What’s Weighing Down Healthcare Deals

A shortage of workers and rising wages is making these businesses a lot less attractive to investors, according to PitchBook.

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An alarming shortage of healthcare workers and rising wages is finally set to slow down private equity deals in the sector.

Private equity firms closed the second-highest number of healthcare deals ever last year, despite the worst markets in more than a decade and a tough labor market. But those conditions are catching up to investors as rising capital costs and inflation continue to plague businesses in the industry.

“What the healthcare sector is going through is unique,” said Rebecca Springer, senior analyst at PitchBook. “It’s a post-Covid story. Other sectors have staffing shortages, but no sector other than healthcare has [seen] the level of burnout and the burden placed on workers during Covid.”

According to PitchBook’s latest healthcare report, private equity firms closed 863 healthcare deals last year, the second-highest annual amount on record. In 2021, deal count reached a record high of 1,013 as PE firms doubled down on high-growth sectors of the economy.

But early signs are pointing to a decline, with only 158 deals closed in the fourth quarter. That’s down 26 percent from the third quarter and more than one-third lower than the quarterly average in 2021.

“The industry is adjusting to a new normal,” the report said, citing rising interest rates and wage inflation as the biggest headwinds. For PE firms and lenders, the top concerns are rising borrowing costs and a contracting economy.

Wage inflation in the healthcare industry has pressured margins. The Golub Capital Altman Index, which tracks revenue and earnings growth across different industries, reported year-over-year growth of 10.3 percent in healthcare revenues and 1.3 percent in earnings in the fourth quarter. Across industries, the average revenue growth was 10.8 percent and average earnings growth was 9.2 percent. The large gap between the two metrics suggests that healthcare companies are trapped in a world of low profitability, according to PitchBook.

According to Springer, dealmakers will likely focus on making smaller add-on transactions instead of buying large platform companies as macroeconomic uncertainty persists. “[PE firms] will keep deploying capital while not having to take on the risk of a really big platform deal,” she said, adding that firms that can improve the operational efficiency of their portfolio companies will have the edge over those that focus mainly on expanding financial multiples.

“Looking ahead to the rest of 2023, we believe deal volumes may continue to decline in the first half of the year due to continued leverage- and staffing-related financial distress,” the report concluded. “Although [PE investors] are particularly interested in healthcare-focused managers during periods of economic volatility, the fundraising environment is increasingly inhospitable, especially for emerging and middle-market managers, and the sluggish pace of exits means institutional investors are running out of capital to allocate.”