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PE health care deals nosedived in Q2

Written on Aug 24, 2023

Private equity deals in health care services in the second quarter of this year dipped “unexpectedly” to their lowest levels since the second quarter of 2020, according to a report from market research company PitchBook. 

There were an estimated 164 deals recorded or announced last quarter, representing a 23.7% decrease compared to the first quarter this year — and the sixth straight quarter of declines. In May, PitchBook predicted that PE deals would be up slightly or flat. 

However, the number of deals is still more than 12% higher than the average quarterly deal counts in 2018 and 2019. Leverage has become the “central story” of the declining deals, with debt-saddled companies facing growing debt service costs and impending maturity wells as the fed raises interest rates to combat inflation — hampering add-on buys by PE-backed health care companies, according to the report. 

Private equity deal-making reached record highs during the COVID-19 pandemic, as low interest rates encouraged M&A, and firms utilized their growing cash reserves, known as dry powder. 

PE firms topped virtually all measures of growth in 2021, reaching multi-year highs in global deal counts, exit values and buyout capital raised, according to consulting firm Bain and Company. In the same year, PE firms closed more than 1,000 deals with health care services, according to the report.  

The deals came even as concerns regarding PE’s management of health care companies garnered national scrutiny and sparked investigations into patient harm at nursing homes. 

But PE deals have declined this year, along with M&A in the sector, as rising interest rates, inflation and fears of a recession shuttered the IPO market and made sellers weary to engage in deals, lest they take a hit to their valuations. Venture capital raising for digital health companies has likewise declined from pandemic highs. 

Highly leveraged companies in particular have suffered as interest rates climbed, with the Federal Reserve setting the federal funds rate at 5.5% in late July. 

A decline in large platform deals, or initial acquisitions by a private equity firm, aided the second quarter’s decline in deals. Eleven and seven platform deals were recorded in the second and first quarter this year, respectively — the lowest of any quarter since 2017, excluding when the coronavirus caused global shutdowns during the second quarter of 2020. 

At the same time, labor cost inflations appear to be easing, with the slowdown in deal-making potentially affording management teams the opportunity to “closely attend to operational efficiencies” including improving workforce retentions. The increased focus has also enabled platforms to take advantage of seller motivation to pursue cheaper deals, according to the report. 

Proposed 2024 changes from the CMS may influence PE deals in the future, especially the agency’s decision to reduce home health payments by 2.2%. A combination of the proposed rule, high interest rate and elevated staffing costs are all factors that may further dissuade investors from home health. 

PitchBook wrote that it anticipates a “gradual reversal” of the current downward trend of deals, toward normalized PE deal-making, as economists back off of recession fears and inflation begins to ease. In addition, the broadly syndicated loan market appears to be improving, with seven leveraged buyout deals financed across all industries in the second quarter this year, according to the report. 

Deal activity is expected to stay flat or remain slightly elevated for the rest of 2023. “Despite challenges, the general sentiment from dealmakers is that things are headed in a positive direction,” the report noted. 

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