As the human and economic toll of the coronavirus pandemic has mounted, companies across industries have fallen into distress, including in the health care sector. As they look for a lifeline, private equity firms are in position to put some of their significant cash on hand to work.
Many of these deals will be found in private capital markets. But the public markets can also provide a leading indicator of the deal-making to come. Revenue and earnings guidance have been lowered or removed, distressed bond trading has skyrocketed and the health care operating environment grows more challenging by the day.
Corporate guidance can indicate executives’ overall outlook on the economy, the sector in which they operate and their own companies. So far this year, 135 publicly traded U.S. companies with a combined market capitalization of more than $1.5 trillion have lowered revenue guidance.
Of those 135 companies, 29 are in the health care sector, the largest of which include Bristol-Myers Squibb, Gilead Sciences and Centene. In addition, 73 more companies, with a market capitalization of $4.8 trillion, withdrew guidance altogether, including Boston Scientific and Quest Diagnostics, an important company in coronavirus testing.
From the fixed income perspective, we can look to the prevalence of distressed bonds. The number of distressed issues traded, according to TRACE, is now the highest in the history of the index, eclipsing levels reached during the financial crisis. A higher volume of distressed bonds has a clear negative correlation to overall financial conditions.
More specific to the health care ecosystem, there has been extreme volatility in the spread between high-yield and investment-grade municipal bonds. Since January 1, the spread between high yield and investment grade municipal bonds has exceeded 1,000 basis points, a multiyear high.
While this spread has surged in prior periods, it has generally not been coupled with a rapidly changing health care environment.
In response to the coronavirus outbreak, the federal government is pouring hundreds of billions of dollars into the health care system while the Department of Health and Human Services and the Centers for Medicare and Medicaid Services briskly alter reimbursement, prior authorization and other rules. At the same time, providers and patients are delaying and canceling procedures, putting further strain on the health care ecosystem.
Some companies in the health care sector will emerge leaner and stronger on the other side of the pandemic. Others will not. This will create opportunities for investors, as periods of economic dislocation always do.
Private equity firms in particular stand poised to capitalize on such opportunities. Health care private equity funds of all sizes in the U.S. have $165 billion of dry powder. Over the short term, this capital has been committed by limited partners, so the “demand” for acquiring health care companies is fixed. And given U.S. demographic trends and susceptibility to future disruption, we do not expect investors’ demand for health care to meaningfully decline over the medium to long-term.
As the financial and competitive conditions force more health care companies of all kinds to liquidate or seek outside financing, the supply of investment opportunities will increase. This will push down valuation multiples since the demand will not likely decline. In other words, not only will the number of potential deals expand but the price that both strategic and financial buyers pay will also decline.
The takeaway
As the dust settles from the initial shock of the coronavirus pandemic, investors must prepare for the new normal of deal making: lower multiples and distressed assets.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center
