A healthy injection

Some specialised healthcare clinics can provide private credit investors with better cashflow than hospitals.

Private equity firms have dived into the speciality healthcare sector this year, providing an opening for many mid-market lenders, including Twin Brook Capital Partners, one of the alternative lenders active in the space.

The Chicago-based firm recently closed add-on acquisitions for two existing portfolio companies: skincare provider Dermatologists of Central States in July and injury recovery provider Ivy Rehab Physical Therapy in August.

In the deals, Twin Brook invested $98 million for DOCS’ add-on of Dermatology and Skin Surgery Center, a Battle Creek, Michigan-based provider of medical dermatology and Mohs surgery; and $90 million for Ivy Rehab’s acquisition of Southeastern Physical Therapy & Southeastern Therapy for Kids in south-east Virginia and Spectrum Physical Therapy in central Virginia.

“I would say broadly [speciality healthcare] has been a hot space for private equity and strategics this year,” says Shannan Murphy, a healthcare credit analyst with S&P global ratings, with much of the deal activity coming from private equity firms.

The add-on acquisitions were larger than the initial loans Twin Brook made when it backed the leveraged buyouts of both companies. The firm had provided $60 million to Sheridan Capital Partners in its buyout of DOCS in April of this year and extended $54 million to Waud Capital in its buyout of Ivy Rehab in April 2016.

Those add-on acquisitions were bigger transactions that required additional funds beyond the delayed draw portion of the term loan that Twin Brook had initially provided when it backed the buyouts, according to Twin Brook partner Faraaz Kamran, a healthcare specialist.

Before the Ivy Rehab add-on acquisition, the Harrison, New York-based company had been growing steadily through many smaller acquisitions, Kamran says. Those deals were financed with money from the delayed draw funding.

“The sponsors for these singles and doubles, they use the delayed draw or cash on hand,” Kamran says, adding that a larger acquisition would require a new term loan, as was the case with follow-on investment.

Being smart

DOCS was seeing acquisition opportunities through its “physician partners”, and did not conduct as many smaller acquisitions before finding the larger opportunity, Kamran adds.

Murphy says speciality healthcare providers can be smart investments for lenders.

“A lot of these types of providers aren’t as capital-intensive as a hospital. From the investor perspective, that’s good,” she says. “Even when you do put leverage on them, as private equity firms like to do, you still see better cashflow than some areas in the healthcare provider [space], which is a good thing for a debt investor. You have cash to service your debt.”

Murphy cautions that reimbursement rates, whether from the federal government or insurance companies, could grow more slowly or decline in the future. And there is another risk for some areas of speciality healthcare: investment oversaturation. As the marketplace for acquisitions grows more crowded, this can lead to inflated purchase prices, she warns.

For Kamran, one of the challenges to the deals was getting all the physicians to roll their equity into the new transactions. As a result of the initial buyout, the doctors saw current compensation reductions after decreasing ownership of their practices. The trade-off for a smaller pay cheque is a larger payoff down the road, which is where add-on acquisitions can be key. A larger business tends to be more diversified, which can result in a higher purchase-price multiple.

So far, investors have been willing to put skin in the game. The speciality healthcare sector, at least for now, appears to be a smart place to park cash, as the deals may need little doctoring up.