Feb 2, 2019 | Techcelerate Ventures |
Health IT & Health Information Services Semi-Annual Market Review January 2019 www.hgp.com Copyright 2019 Healthcare Growth Partners Health IT & Health Information Services: Market Review January 2019 Table of Contents Health IT Executive Summary 3 Private Equity Survey Health IT Market Trends 6 20 HIT M&A (Including Buyout) 23 Health IT Capital Raises (Non-Buyout) 28 Healthcare Capital Markets 29 Macroeconomics 33 Health IT Headlines 34 About Healthcare Growth Partners 40 HGP Transaction Experience 41 Appendix 44 1 2 3 4 5 6 7 8 9 10 11 Health IT Executive Summary It's Getting Louder in Here! If there is any change that we have noticed in the Health IT M&A and private equity world since HGP's founding in 2006, we would boil it down to one word: Noise. Talk to any corporate CEO, and they will tell you that they receive multiple calls or emails in a given day or hundreds of calls in a given year, mostly from private equity (and, admittedly, from our peers in investment banking). The level of noise did not increase overnight, but in the last few years it appears that the competitive dynamics within Health IT private equity have reached a new level of ferocity due to the following: Collectively, the number of funds pursuing Health IT, the overall capital base, and number of outbound calls per fund has compounded to a level that is empowering executives and leaving many investors feeling exasperated and sometimes wondering whether winning a deal in this hyper-competitive environment ultimately means they were the ones crazy enough to pay the highest price. Investors will be happy to know that based on our latest Health IT Private Equity Survey, they are not crazy (at least the majority that responded to our survey). Copyright 2019 Healthcare Growth Partners 3 Health IT is a Maturing Sector with a Strong Thesis and Proven Returns More Capital Competing for Deals Increasingly Automated Digital Marketing and Communications NOISE! 1 2 3 1 1 2 3 As a sector, Health IT has reached a level of maturity that makes it core to the investment thesis of most software- and business services-oriented private equity investors, expanding the number of funds targeting the market. The amount of private equity capital has ballooned, and funds, large and small, are widening their investment criteria to compete further downstream, source more creative transactions, or simply pay the highest price. While still remaining disciplined, investors have a surge of capital to put to work across a market of private companies that has not increased at the same rate. Private equity investors are increasingly leveraging sophisticated CRMs, company databases and tapping digital communications and content-based marketing to expand their reach and their brands. Many investors utilize these tools to approach deal origination with a volume-based strategy that can dilute the efforts of a value-based strategy for everyone. Health IT Market Specific Private Equity & Structural Paradigm Copyright 2019 Healthcare Growth Partners 4 Health IT Executive Summary It's Getting Louder in Here! While the market is hypercompetitive and private equity investors may feel as though valuations are priced to perfection, the reality is that investment valuations are priced to perform, and, based on the findings from our latest Health IT Private Equity Survey, they seem to be doing just that: Aggregate Health IT valuations have remained relatively steady in recent years Health IT trades at comparable valuations to Enterprise SaaS 1 Health IT Revenue Multiples by Period Date Range xRev Median Median Deal Value # of Disclosed Deals 2013 2014 3.90x $109.4 52 2015 2016 3.85x $116.6 78 2017 2018 3.74x $180.0 60 2018 Only 4.62x $215.7 25 We'll be the first to admit that Health IT is as competitive as any segment in the market. And while it may not feel this way, our data indicate that aggregate HIT valuations have been stable in recent years. Valuations ticked up in 2018, a trend we will closely monitor for significance. y = 14.524x + 3.574 R = 0.413 y = 20.025x + 2.7032 R = 0.4163 0.0x 2.0x 4.0x 6.0x 8.0x 10.0x 12.0x 14.0x -10.0% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% EV/2019 Revenue Estimate2019 Expected YoY Growth Rate Enterprise HIT Linear (Enterprise) Linear (HIT) To make the comparison, we performed a simple regression analysis of Health IT and Enterprise SaaS. Put another way, we compared revenue multiples to growth rates across the two sectors to determine whether the two markets are valued similarly when growth is the primary consideration. As evidenced by the best-fit lines, Health IT trades at comparable valuations to counterparts in Enterprise SaaS, at least using this basic formula across a sample size of 40 publicly traded companies. Looking at our survey data, in 2016, Health IT was viewed to trade at a premium to Enterprise SaaS. Based on our 2018 data, the results are more evenly distributed such that Health IT is now viewed to trade in-line with Enterprise SaaS. Does Health IT Trade at a Premium to Enterprise SaaS? Response 2016 Survey 2018 Survey Yes 52% 34% Maybe 34% 45% No 14% 21% The regression data can be used as a guidepost for SaaS valuations. Using the y-intercept as a measure, at a 0% growth rate a HIT SaaS company can expect to trade at 2.7x revenue. For each 10% increase in growth, there is approximately a 2x increase in revenue multiple, and the steepness of that slope underscores the importance of growth for the public company set. This is just one admittedly oversimplified way of looking at the very complex formula of valuation. Copyright 2019 Healthcare Growth Partners 5 Health IT Executive Summary It's Getting Louder in Here! Health IT investments are generally living up to expectations, and, if anything, there is increasing investment interest rather than increasing fear of a bubble Based on the 105 participants in our 2018 Health IT Private Equity Survey, private equity investors are more than satisfied with their Health IT investment performance and strategy. Only 5% of respondents reported that Health IT is not living up to their investment expectations. When asked whether Health IT is in a bubble, the mix of responses did not shift materially from our 2016 survey, with 28% responding that Health IT is in a bubble today versus 25% two years ago. Valuations correlate with expectations, and expectations for Health IT are high, but they've been at these levels for years. A breakdown occurs when reality does not meet expectations, and even deep into this investment cycle, this has yet to occur. Taken together, valuations are priced for performance more than perfection. Given the confluence of favorable fundamentals, the Health IT market is performing and has a strong thesis to do so for years to come. However, valuations are priced with little margin for error, and in order to sustain performance over the course of time, competitive dynamics will force investors to either step up or step out. We hope that amid the moral hazard of healthcare, investors seek the high road of driving strong returns while supporting the greater good of health and wellness. 1 0% 20% 40% 60% 80% 100% 2016 2018 Is HIT in a bubble? Yes Maybe No 0% 20% 40% 60% 80% 100% 2016 2018 Is HIT living up to expectations? Yes Maybe No Copyright 2019 Healthcare Growth Partners 6 HGP 2018 Private Equity Survey Results and Commentary Survey Background HGP surveyed hundreds of private equity funds across all stages and received 105 responses. Responses concentrated toward Growth Equity and Venture Capital investors, who respectively invest in early and earlier stage companies. The distribution of responses across the stages of investing is consistent with the distribution of investment activity across the company lifecycle. The majority of institutionally funded health IT companies are receiving venture and growth investments, with relatively fewer buyout transactions. This investment distribution pattern is consistent across almost any growth industry. It is important to note that our survey likely has selection bias, which we cannot fully assess given the confidential nature of the survey response data. Anyone with a propensity to respond to a survey about investing in health IT is likely to have stronger interest in health IT than those who did not respond to the survey. Furthermore, we are more likely to generate responses from individuals who are familiar with HGP, and HGP generally interacts with investors interested in health IT transactions. It is safe to conclude that our survey findings have a bias toward respondents who are more interested in health IT investments than not. However, we believe that the data set is broad enough to be meaningful and deliver insights, particularly in mapping out the priorities and criteria of active health IT investors. We begin by summarizing the composition of respondents. Q1: What type of fund do you manage? Q2: What is the size of your most recent fund? *3 respondents did not answer this question 2 Venture Capital, 34% Growth Equity, 41% Buyout, 25% < $100mm $100mm - $500mm $500mm - $1B > $1B Total Venture Capital 21 13 1 1 36 Growth Equity 4 19 11 7 41 Buyout 3 12 6 4 25 Total 28 44 18 12 102 Most Recent Fund Size Copyright 2019 Healthcare Growth Partners 7 HGP 2018 Private Equity Survey Results and Commentary Q3: Do you seek a certain revenue threshold for your investments? The response to this question highlights the key distinction of revenue criteria between each investor category. 100% of Venture Capital respondents have a revenue threshold under $5mm with 53% having no revenue threshold at all. This result shows a shift from the 2016 survey results which showed 13% having a $5mm threshold. This news appears exciting for young companies as it indicates that the vast majority of Venture Capital funds having low thresholds and potentially a large share are willing to invest in companies under $1mm. However, it is important to note that as the revenue threshold shifts to being entirely $1mm or none, the opportunity (aka, competitive) set grows larger. Institutional funding for pre-revenue companies remains nearly impossible with funding odds increasing with the proven background and credentials of the entrepreneur. On the other hand, 79% of Growth Equity investors require revenue in excess of $5mm which is consistent with the 83% from the 2016 survey results. However, just over a quarter reported a threshold greater than $10mm, which is a drop from over half in 2016. This drop is consistent with what we saw among venture investors and is in-line with our perspective that investors across the board are stretching into the lower end of their investment criteria to put capital to work in health IT. While $10mm in revenue no longer appears to be a key threshold for Growth Equity investors, it remains key for Buyout investors, with 69% requiring $10mm as a threshold (exactly the same as 2016). What differentiates Growth Equity from Buyout is control and profitability. Buyout investors typically make control investment by buying out the interests of existing shareholders (secondary purchase), often with the help of debt (or leverage) which generally requires profitability to borrow against. Growth Equity investors may buy some secondary shares, but they mostly deploy cash into newly issued shares of the company that is then utilized to make investments in growing the team, expanding the product, or making acquisitions. 2 53% 12% 22% 47% 9% 4% 0% 51% 13% 0% 26% 43% 0% 2% 17% 0% 0% 9% 0% 20% 40% 60% Venture Capital Growth Equity Buyout % of Funds Responding to SurveyNone $1mm $5mm $10mm $20mm $50mm Copyright 2019 Healthcare Growth Partners 8 HGP 2018 Corporate Survey Results and Commentary Q3: Do you seek a certain revenue threshold for your investments? (Continued) The data on revenue thresholds underscore the continued immaturity of the health IT market as well as the vast amount of capital chasing a still relatively small sector. Venture Capital and Growth Equity investors continue to shift towards lower revenue thresholds allowing low revenue companies to choose from an increasingly wide array of investors. This relatively low revenue threshold is undoubtedly bolstering valuations, heightening competitive dynamics across investor classes, and creating opportunity for large returns for early stage companies and investors who can grow into this highly sought investment tier. On the other hand, the large number of well-funded vendors makes for a very competitive market landscape. Due to the scarcity of larger platform investments relative to the supply of capital seeking those investments, many buyout investors are making investments near or even below their minimum investment threshold. This has several implications. For one, buyout investors are competing with Growth Equity investors, resulting in competition that may raise valuations. When reaching downstream, buyout investors are making smaller platform investments but still have the need to deploy capital, which may result in a desire to put additional capital to work through follow-on acquisitions by the platform investment. The latter point is driving significant M&A activity. Private equity backed platforms present an excellent landing spot for earlier stage companies to exit, especially if those early stage companies might consider a deal that involves a portion of the transaction consideration to be paid in the form of rollover equity or earnout. Q4-5: How do you prioritize Health IT as an investment vertical? Approximately how many platform (excluding add-on) Health IT investments has your fund made since 2016? We broadly define Health IT as any health software, data, information, consulting, or technology enabled outsourcing company that may serve providers, payers, pharma, employers, or consumers. This includes both health software and health business services. 2 28% 45% 27% Opportunistic (50%) 18% 31% 23% 28% 0% 5% 10% 15% 20% 25% 30% 35% 0 1-2 2-5 >5 % of Funds Responding to SurveyHIT Investments since 2016 Copyright 2019 Healthcare Growth Partners 9 HGP 2018 Private Equity Survey Results and Commentary Q4-5: How do you prioritize Health IT as an investment vertical? Approximately how many platform (excluding add-on) Health IT investments has your fund made since 2016? (Cont.) Of the 105 responses to our survey, a little more than focus the majority of their investments on health IT, a similar share are opportunistic (10X Software Services Health IT M&A (Including Buyout) Health IT M&A Activity The following chart summarizes annual M&A activity since 2013, according to the Healthcare Growth Partners database. While deal valuation has remained healthy, the volume of Health IT M&A activity seems to have leveled off since 2016, and 2018 has been no exception to that rule. After 372 transactions in 2017, health IT M&A activity remained steady in the 350+ range, closing 358 transactions in 2018. Total transaction value tends to be much more volatile than deal volume since it only takes one or two very large deals to skew the data and the majority of transactions do not disclose value, thus HGP looks toward transaction volume as a better indicator of deal activity. Generally, sub $100 million companies have three valuation inflection points: proof-of-concept, growth scalability, and mature scalability. 24 4 Copyright 2019 Healthcare Growth Partners 0 5 10 15 20 25 30 0 2 4 6 8 10 12 14 16 Stage of Growth Valuation Proof of Concept Growth Scalability Mature Scalability Revenue $20mm Stage of Growth Chart (for Companies
Health IT investments are generally living up to expectations, and, if anything, there is increasing investment interest rather than increasing fear of a bubble
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