Market conditions
The overall environment is very challenging because the pullback on valuations, even for well-performing businesses, in the public markets has been very extreme. In healthcare, the pullback is motivated less by fundamentals than by the need of a whole host of parties to get cash. The result is a liquidity crunch.
Dr. Scullion explains it this way: “First, a tight debt market is reducing the amount of money hedge funds have available, to keep afloat, so they sell securities into the market. Even the best companies are being unloaded, and their stocks are pushed down, which has prompted a rush to the exits. Second, large endowments and investment funds, such as big universities, have allocated a lot of money to hedge and private equity funds, which puts more pressure on the public portfolios of large organizations. “
Previously, these organizations, such as CalPERS, had perhaps 10 percent of their pension funds in private equity, he says, but that amount has since doubled or tripled. At the same time, he continues, another 70 percent may have been invested in public securities; that may now be worth 50 to 60 percent of what it had been.
“Suddenly, they have a 50-50 mix and still have to pay pensions; they have to sell in the markets to pay the next month’s pension installments,” says Dr. Scullion. “That change in allocations and ill-liquidity has exacerbated the market’s downturn. What that’s created is more sellers than buyers. People will buy the best of what’s available, but they’re staying away from anything with any question marks around it,” which they may have gambled on in the past. “If prices were to level off, organizations wouldn’t have as much pressure to sell more in order to maintain their portfolio allocations,” he further explains.
Effect on private companies
“The severe decrease in the amount of debt available is taking private equity investors out of the market; they are disproportionately represented in the M&A market, and their absence is keenly felt,” says Dr. Scullion. “Strategic acquirers such as Covidien, Stryker, Medtronic these companies have several billion on their balance sheets and can still do acquisitions. The companies with $100 million, they’re not going to go out and spend their available cash on a deal. The private equity buyers, the smaller companies, they’re going to be more cautious in mergers and acquisition market because of this lack of available credit.”
There will continue to be pressure, at least for the next several months, for pension funds and endowments trying to meet near-term obligations.
“Unlike with a mutual fund, you can’t call up and take your money back from a hedge fund you have to give notice at the end of the quarter that you want your money back over the next 90 days,” Dr. Scullion explains. “On Sept. 30 there were probably a lot of requests to return capital, and the funds are probably being smart about turning those securities into cash, so we haven’t seen the end of selling; it’s still working itself out through the end of this quarter. As a result, the public valuations of stocks, which influence valuations of private companies, will probably be under pressure through the end of the year.”
On a positive note, the lack of available debt is slowly improving.
“The federal government has made a huge commitment to fix the debt problem; it’s pumping too much money into this to not have a positive effect,” says Dr. Scullion. “In the long-term it might cost us in terms of inflation, taxes or both, but we’ll fix the credit problem. When will we get back go normal? It’s certainly not going to be a 2008 phenomenon.
“And I think we’ll have to redefine normal: We’re not going to see six to seven times leverage for a long time. People will be more conservative deals will have to be clean and projections solid but lenders will be getting back into the market next year.”
Healthcare areas of interest
Here are the areas Dr. Scullion says remain strong:
- outsourced pharmaceutical services (“There’s a lot of interest out there in the segment, even though the stocks are getting beat up.”);
- biotechs (“They’re losing money and aren’t of interest.”);
- diagnostics and imaging;
- medical devices (“Particularly spine.”); and
- wound care (“Both facilities and products are very hot.”)
On the not-hot list are “cosmetic procedures, dental except for implants; really, anything that’s felt to be dependent upon healthy-consumer spending,” says Dr. Scullion. “Dental is different from medical people will put that off, in particular the population that doesn’t have dental insurance, whereas people without medical insurance will still get sick and go to the ER.”
The Healthcare Investment Banking Group at William Blair & Company provides public and private capital raising and merger and acquisition advisory services to healthcare clients. The firm is distinguished in this area by the healthcare experience of its senior bankers, including Dr. Scullion. The group serves the following industry sectors: biotechnology and pharmaceuticals; healthcare information technology; healthcare services; IT-enabled services; life sciences; medical products and devices; medical supplies and distribution; payer systems and services; and revenue cycle management. Learn more here.
