life care.
Collectively, these forces have made for a remarkable period in terms of deal volume and rising asset values with broad appeal extending across most sectors of healthcare.
Implications of heightened PE activity
In this environment, due diligence is becoming more important than ever. As investors face a higher bar for generating targeted returns given elevated acquisition prices, the depth and types of diligence performed on prospective assets must rise commensurately.
It’s no longer enough to simply understand and feel good about the macro forces at play. Given that healthcare remains local, it’s critical that investors understand and feel comfortable with a particular target’s positioning in their local market. That means understanding the target vis-à-vis the local health system environment, regional payers and reimbursement trends, incumbent provider referral channels, area population demographics and consumer preferences, and the employer landscape.
In addition, it often means needing to get deeper “under the hood” during diligence to assess the platform’s true ability to perform and grow. This includes paying close attention not only to the target’s rate of organic growth, but also the durability of existing volume and revenue sources considering the ongoing impact of the pandemic and swiftly evolving local competitive trends.
Due diligence also includes examining the platform’s track record of achieving growth following past tuck-ins to assess readiness and maturity for continued inorganic expansion. And it includes identifying material variability of quality outcomes and performance between sites, which may indicate a lack of alignment among providers or poorly developed operational or management processes.
As a result, expect greater separation between platforms that are truly differentiated and integrated versus those that are merely average or below.
Creating a next-generation playbook
With the higher acquisition prices, the first-order synergies and value creation tactics that investors have relied upon historically are now increasingly built into the purchase price. Realizing returns off this higher basis point will require more intensive and sustained value creation efforts that cover both revenue and expense optimization.
On the revenue side, the pandemic has reminded healthcare platform leaders that their focus must extend beyond simply generating a high enough rate of growth to ensuring that the growth is sustainable and diversified. Partnerships with in-market health systems are one example of how provider platforms are attempting to increase volume and revenue stability.
Many PE-backed platforms have historically tried to win a portion of referrals from all providers in a market. With local networks and referral channels tightening in many geographies, continuing to employ a “Switzerland strategy” can reduce future volume and revenue predictability. As a result, platforms are increasingly seeing value in striking preferred relationships with regional health systems through a range of business arrangements as a means of securing and expanding access to key patient populations.
In addition, platform revenue sustainability and diversification must include a clear strategy for expanding, or in some cases initiating, value-based care involvement. Given the distinct competencies and potential revenue disruptions associated with value-based care, next-gen value creation plans must lay out a clear path to filling and scaling key capability gaps and the transition economics associated with the migration.
On the expense side, investors need to move beyond the 1.0 playbook, which largely consisted of back-office synergy realization, revenue cycle management optimization and professionalization of management teams. Now, platforms need to do all those things while also focusing on optimizing at the point of care —working with clinicians around how they practice.
This is particularly important in value-based care models. Here the ability to perform is going to be driven by alignment on and adherence to clinical pathways and the ability to engage with patients effectively to influence behaviors that improve health and reduce spend.
Partnering with providers to standardize and optimize performance within the clinical practices and at the point of care necessitates a different set of value creation strategies and skills. It’s a departure from what has historically been required to execute more traditional back-office-focused synergy realization and scale readiness plans.
A more nuanced approach to integration planning is also required. This is needed to create operational processes and structures that balance local needs around consumerism, provider engagement, care management, marketing and patient acquisition, and other activities with larger opportunities for centralization and standardization.
Driving value across the healthcare investment life cycle
As the healthcare PE market continues to face intense competition for leading assets and evolving market conditions across many sectors, traditional approaches to deal diligence and value creation are necessary but not sufficient. Transaction diligence must be augmented with more sophisticated assessments of local market and competitive dynamics and risks.
Value creation plans must chart a path for revenue growth that is both sustainable and diversified. And those growth plans must be paired with a more sophisticated and broader approach to expense optimization — one that reaches beyond the typical back-office integration and into the clinical practice.
As both purchase valuations and market complexity increase, they are demanding a stronger approach to unlocking the full potential of cost synergies and growth initiatives. Investors and portfolio companies that create a next-generation playbook will win an advantage as they seek to drive value across the healthcare investment life cycle.
Photo: drogatnev, Getty Images
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