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Problems and promise amid health tech’s complex investment environment

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Investors, enticed by low interest rates and unsustainable health care costs, are pouring unprecedented sums into disruptive primary care models. Many are betting that capitated and at-risk reimbursement models will bring primary care to the center stage; however, significant questions about the sustainability of such businesses remain says Matt Wolf, Davis Nordell and Kurt Shenk from RSM, writing exclusively for Health Tech World

 

As investing in health technology has become more popular for venture capital, private equity and corporate investors, it has also become more challenging. The health care economy is changing, consumers are engaging in the health care experience in new ways, large corporations outside the ecosystem are disrupting and reshaping the health care experience, and the deal process is fast-paced and significantly complex. Navigating the process of raising capital or acquiring has evolved from a single-focused sprint into a strenuous triathlon. 

How did we get here?

Enterprise and retail health technology have long enjoyed a robust deal environment. According to Pitchbook data, 1,154 deals were completed in 2016; and RSM estimates 2021 could see 2,150 deals, nearly twice the volume of only five years ago. This increase speaks to the opportunity applications and analytics could potentially deliver through modern technology platforms  to improve care, improve the patient experience and reduce costs.

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Rock Health data show a similar trend. According to Rock Health, digital health companies have raised $14.7 billion so far this year, which already exceeds the $14.6 billion raised in 2020. According to this same data, deal size has also increased significantly. So far, the average deal size in 2021 is $39.6 million, up from $31.7 million last year and $13.5 million in 2016; a five-year increase of nearly three times.

The reasons for this increase in deal volume and size are numerous, but two key drivers exist: low interest rates and the rapidly increasing cost of health care. Low interest rates incent investors, particularly institutional investors, to allocate more capital for riskier investment vehicles, like venture capital and private equity. Currently, financial markets are supporting over $15 trillion in negative-yielding debt and U.S. treasury yields are at cycle lows, and even negative in real terms on the short end of the curve. When the cash available to invest increases faster than the available investments, valuations increase.

While many sectors have benefited from low interest rates, health tech has also benefited from the unsustainable increases in health care costs. In the U.S., health insurance premiums have increased 22 per cent since 2015, with the employee portion increasing 13 per cent. Furthermore, the Bureau of Labor Statistics estimates that in 2018 45 per cent of all workers were covered by a high-deductible plan, up from 15 per cent in 2010. According to the Kaiser Family Foundation, the average single deductible has increased 111 per cent over the past decade; employee’s earnings increased 27 per cent over the same time period. Total U.S. health care expenditures are expected to top $4.2 trillion dollars in 2021 and increase to $6.2 trillion in 2028.

Seizing opportunities

Low interest rates and unsustainable cost have provided entrepreneurs in health technology with capital, as well as problems to solve. It has also attracted the attention of large, global companies from outside the health care ecosystem such as Amazon, JP Morgan, Microsoft and Walmart. Their involvement in the health care and health technology space creates complexity and opportunity for both established and startup health technology companies.

Broadly, these large companies have entered the health care and health tech ecosystem to accomplish one or more of the following goals:

  1. Reduce the cost of providing health care for employees
  2. Reach new consumers
  3. Expand business services to new clients

For example, Amazon and JP Morgan both have initiatives to reduce the cost of care for their employees. After their Haven joint venture with Berkshire Hathaway folded, Amazon and JP Morgan launched AmazonCare and Morgan Health, respectively. What started as a way to reduce the cost of providing care for their employees by leveraging telehealth and other digital health technologies, evolved into platforms the companies pitched to other employers to help them reduce costs.

The total investment in the employee health care space has increased alongside the activities of large companies like Amazon and JP Morgan. According to Pitchbook data, 2020 saw $30.3 billion invested across 1,035 deals seeking to disrupt the employer health insurance market, an increase of six times the capital invested since 2016. 2021 is shaping up to meet or exceed 2020.

The interest rate environment has created an opportunistic time for companies to leverage debt into deals.  Additionally, big technology companies have substantial cash positions to pursue targets in the health tech space.  Beyond cash and debt, a third currency for large technology companies to use in deal making is their own stock.  For many tech companies, appreciating stock prices over the last several years coupled with large stock buybacks, have provided another way for big technology companies to structure deals and meet the high purchase price commanded by deals in the health tech sector. It is possible that there will be increased antitrust regulation in health tech space, which could be a headwind for big technology companies investing in this sector, but to date there has not been significant regulation over deal making in this space, which we expect to continue in the second half of this year.  

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The interest rate environment has created an opportunistic time for companies to leverage debt into deals. Additionally, big technology companies have substantial cash positions to pursue targets in the health tech space. Beyond cash and debt, a third currency for large technology companies to use in deal making is their own stock. For many tech companies, appreciating stock prices over the last several years coupled with large stock buybacks have provided another way for big technology companies to structure deals and meet the high purchase price commanded by deals in the health tech sector. It is possible that there will be increased antitrust regulation in health tech space, which could be a headwind for big technology companies investing in this sector, but to date there has not been significant regulation over deal making in this space, which we expect to continue in the second half of this year.  

Care expansion and new players

Amazon is also trying to reach health care consumers. Not only through its AmazonCare platform, but through PillPack, the national mail-order pharmacy it purchased in 2019 and its Amazon Basics brand that now offers generic pharmaceuticals. Not to be outdone, Walmart is piloting expanded primary care in freestanding sites adjacent to its stores. The clinics will offer visits for $20 to $40 and imaging as low as $25. 

One hundred forty million people visit Walmart stores and 675 million visit Amazon’s platform weekly. These companies are bringing the scale to the health care ecosystem that most health technology startups dream of. While in some cases this creates competition for native health technology companies, in most cases it creates an opportunity and new channels for health technology companies to bring their solutions to the consumer market. 

In the business-to-business market, Amazon, Microsoft and Google are all building analytics platforms that are both disrupting the health technology space and creating opportunity for digitally native companies to bring their solutions to scale. 

  • Amazon has launched a health care accelerator in partnership with kidsX to focus on pediatric medicine. Cerner has also partnered with AWS to provide analytics, and Amazon is now offering its HealthLake platform which offers health care organizations a tool to analyze and aggregate data in the cloud. Amazon is also exploring how to leverage the Alexa technology suite into its health care offerings.
  • Microsoft purchased Nuance for $16 billion in a bid to fold the company’s leading natural language processing technology into health care. The House of Gates has also partnered with Teladoc to further expand health care capabilities and buttress the former’s Teams platform as a bona fide health care tool.
  • Google has launched a standard, FHIR-capable toolset that will ease the burden health care providers face when migrating their data to the cloud. Google also has a history in health care, precision medicine and natural language processing through DeepMind, a London-based AI company it purchased in 2014.

From the noise, new channels

While this increased activity within the ecosystem is exciting, it has also complicated the fundraising and acquisition process for many founders and companies. With so many disparate players pouring so much money into the ecosystem it is easy to get lost in the noise. 

However, while these outsiders – a subset of the ecosystem, are making waves within the ecosystem they are also creating opportunity. The platforms they are developing may be suitable channels for many companies to leverage as they scale customers and capabilities. Successfully navigating this rapidly changing environment will require new skills of founders and executives, but the potential to create a meaningful impact at scale has never been greater.

The Takeaway:

Low interest rates and unsustainable health care costs are attracting major involvement and investment from companies outside the legacy health care ecosystem. This increased activity is disrupting the traditional health technology environment in irreversible ways.

Enterprise and retail health tech companies can view this disruption is as an opportunity. Large, well-resourced companies like Amazon, Microsoft, Google and Walmart are working to create platforms in health care for the innovative solutions health tech companies bring to the ecosystem. Leveraging these channels effectively will allow health tech companies to scale faster and more effectively than they otherwise could.

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