On this premiere episode of The Banker's Corner, McGuireWoods' Geoff Cockrell sits down with Justin Hand, Managing Director at Westcove Partners, to discuss the trends, solutions, and business issues affecting the healthcare private equity market.

2021 concluded with a flurry of activity for the healthcare market, setting the stage for this timely conversation.  Many deals were squeezed in and closed at the 11th hour, with many more carried over into the new year.

With the past year ending on such a high note, what drives these trends? And what can we expect in 2022? 

For one, there will be more healthcare M&A as a byproduct of the backlog of deals, capital gains, and the tailwinds of smaller practices losing competitive muscle and wanting to sell to larger ones.

This trend promises to continue, although there are concerns over increasing interest rates, larger funds and new players, a shift in multiples, and disruptive evolution in the healthcare sector.

Featured Experts

Name: Geoffrey Cockrell

What he does: Geoff is the Chair of McGuireWoods’ private equity group and serves on the firm's Board of Partners; he has extensive experience in mergers and acquisitions, especially in the healthcare space.

Organization: McGuireWoods

Connect: LinkedIn

Name: Justin Hand

What he does: As the Founder and Managing Director of Westcove Partners, Justin is involved in most active mandates, oversees financial sponsor coverage, maintains key third-party relationships, and leads the firm's Impact Investing initiative.

Organization: Westcove Partners

Connect: LinkedIn

Notes From the Banker’s Corner 

Top takeaways from this episode

★    Healthcare businesses are not immune to the pandemic. According to Justin, entrepreneurs have a hard time withstanding the different variants of COVID, competing with private equity-backed portfolio companies, and dealing with employment challenges.

★    The more complex the competition, the more M&A deals. More acquisitions and consolidations will happen as the competitive landscape becomes increasingly brutal for small and less capitalized practices. More so because the high multiples is a great incentive, but beyond that, it is a more secure way to take the brand into the future. And with the potential for recapitalization, there’s more to consider.

★    Investors have a responsibility to drive disruptive evolution in the healthcare business. Early-stage businesses with a bolder idea of how they can influence healthcare deserve as much funding as those doing five-plus in EBITDA. Ultimately, Justin sees a trend where those five-plus EBITDA businesses will sooner or later have to exit or merge with the disrupters.

Episode Insights

[02:48] Capital gains are driving exits: Justin believes more healthcare exits will continue through 2022 as capital gains are expected to stay the same.

[04:42] More alignments: As small and less capitalized patient-facing healthcare businesses struggle to compete in a COVID world, more M&A is imminent.

 [06:48] Rising interest rates, new money: Justin predicts that private equity firms will be more aggressive in 2022 despite the expected rise in interest rates.

[08:57] Recapitalization is coming. Justin outlines recapitalization precedents and why there is more to partnerships for physicians beyond the cash considerations at the close.

[12:37] Value-based care is here to stay: the market is starting to recognize the benefits of value-based care and the ability to measure outcomes in healthcare businesses.

[14:17] Disruptive evolution: Justin and Geoff cite the immense potential for disruptive innovation in healthcare and the opportunities for investing.

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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 McGuire Woods 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.

This is Geoff Cockrell from McGuireWoods, and this is a continuation of our Corner Series, where we do short podcasts, 15 or 20 minutes, on various topics. So one series is entitled Professor's Corner, where we go through more technical aspects of healthcare deal-making. And then our second Corner Series is called Banker's Corner, where we interview some of the movers and shakers in healthcare, private equity, deal-making to get a perspective on what the market looks like, what trends we're seeing, terms and deals. Today, I'm joined by my good friend, Justin Hand, from Westcove Partners, one of the best middle-market investment bankers that I know. And we're going to talk through the prognosis for healthcare M&A heading into 2022 and some other topics. But, Justin, can you introduce yourself and tell us a little bit about Westcove before we get started.

Thank you, Geoff, and appreciate you allowing us to participate in the Banker's Corner here. Westcove is a boutique investment bank focused in healthcare services, and we've been very successful the last two years really bringing the fundamentals of what a bulge bracket investment bank is to the boutique investment banking setting. We've been fortunate to represent several founders through their first institutional round of capital raise or exits to strategics, and really try to be very aligned with representing the very best businesses in the respective areas of healthcare they have coverage in. So looking forward to sharing our perspectives and talking about 2022.

Justin, 2021 could not have ended in more of a flurry of activity. Just the deal volume was almost soul-crushing of deals getting done and squeezed into 2021 for numerous reasons. In September, there was a lot of concern about taxes going up, but everything coalesced around finishing a whole bunch of things by the end of 2021. And not surprisingly, anything that didn't get started pretty aggressively by September or early October was pushed to next year. So the million-dollar question now is since we've finished a crazy 2021, what can we expect in 2022? So from where you sit in middle-market provider services, Justin, let's talk a little bit about some of the drivers we think that are going to contribute to continuation of the deal pace that we saw in 21, continuing into 2022. Justin, what do you think some of the drivers are that we're seeing?

I think first and foremost, before thinking about 2022, I think it's important to reflect on really the last 18 months concluding in December 2021, capital gains was a big driver of the rationales to why individuals were considering an exit. I think fortunately for those on the phone or those listening, I think that we've got some clarity for the foreseeable future that the capital gains rates will likely stay the same. So I think that will end up being a driver into 2022. The fear of paying more in taxes I think has dissipated for many, but I think more than anything, COVID, and not to continue to talk about this subject area, COVID definitely made all entrepreneurs, business owners, physician groups, shareholders recognize that even though healthcare is somewhat immune, we are not immune to something at a systematic perspective such as a pandemic.

I think when we think about the deals that happened last year, I think a lot of the deals that happened in 2021 was a result of those transactions that would've happened in 2020 actually got delayed until last year. So I do think that is a byproduct of some overflow from 2020 into 2021. But I think more than anything, it's a lot of entrepreneurs recognizing that what they need to do to grow in a COVID world when they're competing with private equity backed portfolio companies is becoming more difficult and I think that was a big reason why transactions happened last year. How that relates to 2022, I think continuing with COVID is just the first rationale and motivation for business owners. I think that all of us bankers, third parties, that are involved in these processes on the legal side, on the quality of earning side, on the insurance side, we're all experienced something that these privately held businesses are experiencing, and that is recruiting and maintaining employees and team member is becoming more of a challenge.

And we are hearing more and more organizations over the last quarter, Q4 of 2021, heading into right now, coming around and saying that they thought they made it through COVID and having to shut their doors and seeing patients or going into the field, they thought COVID was behind us, but now they're facing a whole new challenge, and that is on the employees side and how do we balance the new expectation of how you need to give flexibility to individuals on the employees side with also managing a practice or a business that's patient facing. And so I think a lot of entrepreneurs are starting to recognize that an alignment with the larger organization likely is the way in which they can be successful in carrying their brand into the future. And I think that we'll see that accelerate in 2022 as I don't think the challenges around employment are going to change.

They coalesce around for a smaller business, I think, the experience in the pandemic and the pressure on hiring that you're articulating really brought forward the risks of being smaller and less well capitalized. The inability to withstand the forms of the COVID was very jarring to a lot of smaller businesses and just the difficulty of competing with much better capitalized competitors has just become increasingly brutal. So I agree that those dynamics are going to continue on into the future and also for the foreseeable future, at least, the pricing and the money is still too good to walk away from for very long, obviously multiples can shift a little bit over time and there could be some inputs on that from perhaps higher interest rates, but for the time being at least, the multiples are still super high. So the tailwinds of smaller practices wanting to sell to larger ones and then the ongoing consolidation roll up of the bigger practices into the bigger practices and the bigger practices feels like those dynamics are going to continue for the foreseeable future.

I wholeheartedly agree. And I think that, yes, we will see increases on the interest rates, which will have an impact on private equity firm's ability to lend in some way. But we're also fortunate that we haven't seen a slow down in the dry part that exists in the marketplace, fundraising continues to strengthen. KKR just announced the most recent $4 billion healthcare fund, this other new emergence into the private equity space, which patient is example that making real big entry points into this industry and have a commitment towards healthcare. So even as we see increases on the interest rates that in theory have a impact on returns to private equity firms, the abundance of capital in the marketplace should offset that. So I think that we will continue to see private equity firms be very, aggressive this year likely heading into 2023.

I also think on the physician side I think 2021 was an interesting year in that, from experience, one of the most common comments that we receive from physician groups when they are entertaining a process or thinking about what their options are is this fear that the value of the rollover may be zero because there isn't a large precedent of secondary or third recapitalizations in these processes on behalf of private equity. And that is because physician consolidation dates back 10 years, many of the subspecialties that I mentioned before, GI, OB, orthopedics, fertility, oral surgery, these are relatively new about the last half decade, I'd say, four to five years. What was interesting about 2021 is we did see some formidable national organizations go through their secondary recapitalization. Organizations, just pick with one sector, the OB sector, Axia Women's Health of WHUSA, Women's Health USA, and UWH, all of those organizations went through secondary recapitalizations.

And so to stick with that, I think that provides confidence to privately held organizations, in this example, in that sector that there is an opportunity to realize the value of their rollover shares, and that there's more precedent beyond what was just, say, dermatology going through secondary recapitalizations or ophthalmology. So I think as that trend continues to happen, and we see more of these private equity firms that invested into platforms 2, 3, 4, 5 years ago also experiencing a return on their investment because they're going through a secondary recapitalization, I think that provides more comfort to business, to shareholder basis in the physician space to realize that there is value in what these partnerships look like well beyond the cash consideration they get at close. It supports and builds confidence that this makes sense.

Absolutely. And the market for the larger transactions is evolving and becoming more visible because for a while, to your point, you have a smaller doctor owned practice, they sell to a financial investor. And even in the ones that are more established, they sell, that financial sponsor sells to another sponsor who sells to another sponsor. And the question is there an end point where there's no more buyers is the big box buyer a terminal position, if that were true, then the whole progression would break down. So in the last 12, 18, 24 months, there's been an evolution on the back end of that, to your point, they're larger funds and there were before, the $4 billion KKR fund was certainly a big splash. And so that opens up another level of buyer size. But it's not just an ever bigger fund because that would raise the next question of, well, who do they sell to? The market is evolving as the IPO market is continuing to expand as a landing place for these businesses.

There's also a developing quasi public market where you've got large, large institutional investors that are making investments where their return expectations are more consistent with public market growth, return expectations, so that opens up a more stable buyer for these businesses. We're seeing larger club deals being put together by... The one question is does it have to be an ever bigger fund, and one of the answers is no, you can have clubs of large investors be the next buyer. We're seeing sovereign funds being a ultimate terminal buyers of these businesses. So the back end big box buyer market is getting more clear and all of that bodes well for all the participants downstream from that, that are putting together things of scale to sell to the next person to sell the next person, the success on the back end is going to really validate and continue that process so it's good to see that happening as well.

Absolutely. I think the only maybe comments or correction I make there is finance has the ability to always create something. So I do not think there's ever a terminal value in the way in which you can create value on behalf of assets. I think you see private equity firms pursuing continuation vehicles for assets that they hold within their portfolio companies. Some of those are based off of the private firms still believing the fundamentals of that investment makes sense. I think you could also argue that some of those continuation vehicles are utilized because there isn't a buyer at the value that private firm expected to yield out of a process. So there's a lot of creativity in finance. I think that will always be the case. I think your comments on the IPO market's very interesting.

I think for the first time ever, and probably we'll get to this in this discussion or future one, the market is starting to recognize the benefits of value based care and the ability to measure outcomes in practices or healthcare businesses and I think that all consumers and all investors are starting to recognize that healthcare as a percentage of GDP is too high not to focus on that. And I think because of that, over time, and it's not a short term horizon, this is going to take some time, but I think for the first time ever the public markets will start to recognize that healthcare from an investing standpoint and from a public standpoint needs to be viewed differently than the way we typically think about valuing publicly traded businesses.

So will it mimic the way in which we look past the fundamentals in technology or tech investments? I don't know that that's the case, but I think we will see the public markets start to look past the traditional way in which you value businesses, which is on an EPS or profitability standpoint when you look at healthcare. And I think there's some examples of that. Some of the publicly traded entities that are in the direct primary care space and where they're trading today, while down from a year ago, there's starting to be a recognition that you got to look at the way in which we drive costs down for all of us in the United States, as opposed towards just profitability of a business, and there's value inherent in those businesses if you can actually showcase the way in which you're reducing costs. So I think we'll see a pop on the public side with time for sure, which therefore creates a lack of terminal.

You mentioned the value bank medicine evolution. I think one of the ways that I hear private equity investors talk about that is that disruptions in how things are done creates opportunity. If you're smart and have capital, you can invest into disruptive changes. Well, whether that's the move away from fee for service to value based medicine and the ability to say, "Well, walk into a market if you're an orthopedic practice and start to contract with payers on a capitation basis." That's wildly disruptive in local markets and the potential for disruptive innovation in healthcare is immense. And disruption is happening all around. The resurgence in California of them dabbling with maybe moving towards a single payer system, that would be disruptive and there'll be lots of opportunity for smart and well capitalized investors to participate in that disruption and be a change agent in it and do very well. So I think the disruptive evolution in healthcare is going to continue to create opportunities for investing.

I agree. I think our expertise as of today is more later stage investments. And I think that, meaning businesses that are doing five plus in EBITDA, is our... I don't want to say minimum threshold, but where we spend most of our time five to 20 in EBITDA. I do think that there's more talk around disruptive healthcare today, in particular from the investor community, because, going back to my comment before, I think conceptually private equity firms know that's where we're headed.

There's exception to this, but I don't think that most of them are willing to, in their five year hold period of making an investment, they're willing to take such bold chances that we need to actually have a long term impact on healthcare. Now, why I say the threshold of five plus, I do think there's a whole community of investors more on the venture side or growth side on the healthcare industry that are willing to make those bold investments and make those bold moves or those chances on businesses that have a bolder idea of how they can have an influence on healthcare.

So I think we will see more and more disruption coming from earlier stage businesses over time. And that, going back where we started, I think as those disruptions happen, you'll start to see more of the mature businesses... Again, that will accelerate the mergers and acquisition activity on those businesses that are five plus EBITDA, because they're stuck in their ways and it's more difficult to be agile when you're of that size. They will start to think about doing a deal when you've got the influences of smart dollars at the lower market being disruptive to the industry. So I think that's a trend, they go hand in hand in my opinion. I don't know if you disagree with that or if that makes sense to you, but I think it's the venture, earlier stage investor community that is going to have an influence and force the more stable businesses to really consider an exit in some way or an alignment in some way.

That makes a ton of sense. Justin, I think we'll call it a break here. This has been super instructive and I think our collective consensus is that 2022 shows a lot of promise for a lot of activity. Hopefully not quite the frenetic pace of Q4 of 2021, but 2022 should be good. Thank you everyone for joining us for this installment of The Banker's Corner, and there'll be more of them to come. Thanks a lot.

Thank you for joining us on this installment of The Banker's 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.