Uncertain Opportunities

April 02, 2010

'Enthusiasm', 'regret' and 'fear' have accompanied healthcare investing in the past, and the landscape has only become rockier with the passage of the US healthcare bill, says Neal Morrison, partner at Pamlico Capital.

The healthcare reform law, enacted after a year-long heated political debate, is likely just the first step in healthcare reform as it does not address one of the most critical issues in healthcare today - cost inflation.

Those of us who focus on the healthcare industry and its numerous subsectors are used to constant regulatory change and storm clouds on the horizon. But this bill and prospects for subsequent reform require investors to possess even greater skill to navigate added change and complexity, and exploit current and new opportunities in this huge and growing industry. Given the sheer scope of the law, the many constituencies it impacts, and the jurisdiction it provides to regulators, analysing the longer term implications of the legislation is very difficult.

Fundamentally, the law significantly expands coverage, which will drive much greater demand for healthcare products and services. This increase in demand accruing to healthcare industry participants will be partially offset by the negative impact of industry taxes, reductions in government reimbursement levels and new regulations. The delayed implementation of the law will mitigate these positive and negative factors for the next several years as most major changes will not occur until the 2014 to 2016 timeframe.

The biggest changes will impact insurers. Insurers will no longer be able to deny coverage based on pre-existing conditions. Further, coverage mandates will expand their potential customer base. Going forward, they will face minimal limits on their ability to increase premiums to cover cost inflation. Undoubtedly, the insurers will use the implementation delay to make necessary business model adjustments.

The most worrisome aspect of the healthcare law is not what it does, but what it does not do and the longer term implications for the healthcare system and the U.S. economy. Most industry analysts agree that it does little to address healthcare cost inflation and its underlying drivers. Put simply, the law expands coverage without fixing the economic problems. And this practically guarantees that our country will be forced to enact additional major healthcare reform sooner than we know, which could have far greater impact on healthcare industry fundamentals, profitability and investing prospects.

Despite many people suggesting enactment of the law removes the overhang of uncertainty, experienced healthcare investors recognize we have kicked the can down the road and there remains a day of reckoning which may be sooner than we think.

Despite longer term macro level uncertainty, the main drivers which make healthcare an attractive industry for private equity investment remain intact. These include the sheer size and growth of the industry and its large and consistent need for capital across multiple and relatively uncorrelated subsectors, greater demand for cost-effective products and services and delivery models, and its need for increased automation and technology applications.

We are focused on investing in growth-oriented businesses that enhance both quality and value and improve the efficiency of the system, such as providers of healthcare information systems and services, physician and consumer aligned providers of outpatient healthcare services, and providers of pharmaceutical services, outsourcing and specialty distribution. The industry’s massive inefficiency and wasteful practices promise continuing growth and consolidation opportunities across multiple subsectors for all healthcare focused private equity investors.

When investing in healthcare, experience, skill, and most of all caution, are keys. Historically, this industry has evoked enthusiasm, regret and fear in the minds and portfolios of many private equity firms, and going forward it will get even harder to successfully navigate the healthcare investing waters.

Neal Morrison is a partner at Pamlico Capital.

Pamlico Capital

Pamlico Capital is a private equity firm founded in 1988 that invests in growing middle market companies in the U.S. Pamlico Capital seeks control-oriented growth equity and buyout investments of up to $75 million alongside proven management teams in its target industries, business and technology services, communications and healthcare. The firm, based in Charlotte, NC, currently manages over $2 billion in assets. Please refer to http://pamlicocapital.com for additional information.