Valuation of Healthcare Service Sector Enterprises for Purposes
of Private Equity Investment: Introduction
(Part 1 of a 3 Part Series)

A growing number of private equity (PE) groups are approaching large physician-held groups and other healthcare service enterprises, including hospitals and outpatient enterprises, seeking investment opportunities in the clinical services industry. This influx of PE investment is not only ameliorating a dearth of financial capital available to healthcare service enterprise’s, but are also allowing these provider groups to “step up” to the next phase of growth by providing the management capital (e.g., resources, knowledge, skills, and ability) to facilitate the provider’s transition to value-based reimbursement.

PE is a capital funding source that is not available through a public exchange and is often utilized to: (1) expand a business; (2) fund new technology; or, (3) supplement an established entity’s working capital.1 PE investors often invest in an established (and perhaps faltering) business in hopes of restructuring the business and installing professional business management, with the ultimate goal of making the business more efficient and more profitable.2  It should be noted that this type of investing is distinct from venture capitalism (VC), as VC investors generally invest in the creation of a new business, 3 with the goal of capturing returns resulting from the large growth opportunities of start-ups over a short period of time.

While the global economic insecurity throughout 2016 resulted in a sharp decline in overall PE deals – spurred by uncertainty arising from events such as Brexit and the U.S. presidential election – PE deals in the U.S. healthcare industry hit a decade high in 2016, reaching $36.4 billion.4 This milestone (which will likely be surpassed in 2017, considering the current pace of deals5) continues the trend of significant growth in healthcare PE investment, during which PE deals soared from approximately $16 billion in 2013 to approximately $30 billion in 2014.6  These numbers indicate that, over the past decade, an increasing number of investors have become more knowledgeable about, and more comfortable with, entering a perilous market with complex regulation and uncertain reimbursement.7

Despite rising healthcare costs and the aforementioned volatility of the healthcare industry,8 PE investors have nevertheless been drawn to the stability provided by a reliably aging population with increasing demands for healthcare services; an influx of newly insured individuals due in part to the 2010 Patient Protection and Affordable Care Act (ACA); and, an increasing incidence and prevalence of chronic disease.9 Consequently, the healthcare industry has ranked in the top three industries in rates of return every year since 2011.10  This achievement has not gone unnoticed, as new investors such as generalist PE investors; sovereign wealth funds; pension funds; family offices; and, providers themselves, have invested in healthcare service sector enterprises, creating a new level of competition for general PE buyout funds.11  The increased interest in healthcare PE investment targets has been undeterred by the uncertainty surrounding the future of healthcare reform, possibly due,12 at least in part, to the sheer size and scope of healthcare (as it comprises almost 20 percent of the U.S. gross domestic product13).

Over the past couple of decades, the provider services subsector has ranked sixth in the healthcare industry in median returns.14 These provider service sector enterprises garnered particular interest from PE investors over the past several years, partly due to the success of the buyout of both for-profit, publicly traded health systems such as Hospital Corporation of America (HCA), and large, privately owned healthcare service sector companies such as ManorCare.15 More recently, the deal value for the U.S. provider sector increased from $7.3 billion in 2015 to $11.8 billion in 2016.16 Some of the more popular healthcare service enterprise PE targets included retail health (e.g., physical therapy) and dermatology.17

Moreover, providers themselves are launching other investment arms to support their service enterprise’s initiatives, focusing their investments in digital health, medical devices, and diagnostics.18 For example, in December 2016, Inova Health System, a large health system in the Washington, DC metropolitan area, announced the creation and launch of Inova Strategic Investments (ISI), which “…will invest in healthcare venture funds and will also invest directly into companies aligned with Inova's strategic priorities as part of Inova's vision to be a global leader in the delivery of personalized health.”19 Mid-sized hospitals are also seeking to invest, for example, Spectrum Health, a midsized health system located in Grand Rapids, Michigan, created a $100 million fund in 2017 “…to invest in personalized medicine, information technology, population health management and other emerging technologies.”20

Although the U.S. healthcare industry has been relatively unstable over the past several years, traversing: the paradigm shift from volume- to value-based reimbursement; the increasing regulatory scrutiny of healthcare transactions; and, the continuing uncertainty regarding the state of healthcare reform, the healthcare PE market is considered an opportunity for investors.21  PE investors have turned to specific subsectors that are more likely to remain stable amid the healthcare industry’s political, regulatory, and reimbursement volatility.22  The consistently high returns on healthcare PE investments have kept investment interest in the healthcare service sector high, resulting in increased valuations and a diversification of investors.

The future installments in this three-part series will discuss the special valuation considerations of these going concern enterprises, and will compare and contrast this PE investment trend with the failed physician practice management company (PPMC) business model of the 1990s.


“Private Equity” Investopedia, https://www.investopedia.com/terms/p/privateequity.asp (Accessed 11/10/17).

“What’s the Difference Between Private Equity and Venture Capital?” By Victor Hwang, Forbes, October 2012, https://www.forbes.com/sites/victorhwang/2012/10/01/presidential-debate-primer-whats-the-difference-between-private-equity-and-venture-capital/#7209c9fb3c45 (Accessed 11/22/17).

Ibid.

“Global Healthcare Private Equity and Corporate M&A Report 2017” By Kara Murphy et al., Bain and Company, April 19, 2017, http://www.bain.com/publications/articles/global-healthcare-pe-and-corporate-ma-report-2017.aspx (Accessed 11/10/17).

“Q&A: PE firms keep backing booming healthcare sector” By Adam Lewis, PitchBook, July 18, 2017, https://pitchbook.com/news/articles/qa-pe-firms-keep-backing-booming-healthcare-sector (Accessed 11/27/17).

Murphy et al., April 19, 2017.

“Private Equity Investment In Health Care Services” By Catherine J. Robbins, Todd Rudsenske, and James S. Vaughan, Health Affairs, Vol. 27, no. 5, September/October 2008, https://www.healthaffairs.org/doi/pdf/10.1377/hlthaff.27.5.1389 (Accessed 11/27/17), p. 1389.

“NHE Fact Sheet” Centers for Medicare and Medicaid Services, https://www.cms.gov/research-statistics-data-and-systems/statistics-trends-and-reports/nationalhealthexpenddata/nhe-fact-sheet.html (Accessed 11/22/17).

Murphy et al., April 19, 2017.

“Private Equity and Venture Capital Funds Underperformed Public Markets During Q3 2016” Cambridge Associates, April 5, 2017, https://www.cambridgeassociates.com/press-release/private-equity-and-venture-capital-funds-underperformed-public-markets-during-q3-2016/ (Accessed 11/27/17); “How Private Equity Picks Healthcare Winners” By Kara Murphy and Nirad Jain, Bain and Company, June 20, 2017, https://www.forbes.com/sites/baininsights/2017/06/20/how-private-equity-picks-healthcare-winners/#57db2fc12490 (Accessed 11/10/17).

Ibid; “Where Hospitals Are Investing And Acquiring In Private Markets” CB Insights, Research Briefs, June 16, 2017, https://www.cbinsights.com/research/hospitals-providers-startup-investments-acquisitions/ (Accessed 11/27/17).

Lewis, July 18, 2017.

“2016-2025 Projections of National Health Expenditures Data Released” Centers for Medicare & Medicaid Services, February 15, 2017, https://www.cms.gov/Newsroom/MediaReleaseDatabase/Press-releases/2017-Press-releases-items/2017-02-15-2.html (Accessed 11/27/17).

   “Capturing returns in healthcare” By Feby Abraham, Myoung Cha, and Garikai Nyaruwata, McKinsey & Company, July 2015, https://www.mckinsey.com/industries/healthcare-systems-and-services/our-insights/capturing-returns-in-healthcare (Accessed 11/27/17).

Robbins et al., September/October 2008; “Corporate Matters” HCR ManorCare, https://www.hcr-manorcare.com/about-hcr-manorcare/corporate-matters/ (Accessed 11/27/17).

Murphy et al., April 19, 2017.

Ibid.

CB Insights, June 16, 2017.

“Inova Launches Inova Strategic Investments and Inova Personalized Health Accelerator” Inova Health System, Press Release, PR Newswire, December 13, 2016, https://www.prnewswire.com/news-releases/inova-launches-inova-strategic-investments-and-inova-personalized-health-accelerator-300376716.html (Accessed 11/27/17).

“Midsize hospital systems taking the VC plunge” By Dave Barkholz, Modern Healthcare, March 4, 2017, http://www.modernhealthcare.com/article/20170304/TRANSFORMATION04/170309955 (Accessed 11/27/17).

Murphy and Jain, June 20, 2017.

Murphy et al., April 19, 2017.

Healthcare Valuation Banner Advisor's Guide to Healthcare Banner Accountable Care Organizations Banner