Health investing: waiting lists and a waiting game

Odgers Healthcare Partners SJ Leatherdale and Carmel Gibbons, and Head of Private Equity Solutions, Ross Gordon discuss health investing trends with expert in the field Vernon Baxter, as a general election looms closer.

Few follow the health investing space with as keen an eye as Vernon Baxter. For over 13 years he had his finger on the pulse of M&A and PE activity in UK healthcare as editor and then managing director of HealthInvestor, before moving on in March 2022 to establish the global health tech division of impact intelligence provider HolonIQ.

Today, Vernon has a portfolio consultancy career which includes supporting the expansion of leading healthcare management consultants Carnall Farrar’s (CF) investing practice and working with clients across commercial and operational due diligence, value creation and growth strategy consulting. He maintains an ongoing relationship with HolonIQ, for example presenting at major healthcare and health tech conferences, and also works directly with a range of independent clients.

We asked Vernon for his insights into the health investing market. He began by explaining why right now there is something of a waiting game. “The wider deal market is becalmed currently and this is impacting everyone in the health M&A chain. Activity is expected to pick up in the second half of 2024, or even early 2025. There’s a mindset that this could be the bottom of the market; therefore, if you have the ability to wait, why wouldn't you?”  

Political uncertainty is also in the air with a UK general election set to take place by January 2025 at the latest. And at a macro-level there are concerns over what another Trump presidency would look like if it came to pass and the implications, given the international situation, if there was a big rise in defence spending.

Nevertheless, there are grounds for optimism. Once conditions improve and the political landscape shifts, there will be opportunities – many of them in relation to improving productivity across a health system suffering from record low levels of public satisfaction.

The size of NHS waiting lists is a controversial issue and underlines the fact that the UK faces a major inefficiency problem with its healthcare system. CF research shows that every month, more people are referred to the elective care waiting list than are treated, meaning there is a gap of c.18% to achieve the 18-week standard maximum waiting time. In healthcare productivity terms, this is a yawning chasm.

In 2023, Keir Starmer pledged funding for an additional 2 million elective appointments a year, but even if the Labour Party comes to power it will have to move mountains to bring waiting lists down to Business As Usual targets. Inevitably, frustration at long waiting times for NHS treatment has fuelled a rise in self-pay. 

“People have been driven to self-pay, especially for things like quality-of-life treatments such as hip and knee procedures, or lower down the chain areas such as dermatology, varicose veins,” says Vernon. “One obvious area of this is ophthalmology and there has been a spate of ophthalmology deals. Overall, there is a lot of interest on the areas where there's the most tension on the healthcare system. That is where there are opportunities for the independent sector. If you take the assumption that the primary problem for the NHS is a productivity issue and then look at the types of businesses that are succeeding, it's ones that offer services that reduce cost and increase throughput.”

That said, providing clinical solutions tends to be capital intensive and some PE investors are more excited by SaaS business models designed to improve management efficiency, for instance in areas such as staff rostering – a perennial challenge in healthcare. Investment in taking cost out of the system without financing bricks and mortar can be an attractive proposition.

Political reform of the NHS has mostly stalled over the last six or seven years, says Vernon. As a result, he adds, if a Labour government is elected there is optimism in the independent sector that there will be a fresh sheet of paper and the right conditions to develop some new models. From a PE perspective, pushing the reset button on engagement with a new administration would be welcome.

“There's vast opportunity for more ambitious thinking to unlock the productivity gains of innovation across healthcare,” says Vernon. “That's what I'd love to see. But you've got to lean into the complexity, engage expertise and truly understand how funding moves through the system. These things are what the smartest investors do in the market.”

The biggest barrier is the cost of capital with PE investors having to tweak their models post the cheap money era. Within the dealmaking community, Vernon asserts, a “survive to 2025” mentality is prevalent in many firms.

“The fundraising market for private equity has been poor in 2023 and early 2024, so those firms looking to raise fresh capital have struggled. This is further hampering deal activity,” says Vernon. This contrasts with an almost unbroken succession of successful fundraising over the past 15-20 years where low cost of capital has fuelled a private equity boom.

Stuttering performance has sent a wave of nervousness through the dealmaking community and there is a tension between inertia and a compulsion to act. One side effect is that the deals that do get off the ground almost look over-priced because of a rush among investors to acquire solid assets available in the market.

In terms of valuations, Vernon says that it was the health tech sector in particular where things “went crazy” three years ago: HolonIQ measured that more than $100 billion in venture capital was raised in 2021 alone. In comparison, the figure for 2023 was just $18 billion.

Although a huge amount of money was raised in 2021 there was something of a “healthcare tourism” phenomenon at play, with only a small number of investors following their money. And the number of unicorns [businesses valued at $1 billion or more] in the space has plunged from around 150 to less than 50. This correction in valuations comes with a hangover: understandably no one wants to do a “down round” of fundraising at a lower valuation.

While health tech is its own conversation, on the health services side markets have not lost their pricing discipline, largely because of how such asset-backed investments are structured, with much of the value and risk in the business sitting on the property side. Valuation multiples here have stayed broadly in the “eight to 12 times” range, with the best businesses achieving the upper end.

In some cases, margin has been eroded by rent rises. ““Healthcare investments by their very nature require a long-term mentality. The sector’s defensive qualities attract a certain type of investor but it can often lead to businesses being laden with heavy amounts of debt, due to the capital expenditure required,” says Vernon. “Good businesses can come unstuck quite easily if they are over-leveraged and the market changes.”

Management teams may be tempted to do a 20-25 year “propco deal in return for jam today”. But there can be dangers in such an approach as was seen over a decade ago with the collapse of care home operator Southern Cross and more recently Four Seasons Health Care.