On this episode of The Banker's Corner, Kyle Brown, Managing Director at Brown Gibbons Lang & Company joins McGuireWoods' Geoff Cockrell to discuss the latest developments in healthcare private equity investing.

With the current deal market offering lower valuations, companies are looking at internal improvements, such as operations and platform infrastructure, as well as mergers and organic growth strategies. Kyle discusses how diversification, platform infrastructure, and a true dual-pronged growth strategy are key drivers of value regardless of the sub-sector.

“Sure, buy-and-build all day. You have that integration strategy in spades, great. But I've seen, and not because of the debt financing markets, but really since COVID, folks are putting a premium on de novo growth strategies,” Kyle says. 

Kyle and Geoff also discuss two subsectors that they predict will have increased investor activity in 2023: orthopedics and pain management.  Both sectors have unique traits that add value to investors and make them ideal for investment activity. 

Featured Guest

Name: Kyle Brown

What he does: Kyle is the Managing Director at Brown Gibbons Lang & Company. He is a senior member of BGL’s Healthcare & Life Sciences team, focusing on Healthcare Provider Services. 

Organization: Brown Gibbons Lang & Company

Connect: LinkedIn

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is The Banker's Corner, a McGuireWoods series, exploring investment trends, solutions and business issues relevant in today's private equity and finance industry. Tune in with McGuireWoods' partner Geoff Cockrell as he and specialists share real world insight to help enhance your knowledge.

Thank you for joining another episode of the Corner series where we bring together deal makers and thought leaders in the healthcare private equity intersection, talking through trends, deal terms, and other dynamics in healthcare private equity investing. I'm your host, Geoff Cockrell. I'm the chair of the McGuireWoods Private Equity Group where I spend most of my time in healthcare transactions and more specifically ton of time in provider services. And I'm thrilled to be joined today by my good friend Kyle Brown, managing director at Brown Gibbons Lang & Company. Kyle's one of the best investment bankers I know and spends a ton of time in healthcare provider services, so I'm anxious to be chatting with Kyle. But Kyle, maybe give a little introduction to yourself and BGL.

Yes, thanks Geoff. Great to be here. I feel I was well on my way to achieving status as super fan of the podcast, so it's great to be joining you. BGL classic middle market investment banking advisory firm, based headquartered in Cleveland. Most of our bankers in Chicago, also have New York and LA coverage nationally within BGL. Our healthcare and life sciences group covers a number of verticals, but our main power alley of our healthcare and life sciences group is provider services where I spend all my time. Been with BGL since 2010. We've continued to grow the group and ongoing efforts across sub-verticals, but mainly provider services. So great to be here. I think that's where a lot of our overlap with the McGuireWoods team has been and look forward to digging in.

So many conversations here kind of fairly early in 2023 have been taking stock of where 2022 ended and then probably more significantly looking forward into what we can expect here in 2023 as there's a fair amount of anxiety as to kind of the pattern of deal flow that is going to be coming, impact of inflation, impact of challenges around credit availability. But Kyle, maybe starting with 2022, how did things end up from your perspective?

Yes, so in healthcare services or more specifically into the provider services, 2022 deal volume was slightly up over 2021, and that's a testament to just the high level of activity because 2021 largely still had pent-up demand from Covid and the lingering effects and finally getting back to some level of normalcy. So while 2022, as a whole, was slightly up, that was clearly due to the first half and really the first three quarters because Q4 with we saw almost a standstill. There were still deals getting done, that were the continuation, a bit of the and one if you will, where stuff was already pretty much baked, right? Financing was lined up, but the tumult in the credit markets is real. In Q4, there was uncertainty which led to a lot of folks taking a pause.

And so if you look at Q4 and we're seeing a continued ripple effect into Q1 of this year, activity has by and large been down, I would say while Q4 of 2022 was more of a standstill. There's a reset and lenders are back lending in Q1, although debt financing is more expensive. And when you think about provider services largely buy-and-build strategies dependent upon debt financing, that is dictating a lot of trends in valuation. So right now, I would say by and large multiples are down maybe 10%, and that's leading to a flight to quality. So it's quality over quantity is the theme right now, and that's leading to what we believe is going to be a very strong back half of 2023. A lot of these provider services assets, when talking with a lot of sponsors and independently held companies last summer, the end of March, early April 2023 was going to be a big period of time for transaction activity.

I would say where at my vantage point right now, that looks like end of September, early October, but again, we don't have the crystal ball. If I did, I'm not sure I would be here right now. That that dovetailed into 2023. But when I'm thinking about 2022, it's the continuum of where are we right now and what are we thinking about for next year.

For sure. There were so many kind of cross currents at the end of 2022 and now 2023, means so much of healthcare transactions are very middle market ish and the credit pinch pinched first kind of upmarket. So the bigger syndicated debt deals became more difficult to do. But as you migrated down kind of the feeding chain to smaller deals or middle market deals and certainly lower middle market deals, that credit was a little easier to come by.

A lot of transactions that happen are add-on, so you may have existing platforms that had DDTL availabilities so they could draw on existing credit facilities. And so there was a runway, and I feel like here in January, February that that runway has gotten harder to find for existing credit facilities. And the thought of opening up a credit facility to expand the DDTL availability has been an expensive one. And so the middle market has kind of caught up to the pinch in the upmarket, but as we're sitting here now a little ways in, starting to see kind of signs of life, but it's interesting to hear your prognosis that what we hoped to be much more active a April, May is now kind of pushing back later in the year. That's pretty consistent with what we're seeing. However, deals are still getting done, just there's fewer of them. And like you said, it's kind of a flight to quality.

But maybe coming back to one thing you said on pricing that was interesting, that you're seeing maybe a 10% reduction in multiples. That that's been a little bit more mixed in my experience that of things that have come across my desk that it's actually been a pain point in deals that buyer's expectation on pricing kind of has some formulaic inputs, and one of the formulaic inputs is cost of capital and their return expectations don't change, but a higher cost of capital. The way that shakes itself out in the formula is a lower multiple, but that has been harder for sellers to accept and that a little bit of gap between buyer and seller expectation has been a real friction point. How are you seeing sellers grapple with the idea that a year ago their business was worth, let's call it 12, 13 times, and in the year since then all they've done is performed a plan, but now it's worth 11, 12? How have you seen sellers come to grips with the implications on pricing of higher cost of capital?

Yeah, Geoff, great question and made a couple great points there as well. I have, just first, in the past three months on a couple bid dates, I have heard the reference to the returns model and getting back to financial theory, more so from the private equity community than I had heard in probably the past three years. Where it's not as simple as the multiple years, say, "Well, once we run this out and go into your cost of capital situation," that has reared its head. And right, wrong or indifferent, it just has, and so it's a reality. So I completely agree with what you said there.

In terms of valuations and how sellers look at it, the lag, called the value expectation lag is real, right? On the way up it sticks in terms of the seller's view on value, and then buyers, sponsors, strategics and financial sponsors alike, they're quick to act on market conditions that may necessitate lower value. And sellers, however, it takes them a quarter to two quarters, maybe even a year to realize that. So look, folks that are committed to doing something say, "Look, it's just a longer term strategy." They're going to be inclined to just roll over more and accept it. I think those are perhaps more enlightened folks on the sell side, but also folks just say, "Look, I'm not going to do anything."

And so there has been a lot of conversations going on in 2023 about folks looking internally, what can we do to better build out the platform? So when we come out of this, let's call it Q3, Q4, when the credit markets lighten back up, they're going to be in a position to grow. So folks are looking at operations, they're looking at platform infrastructure. A lot of them are even looking at mergers saying, "Look, do we get to scale this way? And now if we're going to be heads down for six months, why not be looking at a merger of equals?"

And then lastly, trying to fine tune the de novo or organic growth strategies. Because part of this, I think the reality of this is value when you're looking at four drivers of value, regardless of the sub-sector, right? Do you have platform infrastructure? Are you diversified? And do you have a true dual pronged growth strategy? Because sure, buy-and-build all day, you have that integration strategy in spades. Great. But I've seen, and this isn't really just because of the debt financing markets, but over the past really since Covid folks putting a premium on de novo growth strategies.

There are also a number of ways that I see buyers kind of squishing the price a little bit without maybe quite as much reducing the multiple, but you can push on some other things. You can kind of lean a little bit more heavily into contingent consideration. You can be more aggressive on what's going to get credit in proforma. You can be a bit more aggressive on pricing adjustments based on things that come out of the QV. There are also some tools available without explicitly changing the headline number that still translate to pricing pressure. Are you seeing those dynamics as well?

Yes. And look, majority of our work on the sell side, right, earn out contingent consideration has always been the bad word, but if it's icing on the cake, it can be just and acceptable. And I would say that, by and large, our clients have been more open to structure. We've been fortunate to not have a lot of that in our deals, but it started with in 2020, in 2021 still in this whole Covid impact on companies that are directly providing care, right? A lot of those were clearly impacted by Covid.

So you saw structured deals, and I think that's where this lag, so if that was 2020, now we're what I mean, geez, almost three years, three years now in a week from the beginning of Covid. So now folks have seen their friends do deals with structure, earn out, what have you. And now it's perhaps a different reason for that, but it's becoming more acceptable. And if it's sellers would say, "Look, I have no problem putting my money where my mouth is," naturally, Geoff, I think if we're collaborating on something, we're still ... it's tough to get it right, not only from a compliance standpoint, but the concept of what is the target because you're relinquishing control of the company. So point, yeah, just alignment is huge in whatever we do. And I still think contingent consideration is not the best path for optimal alignment, but directly to your point, we are seeing it more. And frankly, sellers are more open to having the discussion.

In the legal analysis of those sort of contingent purchase prices. Five years ago, it was a dirty word as well, more specifically on the compliance end, especially in provider services where we all live and you've got government reimbursement, there's certainly some context where that's just a no-fly zone. There's no way to do it. But there's increasingly some tracks around the edges of that where folks are getting comfortable with certain forms of contingent consideration tied to certain things. If you're careful, there's ways to navigate that as an idea sometimes. So definitely seeing the market moving incrementally in that direction in ways that were thought of as harder to do a few years ago.

But we'll see how that trend continues. Maybe switching a little bit to sector focus. It's always an interesting topic to me to think about where kind of private equity investing is going and there's a level where it all kind of moves in a herd, and there's dynamics around that, and I understand why that happens. But as to particular sectors, notwithstanding the kind of macro headwinds the investment world does keep rolling on, what sectors are you seeing of highest level of interest from both a buyer and seller perspective?

So orthopedics speaking to the higher end of the acuity spectrum, it's been a little bit of a slower burn in terms of the volume of M&A activity, certainly less frequent add-on activity than say in retail medicine. And look, integration's tough. Some of these groups are vehemently independent. There's inconsistencies with comp structure and equity structure. But needless to say, if there's 15 platforms, and two or three of them at least are going to be up for trading in 2023, which is 15 or 20% of the private equity held assets out there. So if you do it on a percentage basis, that's going to be the high activity levels. And now that there are options for the groups that are say five to 10 million of EBITDA because you have the emergence of additional platforms. So time will tell, but I think there's going to be activity good a bit with both the sponsor backed assets and orthopedics and the independence.

Yeah, we're seeing similar dynamics. I think orthopedics is an interesting sector in part because there's disruptive things that can happen, like market disruptive things that can happen. The ability to, if you can get scale in market and then approach in particular commercial payers with more extensive value-based contracting ideas, that's a significantly disruptive effect in a market. Similarly, if you get a little bit of scale in a market, you can do interesting things with joint venturing with health systems that are also disruptive in a market. Similarly, again, the ability to kind of draw more heavily into utilizing ASCs in ways that maybe hadn't been utilized as fully before. All of those things are super disruptive to existing markets. And as I see some of the larger platforms roll into markets, just the ability to disrupt them makes them super interesting investment ideas.

Yeah. And look to echo that, Geoff, it's by definition these orthopedics, cardiology, oncology to be an independent group, that would be a interesting investment opportunity. You have to already have a certain amount of scale, just because you're competing with the health system. So I think part of this, over the past five years, what some of the existing platforms have learned is how to coexist, how to be more creative, because orthopedics is not a one size fits all. And as I mentioned, it's just inconsistencies with comp partnership on ASCs.

So five years ago coming in and saying, "Look, the MSO should own 100% of this ASC," and the one question is whether or not you have physicians owned directly into the ASC or through the MSO saying, "Well, look, a lot of these facilities, MSK backed facility plays, ASC plays, right? They have partners." That's been going on before any of this practice roll up. And I know we had done deals come across McGuireWoods a lot starting in 2012 on the physician owned hospital and ASC plays because those are all anchored by MSK and the power player orthopedic groups in each geography.

So you have some of that, that's had they already done a facilities transaction, because clearly any investor is going to want to be aligned across the practice and the ASC. So needless to say, more complexity takes a bit more time, more work for private equity players, strategic buyers, advisors to the companies. But the juice is definitely worth the squeeze in orthopedics and will continue to be in 2023 and beyond.

Yeah. That dynamic of more complicated ASC transactions has been a recurring theme of some of the areas where we have seen a lot of activity, whether that is ophthalmology, GI, the ASC corner of those deals has gotten way more interesting as platforms are looking differently as to how to maybe joint venture with one of the more national AC management companies, maybe joint venture with a health system. Again, it's a topic where scale in a market lets you think of more interesting dynamics of what you can do. And so that particular ASC dynamic is, while it's been fueling some of the activity in orthopedic arena, it's also fueling activity in those other arenas, are you seeing similar dynamics?

Yes. And one, again, stepping down the acuity spectrum, but still an MSK, pain management was often, I think unfairly penalized by the investment community. There had been some bad actors, compliance is huge. But what we've seen since 2016, 2018, there were some pockets of investment there. You had some reimbursement changes in pain management and then naturally Covid, so the jury's can out on how some of these platforms have performed. But in the past 10 months, you've had four new private equity entrance into pain management. Five if you date back to January of 2022. So that is the most activity we've seen since kind of the first wave of the interventional pain management consolidation.

So I think some of the smoke is settled on reimbursement. 2023 is looking good. ASC codes are more than offset some of the practice Medicare E&M reimbursement cuts. But folks, there's a migration towards more complex interventional procedures, seeing the investment community favor those being a solution to the opioid crisis. And one interesting dynamic in pain from a transaction standpoint, from if you're a roll up strategy or even the first institutional investment we're seeing, and Geoff, I'd love to hear your perspective, a lot of these interventional pain management practices are consolidated ownership. And we are talking amongst our colleagues on this, and you think about because of the historical compliance. So some of these associate big producers, great physicians, it's like, look, I don't really want to have that risk. And then also dovetailing to our prior conversation on these facilities plays a lot of pain management has been a great adjunct to these orthopedic focused ASCs and surgical hospitals.

So it seems like every pain physician had a little bit of an ownership over in a separate ASC, which means they were complacent, they were doing very well, you could be a solo pain operator. But as compliance and reimbursement has kind of forced some of the bad actors out of the industry, what it's left is kind of single owner folks that if they're doing it the right way and they've got an ASC, you can get a lot of yield per physician, meaning just a lot of profitability. And from a transaction standpoint, you're not dealing with 15 owners.

Absolutely. In some of the early dynamics that made it difficult to do deals in that space is just the amount of money that folks were making from the lab side of the business. The idea being like if you get a little bit of scale, you could internalize some of the revenue of a lab, but it was just too much. You'd see these practices that were like $8, $9 million in EBITDA and you'd peel it back and it was a couple million dollars EBITDA from kind of regular practice things and then tons of EBITDA from the lab side. And when you've got that sort of economic boon, something's going to get clipped, either from a regulatory perspective or from a reimbursement perspective, but you have the palpable sensation that, yeah, it's great if you've got a platform and you're adding lab capacity, but it's hard to sell that at a multiple when one way or the other it's going to get clipped.

And some of those were, like you said, bad actors. Some of it was just once the economics settled after that consolidation that the reimbursement was just going to be too high, and that's kind of how it played out. But to your point, that dust settles and then you have more stable yet profitable businesses. And to your other point, it's exactly correct that you end up with shorter list of owners, which makes a transaction easier to navigate as well. So the lifting of the cloud surrounding some of those dynamics has definitely opened up that arena. And we've worked on a couple of interventional pain transactions and definitely think we're going to see some more.

Yeah, I think just on the last point, alignment's huge in physician driven models clearly. So the consolidated ownership, but we'll call it visibly consolidated or eyes wide open, if you will. So it's not this where the associates are promised equity, it's everyone knows what's going on. So I think that's the right type of consolidated ownership. And if you're stepping into an investment, folks say, "Yeah, that's great. No, I will buy in. And I like the idea of having a bigger entity that's institutionalized, and so now maybe it's the right time for me to buy in as a heavy hitting physician who wasn't previously an owner."

Well, Kyle, we can talk all day, but we try to keep these to 20, 25 minutes and we'll have to have you back on and we can explore some more topics. But this has been a ton of fun, and it'll be very, very interesting to see how the balance of 2023 plays out. But thanks again for joining. This has been really a ton of fun.

Yeah, no, my pleasure, Geoff. Great being with you guys, and we'll talk soon.

Thank you for joining us on this installment of the Bankers Corner. To learn more about today's discussion, please email host Geoff Cockrell at gcockrell@mcguirewoods.com. We look forward to hearing from you. This series was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this series, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in this installment. The views, information, or opinions expressed are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state, and should not be construed as an offer to make or consider any investment or course of action.