PE deals dip in Q2 2023 due to rising debt service costs, Pitchbook finds

Healthcare services private equity (PE) deal activity “dipped unexpectedly” in the latest quarter, a new Pitchbook report has found.

The second-quarter 2023 report found that the number of deals recorded or announced, about 164, was the lowest since the second quarter of 2020. It was the sixth straight quarter of deal count declines, though it was still 12% higher than the average quarterly deal count in 2018 and 2019. The report was focused on the U.S. but also included some data on Canada.

Leverage, or debt financing, is the main cause for declining deal activity, according to the report. Heavily leveraged companies are struggling under rising debt service costs and approaching repayment dates. And because of interest rates, their restructuring options are limited.

As a result, many of the largest groups have pressed the brakes on add-on buys, particularly in categories like dental, vision and veterinary, popular for physician practice management roll-ups.

The quarter also saw a decline in exits and large platform deals, or initial acquisitions by PE firms, with 11 being recorded. That’s lower than any quarter since 2017 besides the second quarter of 2020. One of the quarter’s few platform trades between PE Firms was TPG and AmerisourceBergen’s acquisition of OneOncology from General Atlantic and Frist Cressey Ventures. 

At the same time, healthcare specialist firms have a growing arsenal of cash reserves to deploy, per the report. Fundraising by these PE firms took off in 2021 and has remained elevated through the first half of 2023 despite depressed fundraising across PE as a whole.

As such, the good environment should motivate these firms to exit their current portfolio companies and begin fundraising again, Pitchbook’s Rebecca Springer, senior research analyst and healthcare lead, told Fierce Healthcare.

Deal activity typically accelerates as a group of platforms are created or traded, then declines as investments mature. Pitchbook expects deal activity to pick back up once larger platforms are recapitalized. 

Signs of downstream deal-making recovery

Labor cost inflation is easing, offering management teams and investors an opportunity to focus on “operational efficiencies” like workforce retention and up-skilling. And because larger platform deals aren’t happening at high volumes right now, there is a greater focus on proprietary deals downmarket. Such deals entail an interested buyer approaching a business owner privately and asking them to sell it. 

“It’s not this frenetic fast-paced deal-making environment,” Springer said. “Firms have time to look around a little bit more.” 

PE firms prefer proprietary deals because they are less competitive than a bid that’s open to competition, she added. 

The broadly syndicated loan market is also beginning to open up again, though it remains low compared to 2020. “There’s a lot of demand for private credit and those lenders can be really selective,” Springer said.

Nonetheless, Pitchbook anticipates a gradual reversal of the current downturn as fears about a recession ease and inflation cools. 

“The general sentiment from dealmakers is that things are headed in a positive direction,” the report said. Pitchbook expects deal activity to stay flat or be slightly elevated for the rest of 2023.

Policy predictions

In July, the Centers for Medicare & Medicaid Services (CMS) released several proposed payment rules for 2024. While they’re not final, the proposed rules indicate the agency’s policy direction on key issues.

Significant proposed changes to reimbursement rates can stall dealmaking because they mean uncertainty for revenue projections, per the report. 

CMS also proposed a reduction to the conversion factor, used to calculate physician payments, by more than 3%, with the belief that this will improve reimbursement for primary care and behavioral health providers while decreasing reimbursement for most specialists.

Pitchbook believes this fee-for-service rate may encourage the transition to value and more sponsor activity in senior primary care in the coming years.

Reproductive medicine, mental health are hot

There were fewer OB-GYN add-on deals than in reproductive medicine in the quarter, which can be attributed to the difference in financial structure between the two, Springer said. 

OB-GYN practices, which focus on maternity care, menopause and general women’s health, can take on the financial profile of a primary care provider, while reproductive medicine sees a lot of cash-pay patients.

“It’s very procedural, so high-value procedures as opposed to longitudinal patient care,” Springer said.

With women having kids later in life, there is a growing demand for fertility care that currently outstrips supply, she added, which is very attractive to investors. A number of states are also mandating coverage of IVF for employer-sponsored plans of a certain size, and there is a tech opportunity in the space as more startups look to disrupt fertility care.

Substance use disorder (SUD) treatment deals appear to have taken a nosedive. These providers tend to be heavily reimbursed by Medicaid, while PE-backed mental health companies are mostly commercial pay. Though Medicaid reimbursement is improving and Medicaid payers are reliable, SUD deals have fallen after steady investor interest for several years. 

Mental health, meanwhile, is still going strong due to growing demand, though labor shortages and costs pose a challenge for providers. The lull in deals in the space has more to do with the fact that there aren’t many companies for sale than a lack of investor interest, Springer said.

“It’s still a space that many sponsors have a high conviction about and want to be playing in,” she said. “It’s an important space, even though the deal pace itself has slowed down.”