Healthcare Sector

One of the most significant sectoral allocations within the S&P 500 index

The healthcare sector has one of the most significant sectoral allocations within the S&P 500 index at around 14%, behind Information Technology at 28%.

The sector encompasses a wide range of industries providing various consumer services.

Some of the largest industries include Biotechnology which focuses on novel drug development by integrating natural sciences and engineering.

The sector also includes healthcare equipment that focuses on products like PPE kits, Pharmaceuticals that help develop and market medical drugs and vaccinations.

The healthcare sector is different from the other sectors within Finance as it is not closely correlated to the other sectors.

During times of inflation and global events such as the Covid 19 pandemic, there was a lot of uncertainty in the market, though the level of capital in the industry remained at all-time highs.

The amount of capital invested in companies that support healthcare innovation is growing exponentially; in 2012, investors allocated about $1 billion of private capital into the sector compared to $28 billion in 2021.

It is also often subject to government intervention, given the close relationship between healthcare's private and public sides. One aims to maximize profits, while the other aims to maximize social welfare.

The intertwining interests of both these sectors mean that the government is often vigilant about how they regulate the industry and ensure that citizens can gain adequate access to their services.

In 2021, it had the highest deal growth since 2016. This was prominent in the Finance world as we saw that out of the ten largest private equity deals in 2021, three were in healthcare, the largest of which involved a manufacturer and distributor of healthcare supplies.

2021 healthcare review

In 2021, the life sciences companies providing technological tools and software to increase efficiency and research capabilities did exceptionally well.

The industry had seen an increase in technological integration and heightened demand for clinical services.

Hospitals and lab testing companies experienced strong returns because of the excessive demand resulting from COVID-19.

The managed care industry, composed of sizeable U.S.-based insurance providers, benefitted from the positive momentum of the sector.

Home health companies and value-based primary care providers did not react similarly. Instead, they were negatively impacted by increased COVID-related costs, lower adoption rates, and the growth-to-value rotation that moved many stocks that were strong performers in 2020.

Within the pharmaceutical sector, the returns were strong but concentrated across three firms, which drove 91% of the Russell 3000 HealthCare Index return.

The companies were Pfizer, Eli Lilly, and Johnson & Johnson. Much of Johnson and Johnson's and Pfizer's success was attributed to fulfilling COVID-19 vaccine deployment, while Eli Lilly progressed heavily on their Alzheimer's drug.

Medical devices and supplies have also seen heightened returns during the year due to the success of COVID-19 diagnostic and testing companies.

The biotechnology industry experienced the most significant weakness in 2021, with a 20% lower return than in 2020. This was because of the industry going through record 2020 highs, driven by factor rotations in the market and a lack of progress outside of COVID-19 during the period.

In context, Moderna, a company that posted a 143% return in 2020, experienced relatively flat returns in 2021 due to the lack of innovation outside the vaccine.

A global slowdown in M&A activity due to increased regulations and clinical safety setbacks in fields like gene therapy led to lower consumer sentiment.

Given the high risk involved in early-stage biotechnology companies, market sentiment shifted out of favor of the industry, even in cases of positive clinical development.

2021 brought about increased volatility within the healthcare sector, where a handful of companies made up most of the sector's revenue while also creating pockets of opportunity for 2022.

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Healthcare in Finance

Within Investment Banking, healthcare looks at advising companies in the biotech, pharmaceutical, medical device, healthcare services, and healthcare IT sectors on mergers, acquisitions, and raising debt and equity capital.

Banks often split their teams into industry groups and product groups. Industry groups bring together stocks based on standard lines of business, and Product groups advise on only particular types of deals such as M&A transactions. It is an excellent example of an industry group.

The healthcare group executes different transactions, such as M&A, debt financing, equity financing, and more.

Within Banking, most healthcare companies fall into two broad categories:

  1. Pharmaceuticals, Biotechnology, and Life Sciences–An example includes companies that make patented and generic drugs using biotechnology.

  2. Healthcare Equipment & Services–This includes hospitals, nursing facilities, research labs, and medical device companies.

Healthcare companies often provide "essential services" whose demand is relatively inelastic, even during a recession. However, a handful of companies comprise much of the deals and financing activity within the sector by acquiring small-cap companies.

The sector is heavily regulated in countries where "universal healthcare" is not provided to its citizens, such as the US.

U.S.-based healthcare firms account for the highest percentage of the total industry market cap and transactions worldwide.

In terms of classifications within banking, the Healthcare Information Technology sub-sector can also be a part Technology Group, and health insurance companies could be a part of the Financial Institutions Group.

How to get into Healthcare Investment Banking

Unlike biotech equity research or life science venture capital, you do not need an advanced understanding of healthcare or a degree in medicine to work in this group.

Knowledge of the healthcare industry and the business models they use is required to understand the sector well.

Therefore, some background in healthcare is always helpful while trying to break into the sector as it allows you to tell your story more effectively about why you want to be in that industry.

The recruitment process is similar to any other group, where candidates could attend a top undergraduate or MBA program, strive for high grades, receive relevant work experience, do a good amount of networking, and prepare adequately for the interview process.

Some healthcare-specific Investment Banking questions candidates could expect during their interview include:

  1. Which of the sub-sectors in healthcare would have the lowest WACC and why?

  2. What multiples are used for biotech companies

  3. What do Investment Bankers do in Healthcare Investment Banking?

  4. How would you value a pre-revenue biotech company with negative cash flow?

  5. Can you walk me through a transaction you learned about within the Healthcare sector?

  6. How does the cost of capital vary for each healthcare sub-vertical?

Drivers in the healthcare industry

The public and private healthcare sectors are often subject to government intervention, as private healthcare companies are motivated to maximize profit, while public healthcare companies aim to serve the community.

The intertwining nature of the public and private sectors means that the government carefully regulates the industry and ensures citizens can access these necessary services.

The political influence in the healthcare sector often creates uncertainty for investors, leading them to keep track of policy changes and more.

Healthcare is a highly specialized field that only professionals tend to have intimate knowledge of. Therefore, healthcare professionals often act as a principal on behalf of the population without technical knowledge, allowing them to make industry decisions.

Because principals have technical information that affects the agents, principals are expected to act in the agents' best interest. However, misalignment of goals and objectives can lead the principals to pursue other interests that can harm the agent.

For example, pharmaceutical giant Purdue Pharma pleaded guilty to pushing OxyContin, the drug which enabled the opioid crisis. However, they failed to inform the public of the drug's adverse side effects, allowing them to push for profit maximization.

Even with the risks within the sector, healthcare can be a haven and growth opportunity for investors. This is because demand for healthcare is price inelastic–meaning that the market is relatively stable when prices fluctuate, and it is quite resistant to periods of recession and inflation.

Innovation within healthcare, as seen in the race for developing the new COVID-19 vaccine and a shift to integrating virtual healthcare in response to the pandemic.

The risk associated with politics and asymmetric information shows a low correlation with other sectors. Therefore, healthcare is an excellent investment for anyone trying to diversify their portfolio.

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What are the 4 Main segments within the healthcare sector?

The healthcare industry provides various services to support the healthcare needs of the community and individuals. The healthcare industry can be classified into four sectors:

1. Health care services and facilities
The Health care services and facilities sector is comprised of many sub-sectors such as Healthcare Provider and Services, Healthcare Equipment & Services, and Healthcare Technology.

The healthcare provider and services subsector comprises companies that own, operate and facilitate healthcare services. Some of the most prominent services included are:

a) Hospitals
Hospitals conduct treatments, run diagnostics, and provide patients with advisory services based on their medical needs. This category includes General and acute care hospitals, district hospitals, specialized hospitals, teaching, and clinics.

b) Nursing and residential care facilities
The care facilities provide residential care combined with either nursing, supervisory, and other types of care as required by the patient. Within this category are at-home health care services, Nursing Care Facilities, Urgent Care Centers, Mental health facilities, and developmental handicap facilities.

c) Ambulatory health care services
This segment provides both direct and indirect health care services to ambulatory patients. This category includes outpatient care centers, medical and diagnostic laboratories, Ambulance Services, and other mobile health care services.

d) Medical Practitioners & Healthcare Professionals
This segment looks into the healthcare professionals providing services to patients, such as Medical Practitioners, Chiropractors, Homeopaths, Psychologists, Social Workers, Physical Therapists, and more.

2. Medical equipment and hospital supplies manufacturers

This sector includes all aspects of the manufacturing of a medical device, from design to development and then scale to help with ongoing process improvements.

Medical Equipment

This sector also includes the sterilization and packaging of equipment required for shipment. The size of the medical equipment ranges from band aides to MRI scanners.

These companies also offer the latest medical technology products for medical equipment, hospital supplies, and healthcare-related services.

3. Medical services and managed care

Medical services work with companies that provide different types and degrees of services to all stakeholders in the healthcare industry; this includes medical insurance, healthcare consultants, patient financing, and more.

The term managed care or managed health care looks at various techniques intended to reduce the cost of providing health benefits and improve healthcare quality.

This sector includes exclusive provider organizations, Medicare, Medicaid, Healthcare Consultants, Medical Patient Financing, and more.

4. Pharmaceuticals, Biotechnology, and Life Sciences services

The pharmaceutical industry helps develop, produce, and market drugs used for medications. As a result, the industry is subject to various laws and regulations regarding patenting, testing, and ensuring the safety, efficacy, and marketing of drugs.

This sector includes Over-the-counter drugs, Drug Stores, Prescription drugs, Biopharmaceutical drugs, and more.

Biotechnology looks into companies that provide research and development or manufacturing capabilities derived from living organisms, such as Genetically Modified Crops or Developing Biofuels.

Life science services companies study living organisms and provide analytical tools for clinical testing services and research capabilities such as Molecular Biology, Biochemistry, Neuroscience, and more.

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Future of the Healthcare sector 

The pandemic has shifted the global dynamic of the healthcare value chain, with greater importance for innovation and growth within the sector.

Furthermore, healthcare enterprises have digitized their operating models to become more resilient and efficient, which has helped transform the industry.

1. mRNA vaccines

mRNA vaccines are genetically engineered vaccines approved in 2021, given the rise of the novel coronavirus.

The pharmaceutical developers with the highest efficacy rate at the time across the world were Pfizer-BioNTech and Moderna. These companies received impressive results within a ground-breaking amount of time.

Scientists are looking into the use of mRNA in approaching other known infectious diseases, such as malaria, influenza, sexually transmitted infections, and cancer.

mRNA therapies are likely to be used for clinical development within oncology, as the versatility of genetically engineered mRNA is likely to cause a drastic change in medical innovation over the next decade.

2. Diagnostics

In 2020, the FDA granted emergency approval to the first CRISPR-applied product, a COVID-19 diagnostic test that revealed results in under an hour.

Innovation within this field continues to grow as we see new products such as 10-minute blood tests, and at-home rapid antigen swabs, considering the COVID-19 pandemic.

The demand for products like COVID-19 diagnostic tests will likely stay in the near term, given the potential rise of new variants.

3. Antiviral oral treatments

Another prominent innovation caused by COVID-19 was the development of oral antiviral treatments. Launched by Merck & Co, such treatments have had the potential to reduce mortality rates amongst patients sick with the virus significantly.

The drug soon faced regulatory issues after it was announced that it could not meet the required level of efficacy as initially expected.

In contrast, Pfizer's Paxlovid treatment helped reduce the risk of hospitalizations and deaths in high-risk patients by 89%.

4. Oncology – Beyond COVID-19

The field of cancer treatments has expanded rapidly despite record low rates of utilization as the COVID-19 pandemic was many pharmaceutical companies' primary concern.

Furthermore, many patients' hesitation to enter primary care facilities such as hospitals during the pandemic also caused lower rates of diagnoses. With a 26%-51% decrease from pre-pandemic levels, the impact would have created a severe backlog in years to come.

From a development perspective, 17 novel cancer treatments have been approved globally for 2020. Innovative therapies are often concentrated within smaller-capped companies, where emerging biopharma companies develop nearly 80% of early-stage pipelines and 66% of late-stage channels.

5. Alzheimer's

2021 was a milestone year in Alzheimer's research, as the FDA-approved Biogen and Eisai's drug Aduhelm significantly impacted the industry. However, the drug has a volatile road ahead, as it is faced with regulatory scrutiny and hurdles in commercial adoption.

6. Medtech

Medtech has seen stable growth with the advancements of portable MRI (magnetic resonance imaging) machines, ACL (anterior cruciate ligament)-healing tools, and Alzheimer's blood-based diagnostics, among others.

Innovation is likely to grow in this space at a stable rate, from precision surgical tools and non-invasive procedures to the growing trend of wearable tech.

7. Technology in healthcare

Despite constant innovation within the healthcare sector, there is still a lot of scope for improving products and services.

Using artificial intelligence (AI) in clinical trials, gene mapping, and technology-assisted surgery has seen exponential growth over the past few years.

Early adopters of technology in clinical development have looked at the importance of machine learning algorithms to learn about new diseases 30% faster than human pathologists.

Given the average go-to-market rate of 5-10 years for new drugs, AI can speed up drug discovery and development.

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Trends in the healthcare industry

Healthcare companies have turned their attention to integrating technology to help transform the sector by delivering their products and services.

Over the past few years, tech companies have focused on applying their expertise to solve problems caused by the COVID-19 pandemic.

The pandemic has helped accelerate the digitization of the healthcare industry. According to the HIMSS Future of Healthcare Report, 80% of healthcare providers plan to increase their technology and digital solutions investments over the next five years.

Where we can see the sector leveraging trends in different areas, such as:

1. Demographics 

Naturally, as the population ages, the requirement for healthcare-related services will also increase. It is estimated that between 2015 and 2050, the world population over 60 years will double from 12% to 22% adding to the sector's demand.

The past few years have been detrimental to the importance of the healthcare industry because of the Covid-19 pandemic. However, these two trends have helped shape the industry by amplifying demand and showing the growing importance of innovation within the field.

2. Government Policies and Regulations

As mentioned before, the government is highly involved with healthcare in most countries where healthcare is privatized. An example of where healthcare is privatized is the U.S. on the other hand; the U.K. government acts as the sole provider of healthcare.

Governments can help set prices, reimburse medication, and approve new transformative drugs, devices, and treatments. They can also fund and incentivize significant research and development efforts through grants.

3. Product Pipelines and Innovations

Most newly developed medicines and devices are protected by patents and intellectual property rights for a fixed period. Therefore, companies are constantly innovating and developing new products to make up for lost revenue when their patents expire.

Even generic-drug companies think about their pipelines and different avenues they can venture into by monitoring expiring patents and planning new, lower-cost manufacturing processes.

4. Broader Economic and Credit Conditions

Because of the sector's low correlation with other industries, healthcare is classified as a "defensive" sector, which means that it tends to hold its value in an economic contraction.

We experienced such trends in the 2008 Financial Crisis and the COVID-19 pandemic when many large healthcare companies emerged victorious in the end.

Companies In The Healthcare Sector

The ten largest healthcare companies in the world based on 2021 revenue include:

1. CVS Health: $268.7 billion

2. UnitedHealth Group: $257.1 billion

3. McKesson: $231 billion

4. AmerisourceBergen: $189.9 billion

5. Cigna: $160.4 billion

6. Cardinal Health: $152.9 billion

7. Anthem: $121.9 billion

8. Centene: $111.1 billion

9. Johnson & Johnson: $82 billion

10. Humana: $77.1 billion

Investment Banks within Healthcare

The bulge bracket banks within the this sector include Morgan Stanley, JPMorgan Chase, Goldman Sachs, Citibank, and Credit Suisse, as bulge bracket banks within the industry possess the highest net-worth deals when it comes to raising capital or M&A advisory.

Some mid-market and elite boutique banks partake in smaller volumes and sizes of transactions per year. These banks include Houlihan Lokey, Jefferies, Centerview Partners, Evercore, and Lazard.

Within healthcare, many banks could be involved in facilitating the same deal. This is because high-profile deals face a fierce competition between the large banks to reduce, which often leads to a bidding war.

Bulge Bracket investment banks maintain a significant market share of the healthcare investment industry, as they are often diversified and can handle the price fluctuations of some healthcare companies. Particularly during periods of drug pricing or FDA and USDA approvals.

Given that healthcare expenditures as a percentage of U.S. GDP are expected to rise at a faster rate than in the past decade, big banks have positioned themselves to take advantage of such rapid growth.

Unlike smaller banks which cannot commit to the capital required as a safety net when signing large healthcare companies, due to their lack of diversification in other sectors and industries.

Although larger firms are often more successful in winning large-scale transactions. Smaller firms focus on smaller and more specialized market sectors, allowing them to be key players in healthcare investment banking.

On the top of the list is the global investment bank Jefferies, followed by Guggenheim Partners and Greenhill & Co. These firms have a strong history and a growing presence in healthcare.

Particularly Greenhill & Co. has broken into the top ten Investment Banks league rankings, allowing it to compete for some larger-scaled transactions. Cowen Inc. is another up-and-coming brokerage investment bank with two-thirds of its revenue generated from the healthcare sector.

Firms are competing with each other within the sector to grow their practice with talent who are specialists in both the medical and technology industry. Banks are getting heavily involved in the healthcare sector as the industry is immune to disruptions caused by the Covid-19 pandemic.

Private Equity Firms Within Healthcare

The most active private equity firms within this sector since 2017 by deal count include: 

1. Shore Capital Partners (Chicago): 240

2. Audax Group (Boston): 170

3. Waud Capital Partners (Chicago): 130

4. Webster Equity Partners (Waltham, Mass.): 121

5. EQT (Stockholm, Sweden): 110

6. Linden Capital Partners (Chicago): 95

7. Sheridan Capital Partners (Chicago): 79

8. KKR (New York): 79

9. TPG (Fort Worth, Texas): 77

10. HarbourVest Partners (Boston): 77

Healthcare transactions in 2021: Blackstone, Carlyle, and Hellman & Friedman acquired Medline

Towards the end of 2021, the Private Equity firms Blackstone, Carlyle, and Hellman acquired Medline in the largest leveraged buyout deal in more than a decade. The deal was valued at around $30 billion, including debt and a $17 billion equity check.

The group of firms bought a majority stake in Medline, which at the time was one of the largest manufacturers and supply chain leaders of health care products and also reported $17.5 billion in revenue in 2020.

The company has a wide network of operations around the world, spanning more than 110 countries with the U.S., encompassing its largest market share.

In 2021, Medline increased its domestic operations due to the change in market trends caused due to the COVID-19 pandemic, this boosted demand for products such as hand sanitizers and face masks.

Though to help the company diversify its business in a post-pandemic world, the company committed $17.5 billion towards U.S. supply chain expansion, broadening its portfolio of respiratory health products.

According to the CEO of Medline, Charlie Mills, the acquisition from some of the world's most successful private equity firms would enable them to accelerate this strategy while preserving the company's family-led culture.

While the new private equity investors would own a majority share in the company,

Medline's founders would remain the largest single shareholder of the company.

Microsoft acquires Nuance Communications Inc.

Towards the end of 2021, Microsoft acquired Nuance Communications Inc. which is a market leader in conversational AI and cloud-based ambient clinical intelligence used by healthcare providers.

The deal was valued at $19 billion, which marked the software company's second-largest acquisition after buying LinkedIn in 2016 for $26 billion. The acquisition includes $3.7 billion worth of Nuance's net debt, which Microsoft acquired.

Nuance is widely known in the tech sphere to be the company that helped make Apple's Siri, though its voice recognition and augmentation are also used in many other ways within the healthcare industry.

Nuance's technology is currently used by more than 55% of physicians and 75% of radiologists in the U.S. and is used in 77% of U.S. hospitals.

By integrating with Microsoft Cloud, the company will look to address the needs of the rapidly transforming and growing healthcare industry. The company also had a 37% increase in revenue in 2020.

Microsoft and Nuance have worked on artificial intelligence software that helps doctors record conversations with patients and integrate them into electronic health records.

 In 2019, the two companies announced they were collaborating to use technology combined with AI, automation, and cloud computing to create an exam room experience where the clinical documentation "writes itself."

Siemens acquires Varian Medical Systems

In April 2021, Siemens AG, the largest industrial manufacturing company in Europe, acquired Varian Medical Systems, an American radiation oncology treatment, and software maker for close to $16 billion.

The takeover is a pivotal next step in the advancement of cancer research. Varian is now serving a new business segment within Siemens, acting as a pillar in the company's "Strategy 2025"

"Strategy 2025" is expected to produce nearly $360 million in cost-cutting and research advancement strategies annually by the end of 2025. Where Varian would help integrate their advanced knowledge in linear accelerators, radiosurgery devices, and proton therapy suites.

Within five-and-a-half months following the finalization of Siemens Healthineers' deal to absorb the radiation cancer therapy provided by Varian Medical Systems, the acquisition has added value of more than a billion dollars to the company's bottom line.

This added value helped the company post record revenues of nearly $18 billion for its 2021 fiscal year.

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Researched and authored by Aimaan Shergill | LinkedIn

Reviewed and Edited by Aditya Salunke I LinkedIn

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