18 July 2023
On 22 June 2023, RSM UK’s healthcare specialists held a roundtable with a range of businesses in the healthcare sector, across life sciences, pharmaceuticals, residential care and medical devices. The session covered the latest market conditions impacting deals in the sector and key considerations for healthcare businesses to finance growth, whether from M&A, private equity or debt.
Suneel Gupta, head of private healthcare, commented:
‘It was great to welcome such a wide range of healthcare businesses to our roundtable. Despite the economic headwinds, the private healthcare sector continues to be resilient and there are some great investment opportunities across the industry. It was great to hear that investment providers, both in terms of debt and equity, remain committed to the sector. However, businesses need to be aware that current market conditions mean it is likely to take longer to secure funding and the level of due diligence has increased, so management teams need to factor this into their overall investment strategies’
We summarise below the key themes of our roundtable discussions.
Economic update impacting deal activity
Tom Pugh, RSM UK economist
Inflation has been stickier than anticipated by the Bank of England, but is expected to fall sharply in H2 2023 and into 2024 as the impact of the fall in commodity prices feeds through. The Bank of England is concerned about services sector inflation, linked to tightness of the labour market, so we are expecting at least a further 25 to 50 basis point hike in interest rates. Inflation in monthly inputs and outputs in pharmaceutical manufacturing has peaked and is now dropping. Future indicators are that inflation should fall to 4.5% by end of 2023 and 2% by mid-2024.
Sickness in the UK labour market
Since the pandemic, the UK has around 500,000 people out of work citing sickness reasons, about 2% of UK workforce. This is causing tightness in the labour market, pushing up wages and creating services inflation. There is a tight correlation between sickness increase and NHS backlogs. The best way to bring down inflation and boost economic growth is to encourage these sick people back into work.
High pay growth
Tightness in the labour market has led to high pay growth. The Bank of England think around 3% pay growth is consistent with 2% inflation, so pay growth at 6.5% is a worry. Normally, rising pay growth means more consumer spending, but with inflation at 8.7%, real income will fall by a record negative amount this year.
Market interest rates expectations
Despite a strong labour market, we may be on the edge of a recession with growth 0.1% or 0.2% anticipated over this year or next. Financial markets are now pricing interest rates at close to 6%. Modelling and financial forecasts show inflation will fall back with interest rates at 5%, but if inflation stays sticky, the Bank of England has no option other than to keep hiking interest rates, so we suggest 6% interest rate for scenario planning.
Change in government
It is hard to see how a new government could source significant new funding for the healthcare sector. There is not much scope for unfunded spending plans or raising a significant amount of revenue via general taxation, without significant reform to wealth taxation, and there are already huge demands on the health system, defence, and green energy infrastructure. However, there are wider economic benefits to an increase in government spending on healthcare to get the backlog down, so we may see temporary significant funding to get more people back to work. We are already seeing the private sector stepping in to support the NHS, and, depending on the future Labour position, this could offer a positive boost to the private healthcare sector.
Transactions in the healthcare market
Natalie Ord, M&A partner, Jasper Van Heesch, private equity senior analyst, Greg Moreton, head of debt advisory
M&A activity in the healthcare market
Despite an initial drop of deal activity at the start of the pandemic, deal volumes recovered in 2020 H2 and rose during 2021 due to a backlog of deals and are now at pre-pandemic levels. Healthcare has been seen as safe investment and the proportion of deals in healthcare market has gone up, showing appetite from investors and trade buyers. The source of buyers has been relatively consistent with a slight skew during/post pandemic towards private equity (PE) buyers, due to dry powder in the PE market.
PE is institutionally raised money, typically with a three-to-five year investment horizon. The PE market is very broad, with a range of deal sizes, investing minority or majority stakes, and offers flexible capital if some stakeholders want to exit early.
Companies looking to make acquisitions should consider PE-backing, as on average PE-backed businesses, with the capital backing, do three add-on acquisitions, otherwise known as bolt-ons, during the investment lifecycle. Such transactions also represent an opportunity for an exit for owner managed or VC-backed companies, thereby giving those businesses the benefits of effectively being acquired by a trade buyer that’s backed with significant capital.
With the rise in interest rates and economic headwinds, overall deal activity has dropped as sellers wait for a better time to sell and PE investors grapple with high interest rates. Bolt-on deal activity in the UK healthcare sector has however been resilient due to the smaller deal size where all-equity deals are possible and the strategic merits of these acquisitions outweigh the higher interest payments.
Increasingly we are seeing businesses not just seeking funds for growth but other ‘assets’ too, such as access to infrastructure, resources or opening doors to wider markets, which a trade buyer (PE-backed or not) can offer.
The main advantage of debt is that the business owners keep the equity; it works well if you have assets and cash flow to back it. But there is inherent risk, the debt must be paid back, and lower funds are raised than with equity. You can arrange a hybrid of debt and another option, eg deferred consideration.
The debt market is still there but the process is not as easy or quick as it was. We are seeing lenders compete for deals for perceived quality businesses. Deals are also taking longer to complete in the current market. Healthcare benefits from perception of both quality and resilience. It’s important to go smart and go wide: present your business as stable and solid and approach a range of banks and debt funds. Lenders are less likely than PE to have industry specialists, so avoid the use of jargon.
Key value drivers
For banks or PE, how you position and package the opportunity is key, emphasising your growth plans, setting out how they will be delivered, and addressing any risks. PE particularly focus on the management team. ESG and technology are a big focus for many investors now. Healthcare lends itself to ESG. Be clear on your ESG angle. Demonstrate the sustainability of growth and the underlying business performance despite impact from the pandemic. Since Covid-19, demonstrating resilience and adapting to market conditions is key for investors.
Leveraging technology and data to grow or scale the business is also increasingly attractive for investors. We frequently see tech bolt-on acquisitions. PE are typically investing in healthcare or tech services due to their dependable annual recurring revenue which is attractive for lenders on those transactions.
Data and KPIs
Currently, we are seeing deals taking longer for PE and debt-backed transactions, so it’s important to focus on getting your data ready ahead of the deal, as investors will scrutinise numbers and ask for evidence. We are increasingly seeing reporting dashboards used to present KPIs to support the deal process, with some businesses even using the opportunity to become data-driven in their decision making ahead of a transaction.
How can RSM help?
To discuss finance options for your healthcare business, please contact Suneel Gupta.