Even the threat of an unprecedented atmospheric river storm could not stop the tried and true from attending the 41st annual J.P. Morgan Healthcare Conference. With a break of sunshine on Monday, we found ourselves asking, “Will healthcare M&A be able to weather the storm in favor of sunny days ahead later this year?” Here is what we found investors saying as the week, and the weather played out.

What is the outlook for M&A in 2023?

With talks of a recession and ongoing interest rate hikes, most investors are predicting a slow start to M&A in the first half of this year. However, the trough is expected to be “short and shallow.” That is likely to result in pent-up demand when the interest rate hikes subside, paving the way for what we expect to be a busy back half of this year, with some predicting the rebound to begin as early as the end of Q1.

Notably, we have also seen large strategic acquirers with healthy balance sheets active already this year, perhaps looking to strike now with less competition from private equity bidders while the debt and public markets are still unsettled, and synergies can justify an attractive pricing multiple.

What types of deals will get done?

With the increasing cost of debt, pure strategic buyers and portfolio companies with strong balance sheets and less leverage than their competitors should have the opportunity to pick up assets at attractive pricing. However, the current economic environment may impact deal terms, including a return to earnouts and seller financing in the middle and lower-middle market, or even changing structure to a minority investment to help bridge valuation gaps, similar to what we saw in the wake of COVID-19. Look also for companies in failed auction processes to revisit potential buyers to try and strike one-off, negotiated transactions. Expect a “more deliberate and relaxed” timeline in the near term from bankers and sellers willing to transact, as well as increasing openness to supportable purchase price adjustments based on QOE and other diligence findings, which were often spurned in the white-hot market in the fall of 2021.

In addition, many investors report that they are looking to focus on smaller deals that don’t require debt financing or add-on acquisitions for existing portfolio companies in 2023 rather than new platforms, at least for the first part of this year. This is partly driven by a feeling of fewer deals brought to market in Q1, with many bankers/sellers reportedly preferring another quarter of financial and operational performance before coming to market later this year. Many private equity firms were spending their time at the J.P. Morgan Conference building their pipeline through strategic and executive discussions versus hearing the usual high volume of specific deal pitches.

What sectors are hot?

Can we say anything with value-based care? Physician practice management transactions have been in vogue for a while now, but it seems that investors are looking for a new twist. Specialties that can implement value-based care arrangements, including orthopedics and cardiology, are of particular interest. In addition, on the healthcare services side, innovative behavioral health models, including those largely driven by telehealth, are garnering attention.

Other areas of interest that investors expressed include home health, including home care enabler products, supplies and technologies designed to support the progressive shift of care into the home; pharma and payor services continue to stay a hot topic, including CROs and CDMOs as well as consulting services; specialty pharmacy and related/innovative pharmacy distribution models; technology solutions that sell into existing physician practice platforms to further enhance administrative services and back office support; and products and services supporting the medical device value chain. Finally, we expect to see continuing interest in joint ventures across the services spectrums with payors and health systems and others increasingly looking to partner with private equity firms to help de-risk their financial burden and leverage private equity’s ability to help professionalize and grow important business lines or markets.

What about hospitals and health systems?

With the Federal Trade Commission (FTC) challenging several key hospital and health system transactions in 2022, many for-profit and nonprofit hospitals and health systems are hitting the pause button on traditional facility acquisitions. Instead, we see hospitals and health systems looking to outsource entire service lines and find a capital partner.

In addition, in recent years, both for-profit and nonprofit health systems have developed venture funds designed to invest in technology solutions to address some of their most critical issues, from revenue cycle management to care management and staffing. Look for this to continue into 2023.

What about the future of non-competes?

With the FTC issuing proposed rules just last week, many investors were found asking how this could impact the deal environment. The proposed rules, which are subject to a period of public comment, would prohibit non-competes between employers and workers (including employees and independent contractors) without exception while prohibiting non-competes between employers and workers who are sellers in a transaction with the employer unless the worker has a substantial ownership in the selling entity (at least 25%). Enter a renewed focus on rollover equity, which does not seem to be addressed by the proposed rule. Those with an inside track predict that the proposed rule will not be passed, at least in its current form. Stay tuned. For a complete summary of the proposed rule and potential implications, please see here.

Continued Innovation in FBT (Family-Based Treatment) Delivery

We were fortunate to have Kristina Safran, Founder and CEO of Equip, join us at our Women in Healthcare Private Equity event this week. Equip is a virtual eating disorder program that helps patients and families recover at home using the FBT method. Kristina shared that Equip has successfully expanded this model of care by providing a dedicated care team, which includes a peer, family, medical physician, therapist and dietician.

This coordinated approach, coupled with a virtual platform for families to manage treatment around their schedule and needs, could apply to other healthcare sectors. FBT is not a new concept for eating disorder treatments, but after hearing Equip’s story, we expect to see an opportunity for this model to expand more broadly to other areas of behavioral health. To stay up to date on Bass, Berry & Sims’ Women in Private Equity events, please click here.

What about the value of an operating partner?

Finding the right talent is crucial for companies looking to accelerate their growth and maximize their ability to scale. Having people talent is a major advantage for private equity and their portfolio companies, particularly talent that has niche healthcare expertise. The task of finding marque talent can often be daunting. Funds will continue to seek out connections to seasoned executives interested in an operating partner role. Leveraging relationships, including advisors, to find this talent has become more prevalent.

We are looking forward to Kayo’s Women in Private Equity Summit, where some of our attorneys will lead discussions with experienced operating partners and investors who understand how investments in talent can pay off in dividends. Check out the Bass, Berry & Sims Operating Partner Database here.

By all accounts, we expect the headwinds of the current economic environment and debt markets to contribute to a slow start for healthcare M&A in the New Year. However, with private equity firms sitting on over $3 trillion of dry powder and a healthcare industry that accounts for over 18% of the GDP, and healthy strategic players ready to pounce, we expect that there will be a break in the weather in favor of sunny days, at least by mid-year if not sooner. Only time will tell. In the meantime, grab your umbrellas!