There’s no doubt that health is one of the biggest stories in private equity right now. In the second quarter, the healthcare sector accounted for almost a quarter of global PE deal values, according to Preqin – second only to information technology.
It’s easy to see why the sector’s reputation for high resilience and returns is looking increasing attractive to PE in this age of increasing uncertainty. Although, until recently, relatively little of this activity involved pharmaceutical assets. In this week’s blog, we’re going to look at why that’s changing and why PE and pharma have become such a great match.
According to Preqin, there were US$28b of private-equity backed buyouts of healthcare* businesses in Q2 2018. This is only the third time PE’s interest in the sector has surpassed US$20b in the last five years. KKR’s $9.9b acquisition of Envision Healthcare Corporation, the largest deal PE announced in the quarter, clearly contributed significantly to the Q2 figure. That said, there was still plenty of other activity of note, including CVC’s acquisition of a controlling stake in Italian pharmaceutical company Recordati – the fifth largest PE-backed deal in Q2 2018.
Moreover, this comes on the back of high levels of healthcare activity in 2017 that that highlighted PE’s increasing interest in pharmaceutical assets. This included Bain and Cinven’s US$5.3b winning bid for generic pharmaceuticals manufacturer Stada and CVC’s US$700m acquisition of Teva’s women’s health drug business. This interest has continued into 2018, with Advent International Corp recently finalising the purchase of Sanofi’s European generic drugs business.
*Figure includes biomedical, biotechnology, healthcare IT, life sciences, medical devices, medical instruments, medical technologies, pharmaceuticals and healthcare
There is strong investment rationale behind private equity’s interest in healthcare. An aging, stouter and increasingly middle class global population is driving demand for drugs and healthcare services that address chronic conditions. Technology is also adding to the sectors’ capabilities through drug and device innovation. More revenue avenues are also opening up in areas like health monitoring, digitisation and data analysis.
These revenue streams have also demonstrated high resilience – an increasingly attractive quality in an age increasing volatility. The next downturn may not be immediately imminent, but we all know it has to come sometime. According to McKinsey, in 1990-2015 health care offered shareholders higher total returns than any other sector – returns that held up during recent recessions.
Finally, there is also significant potential for increasing returns. The healthcare market is still largely highly fragmented. Until recently, it has also encountered relatively low levels of disruption and impetus for operational efficiencies. This leaves plenty of value for PE to add through consolidation and optimisation.
Evidently PE aren’t the only class of investor to have noticed healthcare’s potential. We’ve seen increasing amounts of activity, including alliances that are looking to disrupt existing models. In the October 2017 edition of EY’s Global Capital Confidence Barometer survey, life sciences executives picked increased competition from companies outside the industry as the top disruptive force. This has certainly come to pass, creating significant competition for assets. But, as disruption and competition increases, this also intensifies the pressure on healthcare companies to specialise and focus their capital – and to sell non-core assets.
Big Pharma’ have certainly been active in rationalising their portfolios. The sector has significant war chests, boosted in the US by the impact of US tax reforms – including the incentives to repatriate overseas cash. Much of this is likely to be returned to shareholders, but some will be used for deals to consolidate market leading positions and add innovation. And, with this increasing focus, pharmaceutical companies are continuing to divest assets that aren’t core to future strategy.
Many of these non-core businesses are large and highly cash-generative; but their owners don’t have the management capacity or inclination to invest further to ensure that they reach their potential. All of which would appear to sit in PE’s sweet-spot, but historically, PE hasn’t been has active in pharmaceuticals.
The problem hasn’t been the availability or attractiveness of assets, but often how they are packaged. Historically, many non-core pharma business have essentially been sold as commercial assets, which have been more attractive for industry buyers. They’ve often come without all of the operational components required to support the business (e.g. regulatory, pharmacovigilance and distribution platforms) that are hard to build organically; but, without which, the business cannot stand alone. This has often excluded PE buyers from the market.
This is changing as the larger industry sellers seek to include PE in the buyer pool. With PE buyers in mind, they are now expanding the perimeters of the deal and including a broader set of operational capabilities to create a standalone business. Hence why – as we note above – we’ve seen some significant PE-pharma deals of late and why we expect to see more here and across the entire sector.
Nonetheless it’s vital that all investors keep a close watch on fluid regulatory and political landscapes. Increasing use of digital technology and the entry of outsiders into previously closed markets means the potential for disruption is higher than ever before. Companies across the sector will have to fight increasingly hard to retain market share.