Capitalize on Private Equity's Adjustments To The New Market Realities
This week Paul talks with Rebecca Springer, Senior Analyst and Healthcare Lead at Pitchbook Data, the premier resource for comprehensive data on global capital markets. Her observations can contribute to your competitive advantage over other sellers today.
Full transcript
Generated from the episode audio and lightly edited for readability.
Good afternoon and welcome to another episode of Paul Martin's Crucial Conversations. Today we are really excited to have with us Rebecca Springer. Rebecca is not a physical therapist, but Rebecca is a research analyst in healthcare, private equity, and venture capital for a company called Pitchbook Data. We subscribe to Pitchbook and have been extremely happy. It's an incredible resource for data, research, and insights that span the global capital markets. They have an enormous amount of information in general health care sector as well as specifically healthc care services and the physical therapy industry.
Rebecca, it's great to have you with us today. Yeah, great to be here Paul. Thanks for inviting me. So, Rebecca, I get this question very often. People are ask me, you know, why does private equity seem to have such an enormous interest and why have they made such enormous investments in outpatient physical therapy? Yeah, it's a great question. I'll start by giving you some numbers to kind of quantify that. So, we've tracked 84 msk deals in 2022. That includes physical therapy as well as ortho. Okay.
Physical therapy being a broader portion of that. We're not tracking the tiniest deals in that, but you know, a large number of larger deals. That's that's a record. It's up from about half that number in 2017. So really up and to the right involvement from private equity. In order to answer the question, why is private equity interested in outpatient PT? Kind of have to step back and answer the question why is private equity interested in healthcare services in general? It's an enormous investment area. We have calculated that around 10% of all US private equity activity is in healthcare providers which is pretty remarkable.
PT in particular includes a lot of the same characteristics that attract private equity to the provider space. It's very fragmented. So you have opportunities in terms of scale and multiple arbitrage. Patient demographics are creating increased demand as the US population ages. Provider demographics are also a tailwind as many independent practice owners are looking to retire. New providers coming into the space may be more interested in an employment model. And then there are also payer tailwinds, right? As your audience know as well, physical therapy can be a really important part of improving patient outcomes while lowering the total cost of care as an alternative in some cases to just rushing right into an ortho surgery or something like that.
So, it's an attractive space for private equity for all those reasons. And I have to add that, you know, we physical therapists are just a great choice for private equity. Yes, I'm sure. Yeah. No, thank you. Thank you. So, walk us through the evolution of a typical healthcare-based private equity firm. Where do they get their money? How do they make their choices on what investments they make? And generally, what kind of impact both positively as well as negatively do they have on companies that they sponsor?
I'm kind of looking for a brief private equity 101 course for our listeners. Sure. So private equity will go and raise capital from what are called limited partners. These are institutional investors, think pension funds, you know large insurance companies, family offices, even sovereign wealth funds. They collect a pool of couple hundred million dollars, maybe a couple billion if they're a larger firm. Go out and deploy that capital over one to three years, hold companies for on average five years, but it can vary. And then return that capital back to their LPs.
So when they're going into a physical therapy business, they are looking to pull a couple of different return levers. And I can kind of go through them in order of importance. Sure. So the first one is going to be multiple arbitrage through M&A. So you think about the EBIT multiple that you can get on a small practice say it's 5x and then a larger practice you have 10x even larger practice 15 you can have combined a bunch of small practices together now you have not only a combined company that has more revenue but is trading at a higher multiple and that's sort of like the breadandut return driver for private equity investment in any physician space including PT you then have organic growth.
So that's going to be increasing patient volume often either through you know denovo clinic offerings or within four walls. That might involve doing some more sophisticated scheduling. It might involve use of PTAs or texts a little bit more than was previously done. Different firms have different levels of approach to that sort of volume lever and how aggressive they want to be with that. Another revenue lever can be referral sources, reimbursement mix. U, typically firms like to have higher commercial reimbursement, less on the Medicaid side, good mix of Medicare.
There are different models again, but they're going to be looking to pull that lever to some extent. Geographic density, payer negotiation, right? If they can build out a practice to be a really a market leader in a given geography, they can then go to payers and get better rates. And then there are sort of the operational and clinical improvements, right? And I list these last not because they're not important, but because in terms of the effect on the final like return for the practice they're probably more incremental or a little bit more difficult to measure even.
But they're going to be looking you know certainly not to d drive clinical decision- making but to you know work with the physician owners to you know make sure that the practice has the investment that it needs to keep up to date you know maybe participating in ortho bundles and like value based care model maybe just optimizing operations practice management that sort of thing. Yeah, it's interesting because you know all those areas are I think what private equity views as are opportunities to improve the business to grow the business and then provide a return to their shareholders, their shareholders, their investors.
Which you know is kind of the world that private equity lives in. And then on the other side of that, as I hear you going through that, I can remember back to when I did study in mergers and acquisitions and it just seems so you take control of the company, you go boom, three or four steps and shazam, you got a much bigger company. You go back to your investors and being on the inside of that, you see, you know, at times there's so many little bumps in the road and it doesn't always exactly go that way.
You know, and I think that what we've been most impressed with is which of the private equity groups respond to, you know, when those things don't always go exactly as planned? How do they respond? And how do they get folks and leaders within the organizations that they control and that they sponsor to, you know, get with them on their program to continue to try to drive that business. So just an interesting scenario as you kind of walked through that. Yeah. And one thing I will say is that I think you know a common misunderstanding about what private equity does when they buy a business is people always think about cost cutting, right?
Oh, private equity comes in and just slashes. I really don't hear private equity investors talking about that. You know, independent practices tend to be pretty lean and actually what they often need is the capital infusion to be able to achieve some of the goals that they want in terms of, you know, operations and and growing the practice. And so having that capital partner and then as you say you know I think healthcare focused firms in the private equity space have become more and more sophisticated over the years as operating partners and being able to really come alongside their portfolio companies.
There's obviously a lot of variation but I think the industry overall is becoming more sophisticated. Absolutely. Absolutely. So, if we could kind of take our focus to the small and midsize physical therapy companies, and that's who our audience is today, and that may be looking to potentially sell their businesses in 2023. How do private equity firms influence how the large acquirers that they are sponsoring, how they set the multiples and structures that they are able to offer to those sellers? Yeah, it's an interesting question. The answer is it depends, right?
It depends on the maturity of the platform company, the large acquirer. And it depends on kind of what stage you're at in the investment process. So, you know, when private equity buys a, you know, larger group that's never been in private equity hands before, so creates a new platform, they're going to be pretty hands-on in, you know, putting in a new management team, sort of getting an M&A machine in place, within the platform and you know, smoothing out some operational stuff to sort of enable the growth group to then go and start growing.
They're also going to be setting some of the geographical strategy and you know in collaboration with leadership of that platform. And they're obviously going to be arranging for financial and legal and banking support and that sort of thing. They're going to be involved in sort of larger add-ons. Maybe if a group is going into a new state, they're going to want the platform to move toward being able to do smaller add-ons kind of on its own through its own free cash flow. Sort of sort of where you fit on that spectrum is going to determine how hands-on the firm itself is going to be versus just the management of the company that's acquiring the practice.
Sure. Sure. But, you know, we've we describe that as, you know, we call it stage one private equity, stage two, stage three. And, it's interesting that you say that a stage one private equity firm typically or stage one backed strategic acquirer by a private equity firm tends the private equity firm tends to be a little more hands-on. But it makes sense because they're putting in those systems as you said to create that M&A machine. Yeah. And then the stage two comes in with, you know, enormous amount of capital.
You know, the stage two private equity companies in rehab right now, some of them are, you know, 40, 50 billion plus of assets under management. So their funds are much larger. They have that, you know, internal team now to just continue to grow. So that yeah, it's interesting that you say that. I think we see we do kind of see that within the rehab industry. So if we could kind of shift now to boy, I'm sure you guys are [clears throat] talking about this a lot.
The US economy. Yeah, I can answer all your questions. I know exactly what's going to happen. I'm sure you do. I'm sure you do. So, what do the economists that Pitchbook rely on? What are they saying will happen to the economy? Interest rates, inflation, are we going to go into a full-blown recession? What's coming here in 2023? Yeah. I mean, you know, who knows, right? I mean, obviously, we're in uncharted territory. I think the consensus view is interest rates, you know, somewhere a little above 5% maybe by mid 2023.
It stays that way until, I don't know, maybe late 2023, early 2024. We have our own recession prediction model internally. The last update showed 62% likelihood of recession. That was toward the latter half or the end of last year. I bet it's kind of moved a little bit down in terms of that likelihood since then. Some of the indicators are coming in a positive way. But you know I think I think the broader point to make there is that in private equity you know you have to remember this is you know firms that are fundraising and investing over a long time horizon.
There's 62 billion dollars of dry powder sitting in US private equity funds waiting to be invested into health care services. So you know the industry isn't going to respond to every you know every new Fed release and every shift in the stock market immediately in an intangible way. It's more about sort of the overall sentiment and then cost of capital is obviously really key. So you gave me a great segue. So how do you expect then the private equity firms who have invested in rehab to react to these changes?
I mean will they advise their large acquirers, you know, to change their strategies in terms of companies they'll acquire, strategies on how they'll acquire. What advice are the private equity firms giving these large strategic rehab companies? Yeah, so a couple of things. I think you're going to see across the board a more conservative approach to leverage, right? Debt service costs are increasing just because of interest rates. There's more uncertainty. Firms are going to want to make sure that their portfolio companies are not overleveraged. That may mean slightly less aggressive growth for a while.
I don't expect like a huge we haven't seen a huge fall off in growth in healthcare services so far. Especially in areas like physical therapy. But you know things will be a little bit more cautious I guess in terms of deal activity. Expect deal timelines to be a little bit longer than they were in 2021. Right? We're not rushing through four-week long processes anymore. And then I think you're also going to see private equity firms and platforms move down market a little bit more than they did in the last year or two.
In 2021, we were hearing things like, "Wow, you know, I just don't even have time to go through all of the deals in my pipeline, like do all the deals that I want to do." now that we're slowing down, being a little bit more circumspect, about some of these deals, firms still have capital to deploy. They still want to, you know, put capital into their platforms in order to fuel that growth. But they're going to be, less likely to go after really big deals. And so, they're going to start looking at smaller acquisitions a little bit more than they were, over the last 18 months or so.
Very interesting. Very interesting. So I if you look at the economic changes, how will it affect going straight down now to the small and midsize PT RPT clients? What should they expect from private equity-backed acquirers? Kind of specifically, you know, how will the deals they are offered compared to the deals that some of their colleagues received, you know, the end of 2020, 2021, 2022? How will it hit the person, you know, the companies on the other side of all this? Yeah. Yeah. I mean, we do expect multiples to be a little bit lower than they were in 2021.
Not not hugely, but like, you know, a turn or two. It's interesting. I'm hearing a lot from the private equity side that they see buyer seller price mismatches as one of the key impediments to deal making in the year ahead. They're seeing sellers who want that 2021 multiple and they're just not willing to pay it anymore, right? And if you think from their perspective, right, you know, their capital costs more. They're not able to rely on multiple expansion as much and sort of making the deal math work out.
So yeah, they are going to be more conservative on price and that's sort of you know, I'm sure not the answer that all of your listeners wanted to hear, but that's what I'm hearing from the private equity side. Yeah. But, you know, in some ways, you know, I would say it may be what a lot of our listeners do want to hear because when we, you know, interview some of the top CEOs and where the way they describe end of 2020,21 and into 22 or N22 is that those were in some cases prices multiples that were way out of market.
Just way out of market. And what they're claiming and very similar to what you're saying is down a multiple maybe two depending upon you know where you are on that spectrum brings those deals to really good deals just not these completely out of market deals that some folks were lucky enough to you know go at the time. But that they're still going to be able to do really good, solid and selected deals. Yeah. Yeah, for sure. I think you know the folks I talked to are thinking about this as kind of mean reversion kind of back to a little bit of a rationalization of pricing and the deal environment.
Yeah. Do you think they would be advising the companies that they're sponsoring to change the focus on what deals they will do or not do? I guess my question is I've talked about selectivity. Will they become more selective in the deals they're willing to do? Yeah, I think look I think in 2021 and I sort of think of 2021 as a long year, right? 20 Q4 2020 to early 2022. I think I think there was, you know, for lack of a better ter term, a sense of FOMO in the investor space, right?
Like do deals just because everyone else is and we want to do this quickly. And yeah, so I think I think there's a little bit more caution. I think you know, acquirers are going to want to see financials that you know, they can be confident making projections from. You know, they're going to want to see, you know, clean TTM look and be able to really justify the prices that they're paying as opposed to just, you know, trying to do deals at any price possible. Sure. Sure.
Yeah. So, if we know multiples may slip down, would you be willing to take a guess at when you see they may go back up again? Are we talking months? Are we talking years? You've been doing this so long. You have such great experience. You know, I'm trying to get an answer out of you. Yeah. I mean, so, well, one thing to say is that there is no historical precedent for this in private equity, right? Like the private equity industry is young enough that it actually hasn't lived through an inflationary period, which is really interesting for an industry that's built on leverage.
So, you know, in addition to all the macroeconomic uncertainty, we actually don't know how private equity fares in a high interest rate environment over an extended period of time. So that's a really difficult question for that reason. But I what I don't hear is folks saying, oh, you know, six months of this and then we'll be back at 20.1 levels. Like I you know I think I think this is a years out sort of prospect where we sort of start to just gradually build up momentum again after we get out of whatever is on the horizon economically.
But what I hear you saying and I've heard this from some others as well is that they may not these multiples may not come back for and who knows it could be months it could be years as you said as you said we don't know but you know typically it's a longer period but it's not like I'll make it up if you could get a seven you're going to get a two right you know it seems to me the bottom's not falling out at this Yeah, it's slipping back slightly and but still good deals.
Yeah, and I think you just answered a question that I had which is you know are there any classic patterns as acquisitions kind of surge and recede and I think what I heard you say is for private equity through an inflationary period there really is no historical pattern. Yeah. Yeah. We don't have we don't have a pattern for inflation. We do have a PL pattern for how private equity invests in different physician categories. So if you look at like dental or dermatology areas that private equity has been in for a longer period of time, you do kind of sort of kind of see a like first wave second wave effect and then you see some platform consolidation.
We can see that a little bit in our data. I would say that the msk category broadly is kind of like cresting second wave like it's still up into the right deal activity. So this is a pretty good time to you know be looking to exit a business to private equity because we have a number of active platforms a number of firms still getting into the space. You know we have small platforms we have mature platforms. It's a pretty dynamic space. Some other categories like you know dermatology for instance are actually seeing declining deactivity just as part of that cycle because they're a little bit farther along in process I guess.
Sure. So define for our listeners msk. Oh muscularkeeletal. I'm using that acronym to not get tongue tied but sure. No, no. Got it. Yeah, the muscular skeletal can be can be rough. And obviously you're kind of pooling physical therapy within that muscular skeletal. We do. Yeah. Yeah. Yeah. Makes sense. Makes sense. So I'm going to ask you to make some recommendations for rehab companies. If you were to give a small to medium-sized physical therapy company out there that's interested in selling in 2023 23, what would be [clears throat] your recommendation?
Yeah. You know, I think just to summarize things that we've already talked about, I think this is actually a time, that could be an good opportunity. Again as more platforms, more firms start to look down market I think you know having a really solid business foundation in place is going to be really key. Having those financials ready to go and just being able to make a strong case as to the sort of forward you know forward cash flows and forward health of the business is going to be really important as well.
But I wouldn't try to you know hide under a rock right now if you're thinking about selling. I think it's actually a pretty good time. Sure. Sure. And you know you said earlier that you know some of these large companies may be a little less app have a little less of an appetite for really big you know platforms that they would be acquiring. So if you are a large platform right now you want to get out in front of these companies pretty much as quickly as you can.
Would would you is that what you would recommend? Yeah, for a larger group that's a it's a little bit trickier because part of this is related to financing, right? And syndicated loan markets are effectively closed right now. So we know of a number of large platform deals that are sort of in the market in process but have not closed and keep getting delayed because of that. So for a really big group, it actually might be worth waiting until things kind of open back up in terms of the debt financing in order to make bigger transactions.
But I mean, when I say big, I'm talking like the$1 billion mark and above that. So [snorts] the 100 to$200 million, there's still capital in place to do those kinds of deals. So far, yeah, private private credit funds have not yet run out of capital. They may do if this indicated loan market stay closed though. So that's something to watch as well. Yeah. Sometimes, you know, private equity folks like yourself when you talk big, you're talking we're talking really big. We're talking the B- word. When when we talk big, we talk like$1 150 to $200 million.
Those are big. You would probably recommend getting those in front of these companies fairly rapidly, right? Yeah, I think so. Okay. Yeah. I just wanted to make that clear. Yeah. Yeah, that's a good call out. Okay. Okay. Rebecca, this has been absolutely, you know, exhilarating again talking to somebody with your knowledge that has such a perspective for not only what private equity is doing in the msk space as you describe it but also kind of globally looking at other healthc care sectors. I hope it's okay, but we may tap into some of your knowledge again at some point in time.
Again, really appreciate your time today. Yeah, it was great to talk to you. Thanks so much. So, for any listeners out there today that you have a question for myself or maybe even for Rebecca, just click below and let's talk. Thanks and have a great rest of your day.
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