Overview
In this session, Stephanie McCann, Partner and Co-Head of McDermott’s Finance Practice, led a wide-ranging discussion of critical strategies for investors to consider as they seek sources of capital to finance healthcare deals. Session panelists included:
- Javier Casillas, Chief Credit Officer & Managing Director, WhiteHorse Finance
- Matthew Evans, Managing Director, Head of Healthcare Finance, Monroe Capital
- Scott Gallin, Partner, Linden Capital Partners
- Aman Malik, Managing Director, HPS Investment Partners
- Bryan Rupprecht, Managing Director & Head of Healthcare, MidCap Financial
In Depth
Top takeaways from the panel included:
1. Although 2021 was not without its issues, the first quarter of 2022 has already provided a long list of challenges for healthcare markets: geopolitical uncertainty (including US and global sanctions on Russia), rising interest rates, increasing prices for energy and other goods and services, ongoing COVID disruptions and the LIBOR transition, to name just a few. Despite the expected bumps, Scott Gallin noted that his company is “absolutely expecting 2022 to be as busy as the last couple of years have been.” With many companies coming to market, Gallin noted, “we are fortunate that healthcare, despite all these macro-pressures, is still pretty resilient.” He added, “We just have to incorporate those macro-vectors into our models to ensure that we are doing sound underwriting.”
2. The energy industry may seem distinct from the healthcare industry, but, said Aman Malik, rising fuel prices will have an impact on certain activities such as home healthcare services. “Reimbursement doesn’t flex up immediately,” he noted, it is typically set at the start of the year. Regarding inflation, Malik said “If you have interest rates go up by a point and you have growth slow down a little bit, you’re going to be in a world where interest payments and everything could be [an issue].” On the subject of rising wages, Bryan Rupprecht said, “I would emphasize that there are certain subsectors—say, skilled nursing homes—where the model literally is not going to work. Wages are such a high percentage of the total costs that, when the pandemic is over and they stop getting the increased payments from the government and they have this new cost structure, every nursing home in the country is bankrupt.”
3. Stephanie McCann noted a number of issues underwriters must consider, including timing and diligence, loan to value (i.e., purchase price), sponsor-backed versus non-sponsor-backed options, sector/industry differentiation, and asked the panelists for their thoughts. From an investment committee perspective, Javier Casillas said, “Aside from obvious credit criteria, we are focused the enterprise value of the firm and its resilience and sustainability.” Rupprecht added, “What’s unique to today, relative to history, is the COVID bump stuff. Every company that we invest in that’s doing super well, the management teams and the equity firms are saying that ‘this is the new normal,’” while the companies that are not doing well, “say ‘This is a COVID hit and we’re going to bounce back as soon as COVID is over.’”
4. McCann posed a question about EBITDA adjustments and company valuation and wondered if the panelists gave any consideration to whether the company is sponsor-backed or non-sponsor-backed, and whether there was any leniency for sponsor-backed companies. Casillas pointed out that there is now a third category: independent sponsors. “We find that to be a very fruitful and interesting place to play. You have a lot of institutional sponsors that have spun off funds that have very smart and experienced people who are buying companies, and there’s good business there and there are good fits—we are very actively in that market.” Matthew Evans noted that, “At the end of the day, if you have the majority of your underwritten EBITDAs in adjustment, there still needs to be cash flow at some point.” He said that his firm is looking “at 13-week cash flows at a close to make sure we’re going to have cash to service the debt.”
5. When asked about a growing tendency for lenders to go “capless,” Rupprecht noted that a large majority of deals have no covenants. “These companies are going to run out of money before they trip a covenant,” he said, “that’s just the straight-up reality. What we try to do is keep the revolvers small, because a) they’re extremely expensive for us, and b) when you run out of money, we don’t want you to go hit a $40 million revolver and just keep bleeding this company for the next two years because I know you’re not going to trip the covenant.”
6. At the mid-cap level, said Rupprecht, regulatory enforcement and qui tam issues have traditionally been a major concern, but that this was not unique to the healthcare environment. The big challenge today, he said, is “trying to figure out what is the new normal.” He mentioned telehealth as something that is here to stay, but added that this wasn’t true of all companies that experienced revenue growth during the pandemic. Gallin elaborated on the new normal and questioned whether some of the changes in consumer behavior are a result of the pandemic only, or because of better marketing or information sharing. Evans noted that underwriting processes have accelerated and that deals are being negotiated very quickly—a compression of timeframes that makes it very difficult to conduct appropriate due diligence, and an issue that doesn’t appear to be going away very soon.
