NextWave Private Equity

Jeff Woods, EY-Parthenon US Co-Head of Healthcare, joins Winna Brown to explain why PE should remain optimistic about investing in the healthcare sector despite the short-term detriment of COVID-19.

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The assumption that the healthcare sector is “recession proof” has been debunked as the pandemic usurped traditional assumptions among both patients and investors. Now, there is heightened awareness of how patients access (or don’t access) the healthcare system after utilization plunged nearly 20%. According to EY-Parthenon research, 10% of Americans have decided not to access the healthcare system for the rest of 2020 or until a viable vaccine is available.

Despite the short-term impact of the pandemic, PE investors have been encouraged by recent return to volumes and are more optimistic now than they were in the spring.

The US payer mix is unique in a global landscape of government-sponsored healthcare systems. While there has not been a strong shift in favor of universal healthcare in the US, there has been a secular shift in healthcare expenditure from commercial to government that has accelerated due to rising unemployment caused by the pandemic. While the US healthcare market is ripe for efficiency gains, private equity (PE) can drive innovation in any healthcare market, regardless of the payer mix.

Shifting patient behaviors and preferences are accelerating experience-led transformation and inspiring an increasingly patient-centric approach, creating opportunities for PE to drive innovation and improve patient experiences.

The healthcare/technology deal environment continues to be very active. The pandemic has impacted the deal lifecycle in several ways, including valuations and timeline to exit. In addition, PE has looked to deploy digital across the portfolio to address access, engagement, navigation, care transitions, cost management and staffing.

Summary of the PE/healthcare landscape over the next three to five years:

• Deal landscape remains very strong and is expected to recover to pre-COVID levels
• 2020 deal volume will be down 15-20% from 2019 but the worst is over
• Providers will be the largest deal category and healthcare/technology deals will be the second largest
• Private capital remains the fastest way to innovate
• The healthcare sector will no longer be thought of as “recession proof”

Josh Lewsey, EY-Parthenon Strategy & Transactions Partner, and John Levack, Vice Chairman, Hong Kong Venture Capital and Private Equity Association, join Winna Brown to help private equity investors understand how new regulations will impact the current and future private equity ecosystem in APAC.

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The global trade environment has increased geopolitical uncertainty, making forecasting difficult. The Organisation for Economic Co-operation and Development (OECD) is predicting 2020 will see a 4% global contraction in GDP with only one G20 country having a positive GDP: China.

It is possible that a bifurcation between US/Europe and Asia of both markets and products will occur as a result of politics rather than consumer requirements. This combined with the region’s growth potential and faster post-pandemic recovery can potentially result in Asia as a more promising market in which to deploy private capital.

Hong Kong is the biggest cross-border center for private equity (PE) in Asia. While the National Securities Law in Hong Kong has caused significant discussion, the impact on Hong Kong-based PE firms has been nominal: this is because China is already a major investment market for these firms and anyone investing in China is already subject to the Chinese national security law, which is quite similar.

The Hong Kong Government recently passed the following three landmark laws that solidify Hong Kong as an ideal base for private equity operations:

1. Unified Fund Exemption Regime: extends the profits tax exemption to all funds, whether or not the fund's central management and control is exercised in Hong Kong.
2. New Limited Partnership Fund Law: allows a limited partnership to be set up in Hong Kong so a PE fund vehicle can be based there.
3. New concessionary tax rate on carried interest starting in 2020.

Over the next three to five years, PE in Asia-Pacific (APAC) will see:

• Fee pressures and low yields in developed markets will push more capital allocation to APAC.
• Funds that drive sustainable returns through operational value creation and prioritize ESG will emerge as market leaders.
• Bifurcation of funds into financial conglomerates and small specialist funds.
• Minority stakes in local SME companies coming to market as new generations explore exit opportunities.
• An influx of capital from pension (defined contribution) investors will increase dry powder and exacerbate the challenge of deploying it successfully and responsibly.

Andres Saenz, EY Global Private Equity Leader, shares his observations regarding the evolution of private equity and the role it will play in a post-COVID world.

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The initial impact of COVID-19 on the private equity complex echoed what was seen in businesses across all sectors, with workplace safety, remote ways of working, investor and employee communication, liquidity and supply chain being top of mind to triage. In addition, deal markets (with the exception of credit funds) practically shut down overnight.

PE firms are well-positioned for an economic downturn and have been preparing for this type of event in recent years. With over US$750b in dry powder in what is now a favorable buyer’s market, PE is looking to be as active as possible, as soon as possible.

A few impediments to deals have included the inability to travel, a lack of available financing, and valuation disconnect between buyers and sellers in pricing assets. Despite these challenges, firms have become creative around investments in public equities as well as credit opportunities. Barring a resurgence of COVID-19, we anticipate buyers and sellers to converge sooner on valuations and in addition to pursuing opportunities in corporate carve-outs.

PE-backed companies have a real advantage in this volatile environment: not only do funds have greater access to capital, they also have a mix of operating resources, expertise and advisor relationships ready to deploy across the portfolio.

As PE navigates through COVID-19 and prepares for a momentous shift, a few trends will accelerate, including:

• Investing up and down the capital stack
• Defining digital transformation and enablement
• Refining their value proposition to attract incoming talent
• Hiring talent with the right skill sets
• Elevation of D&I and a broader focus on social responsibility
• Widening the aperture and representation of stakeholders
• Pivoting strategy towards long-term value

Jon Shames, Senior Partner and Leader of the EY Geostrategic Business Group, joins Winna Brown to explore why PE must embed geostrategy in both deal lifecycle and organizational culture to recognize unique opportunities and drive investment decisions.

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The geopolitical landscape is shaped by four disruptive forces: globalization, technology, demographics and the environment. Private equity firms need geostrategy to manage a shifting political environment with the objective of finding opportunity amid geopolitical risk. It is necessary to develop a culture in which these considerations are explored, resourced and incorporated into all steps of deal flow, ESG and LP relationships.

A geostrategy is a powerful way for private equity firms to differentiate themselves and win in the market. Some PE funds have a more sophisticated and proactive approach to geostrategy while others are more reactive and ad-hoc: whatever the chosen approach, there is ample room for PE to further embed geostrategy into investment committee decisions.

Geopolitics shouldn’t just be about risk and worrying about the downside: it should be about driving the investment strategy from a proactive, informed perspective that yields unique opportunities that may not have otherwise been considered. It’s also about making sure a deal makes sense given the complexity of risk in the current geopolitical and broader ESG environment.

A successful geostrategic framework should follow:

• Scan: establish and maintain the ability to identify, monitor and assess political risk.
• Focus: evaluate the impact on key performance indicators, mapping the political environment to the company footprint.
• Act: develop a portfolio of robust geopolitical risk management instruments and build a growth-oriented geostrategy.

Five key geostrategic practices PE executives can adopt:

• Political risk is here to stay and is increasingly more complex.
• Firms need to refine their philosophical and organizational perspective.
• PE firms must embed geostrategy into every stage of the deal lifecycle from origination to exit.
• Consider developing a geostrategic center of excellence (COE) that empowers executives to move beyond risk identification to opportunity assessment.
• Geostrategy is more than a “check the box” compliance exercise: it should be integral to a firm’s investment decision process, incorporated into ESG and culturally valued.

Jeff Schlosser, EY US Supply Chain Transaction Leader and Jay Camillo, EY Americas Operating Model Effectiveness Leader, explain why a post-pandemic supply chain will prioritize resilience over efficiency.

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• COVID-19 has forced companies across all industries and geographies to pivot towards a “new normal” related to their supply chains.
• Supply and demand plans became irrelevant practically overnight as companies reprioritized to serve critical needs
• Lean, linear supply chains are losing favor to parallel structures that allow executives to pivot production in response to demand shocks
• Traditional levers of consolidation and rationalization will lose popularity and efficiencies will have to be found elsewhere amid rising costs and condensed margins
• Companies are modelling future scenarios to plan for catastrophic events
• Regulation is widely anticipated to be a global response to the pandemic, as companies will be increasingly scrutinized (and rewarded) for supply chain resiliency

In order to forge a sensible path to this new world, tax teams will need to work closely with business and operations teams and ensure tax efficient measures are considered including evaluating the challenges and opportunities inherent in this pivot from lean to agile.

• Near term: for liquidity and tax liability management, internal reviews of legal contracts and government agreements to find opportunities for flexibility and efficiency
• Medium term: as companies pivot, external evaluation of new incentives as tax authorities seek to help companies cope
• Long term: as companies move to resiliency, shifts of manufacturing require close evaluation of exit liabilities, IP development and use will require careful review, and indirect tax consequences in the excise, customs and VAT area will require management