John Newton, co-lead of the European private equity transactions practice at Ropes & Gray, explains why private equity investment in healthcare and pharmaceuticals is about to pick up.
The deal volume for healthcare mergers and acquisitions (M&A) activity in the UK remained steady but not exuberant in the first half of this year.
According to the latest UK healthcare M&A report from Heligan Group, the number of deals was broadly in line with the same period last year. There were 134 deals, dominated by health and social care, and healthcare IT, which made up almost three-quarters (74%) of deal volume. This is up from 51% in the same period last year.
Digging into the data, however, two points jumped out. What was noteworthy first of all was the decline in pharma and life science deal volumes, which has long been the superstar of M&A activity. Deals in that sector slipped from 29% to 24% of the total number of deals.
The other point was the decline in private equity interest. The landscape, instead, was dominated by trade buyers who accounted for 84% of deals, while private equity has kept its focus on bolt-on acquisitions.
To explain what has been driving the changes, Healthcare Today sat down with John Newton, co-lead of the European private equity transactions practice at law firm Ropes & Gray.
Greater expertise
“If you look back 20 years, private equity’s involvement in healthcare was largely limited to areas such as nursing homes. Anything beyond that was considered too technical, and the funds often lacked the expertise to venture into pharma or more complex sectors. That picture has changed dramatically over the past decade,” Newton says.
Now, he continues, many funds have dedicated healthcare teams, and in larger private equity firms, you might expect half or more of a ten-person team to have a scientific background, even if only at a university level. In addition, some funds have established specialist life sciences arms, whether standalone or as part of a bigger private equity house, which focus on earlier-stage investments and drug development. The people in those funds tend to be genuine experts, often with the unusual combination of scientific training, investment banking experience and financial acumen.
The result is that private equity has become much more sophisticated and engaged with the full spectrum of the life sciences industry. Firms are hiring the right talent to give them that capability. For those with the expertise, there are few areas offering greater potential returns than investing in healthcare and life sciences through private equity.
The surge in private equity investment in healthcare, particularly life sciences, over the past five years, Newton says, has been driven by a belief that large pharmaceutical companies were happy to outsource many non-core functions. This led to a boom in investment in areas such as contract research organisation (CROs), contract development and manufacturing organisations (CDMOs) and active pharmaceutical ingredient (API) manufacturers.
“The reality has been more complicated,” Newton says. “Many funds that acquired these businesses two or three years ago are finding that they are not performing as well as expected,” says Newton.
Several factors, he continues, have contributed to this, including an unhelpful tariff situation and the idea that US pharmaceutical companies would eventually reduce their reliance on Chinese outsourcing and turn to European providers. It has not been as smooth a transition as expected.
“There are signs that pharmaceutical companies are not as comfortable with outsourcing as once assumed, and globally there has also been a degree of pullback in drug research,” he explains.
Three years ago, the private equity thesis was that pharmaceutical services represented a huge growth opportunity. In reality, it has turned out to be much more complicated, which is why this year there has been less activity in that sector. “It is a highly complex business with significant compliance demands, and [private equity firms] have had to devote substantial time to getting both the regulatory side and the management team in order,” Newton says.
Where private equity funds are investing, he explains, they are shifting away from services and asking instead how they can participate more directly in the profits from selling drugs.
Put bluntly, private equity firms are all looking for the next Ozempic.
The next generation
While the figures may not be much to shout about for the first half of the year, Newton is adamant that investment will return.
“Private equity funds are, by their nature, cyclical – they have to invest money, that’s their job,” says Newton. “They can shift between sectors, but most make a commitment to their investors that a portion will go into healthcare and life sciences. So even if focus has swung elsewhere for now, the cycle will eventually bring them back.”
The other reason to be optimistic is where many private equity firms are in the current investment cycle. Many funds that invested heavily two or three years ago have spent the past year or so working hard on their portfolios – refinancing businesses, making management changes, adjusting models, or doing bolt-on acquisitions to drive growth. “That work is now largely done,” he said.
Private equity firms are now at the point where they can focus on growth ahead of an exit and will need to look ahead to the next generation of investments.
“I sense that the shift is beginning. Mentally, people are starting to plan for what comes after the 2021-22 cycle, when everyone was buying aggressively. That wave will run through to 2026-27. But attention is already turning to what follows,” he concludes.
