Digital health exits and investment in the sector have not been affected by the slowdown in private equity markets seen elsewhere in the early part of 2017.
In fact, investment levels in digital health in 2017 to date are tracking on par with 2015 and 2016, despite uncertainty in the healthcare sector amidst steps taken by the Trump administration and GOP to repeal and replace the Affordable Care Act. The expected slowdown in investor interest and M&A simply hasn’t materialized, indicating a surprising immunity for the sector to potential broad economic changes. According to recent reports, this week alone has seen $885 million invested in the digital health sector.
We see sustained interest from both strategic acquirers and private equity investors to invest at a strong pace in the healthcare market. This in part is due to the size and complexity of the healthcare industry issues in the US and the levels of spending required to address them – currently 18% of GDP, and still expected to rise. A problem this big breeds opportunity, and acquirers and investors are keen to be part of it.
While we have observed declining investment in other sectors, including technology, consumer and retail, it is simply not occurring in digital health. The healthcare problem is so vast that investment activity continues to be strong at about $4.3 billion each year.
One meaningful difference, however, is a trend toward fewer deals of larger amounts. This shift is partly due to a maturation of the cycle, which has led to the departure of the less informed and unsophisticated investor. Many have learned the hard way that digital health is not synonymous with technology for healthcare. This sector is far more regulated and is highly resistant to change, and therefore it is increasingly difficult to predict the potential winners and losers.
The departure of less sophisticated investors has cleared the way for healthcare experts to make strategic moves and select the highest quality startups from the pack. In fact, there were several significant investments made in the first quarter of 2017, including Patients Like Me ($100M); Livongo ($52.5M); and Vera Whole Health ($24M).
A Deep-dive Into Specialty Pharma
A specialty drug is a class of prescription medications used to treat complex, chronic or rare medical conditions. Although this classification was originally intended to define the treatment of rare, also termed “orphan” diseases, affecting fewer than 200,000 people in the US, more recently, specialty drugs have emerged as the cornerstone of treatment for chronic and complex diseases such as cancer, autoimmune conditions, diabetes, hepatitis C, and HIV/AIDS.
M&A activity continues to be strong, with McKesson leading the largest acquisition of the quarter in its purchase of CoverMyMeds for $1.1 billion. Other interesting moves in the market include WebMD and The Advisory Board both announcing a search for potential suitors.
Smaller players have been active too, exemplified by DirectPath’s acquisition of Patient Care, Mango Health’s $9 million financing from Express Scripts and PokitDok $5 million financing from McKesson.
A flight to quality
We are also starting to see what could be best described as a “flight to quality,” driven by the more discerning investor. Valuations have dropped significantly since 2014, when we often saw buyers pay over-inflated values for digital health companies. Today, those businesses attracting the most interest make existing health-related processes more efficient by connecting patients, providers and payers through easy-to-use technology. This trend is illustrated by Fitbit’s $15 million acquisition of Vector, a designer and developer of wearable technology aimed at streamlining the complexities of life.
But technology alone is no longer enough. The most successful companies have combined digital health technology with a service delivery component that ensures better and faster market penetration.
Broadly, the companies generating the greatest investor interest over the past several months tend to provide solutions in one of the following spaces:
- Patient engagement
- Analytics, artificial intelligence, smart machines
- Care coordination
- Telemedicine
- Wearables, biometrics
- Hospital administration
- Precision medicine
Activity in the public markets has reinforced the importance of these themes. Recent IPOs like Evolent, iRhythm and Teledoc have all enjoyed strong performances in early 2017 and, if that level of performance continues and more solid performing assets come on stream, it will translate into stronger M&A and equity markets. Still, many public digital health companies have smaller market capitalizations, which could negatively impact their ability to do deals. Big market cap players like Microsoft, IBM, Google, Accenture and Cognizant need to continue engaging in healthcare M&A to lay the groundwork for further activity and a truly dynamic market.
In terms of market consolidation, we will continue to see activity among networks of providers in sectors where new business models are emerging. There continues to be an aggregation of dental practices, behavioral health practices and radiology.
There is also consolidation activity in the patient engagement space, as these companies look to provide a broad, holistic platform that delivers multiple capabilities to provider and consumers as illustrated by the acquisition by WNS Global Services of HealthHelp, an industry leader in care management.
Four tips for entrepreneurs
In our role as advisers to entrepreneurs and private family businesses in the healthcare and digital health sector, I am often asked for advice by entrepreneurs who are considering an exit. While good counsel is tailored to the business and market conditions, there are a few perennial pieces of advice that almost always apply.
Revenue growth is imperative. Investors and strategic buyers want revenue visibility and quality. The chance to show a balanced pipeline of recurring revenue with high predictability will give investors and buyers confidence that you’ve found the right formula.
Demonstrate an ability to be profitable. While equity investors encourage businesses to grow and help fast-growing companies take on resources ahead of revenues, profits are also critical. Those very investors, along with the eventual buyers of your business, will require, at minimum, visibility into actual profits.
Corporate relationships can be a precursor to an acquisition. Spend time educating your ecosystem on who you are, what you do and what makes you different. Build your corporate relationships early, long before you are considering a financing or exit. Talk to potential buyers to see if there is a corporate relationship that makes sense. This will pay dividends in terms of process, trust and valuation, further down the road.
Differentiate your product or service offering. There is no shortage of good ideas out there. Building a product or finding a business model that is truly proprietary will separate you from the pack. That differentiation usually reveals itself in revenue growth – creating a solid cycle that drives value.
Photo: maxsattana, Getty Images
