After steadying during Q2, it appears the overall volume of deals in the healthcare industry declined in Q3 compared with Q2, and year-to-date 2023 is still down from last year. A slumping economy has no doubt played a large role in the decline, and, as discussed in our last report and below, the current regulatory environment is only exacerbating the situation.
Physician Practice Management
While Q2 seemed to promise a rebound in private equity (PE) investment in healthcare, Q3 largely saw decreased activity in the physician practice management (PPM) space. In fact, LevinPro reported only 120 deals in Q3 2023 (16% lower than Q2 and 19% lower than Q3 2022). However, it is unclear whether this investment slump will continue. While macro-economic factors such as inflation, rising interest rates and the increasing cost of labor have influenced investing habits, the market remains replete with sellers looking to off-load the heavy administrative burdens and take advantage of higher reimbursement rates by partnering with PE firms or large health systems.
Barring an unlikely significant decrease in interest rates, large deal volume is unlikely to pick up during the remainder of 2023. Indeed, while some investors have launched or acquired new platforms, including by turning to non-traditional financing (e.g., seller financing, rollover equity arrangements and earnouts, as seen in the early post-COVID-19 period), many investors have focused their attention on solidifying existing platforms with additional, smaller tuck-in transactions. Moreover, the renewed scrutiny from both the federal and state governments may be having a chilling effect on larger physician practice transactions.
State Transparency Law Expansions and Developments
As highlighted in our Q2 report, many states are either proposing or passing transparency laws that require pre-closing notification to the state for certain healthcare transactions. Many claim that these new regulations are largely targeted at PE's continued expansion into healthcare. Predictably, California finally joined the growing trend.
Pursuant to its authority under the recently enacted California Health Care Quality and Affordability Act (California Health and Safety Code § 127500 et seq.), the California Office of Health Care Affordability (OHCA) proposed expansive regulations on July 27, 2023. As initially proposed, the regulations seemingly targeted PE investment and imposed cumbersome pre-closing notice requirements. Subject to certain financial thresholds, "Health Care Entities" (which include "payers") must file a written notice of a "material change transaction" at least 90 days prior to closings that will occur on or after April 1, 2024. Similar to the New York law, the regulation was clearly meant to target management services organizations (MSOs), as evidenced by the proposal's definition of "payer," which expressly included MSOs. After the initial comment period, however, the October 9, 2023 revisions removed all explicit references to MSOs after some commenters argued that OHCA was exceeding its authority as MSOs are traditionally thought of as service administrators and not "payers."
While MSOs may not be explicitly included, some experts believe that MSOs could still be brought under the definition of "Health Care Entity" as the new revisions to the definition include "any parents, affiliates, subsidiaries, or other entities that perform the functions of a health care entity and either: (i) control, govern, or are financially responsible for the health care entity or (ii) are subject to the control, governance, or financial control of the health care entity, such as an organization that acts as an agent of a provider(s) in contracting with payers, negotiating for rates, or developing networks...." Considering the clear intent behind the original statute, MSOs still appear to be a target for regulators. Therefore, any MSO arrangements based in California must be carefully vetted and updated to ensure that MSOs are not stepping into the role of a "Health Care Entity."
If a party is brought under the regulation, the notice requirements would be extremely comprehensive and require a description of prior healthcare transactions over the last 10 years. Additionally, interested parties would be required to submit copies of definitive agreements and term sheets. All submissions would be deemed public record unless the parties request confidentiality and OHCA grants the request.
Additionally, New York's new Article 45-A to the Public Health Law (covered more extensively in our Q2 report) officially took effect on August 1, 2023. The new statute requires healthcare entities, including MSOs, to provide the New York Department of Health with at least 30 days prior notice before the closing of a "material transaction." The Department of Health's webpage summarizes the law's requirements and notes that the required form and FAQs will be coming shortly.
Currently 16 other states have either proposed or enacted similar legislation.
FTC Pushing Back on PE Investment
While the new merger guidelines outlined in our Q2 report certainly present new hurdles for dealmakers, the Federal Trade Commission's (FTC) enforcement efforts are also on the rise. In Q3, the FTC filed suit against U.S. Anesthesia Partners (USAP) and its financial sponsor, Welsh, Carson, Anderson & Stowe, alleging, among other things, that the roll-up strategy often employed by PE firms looking to expand existing platforms decreased competition and resulted in higher prices in Texas. USAP has publicly responded by pointing out that its rate increases are consistent with industry standards and have expanded care to otherwise underserved populations. This suit and the FTC's recently proposed Hart-Scott-Rodino (HSR) Act revisions (which also call out PE roll-up strategies) both signal that additional enforcement actions are likely to come.
Notable Deal Activity
Continuing trends seen in 2022, Q3 saw activity in several specialties, including orthodontics and cardiology. Both MB2 (backed by Charlesbank Capital Partners) and Dental 365 (backed by The Jordan Company) have remained active in orthodontics. MB2 announced 14 new partnerships with dental groups in Michigan, California, Arizona, Texas, New Mexico, Indiana, Ohio, Virginia, Georgia and New Jersey. September also saw MB2 expand into Wisconsin by partnering with Green Bay-based Eastridge Dental. Currently, MB2 has more than 600 partnerships and spans 39 states. Dental365 further expanded its Northeast portfolio in Q3. In August, Dental365 announced the acquisition of New Jersey-based Bowden Dental and Massachusetts-based Theroux Dental Associates. September also saw Dental365 expand into Pennsylvania when it acquired a six-location group practice (names were not provided).
The previously fractured cardiology specialty continues to pick up steam. Webster Equity Partners-backed Cardiovascular Associates of America (CVA) saw a flurry of activity in Q3 as it continues toward its goal to get "a thousand physicians in our practice over the next three to four years." Picking up where it left off in Q2, CVA added its sixth and seventh Florida partnerships by adding Kissimmee, Florida-based Cardiovascular Associates and Orlando-based Cardiovascular Center of Florida on July 18 and September 5, respectively. Finally, CVA announced the acquisition of Florida Beach-based Daytona Heart Group on September 12, its eighth location in Florida and 36th location overall. Daytona Heart Group features 13 cardiologists, four APRNs and over 100 staff members. As mentioned in Q2's report, cardiology remains highly fragmented and is primed for continued investment going forward – especially now that more cardiology procedures are moving to the outpatient setting.
While activity in the urology space has remained low (only eight deals this year as of June 30), experts predict urology could be the next specialty that begins to see consolidation because it remains highly fragmented and because it offers a suite of ancillary services (e.g., lab services, chronic care, clinical trials, and ambulatory surgery centers (ASCs)). Despite its attractiveness, it has seen much less attention than similarly fragmented specialties, such as orthopedics and cardiology. In fact, Levin Associates recently indicated that as few as 26 urology deals have been announced since January 2018. For context, there have been approximately 200 dermatology deals and at least 40 cardiology deals in the same timeframe. Of those 26 urology deals, six investors participated in 21 of them.
Most of the hesitation appears to stem from urologists as they typically face fewer barriers and challenges than their counterparts in other specialties. Levin Associates highlights that urologists are among the most highly-compensated specialists and often invest in ancillary services on their own—without the need for external financing. Additionally, they are not subject to the same reimbursement headwinds with which other specialties must contend. Therefore, the benefits associated with PE investment are not as appealing to independent urologists. However, 58% of private practice urologists are 65 and older as of 2022 and many look to retire by 70. As seen in other specialties, physicians who are close to retirement often see PE as an opportunity to retain equity in their practice even after they slow down or no longer provide care. Additionally, many will simply want to focus on practicing medicine and leave the administrative and business tasks to PE investors.
Urology investment does present some challenges for PE firms. Most urology groups have six or fewer physicians and, according to Levin Associates, nearly 40% of independent practices have fewer than three physicians. Therefore, more time must be devoted to building out an initial platform. Larger practices with pre-built ancillary services will likely be the first to draw significant interest. While multiples have gone down for all specialties, we believe that large urology practices could still trade for 10x EBTIDA or more. Once the initial investment hurdle is cleared however, urology practices are ripe for roll-ups and could trade for 4x to 8x EBITDA, depending on the number of providers and ancillary services.
Ambulatory Surgery Centers
As more specialties shift toward the outpatient setting, investment in ASCs is expected to grow. According to data from VMG, 70% of ASCs are still independently owned. Orthopedics, which has historically relied on the outpatient setting, has unsurprisingly remained the most popular specialty with around 2,233 ortho-centric facilities. However, pain management (2,162 facilities), ophthalmology (2,110 facilities) and GI (1,961 facilities) are close behind. Cardiology has outpaced other specialties in terms of ASC growth. While cardiology services are still primarily provided in a hospital setting, relaxed standards from the Centers for Medicare & Medicaid Services (CMS) and ASC investment in the necessary technology have fueled a rapid shift to ASCs. When coupled with the rising patient population and incidence of cardiovascular disease, PE firms, in particular, are taking notice and see cardiology as a unique investment opportunity. However, due to macro-economic factors, experts predict PE firms to roll-up smaller ASCs to build out pre-existing platforms (similar to the PPM sector).
There were several notable Q3 ASC deals. According to an August 22 press release, DxTx Pain and Spine received a $50 million investment from BC Partners Credit, an international PE firm. DxTx has over 60 locations and aims to expand its operations nationwide. Additionally, Tennessee-based Surgery Partners (backed by Bain Capital) announced a new joint venture with Dallas-based Methodist Health System. According to an August 1 earnings call, Surgery Partners will acquire a minority interest in and manage three new ASCs. More recently, HealthPartners (a health maintenance organization) broke ground on a $50.5 million specialty surgery center in Woodbury, Minnesota. HealthPartners has more than 90 clinics and hospitals across six states.
As in Q2, M&A activity in the hospital sector in Q3 largely involved health systems merging with other health systems. Indeed, as seen in Q2, transactions in Q3 involved both cross-market mergers as well as mergers of health systems within the same geographic market. In the latter category, Georgia-based Wellstar Health System and Augusta University Health System combined to create a 12-hospital entity, and Oregon-based Legacy Health and Oregon Health & Science University signed a non-binding letter of intent to combine and create a 10-hospital system with more than 100 locations. Montana-based Logan Health and Billings Clinic also closed their merger on September 1. Each of these health systems cites ensuring financial stability and the ability to sustain and expand services as motivations behind the combinations. Froedtert Health and ThedaCare, two Wisconsin health systems, also signed a definitive agreement to combine into a single health system in September, similarly citing the ability to offer expanded services as a motivation. Florida-based health systems UFHealth and Flager Health+ also announced they closed their deal for Flager Health+ to become part of the University of Florida's academic health center and to be renamed UF Health St. Johns.
As regulators increasingly continue to scrutinize proposed transactions in the same geographic area, we expect cross-market mergers of health systems are likely to be at the forefront of healthcare M&A in the future. For example, in Q3, Michigan-based Essentia Health and Wisconsin-based Clinic Health System signed an integration agreement to form a 25-hospital health system across four states (Wisconsin, Minnesota, Michigan and North Dakota). Similarly, following regulatory approvals, UCHealth – a nonprofit health system with hospitals across Colorado, Wyoming, and Nebraska – completed the steps necessary for its planned partnership with Colorado-based Parkview Health System. Parkview's employees will join UCHealth on December 1. Notably, however, UnityPoint Health and Presbyterian Healthcare Services called off their cross-market merger in October. The systems did not share the reason for calling off the deal, but noted regulatory approvals did not play a role.
Independent hospitals also continue to combine with larger health systems. For example, on July 1, international, not-for-profit health system Christus Health acquired Gerald Champion Regional Medical Center, an independent hospital in Alamogordo, New Mexico. Similarly, on September 18, it was announced that Novant Health, one of North Carolina's largest health systems, received the necessary county approval to consummate its acquisition of 25-bed acute-care Pender Medical Center located in Burgaw, North Carolina—a deal which is expected to close in November 2023.
In Q3, there was also a significant number of deals involving bankrupt hospitals. In the face of economic headwinds and workforce shortages post-pandemic, many hospitals had to completely shutter operations. Several of them are now getting a new life. For example, Methodist Healthcare System invested $75 million to reopen a shuttered San Antonio hospital, Forest Park Medical Center. American Advanced Management has also entered into a letter of intent to operate the bankrupt Hazel Hawkins Memorial Hospital. DAP Health has received final approvals to acquire the bankrupt clinic chain Borrego Health, and the two will now operate as one integrated system. Shuttered Madera Community Hospital also reached an initial agreement to have Adventist Health take over operations in late July 2023.
Home Health & Hospice Care
Although we saw a slight bump in Q2 and deal volume in Q3 remained on track with 2023 deal volumes, year-to-date deal volume in the home health and hospice sector is down 50%-60% from the previous two years. There are several reasons for this slump, much of which has to do with the dynamics of supply and demand. The number of transactions in the past three years has depleted the supply of acquisition targets, particularly in the lower middle market. As a result, we have not seen as many add-on transactions as expected. Further, CMS's proposed regulations limiting the "license flipping" of hospices (described in our Q2 report) will likely deter some buyers from entering or expanding in the sector.
Payers and strategic buyers appear to be leading the current wave of investment in the sector. Notably, UnitedHealth Group's (NYSE: UNH) subsidiary Optum, Inc. is making progress on its acquisition of Amedisys, Inc. (Nasdaq: AMED), described further below. Additionally, another notable transaction closed in September. The Pennant Group, Inc. (Nasdaq: PNTG) – an Idaho-based home health, hospice and senior living company – continued its expansion by acquiring Arizona-based Valor HospiceCare—this following Pennant's recent acquisitions of Benefit Home Healthcare and Benefit By Your Side in Colorado and Bluebird Home Health, Bluebird Hospice, and Bluebird Home Care in Idaho in Q2. We anticipate Pennant will remain active in the last Quarter of 2023 and into 2024. Optum's and Pennant's activity in the sector may also suggest a shift away from PE-backed buyers to other buyers ranging from existing operators to payers.
While PE activity has slowed, we did see two notable hospice transactions close this past July. Agape Care Group (backed by Ridgemont Equity Partners) acquired two hospices for undisclosed sums: Birmingham, Alabama-based Hope Hospice and Cartersville, Georgia-based Assured Hospice. With the addition of Hope Hospice, the company's footprint covers every county in the state of Alabama. These two transactions come on the heels of a series of transactions Agape closed in late 2022, which shows PE remains active in this sector, just not as active compared to previous years.
Recent reported upticks in admissions and census among large regional and multi-regional home health and hospice providers suggest that the market may be stabilizing. Thus, it is possible we could see an increase in deal activity in Q4 or, more likely, in early 2024.
Digital Health & Health Information Technology
We have seen relatively few, smaller deals in the digital health and health information technology sector in 2023. Q3 was no exception. Researchers have called this a market reset; however, we are optimistic that this reset will bring fresh and focused perspectives to digital health product development, partnerships, and commercial approaches, providing for a more steady future.
One notable transaction is Kansas-based WellSky's acquisition of the post-acute care software firm Experience Care. Experience Care has developed an electronic health record (EHR) platform and financial solution designed for long-term care facilities. The system can also help long-term care operators ensure that residents receive appropriate care at the right time. WellSky provides software and analytics to more than 20,000 client sites, including hospital systems, blood banks, cell therapy labs, home health and hospice and other post-acute providers, government agencies and human services organizations.
QuantHealth's raise of $15 million in Series A financing during Q3 came after the Israeli startup announced its expansion into the U.S., where QuantHealth will use artificial intelligence to simulate clinical trials at scale, with the goal of reducing clinical trial waste.
Several noteworthy partnerships were announced in Q3. These partnerships illustrate the opportunities in the digital health and health information technology sector that could lead to future transaction opportunities. For example, Providence, a Washington-based nonprofit health system, consolidated its business systems on Oracle Fusion Cloud Applications Suite. With a single integrated suite to manage its finance, HR, and supply chain processes in the cloud, Providence has enabled its workforce to focus on providing high-quality, compassionate patient care by reducing costs, improving productivity, and enhancing the caregiver experience. Additionally, health information technology has been used to solve issues plaguing the healthcare industry. For example, Illinois-based OSF Healthcare, South Carolina-based MUSC and Illinois-based CommonSpirit Health have announced their use of virtual nursing to alleviate the strain on employees caused by the national nursing shortage. Finally, Curai Health announced that it is officially available on Amazon (Nasdaq: AMZN) Clinic's virtual healthcare marketplace to provide message-based care. Individuals can choose Curai Health when seeking support for a broad range of concerns, including UTIs, COVID-19, birth control, etc. The addition of Curai Health helps bolster Amazon's goal of bringing affordability, access, and more affordable medical care for patients across the U.S.
Despite the benefit of these innovations, they are not without regulatory concerns, so it is possible the regulatory regime may deter buyers from entering or expanding in the market. These concerns and the high-cost of borrowed money may therefore cause the sector to remain slow through the remainder of the year and into 2024.
M&A activity in the behavioral health sector remained steady in Q3 from Q2, with PE firms continuing to lead investment activity in the sector.
The majority of transaction activity in Q3 was in the mental health subsector of behavioral health. This is consistent with the first half of 2023, during which mental health M&A was approximately 62% of all transaction activity in the behavioral health sector. In Q3, for example, Childhaven and Washington Association for Infant Mental Health agreed to merge organizations, effective July 1, 2023, to launch a center for workforce development in infant and early childhood mental health. Daybreak Health, which works with school districts to offer online mental health services, also closed on a $10 million Series A round, and Oxford Finance provided Headspace, the digital health platform offering mental health services, with a $105 million senior debt facility, allowing the growth of its mental health services.
Technology is also playing an increasingly important role in behavioral healthcare, driving M&A activity that will allow providers to adopt new technologies and expand their telehealth offerings. For example, in Q3, Community Health Systems, Inc. (NYSE: CYH) and Mindoula, a population health management company, announced plans to implement an innovative program integrating virtual behavioral health services into the primary care setting. Brightline, the leader in virtual behavioral health care for children, adolescents and families also announced a $10 million investment by Northwell Health.
Several private-public partnerships were also announced in Q3. Ten cities and counties have partnered with the Harvard Kennedy School of Government Performance Lab to expand access to mental health services and introduce alternatives to police responses in mental health emergencies. Washington State also purchased the recently closed 137-bed psychiatric hospital, Cascade Behavioral Health Hospital, for almost $30 million. These beds will be used by the state for patients committed to state hospitals and should free up beds for people in jail awaiting competency services.
Other deals in Q3 included Eastpoint and Sandhills Center agreeing to merge to form the second-largest behavioral health managed care organization in North Carolina. Additionally, Talkiatry and NOCD, the leading providers of obsessive-compulsive disorder therapy and high-quality virtual psychiatry, launched a partnership to help OCD patients' access holistic treatment.
While M&A activity in the behavioral health sector is down in 2023 compared to 2022, the rapidly growing demand for behavioral healthcare will continue to drive deal activity in the sector.
Optum's cross-sector acquisition of home health and hospice provider Amedisys, first announced in June and which has been described as "a market leading deal" blurring the line between payer and provider, appears to be moving along. In a Securities and Exchange Commission (SEC) filing dated September 8, 2023, Amedisys confirmed its shareholders approved the adoption of the merger agreement effecting the acquisition. However, the transaction remains under regulatory scrutiny. In August, the Department of Justice (DOJ) issued a further request for information under the Hart-Scott-Rodino Antitrust Improvements Act, which extended the waiting period for the parties to complete the transaction. The request for information follows the DOJ's and the FTC's proposed updated merger guidelines released in July and may signal an increasing crackdown on transactions the magnitude of the Optum-Amedisys merger. On the other hand, other recent mega-deals that received additional requests—Amazon's $3.9 billion acquisition of One Medical, CVS's $8 billion acquisition for Signify Health, and Optum's $5 billion acquisition of LHC Group—all went through, so such requests are not (yet) a death knell. Would-be buyers will no doubt be watching the Optum-Amedisys merger to see how, if at all, it is impacted by the proposed updated merger guidelines.
In August, the FTC and the DOJ's Antitrust Division extended the public comment deadline for the proposed changes to the FTC's pre-merger notification requirements to September 27, 2023. As discussed in the last quarterly report, the changes to the requirements would require, among other things, parties to submit significantly more information and documentation than the current form, giving regulators more information to review during a deal's initial waiting period. If finalized, these changes could help avoid the issuance of additional requests, but commentators are also fearful it could give the agency more fuel to block mergers it views as anti-competitive. Only time will tell.
Pharmacies, Pharma Services & Pharmacy Benefit Managers
M&A activity in the pharmacy space slowed in Q2, and continued to stagnate in Q3. We have, however, seen PE firms continue to build out and expand existing pharmacy services platforms. We noted in our last report the recent formation of new behavioral-focused pharmacy platforms Altruix (backed by WindRose Health Investors) and ArtexRx (backed by Flexpoint Ford), the latter of which, as previously reported, closed its first investment into Parkview Health Services in late June. Parkview is a provider of pharmacy services to patients who are treated in group homes, mental health clinics, addiction services provider offices and other care settings. On August 8, ExactCare Pharmacy, a pharmacy care provider backed by Nautic Partners, announced it had entered into a definitive agreement to acquire Tabula Rasa HealthCare, Inc. (Nasdaq: TRHC) in a going private transaction. The transaction is expected to close in Q4 and, according to press releases, will bring together "two preeminent healthcare companies whose pioneering work integrating comprehensive pharmacy services into population health has improved outcomes and reduced total cost of care for people with complex needs allowing them to thrive in home and community-based settings."
Despite slower activity in this sector—and across the board—sector stakeholders remain optimistic and believe M&A activity will pick up in Q4.
Many commentators believe the current slump may continue through 2024—that we should be bracing for a longer than normal winter. The New York Federal Reserve did not allay these concerns when it announced last month that the U.S. is more likely than not (i.e., has a 56% chance) to fall into a recession by September 2024. The next quarter and indeed the next year, then, may continue to be highlighted by small, strategic expansions and creative cross-sector transactions.
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