The healthcare sector has shown growth year after year and demographic changes in the United States and abroad (longer life expectancies and an aging population) portend more growth to come. Moreover, changes in the industry, including the continued movement toward value-based care and an increasing focus on technology and data to reduce costs and drive results, make the industry an exciting investment opportunity for private equity. Private equity buyers, flush with cash from record fund-raising years, are poised to help drive health care deals in 2018 and beyond. Some of the trends and opportunities to watch include the following.
Industry Shifts: Going forward, private equity investors will increasingly have the option to invest in patient-centric, cash-pay companies rather than providers that primarily rely on government and third-party reimbursement models. For example, behavioral health, including the areas of addiction, autism, and other mental disorders, represents a new frontier in the health care industry and is increasingly viewed as an exciting area of investment. Growth in the behavioral health industry is being driven by an increasing awareness and lessening of the historical stigmas associated with, mental health issues. Coupled with the sense of urgency that often accompanies patients seeking behavioral health treatment (who are increasingly connected to behavioral health communities via the Internet and social media), the industry has transformed into a high-cash-pay, high-volume and high-growth sector. Furthermore, there has been a stratification of the behavioral health field, with certain areas migrating toward in-network coverage while others remain out-of-network and primarily cash-pay. This has created a dichotomy in the sector which presents opportunities for investors. Going forward the question of whether behavioral health will be able to demonstrate patient outcomes and value will remain the critical questions for the industry and its investors. Finally, the rise of digital health has led to an explosion of international investment and medical tourism, with international investors, often from China, exporting diagnostic and digital medicine models to their home countries.
Dedicated Healthcare Funds: Another trend that is set to continue is the recent rise of health-care-specific private equity funds. These funds not only have a have a high level of understanding of the field’s regulatory concerns, but also strong relationships with regulatory agencies. In the past, less-sophisticated investors have had difficulty understanding healthcare business valuations and deal structures due to an inability to economically quantify the industry’s risks. Now, industry-savvy investors are differentiating themselves through depth of reach and connectivity. Coupled with their newfound regulatory expertise, health care-centric private equity investors will be able to not only identify appropriate targets and close deals but, post-closing, they can fundamentally change the growth trajectory of the target business and drive the value needle.
Digital Apps, Devices and Disruption: Private equity investors will increasingly look outside the four walls of the hospital to alternative investment opportunities in patient-centric care. Ancillary services, which serve as a way to identify and eliminate adverse events, and ultimately as a means to reduce the overall costs of care, will continue to attract investment. Additionally, investment in companies providing health services digitally through digital apps and devices, and through telehealth and telemedicine (such as rural hospitals accessing physician specialists through web and phone conferencing applications), will continue to grow. These digital and patient-centric companies will continue to disrupt the industry, blur the lines of how and where care is provided, and affect how providers are paid. This growing portfolio of healthcare/technology hybrids will continue to create ample opportunity for private equity investors looking for targets and, ultimately, returns.
In December of 2015, some predicted we would see “‘continued strong’ activity in the food and beverage industry” heading into 2016. This appears to ring true as the first quarter of 2016 had a transaction volume of 117 deals in the Food and Beverage M&A space, not far below the record level of 127 deals in the fourth quarter of 2015.
In addition, the second quarter of 2016 has provided a number of private equity deals in the food and beverage space. These deals include GI Partners’ acquisition of Far Niente Wine Estates, Geneva Glen Capital LLC’s acquisition of Dianne’s Fine Desserts Inc., Fundcorp Inc.'s acquisition of Gigi’s Cupcakes and Patties Foods Ltd. acquisition by Australasian Food Group Pty Ltd. Private equity buyers already in the space continue to stay active as well, including a recent acquisition of Mesa Foods by Teasdale Foods Inc. (which is backed by Snow Phipps Group, LLC).
However, despite the recent acquisition activity in the food and beverage space by private equity buyers, strategic buyers continue to dominate the activity in the space. Year to date in 2016, strategic buyers actually account for approximately 90% of the food and beverage M&A transactions. This is up from the 87% of all such transaction in 2015. For North America and Europe, the buyers in 84% of M&A deals in the first quarter of 2016 were strategic buyers, so the food and beverage space remains slightly higher than average for acquisitions by strategic buyers. This is perhaps due to the high valuations and multiples that remain in the food and beverage space.
The folks at PitchBook have crunched the data for U.S. private equity deal activity in the first quarter of this year and have outlined some very interesting early trends for 2016:
1. Private equity’s “buy-and-build” strategy continues to be a significant portion of the private equity investment activity with add-on investments representing nearly 70% of the private equity investment activities in Q1.
2. Macro-economic uncertainty and a competitive middle-market lending environment continues to reduce the use of debt in private equity deals in Q1.
3. While deals in the lower middle market may require additional effort, funds continue to find attractive valuations in this segment of the middle market with a bit less competition.
4. U.S. PE-backed sales saw a dramatic decrease in Q1 (as compared to the same period in 2015) with only 198 completed sales and not one PE-backed IPO!
5. PE-backed exits remain robust in the healthcare, business-to-consumer, and financial services sectors.
6. Private equity fundraising remains strong. Of the 71 U.S. private equity funds closed in Q1, 98% of all these funds either hit or exceeded their fundraising target. (More info on this trend from PitchBook can be found here.)
7. The median size of U.S. private equity fund vehicles in Q1 were larger relative to prior years.
8. Notwithstanding the increased median size of fund vehicles, limited partners appear to have an increased appetite for smaller fund vehicles (between $250 million to $500 million) with focused and niche investment strategies.
9. There is a higher success rate of private equity fundraising due to increased limited partner demand for established fund managers and for new managers with unique/specialized strategies.
(For additional information from PitchBook, please click here.)
Thus, while private equity deal activity was off to a slow start in Q1, the strong fundraising environment demonstrates limited partners’ continued confidence in private equity as an asset class and in the ability of private equity managers to carefully and creatively execute on their focused strategy in an otherwise uncertain economic time to generate consistent and attractive returns for its LPs.
Three key takeaways arose for private equity investors in the food and beverage industry at Nixon Peabody’s April 13 Hot Topics event in Boston. Panelists included Peter Banat, CFO of Bay State Milling Company, Patrick Crocker, Managing Director of MHT MidSpan, David Krauser, Partner at Highland Consumer Partners, Nick McCoy, Co-Founder and Managing Director at Whipstitch Capital, and Leonard Pepe, Partner at Grant Thornton LLP.
In this interactive roundtable event, panelists discussed the significant changes that the food and beverage industry has experienced in the past five years.
Influence of millenials
More than ever before, millennials are a controlling force in the market. They are looking for convenience-oriented brands with “clean” labels. One panelist indicated that millennials pay closer attention to labels than any other age bracket, and have a tendency to put down a product if they do not recognize an ingredient. This has caused virtually every manufacturer, including operating companies overseeing vast supply chains, to try to get closer to their sources. Millennials also have significantly less loyalty to brands than prior generations.
From a buyer’s perspective, the most important factors in evaluating a target company are the possibility for growth, the company’s gross margins relative to peers, and the entrepreneur’s “story”. As many target companies in this industry are not yet profitable, profitability is not as important. But buyers typically seek to capitalize on a target’s gross margins, particularly if that buyer is a strategic company that already has the necessary infrastructure in place.
The panelists have seen PE buyers paying the same price as strategics for food and beverage companies, thinking that they will be able to sell at strategic-level prices when they exit. However, this could by a risky move for PE buyers. The panel agreed that strategics are more subject to changes in markets, and by the time a PE buyer is able to exit, strategics may have already made acquisitions in the relevant sector.
Legacy brands in decline
Many PE buyers are looking to replace legacy brands in their portfolios. Legacy brands are in decline, and the frozen foods sector has been hit particularly hard. There is significant competition in this part of the store due to new offerings from niche brands targeting millennials who are looking for healthy, convenient offerings.
With nearly 100 people in attendance at the event, it is clear that interest and activity in this sector are growing. Nixon Peabody’s Gregory O’Shaughnessy, David Martland and Philip Taub led the discussion. If you are interested in attending our ongoing Hot Topics in the Middle Market series, contact firstname.lastname@example.org.
2016 is a seller’s market, according to the panelists at our recent Hot Topics events. Investors, dealmakers and advisors came together in Boston and Los Angeles to discuss what’s on the horizon for private equity in 2016, including the impact of high valuations and rising interest rates on M&A activity, and the regulatory hurdles facing the financial institutions supporting the industry.
In Boston, panelists included:
• Gregory Bondick, Managing Director at Windjammer Capital Investors
• Jason Fennessy, Director at RSM US LLP
• Jay Hernandez, Director at Harris Williams & Co.
• Kevin Jolley, Managing Director at MHT MidSpan
• Matthew Keis, Managing Director at Gemini Investors
• William Nolan, Managing Director at H.I.G. Capital
• Andrew Shiftan, Managing Director at BHC Interim Funding, LP
The panelists had the following observations and predictions for middle market M&A activity:
Recap of 2015 – The past year had a healthy volume of M&A deals, with valuations in many instances at levels not seen since 2007. For many PE funds, fundraising was strong, giving these funds ample capital to deploy in 2016. The credit markets were also friendly to buyers with healthy balance sheets, giving many buyers sufficient cash to deploy on M&A activity. The health care and health care IT sectors were big winners in the past year, as companies and investors became increasingly familiar with the Affordable Care Act and corresponding investment opportunities. Brewery and SaaS-based businesses also drove high multiples.
The Year Ahead – The panelists agreed that while growth may have moderated, it is still a seller’s market. That said, sellers’ expectations may have started to exceed the market reality and valuations are likely plateauing. Despite this realization, the metrics driving deals will hold true. The middle market and lower middle market are a good place for buyers seeking reasonable valuations. Buyers who are flexible in terms of the capital structure of an acquisition and can provide certainty related to the closing of a transaction will continue to be more successful in competitive bid processes.
M&A activity will continue to follow growth sectors. The panel agreed that the natural and organics, outdoors, pet product and business services industries would remain hot. The pet products industry, for example, is growing faster than GDP and appears not to be affected by market cycles. The industrial sector will likely not fare as well, and finding growth here may be challenging. The revenue of companies in this sector is often tied to the oil and gas industry, which is hurting, and the U.S. dollar, the strength of which hurts companies who have operations offshore.
From a lender’s perspective, 2016 will continue to present challenges as banks, business development companies (BDCs), SBICs and insurance companies compete to deploy capital. Uneasiness will remain in the high yield market related to macroeconomic conditions such as the price of oil and China’s economy. At the upper end of the credit market, there is a lack of liquidity. Larger institutions are holding debt in industries like oil and gas that are not faring particularly well. Lenders are also facing regulatory pressure related to balance sheet requirements. The panelists agreed that only time would tell whether this uncertainty would trickle down to the middle market.
Speakers at our Los Angeles event included:
• Brad Meadow of SPK Capital LLC
• Andrew J. Howard of Shamrock Capital Advisors, LLC
• Naeem Arastu of Solace Capital Partners
• Saif Mansour of Breakwater Investment Management, LLC
• Brad Holtmeier of CriticalPoint Partners, LLC
• Yem T. Mai of Marsh Risk & Insurance
• Tracy Washburn Bradley of Fortis Advisors LLC
• Margaret Shanley of CohnReznick LLP
• Vince R. Lawler of Bernstein Private Wealth Management
Here are some of the key takeaways from the discussion:
Deal Environment – In general, 2015 was a sellers’ market with buyers competing for fewer quality assets and generally buyers paying top dollar in the process. With relatively modest economic growth forecasted in the U.S. for 2016, the consensus at the event was that corporate strategics would continue their strong pace of M&A activity in 2016 in an effort to acquire revenue streams to bolster their profits. Private equity funds would also deploy their abundance of “dry powder” in this environment on the buy-side (platform, add-ons, and growth investments), but would continue to do so only in a very selective and careful manner. Entrepreneurs and private equity funds will likely continue to seek opportunities to sell their companies, but should be aware that the high valuation environment may be showing signs of compression.
Valuations – Valuations remained high throughout much of 2015 and, in general, the increasingly elusive high-quality assets should continue to demand higher valuations in 2016. With that said, portions of the middle market (especially the lower middle market) showed signs of valuation misalignment between buyers and sellers during the latter part of 2015, and the general consensus is that this disconnect would likely continue in 2016. As a result, this misalignment has resulted in the increased use of earn-outs in the latter part of 2015 and will likely continue in 2016, especially in the life sciences and biotech sectors.
M&A in a Rising Interest Rate Environment – The general consensus is that the Federal Reserve’s anticipated gradual increase of interest rates should not dampen M&A activity in the U.S. in the short term, and that debt should remain generally available notwithstanding the volatility in the debt markets over the past few months. In the long term, however, there was some concern as to whether a higher interest rate environment in the near future might impact a private equity fund’s internal rate of return on companies bought today but sold in a higher interest rate environment in the future.
Preparing to Buy and Sell – Notwithstanding the competitive environment for desirable companies, the general view was that it is essential for companies approaching a sale today to engage in a thorough sell-side diligence process before engaging with prospective buyers. Such a process allows the seller to identify any issues that may impact the value of the business or the ability of the seller to close the transaction quickly. As noted during the discussion, the failure to identify and address issues before engaging with prospective buyers could result in a broken deal process, which could negatively impact the company’s business and valuation. On the buy-side, it was suggested that it is equally important for buyers to be patient throughout the process and invest the time to thoroughly understand the seller’s business and build stronger relationships with the seller’s management team – an evaluation and building process that may, at times, last more than a year. Spending that investment time, however, allows a buyer to fully understand the challenges and opportunities facing a company and gives the buyer the opportunity to be transparent with the buyer’s lending sources.
2016 Forecast – There was a cautious optimism that the M&A environment will continue to remain strong in 2016. Corporate strategics will remain active on the buy-side, who will likely do more “carve-out” transactions in 2016. PE firms will keep deploying capital, but they’ll continue to be patient and disciplined in their buy-side activities. Firms will also address the perennial issue of the “portfolio company overhang” and, in doing so, will continue to sell companies into a market with so many willing buyers. The new norm of rep & warranty insurance will continue in 2016 as more and more buyers obtain these policies in an effort to remain competitive for quality assets.
On April 30th, Nixon Peabody LLP hosted a Hot Topics in the Middle Market event entitled “Private Equity Investing Outlook: What is next for Consumer Products and Services” in its downtown Los Angeles office. Los Angeles partners Matt Grazier and Marc Kenny (Private Equity & Investment Funds) served as moderators for a roundtable discussion with several industry leaders in the consumer products space:
· Adam Abramowitz, Senior Vice President at Intrepid Investment Bankers
· Nick Desai, CEO at Snack it Forward
· Rachel Foltz, Vice President at Endeavour Capital
· Ryan Gallagher, Senior Counsel at Roll Global
· Derek Peterson, Director of Business Development at Transom Capital Group
· Peter Rosenberg, Managing Director at Duff & Phelps
· Margaret Shanley, Principal at CohnReznick
· Erik Snyder, CEO at Armada Skis
Here are some of the key takeaways from the discussion:
Valuation. Deal activity in the consumer products space continues to be very robust as private equity, angel investors, and strategics compete for acquisition targets. Price multiples are reaching levels similar to those typically seen in the high tech space, especially when the buyer is a strategic. Many types of consumer products and services companies are attracting high prices, especially health and wellness, beauty, food and beverage, and luxury products. Given the frothy market and high valuations, some potential buyers are wary of expending significant resources evaluating certain targets, especially when faced with an auction process where they may not be granted exclusivity or confident of winning the bid.
Preparing for a sale. Given the high valuations, the importance of due diligence and identifying quality targets has become even more essential. Buyers are digging deeper into the various financial metrics, the sustainability of the company’s products, the loyalty of the current customer base and prospects for expanding it, regulatory concerns, foreign currency risk, supply and distribution chain risks, talent, and many other areas. Well-run targets are taking steps, whether simple housekeeping or otherwise, to do their “sell side” diligence to expedite the buyer’s diligence and get ahead of any potential issues.
Impact of social media on brands. In the past, consumer products and services companies built their brands through traditional advertising and with the help of retailers selling their products. Typically, building a brand was slow and expensive process. With the advent of social media, such companies are able to build their brand more quickly and efficiently. In particular, newer and smaller companies are able to quickly reach the increasing number of modern consumers who have become attracted to brands associated with a unique community or experience. However, these fast and low cost branding opportunities have also increased the number of competing companies and the intensity of competition among such companies.
On February 4, 2015, Nixon Peabody LLP hosted a Hot Topics Event in our New York City office on the Private Equity Investing Outlook: What's Next for Food, Beverage & Agriculture. The speakers were David Benyaminy, a partner at AUA Private Equity Partners, LLC, Carlos Ferreira, a partner at Grant Thornton LLP, Benjamin Fishman, a managing principal at Arlon Group LLC, Christopher Huisinga, a managing director at Stephens Inc., Richard Langan, a partner in the Private Equity & Investment Funds group at Nixon Peabody LLP, and David Martland, a partner in the Global Business & Transactions Group at Nixon Peabody LLP.
Following are the top takeaways from this Hot Topics Event:
1. Healthy eating is not a fad but is now a way of life for many people.
2. There are a few trends to watch in the food and agriculture industry in the next couple of years from an investment perspective, including:
- The continued interest in natural foods, organic foods and foods that generally provide nutritional value;
- The snack food space, specifically healthy and natural based snacks;
- The growing interest and acceptance of ethnic foods in mainstream America;
- Focusing on boosting yields, such as specialized fertilizers; and
- Gourmet easy cooking at home.
3. There are numerous risks and challenges when investing in the food and agriculture industry, including:
- The volatility regarding the input and cost of food products;
- The regulatory environment surrounding food safety;
- Competition with new products; and
- Shelf space.
4. The main way to mitigate risk in this industry is diversification.
5. There is an increasing need to have an international presence in this space.
6. The following are some predictions for upcoming trends in the next 5 years, including:
- Ownership of farms whereby farms would be owned directly by investors;
- Eating good fats, such as avocados;
- Eating bugs and insects as protein; and
- Using technology in all aspects of the process, from the fertilizer to the delivery and consumption of food.
In light of President Obama’s historic announcement in December to revisit and revise the U.S.-Cuba relationship, U.S. firms interested in this emerging market will need to understand the current landscape and keep abreast of changes as the new U.S.-Cuba relationship evolves. Although many believe that U.S. firms will not be investing in the region for many years to come (see the recent article in Pensions & Investments entitled “No Gold Rush for Cuba Despite Diplomatic Thaw” found here), the private equity community is (or should be) closely following developments in the region in light of the number of potential opportunities in Cuba, which, according to one commentator, such opportunities could be anything “because Cuba needs everything.” In that regard, my colleagues in our Washington, D.C. office (Douglas Dziak, Alexandra Lopez-Casero and Lindsey Nelson) recently held a fantastic webinar that provides an extremely helpful overview of the existing U.S.-Cuba relations, the policy changes proposed by President Obama (and the new business opportunities coming from the President’s actions), and the political hurdles facing the new U.S.-Cuba paradigm. You can access the webinar where we answer your questions about investing in Cuba here. As noted in the webinar and referenced article, there are a host of issues that will obviously need to be addressed before U.S. firms start investing in Cuba, including, among others, the U.S. Congress’ removal of the existing embargo, convertible and non-convertible currency in Cuba, and legislative and other changes in Cuba with respect to foreign investment.
It has been said that “Rome wasn’t built in a day,” and the same is true for Havana with respect to U.S. investment in that country. But, notwithstanding the time and challenges ahead, U.S. firms interested in this emerging market would do well to start their preparations now by keeping close attention to the evolving regulatory, financial and political landscape impacting the U.S.-Cuba relationship.
As part of a recent year-end review of the Food & Beverage industry, Nixon Peabody attorney, John Moragne, had the following positive outlook on private equity's opportunities in the craft brew and spirits space:
"Craft brews are increasingly the choice for American consumers, and as the demographics of craft beer consumers shift (many are millennials), their tastes are changing as well. We’ll see more "big" companies entering the craft brew sector to stay competitive and maintain market share. Large producers and the private equity world have taken note of this boom market. Anheuser-Busch InBev acquired three craft brewers in recent years and MillerCoors’ craft division (Tenth & Blake Beer Co.) has taken a minority stake in Georgia’s Terrapin Beer Co. In the spirits world, new craft offerings have sprung up across the country and are ripe for private equity investment. Look for more industry-specific funds in 2015 and for the larger alcoholic beverage producers and private equity firms to continue to take stakes in the craft market, either through outright acquisitions or minority interests."
Unlike those in the venture capital community, private equity funds have historically been generalist rather than industry specialists. Yet, over the past few years, private equity firms have begun to tout their industry expertise to differentiate themselves in an otherwise crowded and competitive marketplace for LP dollars and deal flow. In fact, at Nixon Peabody's recent Hot Topic roundtable event in Los Angeles (see post), I asked our panelist whether they thought specialization matters. And, in response, some panelists noted that specialization did give private equity buyers an advantage over other non-strategic buyers in today’s competitive landscape. So, the query is whether such specialization matters beyond getting your foot in the door. A report published by Cambridge Associates concludes that “declaring a major” and specializing does, in fact, matter. According to the report (which can be found in link following this post), sector-focused managers outperform generalist managers on both an internal rate of return (“IRR”) and multiple of invested capital (“MOIC”) basis – sector specialists (in the consumer, financial services, health care and technology) returned an aggregate 2.2 times MOIC and a 23.2% gross IRR, handily outperforming generalist investments that returned an aggregate 1.9 times MOIC and a 17.5% gross IRR. Moreover, it appears from CA’s research that such sector-focused managers outperform their generalist colleagues regardless of the fund’s size or investment size. CA’s report can be found here. So, perhaps declaring a major might help not only in terms of winning competitive deals, but also in a fund's returns.