From orthopedics and cardiology to urology and even med spas, the future of specialized healthcare clinics is here — and growing rapidly each quarter. 

“The med spa industry is growing double-digit right now. The patient total addressable market continues to expand with the younger generation utilizing those products and services, and male patients and consumers using those products and services,” Rich Blann says of this current trend in healthcare private equity. 

On this episode of The Capital Corner, McGuireWoods' Geoff Cockrell sits down with Hector Torres and Rich Blann, both of whom are Managing Directors at DC Advisory on their global healthcare team. They discuss market trends and some current areas of interest from both investors’ and sellers’ perspectives.

Hector and Rich share the challenges they’ve seen to the market this year, as well as where they see the upward trends heading. From the bid-ask spread to physician practice consolidations, they share plenty of advice and hope for the remainder of the year.  

And while general M&A volume is down, Hector and Rich find there’s a silver lining: the decreased volume is actually better for the industry as a whole. In 2021 and 2022, there was an overabundance of M&A. Now, this general decrease gives these groups the opportunity to digest all of the M&A deals and integrate those businesses the right way. This will better set the stage for the market in the coming years. 

Tune in to hear more about the current market and why the dismal year so far is no reason to fear the months to come.

Featured Guest

Name: Hector Torres

What he does: Hector is a Managing Director of DC Advisory’s global healthcare team. With nearly 20 years of investment banking experience, Hector specializes in M&A and strategic advisory transactions.

Organization: DC Advisory

Connect: LinkedIn | DC Advisory

Name: Rich Blann

What he does: Rich is a Managing Director of DC Advisory’s global healthcare team. Rich brings more than 23 years of global investment banking experience to the table, with a focus on M&A and capital raising.

Organization: DC Advisory

Connect: LinkedIn | DC Advisory

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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 Capital Corner, a McGuireWoods podcast exploring investment strategies, capital structures and topics relevant in today's middle market private equity. Join McGuireWoods partner Geoff Cockrell as he and specialists share practical insights to inform your deal work.

Thank you for joining another episode of the Corner series. I'm your host, Geoff Cockrell from McGuireWoods. Here at the Corner series, we bring together thought leaders and deal makers in healthcare private equity investing. Today I'm thrilled to be joined by two of my friends, Hector Torres and Richard Blann from DC Advisory. We're going to talk about some of the market trends that we're seeing and some areas of interest from both investors and sellers. But Hector, maybe start us off and introduce yourself and DC Advisory, and then Rich, if you could as well.

Thank you. Pleasure to be here, Hector Torres. I'm a Managing Director with Daiwa Corporate Advisory, which is the global investment banking arm of Daiwa Securities and Daiwa Financial. I've spent my entire nearly 20 year career working on behalf and at the service of provider-based and healthcare services organizations to explore and execute on all forms of strategic transactions. DC Advisory is a global investment banking franchise and enterprise. Rich and I have the pleasure of working together and leading all of the efforts that we cover in the United States across the full healthcare services continuum. So pleasure to be here.

Great, and my name's Rich Blann, Managing Director with DC Advisory, and thanks to Geoff and the team for inviting us onto the podcast today. I've been in investment banking, primarily focused on mergers and acquisitions and capital raising for almost 25 years. Joined Hector and several other partners a little less than a year ago to establish and form the US healthcare group for DC advisory. I focus 100% of my time in the physician practice management space with a heavy lean towards some of the more mature consolidating sectors like dental and dermatology and vision, as well as the pleasure of partnering with Hector in some of the newer areas of consolidation where we're seeing M&A activity like med spa and cardiology and orthopedics. So very excited to have a conversation today.

This will be fun. Maybe Hector starting with you, so we're a little over halfway through the year. The general vibe has been that transaction volume has been materially but not atrociously off of last year. What has the market looked like for M&A activity from your perspective? And then maybe turning that lens forward, what do you anticipate now for the second half of the year?

Yeah, certainly agree with your initial sentiment that it has been relative to years past, much lower volume and overall transaction activity, but not atrocious. And I think the dynamic we're seeing is fairly consistent in it is a tale of two worlds. World A being transactions generally in the 300 million plus of enterprise value range have just really come to a significant halt in large part due to the disintermediation in the broader capital markets environment. But more specifically in the debt capital markets environment and the availability and willingness of lenders and debt capital to be deployed in support of those larger sized transactions.

The other world and element we see is transactions below that $300 million enterprise value mark are still getting done, but with some of the strictest levels of scrutiny that we've seen from a buyer diligence perspective, and then really just a focus on really delineating between the Class A assets and organizations that have size scale are growing in a defensible and organic manner relative to the Class B, C and below organizations. And the market's just become, like I said, very scrutinous in applying valuation points of view and perspectives relative to A, B and C type of organizations. But what we would tell you is the Class A organizations, those transactions and those companies are being completed. The problem is that there's just not as many A+ assets that are less than 300 million as we all would like, and hence I think that contributes a lot to the current transactional volume that we're seeing today. Rich, maybe if you want to add and then maybe give a perspective on how we see the year and 2024 evolving.

Yeah, echo the sentiment. The back half of last year, we started to pivot quite materially as broader economic challenges, created a lot of headwinds with inflation, with fed funds increasing, and then obviously a bit of a pause from the lender community to understand what the new norm is going to look like. And as we started to crawl out of our shell, if you will, we got hit with bank failures in Q1 that further delayed a market reset.

I would say in the last maybe two months or so, there's been a renewed optimism and a return to funding deals. And what it's really done is it's given us the opportunity now to feel like we're in a much more normal environment with probably a little bit less volatility than what we saw six, nine months ago. And when there's less volatility and more certainty around market conditions, it gives buyers and sellers and lenders and opportunity to feel like they're working through the traditional challenges of doing a deal, but don't have to also wrestle with market conditions that are creating headwinds as well.

So long-winded way of saying the market activity has picked up materially in the last two months, but what we're expecting to see is almost a tsunami of opportunities coming out in late 2023 and early 2024 that's going to create a very robust M&A market for all types and classes of organizations and sizes as well. As the credit markets have now loosened, we have a much clearer visibility towards the broader economic conditions and a potential of recession is mitigated. Even if it does happen, I think the general consensus is it won't be long and it won't be deep. And with that as the backdrop, people can get back to deploying capital, making investments and narrowing the bid-ask spread between buyers and sellers in this new regime.

You mentioned the bid-ask spread and in the sub 300 market that you were talking about, one of the recurring challenges that I hear buyers articulate is that sellers have had a difficult time absorbing the valuation implications of higher cost of credit, that the buyers are still going to have to model out cashflow and layering in three, four or more extra percentage points has an impact on valuation. And it's been difficult for in particular, take physician provider groups, for them to internalize the idea that, "Well, you said my practice was worth whatever 12 times a year ago, and all I've done is perform to plan and now it's a full turn less." That's been difficult to internalize. How would you describe that dynamic for the first half of the year and is that bid-ask spread narrowing kind of organically now?

Yeah, great question. It's definitely narrowing, but perhaps not as not with the velocity that we all wish. Look, at the end of the day, this really comes down certainly when we're considering the lens and vantage point of a private equity firm or a financial sponsor. In large part, it's a math equation and it's a risk underwriting equation. In the go-go post COVID 21 period, cost of capital was at all time historical low. You could stretch given that your overall weighted average cost of capital was relatively low, it still allowed for a lot of room and margin for error, and you were underwriting the risk weighted probability of growth vis-a-vis those heightened valuation multiples and ultimate deal terms.

When the cost of capital goes up 500 basis points in a relatively short period of time, it's very difficult to let alone attain the financing, but be able to gain comfort in underwriting a growth trajectory plan that may or may not come to realization within the forecasted period. So that is the new normal.

But what I would say is this is where creativity, and it's a commercial, so bear with us, but this is where having really good seasoned advisors that have been in these types of markets really pays dividends because one thing we're seeing is the return of the structured deal. We recently advised on a great outcome for our client whereby the management team and leadership team and owners of the enterprise felt compelled that they would realize relatively outsized growth trajectories and performance. The buyer wasn't necessarily willing to underwrite and pay full price upfront for that growth, given all the dynamics we've just unpacked here. But what they said was, "Look, let's put earnouts into the composition of the enterprise value of the deal. Let's use a seller note and let's use a bit more rollover equity. Because if you have so much faith and conviction in the realization of that growth, then you should be willing and able to align vis-a-vis more rollover equity versus less."

So I think the error of the structured deal is going to be here for a while. It'll probably become more relevant and prevalent this year and beyond, but there are ways to align outcomes, find the math equation result that everyone strives for and get good deals done. It just takes a little bit more work in this market.

And just to add to that, Geoff, what I would say is we had to have some time to reset. Before COVID as we all on the podcast remember, we were at all time high level valuations. It was a great market before COVID. COVID shut things down temporarily for about nine months in terms of material M&A being done. And when we reopened, we still had very inexpensive cost of debt, the lowest in history, but we had nine months of M&A to make up for. And what that happened was it pushed buyer dynamics and behavior into an area and an experience like we've never seen before.

I typically call it the feeding frenzy effect where it pushed valuations well beyond what we've ever seen historically, and a lot of our physician, clients and relationships had anchored to those valuations. We were saying during that time, and we'll continue to say it, those valuations were temporary. They were not sustainable at those levels and we've now fallen back a couple of turns of EBITDA multiple, but we're back where we were pre-COVID, which was the prior peak. So it's still a very good market from a seller's perspective versus 5 years ago or 10 years ago. So while maybe the outsized once in a lifetime valuation is not readily available, it's still a very robust market and attractive one from a seller's perspective.

Let's talk a little bit about physician practice consolidation where all three of us spend a ton of time. There's certainly right now a sensation of headwinds from a number of sources. You have these valuation challenges that you were just talking about. You also have labor pressures on compensation in an environment where increasing labor costs isn't quickly met with increasing reimbursement from say, the federal government, which puts a lot of pressure on. How would you describe the overall kind of physician practice consolidation market? And as that has been strained for the last 6, 9 months, how do you see that evolving in the next 6 to 18?

Yeah. Great questions and probably one of the most questions we field most consistently perhaps, but look, I think it's also a tale of two worlds. The organizations that took it upon themselves to consolidate and aggregate for the sake of consolidation without a real true focus on operational efficiency, clinical and financial integration, and building these provider-based businesses in the right way. We're starting to see the beginnings of what will be perhaps a prolonged cycle where those organizations, whether they're PE-backed or not, are going to be severely challenged. From liquidity, from an access to incremental capital and from inability to really grow over the coming years. We are seeing a lot of situations that we're being called in where it's a great business, world-class clinical enterprise, agnostic of whatever specialty or setting of care they're in, but really bad balance sheet. And either already in technical default with their lenders or on a glide path towards that, or unfortunately have already been turned over to the lenders. And the lenders are asking us, "What are our options with this asset in the current market environment and what should we do?"

The differentiator there is there's a lot of organizations that did things the right way and it was a little bit slower and less sexy than pumping out 28, 30 M&A transactions to grow EBITDA inorganically, but those are the ones that are actually taking advantage of the current market environment because they're not beholden to a growth strategy that's 90% oriented towards M&A. They can grow inorganically, they can grow on a de novo basis and have the ability to maintain streamline operations and financial performance.

The thing I would add to that is, and also half commercial from our perspective, is that I have an enormous and increasing number of conversations with buyers where we're really trying to creatively think through and address provider alignment. Because to your point, if you're just pushing together pieces that aren't integrated, you're going to have trouble. You're also going to have trouble if you've not really thought through how is physician alignment going to work through more complex and nuanced compensation arrangements, more complex and nuanced equity arrangements? Because if you're not able to thread some of those needles, you're going to be really challenged with retention of providers and growth where you're not driving growth by kind of dropping a big check in a group provider's pocket in an acquisition context, when you're needing to drive the alignment through kind of the operational resources you have on a year by year basis. If you're able to thread that needle, then you can really build a big organization. If not, you're going to face headwinds.

That's a great point. The one thing that I'd say from a industry dynamic perspective that we're seeing right now that probably is different than what we've seen for the last 8 to 10 years is while ... Or a big reason why the M&A volume is down in general, it's not just down at the platform level, meaning recapitalization of PE-backed platforms. That volume is definitely down, but the add-ons are down as well. We saw in 2021 and 2022 record volume of consolidation. And when you're going through 25, 30, 50, 100 single site or group acquisitions, you need to give your organization time to integrate, to drive performance improvement, and systematize the operational elements of the business that are the fundamental core of creating value through a consolidator PPM platform to begin with.

So while it hurts advisors in our pockets a little bit because there's less volume, it's actually better for the industry because I think in many respects, there was an overabundance of M&A that happened in '21 and '22, and it gives these groups now the opportunity to digest all of the M&A that they did and integrate those businesses the right way so that in the next two years, three years, four years, when those platforms come to market, they're that much stronger, they're that much more attractive to the next set of investors.

Let's maybe pivot the conversation towards some more detailed sector discussions. So within the broad provider arena, we've talked about some of the challenges around physician consolidation through acquisition, which we're all feeling some of those headwinds. What sectors have been active and really moving forward from your perspective?

Yeah, there have been pockets of hyperactivity regardless of the kind of more broader macro picture within healthcare specifically, but I would say orthopedics has been and remains extremely active. What we're fascinated by, look, financial sponsor consolidation of physician group specialties is nothing new. There are over 100 plus dental services organizations that are out there being consolidated and consolidating.

What really surprised us in orthopedics and musculoskeletal care is the velocity with which upwards of 20 private equity backed, sponsor backed organizations have been formed in really a 24-month period, 2 year period and growing. It seems like every three to four weeks, there's a new one being formed, and it's probably one of the areas that we are spending the most time as a firm and practice here in the US within healthcare.

I would highlight cardiology also very, very active, not as active and not as much volume as we've seen in orthopedics.

And then lastly, this one's probably the newest and probably the flavor of the month and perhaps the rest of the year is all things medical spas and aesthetic medicine. Just a renewed but very strong and persistent interest in that category as well. Rich, I don't know if you want to add anything else that you had from your side.

The fundamental investment thesis in physician practice management has been proven out for 30 years. We are now deploying that into some of the newer areas that haven't been consolidated yet that Hector mentioned, like cardiology and urology and GI are relatively newer to attract private equity investments.

And on the med spa topic, I would say there is a heightened level of interest, particularly in that space because the industry tailwinds are very attractive. It's an industry that's growing double-digit right now. The patient total addressable market continues to expand with younger generation utilizing those products and services, male patients and consumers using those products and services.

But a big driver actually behind the interest from investors in med spa goes down to reimbursement and pricing. So we're talking about products and services that are not reimbursed by commercial or government insurance programs. So this is an out-of-pocket spend by the consumers, and when you have cash paying patients, it allows the providers an opportunity to drive price increases in an inflationary environment the way that a lot of the other medical specialties like radiology or dental or cardiology, they're beholden to the payers and the rates that they negotiate with them in terms of getting reimbursement. And they don't have the ability to combat inflation the way that sectors like med spa do, which is part of the reason why there's so much excitement and activity in sectors like that.

Yeah, and I think each of those sectors has a catalyst that has made it rise to the top. Take orthopedic, which I would kind of lump in urology, GI. To me, the catalyst is that when you get a scale in a market, it opens up some potential that hadn't really been there before. And I'm thinking specifically of the ability to joint venture with health systems or kind of national ASC management companies to joint venture around ASCs in ways that A, without the scale you couldn't do. And B, the hospitals and those national management companies were historically not super interested in partnering with bigger platforms, but now they are. And that kind of opens things up in ways that has really made them attractive.

And then another dynamic as you talk about orthopedic is I would put it in the subset of provider services arenas where if you get some scale, it opens up the potential to do value-based contracting. And orthopedic is a good example where with Medicare, hip and knee replacements are all kind of bundled payment treatment already, but if you get a little bit of scale, you can expand those value-based contracting into other areas, especially with commercial payers. And that's a transformative dynamic that has made some of those sectors really interesting.

And then on the cardiology, the catalyst from where I sit is changes in the law, of site of location of where you can do procedures, moving that first out of the hospital into an ASC setting, and then for certain things out of the ASC into some sort of office setting that has opened up revenue streams in those practices that have made them super attractive. So there's often a catalyst that moves those sectors.

Agreed 100%. And I think in orthopedics, agree with everything you articulated, but even the old school industrial logic that attracted PE to physician practice management of large and growing addressable patient populations. Well, I mean you could argue 100% of the US patient ... Of people in the United States will at some point have some orthopedic care need, whether it's a broken bone when you're a kid or your spine degenerates naturally as you age, at some point you're going to need interventional care for that treatment pathway. Then you juxtapose it with the supply and demand imbalance of available providers relative to the patient population and the demand for orthopedic care. It's a great place to be, but then it really overlays all those elements you mentioned.

Every high volume, high margin surgical case is migrating out of the acute care setting and into the ASC setting. And when you partner with entrepreneurial physicians and orthopedic surgeons that say, "Hey, we've stood up one ASC, but we have the capacity to stand up three or four, a partnership with a private equity firm can help catalyze and realize that in record time." And then ultimately to your point, getting to the promised land of now you've created the full continuum of orthopedic services and care, you have real true financial and clinical integration and you have full alignment of provider goals and objectives. You can really start to enter into risk-bearing arrangements and ultimately move to a value-based care model, which we've already seen one financial sponsor backed organization really take the flag and the helm of that strategy. So we think that trend and that evolution is going to continue to evolve and we will provide for more transactional activity.

Yeah. To bring us to close here, it's been a challenging six, nine months, and there's still headwinds facing a lot of these sectors, but there's also a lot of tailwinds. The underlying dynamics of consolidation and value-based medicine and movement towards lower cost locations of care are continuing to drive this market. And a lot of these private equity backed platforms, they're built to be able to take a pause for a while while you consolidate what you've purchased, but they're really not built to not be active for very long. And just the buildup of platforms held by private equity funds for increasingly long period of time, they're not built to do that forever either. And so the transaction flow for the next 6 to 18 months is feeling like it's going to be good, and everything's going to be just okay.

There's a lot of forward-looking optimism is how I would characterize it. The money isn't going to spend itself, Geoff, so our private equity friends need to deploy capital. They need to invest in quality businesses and to your and Hector's points earlier, the healthcare landscape is continuing to evolve, and it does at a rapid clip. It often requires significant amount of investment, both money and resources and expertise to be able to build organizations and deliver better care. And with that as the goal, it's in everyone's interest to always put patient first and think about what the outcome is in helping our clinicians to better deliver care in a more flexible environment with the support of the administrative and support services of the platforms.

Thank you guys for joining me. This has been super informative and a ton of fun, and we'll have to have you guys back sometime soon.

Thanks, Geoff. We appreciate it.

Thank you very much. Our pleasure. Thank you.

Thank you for joining us on this installment of the Capital 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.