Health system investors unfazed by 2017 lull in digital health deals

Health systems remain interested in investing in digital health startups, despite a slowdown in activity in 2017 from potential buyers.

While last year saw record-breaking investments in digital health startups, it was the second year in a row of declining digital health startup acquisitions and, more importantly, the sector saw no initial public offerings in 2017, according to Rock Health, a digital health investment firm based in San Francisco.

Health system venture capital units are still seeking both longer-term investment opportunities and innovative ways to solve the industry's chronic problems.

"I didn't know about the trend, so I guess I must not be concerned," said Tal Heppenstall, president of UPMC Enterprises and treasurer of its parent, Pittsburgh-based UPMC.

Last year's slowed activity may have been a bigger deal to VC investment funds that expect to see an exit after investing for one or two years, Heppenstall said. UPMC Enterprises, by contrast, expects to work with its portfolio companies over a much longer time frame. In fact, he said he welcomed the lessened dealmaking because that could mean good companies wouldn't be as expensive for UPMC to use as a customer.

Rock Health found that despite U.S. digital health venture funding approaching a "record-smashing" $6 billion last year, there were only 119 disclosed acquisitions of digital health companies and a "surprising" zero IPOs. In fact, Rock Health wrote there hadn't been a digital IPO since iRhythm in 2016. Healthcare providers still constitute a modest proportion of that funding; about 11% of companies funded in 2017 received investment from at least one provider, Rock Health found.

It's important to note that the IPO trend transcends healthcare: You'd have to go back to the 1960s to find a time when there were fewer companies listed on U.S. stock exchanges, according to Rock Health's report.

And digital health is still a relatively new space, with many young companies experiencing growing pains, so the trends aren't entirely surprising, said Megan Zweig, Rock Health's director of research and author of the report.

"Though investors are a little wary of these numbers, overall the sentiment is that this is somewhat to be expected," she said. "This is a long journey and we wouldn't have invested in healthcare if we wanted a super fast turnaround."

Digital health M&A activity declined 18% last year compared with 2016, a year that saw 36% fewer deals than 2015, when digital health M&A peaked, according to Rock Health.

However, another piece of good news in 2017 was a record number of so-called "mega-deals," which Rock Health defines as those that surpassed $100 million. Rock Health added the caveat that 2017 arguably saw more mega-deals simply because there are more mature companies in search of large investments than in previous years.

The conclusion that last year was the largest on record for digital health funding was echoed by digital health investment and coaching firm StartUp Health in its 2017 year-end report on global funding for the sector. StartUp Health found worldwide global digital health investments totaled $11.5 billion in 2017, well above Rock Health's U.S. figure and surpassing its own 2016 number by nearly $3.5 billion.

StartUp Health found that the most active digital health sectors for investments last year were patient and consumer experience, with 191 deals and $1.64 billion raised; personalized health, with $1.59 billion raised through 71 deals; and big data and analytics, with $1.39 billion raised through 56 deals.

Healthcare providers differ from other types of investors because getting a financial return on investment from a startup's exit or acquisition deal isn't always the top goal. Rather, health systems often say they mainly want to use portfolio companies' technologies to lower costs and improve quality, among other objectives.

Sometimes, just using that technology provides a financial return even if there hasn't been an exit or acquisition, Zweig said. She gave the example of Sutter Health using Augmedix, which aims to lower the amount of time physicians spend on documentation, ideally allowing them to see more patients.

UPMC Enterprises has invested in a company called Vivify Health, which provides remote patient monitoring after patients are discharged with the goal of reducing unintended readmissions. Patients talk to nurses or doctors using iPad-like devices to determine whether they need to be readmitted. Within the first week of deploying the technology, it prevented two unnecessary readmissions, which Heppenstall said "was really good for our operations, but more importantly, it was really good for the patients."

Jack Miner, managing director of Cleveland Clinic Ventures, said some of his portfolio companies are also used within the health system, including a device designed to improve stroke victims' motor control.

"The return doesn't trump certain aspects of what we do, that we really have to get those technologies from bench to bedside," he said.

Mary Jo Potter, a senior adviser with Miami-based healthcare strategy consulting firm BDC Advisors, agreed that digital health is still an immature market, and exits take longer than people are willing to admit. In the future, though, she said she believes health systems will see returns coming from exits or acquisitions.

Regardless, she said health systems should want to be part of the solution to the industry's problems.

"If you're going to be disrupted, you may as well bring in the disrupters rather than be on the inside looking out and not even knowing who they are," Potter said. "So I think it's fundamentally healthy."

Healthcare providers still represent a small percentage of overall funding in the digital health arena, said Unity Stoakes, president and co-founder of StartUp Health. Some are in survival mode, so health innovation is low on their priority lists, he said. Others are more focused on mergers and acquisitions.

Going forward, though, Stoakes said he thinks health systems should make digital health investments a key strategy for combating the real threat of disruption from outsiders like Amazon and Apple. When it comes to using technology to improve healthcare, providers still have the upper hand, he said.

"Healthcare institutions are in a unique position to add technology to their core workflow, their core way of operating, much more effectively than technology companies are able to integrate healthcare into their core platforms," Stoakes said. "So I think it's a real missed opportunity if health systems don't lean in and start to find ways to integrate health innovations throughout their entire way of operating."

When people think of digital health they tend to think first about new ways to diagnose patients or therapeutics, Zweig said. But Rock Health found that the largest digital health investment area for healthcare providers last year was in solutions that helped with administrative functions like scheduling, inventory, revenue cycle and supply chain.

Rock Health is gearing up to release its digital health funding report for the first quarter of 2018, and Zweig said there are "a lot of big deals" and no indication that healthcare providers or other investors are scared off by the declining acquisitions and lack of IPOs.

"We aren't really seeing any pullback yet in terms of the venture investment dollars flowing into that space," she said. "I think that's just because there is a ton of opportunity."