Healthcare's starring role in private equity

The healthcare industry's Covid-inspired technological revolution could open up new opportunities for investors in private markets.

Di Yann Mauron Gestore private equity, Pictet Asset Management

Even before Covid-19 spread across the world, humanity was facing a number of serious health threats. Pollution is killing more than 10 million people a year[1] and cancer is just as deadly.[2] At the same time, one in five of the world's population will be obese by 2025[3] while the number of bacterial infections resistant to antibiotics is rising at an alarming rate.

But the pandemic has the potential to transform how we diagnose and treat disease. The disruption it unleashed has given way to a sustained burst of innovation that could help eradicate many of the health problems we face. The rapid development of the Covid vaccine bears testimony to this.

What would normally have taken virologists 10 years to complete was accomplished in less than one. There is more upheaval to come. In tackling the coronavirus, the health industry has learned to embrace technology with renewed enthusiasm. This will have implications for investors, too. As the health industry evolves, new investment opportunities are sure to arise.

The investment potential appears greater still when we consider how much money governments, businesses and individuals are committing to improving health. In the US for example, monthly health spending has risen to nearly 20 per cent of GDP, compared to just 5 per cent in 1960 (see Fig. 1). This means more investment, particularly in preventive medicine.

More choice, more opportunity

Investors in the health care will always face such uncertainties and risks. Yet some investment approaches offer better risk-reward trade-offs than others.

In our view, private market investing can be a particularly effective way for investors to capitalise on the innovation in the health industry. Private markets have a number of advantages.

To begin with, the range of investment options is wide, with privately held healthcare companies far outnumbering publicly traded ones. What’s more, deal activity is strong. In 2020, even as the Covid-19 pandemic was dampening investors’ enthusiasm, the number of private deals in the healthcare sector rose by a fifth. This burst of activity is all the more remarkable given that private equity (PE) activity overall declined by 14 per cent.[6]

Investment returns from private healthcare companies have also been attractive.Healthcare has historically delivered higher PE returns than other areas of the market. That’s in part because in healthcare — arguably more so than in other industries — innovation often comes from small, early-stage companies. The shift from academic labs to businesses happens quickly, which gives an edge to those healthcare investment teams and businesses with close links to academia.

A significant proportion of investment value is often created prior to public listings of companies or takeovers. IPOs offer a valid exit strategy for PE investors, with a wealth of transactions in recent years. In times of lower liquidity, however, it is more important than ever to focus on companies with strong technology and products.

Another attractive exit route comes via acquisitions by large pharmaceutical companies, which are always alert to promising investment opportunities among earlier-stage peers to develop their pipeline. Of the novel medicines green-lighted by the US Food and Drug Administration between 2014 and 2018, for example, 54 per cent ‘changed hands’ before approval.[7] The majority of those were developed by smaller biopharma companies, and were then commercialised by larger, well established peers.

Star subsectors

While new drugs may capture the public imagination and investor attention, it is important to remember that they are only one part of the healthcare universe. The investment opportunities within private markets are far broader. Other areas with strong potential to generate superior investment returns include therapeutics, diagnostics, digital health, medical technology, and care providers. Together, they offer diversification across (sub) industries, geographies, types of companies and stages of maturity.

• Therapeutics —The pace of innovation in therapeutics is high and the regulatory environment is becoming increasingly favourable. AI and machine learning are increasingly being applied to drug design and discovery, improving efficiency and paving the way for precision medicine. Biotechnology attracts strong investment from both venture capital and buyout firms, supporting R&D.
• Diagnostics — Ageing populations and changing lifestyles mean that chronic conditions like cancer, diabetes, and heart disease have become more prevalent, which, in turn, has fuelled growth in demand for diagnostics. Governments are increasingly investing in major public screening initiatives. Self-diagnostic and precision medicine industries are growing. Early diagnosis can increase the chances of a positive outcome, helping to improve the lives of patients and save costs of further treatment. New diagnostic approaches also tend to be less invasive (eg liquid biopsy). In the longer term, there is potential to quantify an individual’s likelihood of developing a given disease, giving them the opportunity to take evasive action.
• Digital health — Digital health experienced a big boost during the Covid-19 pandemic and the resulting lockdowns. Although face-to-face medical appointments have now resumed, patients and health practitioners have woken up to the potential of digital. In the US, 43.5 per cent of Medicare primary care visits are now remote.[8] Digital health is also key to serving poorer and harder-to-reach areas — a crucial part of the UN’s Sustainable Development Goals. On a national level, digital platforms can analyse data to identify risks, such as gaps in health screening. As well as potential for growth, this is also a space where we see room for consolidation.
• Medical technology — The medtech industry combines engineering with the medical expertise of doctors to produce instruments, reagents, smart implants, and more. Valuations are supported by the scarcity of high-quality assets. The sector is also characterised by heavy fragmentation, which suggests consolidation on the horizon.
• Care providers — Ageing population is a key driver for both private and public care providers. The sector had the second-highest disclosed deal value globally (after biopharma). New payment and care models are being developed, and value-based healthcare is gaining traction. There is a focus on improving safety and efficiency — two areas where technology and AI can make an impact. Encouraging engagement is a priority. The more frequently patients interact with healthcare professionals, the better their adherence and behaviour, and therefore outcomes.

Fig. 2 - Healthy flows

US digital health funding: number of deals, capital raised , USD billion

Source: Rock Health Digital Health Venture Funding Database. Data covering period 01.01.2011-31.12.2021. Includes US deals >USD2 million.
 

From a private equity standpoint, the five sub-sectors provide opportunities across the full spectrum of company maturities. Therapeutics, digital health, and diagnostics are particularly strong in the early and growth stages. Medtech and care providers, meanwhile, tend to be more suited to buyout stages.

Geographically, both the US and Europe continue to lead the field for research, whereas the US maintains an edge when it comes to commercialisation and IPOs. Asia, meanwhile, is rapidly catching up. China in particular is starting to produce therapeutic innovations. By investing across the whole healthcare value chain, therefore, one can achieve good geographic dispersion. A mix of direct and indirect investments can further improve diversification and boost risk-adjusted returns.

Health is a major priority for everyone from governments to individuals, and all the more so in the wake of the Covid-19 pandemic. Investment is growing, regulation is becoming more supportive, and technology offers ever more potential solutions. Private equity is an attractive way to tap into the opportunity across the full healthcare universe, while limiting risks through strong diversification and risk management.

Biography

Yann Mauron joined Pictet in 2016, first in the Strategy division and later as Private Equity Investment Manager. His responsibilities include the selection and monitoring of private equity funds, secondary transactions and co-investment opportunities across the technology and biotech sectors. Yann is also responsible for the Group Corporate Venture Capital initiative.

Prior to Pictet, Yann spent more than five years working as a business strategy consultant at McKinsey & Co. and KPMG. Yann is a biologist by training and started his career working for several blue-chip pharmaceutical companies. His PhD in bioinformatics gave rise to multiple applications in biologicals identification and emergency medicine.

[1] Estimated death toll from PM2.5 particles. ‘Global mortality from outdoor fine particle pollution

generated by fossil fuel combustion: Results from GEOS-Chem’, K. Vohra et al., April 2021

[2] Globocan, February 2021

[3] World Obesity, March 2020

[4] McKinsey, ‘Prioritizing health: A prescription for prosperity’, July 2020

[5] ‘Estimated research and development investment needed to bring a new medicine to market,

2009–2018’, O.J. Wouters et al., March 2020

[6] Bain & Company, “Global Healthcare Private Equity and M&A Report 2021”, March 2021

[7] FDA, HBM New Drug Approval Report, January 2019

[8] U.S. Department of Health and Human Services, April 2020

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