Despite Rising Interest Rates and Economic Uncertainty
Over the past several weeks, we have had numerous conversations with private equity groups, large, publicly traded home-based care companies, and healthcare lenders. Conversations have been as broad as the debt and equities markets in general (considering recent banking turmoil) and as narrow as specific transaction opportunities we have recently taken to market. These discussions and 16 years of healthcare services M&A history have allowed us to formulate our current thoughts on the M&A marketplace for home-based care. And it’s not all bad. In fact, a lot of it is very positive.
Interest Rate Impact
With rising interest rates, compounded by stresses imposed on the U.S. and international banking systems, debt financing is getting more challenging and certainly more expensive if you can get it, especially for larger transactions. This has created a shift in the M&A world.
On the one hand, financial theory will tell you that interest rates are fundamental to company valuation. As interest rates and uncertainty increase, the cost of capital increases, and investors demand higher returns. As a result, valuations will drop, all else being equal. However, we have a significant supply/demand imbalance of quality Care-at-Home agencies on the market.
At the high end of the market – transaction volume in the ~$100M to $1B+ has come down as capital has become more expensive. At this end, transactions tend to be much more highly leveraged. So, we’re seeing fewer large “platform” transactions.
Because of this, and the public home care companies' lower overall valuation, many private equity-backed portfolio companies have delayed their exits, opting to double down on smaller ‘add-on’ or ‘tuck-in’ transactions. Generally speaking, private equity still has significant dry powder to invest as they continue to close new funds.
At the lower end of the market, demand and, therefore, valuations are as strong as ever.
“A lot of agency owners see the lower transaction volumes and hear the news of the financial markets and assume that demand has diminished. We have not seen this at the lower end of the market, say companies in the $3 million to $50 million range, which is where the majority of transactions occur,” said Mertz Taggart Managing Partner, Cory Mertz. “There are no hard lines here in terms of valuation, but generally speaking, the top has come off the high end of the market from the 2021 highs. We will not see a lot of transactions with valuations in the mid- to high-teens right now. But the lower end of the market is holding up fine. I can make the case that values for companies in this size range are higher today than before interest rates started to rise.”
Supply and Demand
So what is allowing values to stay afloat despite the current interest rate environment? It’s all about supply and demand.
The supply of quality agencies going to market is low due to two factors:
Owners accelerated their exits in 2020 and 2021 to avoid the not-yet-seen capital gains tax rate increases. One of the current administration’s priorities was double the capital gains tax rate from the current 20%. This created the rush to sell, which only subsided in late 2021 after it was clear this legislation didn’t have legs. This drove record transaction volumes in those two years but left a shortage of quality providers wanting to sell in 2022 and 2023.
The perception is that valuations across all sizes must have come down due to rising interest rates.
On the demand side, many PE-backed acquirers have postponed their exits. Those portfolio company transactions tend to be more highly leveraged, where the cost of capital will significantly impact valuations. Public company valuations have also come down, impacting the price they can pay for large PE portfolio-type companies seeking a transaction.
Generally speaking, private equity has the mandate to grow. So many PE-backed portfolio companies have doubled down on ‘tuck-in’ or ‘add-on’ acquisitions, which they can fund using the increasing piles of cash, both on the company and fund balance sheets
“To be fair, buyers have gotten more disciplined in many ways,” said Mertz. “In some cases, they have honed in on what opportunities they want to pursue. In some cases, they’ve narrowed their criteria in terms of service lines/payors and geographies. Others are less likely to stretch on synergies they’ll factor into their valuation models or to look the other way on a small quality of earnings miss. As a result, we may end up getting fewer offers for an opportunity we take to market, but the offers we are getting are as strong as we’ve seen.”
Interested in a confidential, complimentary valuation? Please contact us at firstname.lastname@example.org.
The Resurgence of Private Duty Home Care M&A - [...] 2018 was a booming year for health care M&A activity. That’s especially true when it comes to private duty home care transactions...
Treatment Center Value Insights: It’s All About the Multiple (…Or Is It?) - [...] I would go as far as saying it’s irresponsible to give guidance simply in the form of...