A handful of private equity-backed healthcare companies met their demise earlier this year, but industry watchers say recent woes won't deter the search for acquisition targets.
In May, physician staffing company Envision Healthcare, backed by private equity firm KKR, filed for Chapter 11 bankruptcy protection and entered into a restructuring support agreement for $7.7 billion in debt. The next month, cancer treatment provider GenesisCare, also backed by KKR, filed for Chapter 11 bankruptcy to offload its U.S. operations. Less than two weeks later, the Center for Autism and Related Disorders, majority-owned by investment firm Blackstone, filed for Chapter 11 bankruptcy and agreed to a $25 million sale.
Private equity has had its eye on healthcare for years, considering it as a stable, recession-proof investment option. Recently, specialty services such as cardiology or oncology have gained the most attention.
In the past decade, physician practice acquisitions have grown more than six-fold, according to a study from the American Antitrust Institute, the Petris Center at the University of California-Berkeley and the Washington Center for Equitable Growth. A separate report this month from the American Hospital Association found 65% of physician practices acquired in the last five years were bought by private equity firms.
“In the latter part of this year and the first half of next year, I think we’ll see a significant acceleration in deal activity,” said Devin O’Reilly, partner and head of healthcare for Bain Capital’s North American private equity division.
Companies like Envision and the Center for Autism stumbled amid a challenging macroeconomic environment, compounded by reimbursement rate pressures and high debt levels making them more vulnerable, experts said.
Here's a look at what went wrong with these companies and where private equity firms are finding new investment opportunities.
Payment rate pressures hit hard
Payment rates are undoubtedly one of the biggest factors determining a healthcare company’s success. They become even more important as inflation rises and payers aren’t keen for reimbursements to follow suit.
Companies, including those backed by private equity, often look for loopholes in the payment structure to capture higher reimbursements. When this happens enough, payers or legislators step in to close them.
The No Surprises Act passed in 2021 hurt Envision’s business model, which relied heavily on unexpected out-of-network charges, which the legislation largely prohibits to protect patients. When Envision announced the bankruptcy, it said the No Surprises Act cost it hundreds of millions of dollars in underpayments and delayed payments. That, in combination with rising labor costs, pushed the staffing company to file for bankruptcy.
Envision has also been embroiled in legal disputes with UnitedHealth Group, which removed Envision from its provider networks in 2021.
“It’s not anything new or surprising to anyone in the industry to see a group like Envision go under, unfortunately,” said Rebecca Springer, a senior research analyst and healthcare lead at market database PitchBook.
Springer noted most healthcare investors look for companies profiting from in-network rates.
Historically low rates for autism care have been a contentious issue nationwide for years. Before its bankruptcy filing, the Center for Autism tried to expand in states with higher reimbursement rates but that strategy didn’t work, said Eileen O’Grady, research and campaign director for nonprofit organization Private Equity Stakeholder Project.
Invo Healthcare, backed by Golden Gate Capital, decided to shut down Autism Home Support Services in June, laying off hundreds of employees and citing pandemic-related challenges that led it “to a place where the quality we committed to would be at risk,” according to a Worker Adjustment and Retraining Notification filed June 20 in Illinois.
High debt means high risk
Leveraged buyouts—when companies use debt financing to acquire another business—are a common part of the strategy at private equity firms. It leaves the acquired businesses with high debt levels, which becomes a problem when those businessesspend too much cash to pay it down, instead of reinvesting in their business. Higher interest rates in the past couple of years have added to debt service burdens.
“That doesn’t mean that a firm necessarily has to put a huge amount of leverage on a company. Some do and some don’t, and you see the difference in the outcomes in this environment. In 2021, debt was basically free, and so you could get away with doing a lot,” Springer said. “Deals that are getting done now are getting done with a lot less leverage than they were a year and a half ago.”
A recent report from Moody’s Investor Services determined most distressed healthcare companies were backed by private equity firms. Thirty-four North American healthcare companies, or almost 18% of the list, were rated B3- or lower moving into 2023. Envision made the list with a “C” rating. Also getting a "C" rating was fellow staffing company TeamHealth, which is looking for solutions to repay more than $1 billion in debt due in 2024, according to the Wall Street Journal.
Investment opportunities are still out there
Despite the risks, private equity firms keep investing. Behavioral health is a focus area amid the high demand for those services, in addition to cosmetic dermatology, adolescent care and cardiology, Springer said.
“I think where there is any kind of payer, there will be private equity firms attempting to fill the gap,” O’Grady said, adding that private equity firms like fragmented markets where they can consolidate individual operations across a geographic area.
Outpatient care, including ambulatory surgery centers, was cited as another big area of opportunity.
Private equity firms are also paying more attention to value-based care models, Bain’s O’Reilly said.
“We always try to step back and say, ‘Is this particular company doing something that makes clinical outcomes for patients better?’” O’Reilly said. “Question two: ‘Is this company doing something that makes the overall healthcare ecosystem more efficient?’”
Clarification: Golden Gate Capital is no longer majority owner of Invo Healthcare after selling some of its stake last year.
