The Private Equity Investor Lost His Heart...Literally.
Chapter 7 of the Wizard of Odds.
This is the 7th installment of my absurdist Wizard of Oz parody about money in healthcare. Read the rest here. It is my excuse to use a classic story to talk about healthcare economics.
So, while they were walking through the forest, the Private Equity Investor told the following story:
"I was born the son of an Investor who chopped down trees in the forest and sold the wood for a living. His fund mostly worked in agribusiness, and they did a great job of accelerating the rate at which trees could be cut down. When I grew up, I, too, became an investor with other people’s money. After my father died, I cared for my old mother as long as she lived—by paying for a nice retirement community with restrictive hours for visitors. I had a good excuse not to visit Mom that often. Then, I decided that instead of living alone, I would hire attractive people to work at my fund so that I might not become lonely. I wanted a girlfriend, but it seemed like a lot of work. I was still focused on slashing and burning… deal flow, you know how it is.”
"There was one of the Crypto Influencer girls who was so beautiful that I soon grew to love her with all my heart. She totally promised to marry me as soon as I could earn enough money to fund her next NFT project’s launch, so I set to work harder than ever. But the girl lived with a guy who did not want her to partner monogamously with anyone, for he was so lazy he wished the girl to remain with him and use her 16M followers to drive traffic to his pump and dump. So the guy promised her a pretty sweet term sheet on her next raise and helped syndicate a whole deal if the Influencer would just look at the baysean priors on getting sucked into the monogamy Ecosystem.
Thereupon, he on again off again boyfriend made a call to the Oracle of Omaha, and Berkshire-Halfway shorted my positions in some key public companies. One day, when laying off people at my best, I accidentally laid myself off in one of my key firing decisions. I would have been in deep sh*t from an HR perspective if I tried to reverse It—since I eliminated a whole division. And I was employed by that division. So, It blew up my ability to cash out any liquidity and fund her project. I was super illiquid.”
"This at first seemed a great misfortune, for I knew an illiquid man could not do very well as an Investor, especially since I wanted to be able to cut a check into her web3 project and take her out to Omakase to celebrate and maybe make a move, you know?”
“So I went to a family office and had the fund manager make me a new fund out of static capital. The fund worked well once I realized I made more money by debt-leveraging every deal. But my actions angered the Wicked Oracle of Omaha– for he had promised the people that low-cost exchange-traded index funds would yield higher returns! When I began chopping heads again to reduce burn in our portfolio companies, my axe slipped and cut off my right leg. I went to the orthopedic surgeon, and again, he made me a leg out of titanium alloy. After this, the enchanted axe cut off my arms, one after the other, but nothing daunted; I had them replaced with cybernetic ones– I was also early in Neuralink, and the Luke Arm play so that I could get access to some pretty next-generation BCI technology. The Oracle then used his ability to move markets to make the axe slip and cut off my head. Metaphorically. He won the bet about hedge funds, which was embarrassing to PE guys like me. At first, I thought that was the end of me. But a neurosurgeon in the ortho spine group happened to come along, and he made me a new head.
"I thought I had beaten the value investors then and worked harder than ever, but I little knew how cruel my debt-leveraged deals1 could be. Interest rates were a new way to kill my love for the beautiful debt-leveraged deal2. My margins slipped3 again! I also had another axe incident. It cut right through my body, splitting me into two halves. Once more, the surgeons came to help, and this time also brought reconstructive plastics and trauma colleagues. They did nice work, and made me a body of next-generation alloys and advanced brain-computer interfaces, fastening my cybernetic arms and legs and head to it employing novel joints in which, through another investment vehicle, I had some of the residuals that IP, so that I could move around as well as ever. But, alas! I had now no heart, so I lost all my love for anything much. I did not care whether I got a good exit or made a lot on the carry. I didn’t seem to care enough about wins anymore. I was very sad. Also, Caroline was poly and dating— but sort of not—
it turns out, and by the time I had the cash to capitalize the play? FTX had imploded along with Alameda Research, so it seemed I might as well take a pass on love and not risk a DOJ probe, you know what I mean?”Whence will our hero’s journey take them next?! Subscribe to never to miss another installment.
This is based on the not-so-excellently written but fascinating historical agit-prop (video link) The Wizard of Oz by L. Frank Baum (illustrated book). Your child can be dressed as this main character for Halloween with this affiliate link!
For-profit healthcare rating quality has deteriorated since the last downturn, in part because of private equity interest. With the increasing number of small, niche companies with significant leverage, more than 60% of ratings are at or below 'B.’
The healthcare industry is increasingly focused on value-based care models and consumerism, leading companies to make significant investments that may take longer to materialize into EBITDA. However, High valuations and aggressive capital structures have burdened the balance sheets of new issuers, leaving little room for error.
According to a Bain Report:
If current trends continue, this downturn will have different implications for PE activity writ large and healthcare private equity specifically. Unlike the recessions in 2000-01 and 2008-09, current macro challenges are fueled by geopolitical uncertainty from Russia’s ongoing invasion of Ukraine and resulting energy supply insecurity, inflation at levels not seen in decades, and rising interest rates restricting credit access. Additionally, the recent stream of high-profile bank failures creates a host of other uncertainties for HCPE investors and their portfolio companies.
Wage inflation has varied by geography but rose to elevated levels in 2022 (roughly 5% in the US and around 4% in the European Union). Healthcare wage inflation is driven by two factors: General goods inflation drives demand for higher compensation, and healthcare-specific labor shortages exacerbate the general trend. Provider businesses are markedly exposed to labor cost increases as workforce salaries and wages represent roughly 50% of operating expenses for hospitals; this can be even higher in more labor-intensive provider businesses such as home care, personal care services, and hospice. While costs are up, reimbursement is only modestly higher as rates are negotiated on a multiyear basis with payers or adjusted annually by governments.
If these dynamics result in depressed 2022 EBITDA values for provider businesses, sponsors may look to hold their provider businesses through the downturn, reducing potential provider deal volumes further into 2023. Provider-based businesses (excluding related services and healthcare IT) typically represent around 20%–30% of HCPE buyout transactions. While we have not seen a disproportionate decline in provider activity on an annual basis, provider deals dropped nearly 50% from Q3 to Q4, and may continue to impact HCPE deal volumes in 2023.
In parallel to the challenges presented by labor inflation, changes in central banks’ policies to temper price pressures in Europe and North America have restricted financing availability and driven up interest rates. Deal activity in the second half of 2022 reflects signs of these financing constraints, with fewer overall deals done compared with the first half of 2022.