Health services: US Deals 2023 outlook

Non-controlling investments, club deals, and strategic reallocation will continue to drive capital deployment

Headwinds from the macroeconomic financing environment are causing companies to re-evaluate the capital allocation approach. The higher cost of capital is a challenge to larger, platform-sized deals, and is driving more club deals and non-controlling investments. Private equity sponsors in particular have re-adjusted capital towards their existing platforms via add-ons and an increased focus on organic value-enhancing initiatives. Some evidence of this approach is the ~15% increase in transaction volume despite overall deal value declining nearly ~40% since the prior year.

The potential for a downturn is also increasing risk aversion towards more cyclical sub-sectors, which will likely continue until it becomes clear that a “softer landing” is likely.

Lastly, health services has benefitted from a disproportionate share of capital, particularly from PE, over the last few years. As these portfolio companies run up against their traditional holding periods, there will be increased incentives for effectuating sales or significant recapitalizations that allow original sponsors to cash-out and demonstrate marked returns to limited partners.

Newer challenges are driving targeted approaches to deal evaluation and diligence

Cyber-criminals are increasingly attacking health systems and related entities in the sector. Nursing and other clinical labor wages continue to increase. Home health agencies are turning away referrals because they don’t have enough labor to meet demand.

These are examples of challenges felt across the entire sector that don’t have an endpoint in sight. Investors are increasingly wary of these threats – elevating their status within the overall deal evaluation and risk-mitigation process. In addition, investors are prioritizing these areas early on during diligence rather than waiting to address post-deal.

Buyers are performing more detailed analysis of local market labor supply / demand dynamics. Targets more highly-susceptible to wage pressures have been prime candidates for earn-out based deal structures, allowing buyers to mitigate the potential risk of continued elevation of wage levels. Cyber concerns are being addressed through increased efforts on network penetration testing and broader cyber-security diligence, along with enhanced focus on the broader information technology strategy, reliance on vendors, and leveraging of the cloud. 

These two areas – cyber and labor market dynamics – are specific areas of enhanced deal-evaluation focus that we’ve seen over the last year and expect that to continue, along with increased consideration of ESG factors.