In the fifth and final installment of McDermott’s HPE Europe 2020 Summer Webinar Series, McDermott partner Tom Whelan hosted a discussion with Marc Benatar of Apax Partners, Markus Peterseim of Alvarez & Marsal, and fellow McDermott partner Dr. Nikolaus von Jacobs to examine how the Coronavirus (COVID-19) pandemic is affecting deal making in the healthcare industry.

Pricing

“You’ve clearly seen a polarization,” Benatar said. “Nonessential businesses were hit hard by the lockdown effect and remain impacted, while those that were related to essential elements of healthcare were hit but started to experience a catch-up at the beginning of May and are already getting close to the normal run rate volume. I think that businesses that demonstrated that they are related to an essential part of the healthcare offering and that they can survive this type of crisis have almost strengthened their value. Those businesses that we know have experience with this first wave and those that are getting even more prepared for the next one will probably attract the highest valuations.”

COVID-19 has had a significant impact on the due diligence process, Peterseim noted. “When you’re advising investors on commercial or operations due diligence, there are always questions such as, ‘What will be the new normal of profitability? Will it be a swift recovery, like the typical V-shape for the essential companies that were not hit hard? What do you do with cost structure for those that faced a complete shutdown, and there was no revenue? Will there be fewer patients moving forward due to either consumer sentiment or the increased time required for disinfection between every patient?’ Those companies that really have been affected hard by the crisis have a harder time answering those questions, and have either pulled processes or postponed processes, while those that were not that affected are now back on the market with price expectations at pre-COVID-19 levels. Competition definitely is high, because the number of deals is low at the moment.”

Benatar agreed, noting that while the S&P market on the healthcare side was down by 30% at the outset of the crisis, it has now returned to normal levels. “Healthcare valuations have gone back up to where they were before the lockdown effect,” he said.

The fact that prices have bounced back to pre-COVID-19 levels, if not higher, has been surprising for many stakeholders, von Jacobs said. “Some sponsors have already experienced that they lose out on transactions because they were offering a good pre-COVID-19 level price believing that would certainly make the bid,” he said. “And then they have realized that somebody else bid 10% or 15% more, so there’s quite a gap. It has been a surprise to all players that prices have not really declined.”

Process

In light of COVID-19, dealmakers should carefully examine the product portfolio to evaluate to what degree it might be vulnerable to consumer sentiment or current changes in healthcare procedure volume. “A pharma company that produces, for instance, antibiotics used in elective surgery for hip or knee replacement will see slower sales because they’re not currently needed in the operating theatre,” Peterseim said. “But if a pharma is in life-saving cardiology or in oncology, there is steady demand, because life-threatening conditions will still be treated. You even need to take a look at things like the pace of recovery and capacity levels in hospitals to get people in to have procedures that were postponed while accommodating the new procedures coming along.”

Many deal making processes have adjusted to accommodate social distancing needs during the pandemic. “We’ve seen there are lots of things that can be done from a distance,” Benatar said. “We’ve done a couple of management presentations. We’ve done a couple of site visits. We’ve done a lot of due diligence during the lockdown period. And people adjusted very quickly. Even during these constrained times, I think we can manage relatively efficiently.”

Peterseim agreed, noting that due diligence can be accomplished in a variety of ways. “I did, for instance, my first remote operations due diligence when only two weeks into the project we ran into the lockdown,” he said. “And judging distribution networks, facilities, supply chain structures, manufacturing vessels going back and forth—it’s not that easy doing this by video, but there was enormous momentum within the companies and within the project teams to really accommodate virtual methods and not allow things to slip. I think just getting acquainted to the new means and modes went perfectly fine. Of course it’s better to have personal contact to build relationships and to have real good interaction, but at the end of the day, if a new wave comes, I think everybody will be very much used to these new methods.”

While remote engagement might be more difficult, it is vital to keep existing projects moving forward and to identify new opportunities. “The pipeline that was built over the past few months is still progressing, which is a good thing,” Benatar said. “But engaging in new discussions and new relationships is proving to be a bit more difficult right now. You need to make extra efforts to do that. Otherwise the pipeline will dry out.”

Timing

“Timing of the processes is getting back to normal, although slowly, because everybody has to ramp up again,” von Jacobs said. “It gets a bit more difficult when the United States is involved. But within Europe, at least, it’s really getting back to normal.”

Some businesses that were hit hard by the lockdown are experiencing a “catch-up” effect. “They are waiting until probably the end of the summer to be able to prove that the catch up actually exists before being able to sell on that basis,” Benatar said. “But for the essential businesses, we aren’t seeing more than two or three months delay in the process. These are strong businesses and their owners are pushing ahead as planned.”

Peterseim agreed that the pace of deals overall is improving. “I think those assets that managed to come through the crisis quite swiftly, they’re on the block now. And we will see, I think, a strong uptake and strong deal activity toward the end of the third and fourth quarter,” he said. “Other businesses might need more recovery time until, for example, we have found an effective vaccine so that people are not afraid to go to a doctor’s office or choose to get an elective procedure.”

Regulation

“We have certainly seen it get a bit easier to support innovation when it comes to vaccines,” von Jacobs said. “But consider what happened when the United States was interested in buying a big stake in a German biotech company which was producing a new vaccine. The German government raised its hand and said, ‘no way.’ So foreign investment control issues may come into play to a stronger extent here. And from an investor and valuation perspective, that may be good in the short term with less competition. But regarding exits over the long term, it’s bad. So it will affect pricing.”

The United Kingdom is introducing similar protective legislation on foreign investment, particularly around healthcare and essential infrastructure, Whelan noted.

“There is also concern about a Chinese ‘shopping spree’ coming into European markets and trying to get a grip on assets here,” Peterseim said. “So it will be interesting to see whether there will be real intervention on that front.

Supply chain regulation may also come into play. “Within healthcare, there has been a big discussion around nearshoring of certain supplies back to Europe,” Peterseim said. “Policies haven’t been spelled out so far, but a desire remains to have certain medications, medical equipment and consumer goods at hand. But it’s completely unclear who actually pays the bill when you nearshore back into higher-price labor markets in Europe from India or China. So, that is an area where you might need to watch out for regulation.”

The bottom line is that healthcare regulation is likely to increase. “Healthcare has been recognized as almost part of the core national infrastructure,” Benatar said. “So being able to buy and sell those assets will probably come under increasing scrutiny overall,” concluded Benatar.

Looking Forward

“The good thing is that a crisis like this one is the ultimate stress test on a business, and many businesses have proven to be really solid,” said Benatar. “We saw how management teams reacted. This was a good opportunity to shine, in a way, and to demonstrate that you can control your own destiny.”

“It’s been the ultimate learning laboratory,” Peterseim added. “I think we can now really see, country by country, what worked well and what could be improved. We can take best practices and really try to just take a step back from a regulators point of view and see what needs to be changed. And I think the winners versus losers in this game will definitely be those companies that adapt and drive change versus those that cling to their old operating model. Businesses need to use our current reality as the ultimate kickstart to rethink things and figure out how to best cope with them, country by country.”

Businesses that struggle with this transition likely will turn to consolidation, Benatar said. “The smaller scale businesses will suffer in crisis environment, even if they are focused on essential care elements,” he said. “And so the opportunity to consolidate the market is going to come.”