Interview with Abe M’Bodj: Impact of COVID-19 on private equity in gastroenterology
Yesterday, I spoke to Abe M’Bodj from Provident Healthcare Partners, an investment bank that’s been very active in the gastroenterology space. Abe has always had a pulse on where private equity is headed in healthcare.
During our chat, I was pleasantly surprised to learn that Abe’s parents are gastroenterologists. This super insightful interview would help you understand what private equity is thinking while COVID-19 is on.
You must watch it in full to get to the depth of these insights. Here are some key highlights:
◘ What’s PE thinking? How has COVID affected private equity?
◘ There are transactions that are getting done but with creative transactions
◘ Number of transactions that would be underway even during COVID-19
◘ Will valuation remain the same if you choose to wait until the other end of COVID-19?
◘ Will multiples (valuation) drop? (cash in closing changing)
◘ In any transaction, there are 3 parties: seller, buyer and the lender
◘ What would happen to highly leveraged transactions?
◘ It’s a possibility that companies can end up in bankruptcy (may be not GI)
◘ If this uncertainty plays out longterm, what will investors do?
◘ Use the capital to help GI go digital?
◘ If we sit here 24 months from now (similar situation), if they’ll invest in GI anymore
◘ Advice for mid-size or small GI groups considering PE (pros and cons) – his parents are gastroenterologists in Maryland
The Transcribed Interview:
Praveen Suthrum: Abe M’Bodj firstly thank you so much for joining me today. You have been very involved in private equity transactions throughout 2019 and even before that and PE in gastroenterology has been a hot topic for 12 months to 18 months now and then COVID hit. A lot of physicians are actually wondering how it’s going to pan out from this point on. And I’m so glad that you could join me today and I look forward to chatting with you about this.
Abe M’Bodj: Absolutely Praveen. Thank you for having me. I have watched the interviews you have done previously and thought they were well done. So, very happy to participate. Again, I’m Abe M’Bodj with Provident Healthcare Partners and we are a healthcare focused investment bank that has large focus on physician transactions. So, lot of work in the GI space, lot of work in the physician space in general. So, we have been on the frontlines of seeing private equity and the change that COVID has brought to the market. So, happy to talk about that.
Praveen Suthrum: Thank you. Let me start by asking you a broader question. During this COVID period, what is private equity thinking and how has it affected private equity as an industry in general?
Abe M’Bodj: Yeah. Well, I think it has forced everyone just like society at large. It has forced everyone into two buckets. There are people who are pressing forward and are trying to figure things out from adeal standpoint and then there people who have taken a step back and are evaluating ‘is it the right time to deploy capital?’ ‘should we be investing right now?’. A lot of them have been forced to focus on their portfolio companies or the businesses that they have already made investments into.
I think now we are starting to see the dust settle not entirely in regard to COVID or what’s going on but in regard to getting a hand on what’s going on within our businesses. We are starting to see some private equity firms return to at least talking about the timeline to either completing the older deals that were put on hold as a result of COVID or looking at new opportunities. You did an interview with the president of OneGI, there have been couple of transactions that have closed as well. With OneGI and Webster in the GI space. In April we closed a women’s health transaction, in another space obviously but there are transactions getting done albeit I think all transactions are getting done at this point of time. They have creative structures that are involved that are different than what everyone thought they were going to be.
Praveen Suthrum: (Now before COVID hit), we used to talk about the number of transactions that were underway in GI and you would come up with a number of 16-20 and we went with that for a while and that was my estimate as well. So, If I ask you the same question now, so, how many transactions are underway in GI, what does that number look like right now?
Abe M’Bodj: Yeah. I think the number of transactions underway hasn’t changed significantly, right. So, some of them have closed, some of them have stopped. So, I’d say they are still in around the 15 range. That being said, those transactions I’m certain are all figuring out what are they going to do and just because they are not going doesn’t mean they immediately want to close, right? They are figuring out and it doesn’t make sense for us to wait for things to turn around. What impact could that have on our transactions and at the time when we went to the market? Will our valuation remain the same if we chose to wait till the other end of COVID-19? Some people are going to wait. Others are trying to figure out are there structures that can make sense for them to close the deal in short-term, is there an opportunity to structure the cash pay-outs because really everyone is concerned about cash right now. Or private equity firms with platform transactions it is difficult to get third party lenders or outside financing to close those transactions.
So, they need to put more cash out there out of their investment pools. If you’re an established platform, you know, their lenders are skeptical to give them more money or let them draw too much of their credit facilities or revolvers that they use to finance transactions and frankly, they have a business to run as well, right? So, they want to conserve as much as cash as they can also. It is our firms expectation that this is going to accelerate the M&A activity, when that’s going to happen we don’t really know but on the other side of this, it is painting a picture that absolutely shows the benefit of being involved with a large organization of this scale that can navigate an environment like this as opposed to having to navigate this as an independent practice. And, I have seen the mindset change from physicians and practices that were skeptical about ideas like this. They are seeing the value in some of it now.
Praveen Suthrum: So, pre-COVID, the multiples were pretty good for private practices in general and even in gastroenterology. How have these multiples changed after COVID? Or how do you expect this to change now? Are the valuations going to drop? From the point of view of private equity, how will they compute valuation at this time?
Abe M’Bodj: Well, most deals that are currently underway and when I say underway, they have moved all the way to the point of identifying the actual party they want to get a transaction done with and are in which is called due diligence, right? Those transactions we are actually seeing valuations remain the same in terms of the total purchase value or the enterprise value of the transactions are remaining to what was agreed to at the letter of intent stage when they identified the buyer and chose to move with that party. Now, that been said, what’s changing is really the cash at closing. So, you may not get as much cash at the closing of the transaction as that you originally signed the letter of intent for. But cash deferrals or seller notes or different source of financing you’re getting back to the same place over, you know called 12-24-month period.
From a multiple standpoint going forward, we are expecting multiples to come down a little bit, without questions there are transactions in the market maybe not necessarily specific to GI but healthcare services and physician investment in general. Just valuations have been absurd for the last few years. Valuation routines, double-digit multiples were at normalcy at non-normalcy if you look at the history of healthcare services investing. So, we do expect those to come down.
I think also, the other impact, this is again in any transaction where there are three parties, there’s the seller, the buyer and there are lenders who finance a lot of these transactions. Lenders’ perspectives on the economy and COVID and the deal environment are going to impact valuations as well. They are going to be more skittish to lend money for new platforms that have recently gone through a new traumatic business event thinking about this from the other side now, they’ve got to have a very strong certainty on what the future cash flows of this business is going to be, what are the profits going to be, because they need to get paid back whatever capital they are lending to this company.
So, if the lending markets or the debt markets are frozen as well then you can’t raise as much debt or finance a transaction which also has an impact on valuation. People used to quote ‘dental practice management never had a down year’ the only year the industry didn’t grow was in the midst of the financial crisis no way to know they did not. That was probably one of the hardest hit industries in terms of the electives procedures dropped with COVID and a lot of businesses are in serious trouble. So, people are finding these areas of investment that they thought were originally untouchable are not so untouchable and as a result it’s going to change their risk evaluation of practices and valuations will come down.
Praveen Suthrum: So, you brought up the third player in a transaction, the lenders and these are typically for deals that are leveraged. Meaning you take debt on behalf of the company that you’re investing in and that’s how the transaction happens, correct?
Abe M’Bodj: Yep. That’s correct.
Praveen Suthrum: So, now I would assume that a lot of private equity transactions that have happened not just in GI but in the medical practice industry in general would be leveraged. Which means that it is like taking mortgage to understand very simply, right? Now, it is imperative that I generate the amount of cash that is required to pay my mortgage every month, every quarter, every year, whatever that is. now, in a pandemic situation like this, like you know when there is uncertainty about cash flows in general for all businesses, what happens to lender behavior? I’m not talking about new transactions now but I’m talking about transactions that are already in existence now. How would lenders behave with companies that might be struggling with cash flows in the future, who knows? Just wanted your views on that.
Abe M’Bodj: I mean you have seen large companies out there enter chapter 11, I mean that’s the worst-case scenario, right? If these companies get to busting, they call it in the industry, busting their covenants. There are certain covenants, think of it like a house, you need to maintain a certain amount of value ratio, or just to stay up on the payments but the companies generally need to maintain some sort of EBITDA to debt ratio and that’s there in their loan covenant for agreement. You obviously have COVID which is causing EBITDA to drop, and they have a certain amount of debt in the books or the ratios are coming up. Some lenders who are willing to stand by their portfolio companies and actually will lend them more money that will get them through this short-term fall-out because of COVID.
Look it is certainly a possibility that there are companies that end up in bankruptcy. I don’t think that’s the case specifically with GI and healthcare services in general. You know there are companies out there that have taken on the outside debt financing and they are not going to be able to pay those obligations so, that does happen. Now, how that plays out practically, if we think about it like a house, the last thing the bank wants to do is foreclosing the house, that’s a headache for everyone, the bankers don’t enjoy doing that. They haven’t got paid back and they are trying to recoup their investment through the foreclosure of the house, I mean, physician practices or private equity portfolio companies it’s the same thing, the last thing they want to do is foreclose or force these businesses into bankruptcy. What happens a lot of times is they end up taking the equity of the company because that’s all that the company has as they’re not paying back their debt. But everyone in the market at least from a lending perspective from what we’ve heard has been pretty rational about this stuff. In a sense that the expectation is that things will get back and return to normalcy.
Praveen Suthrum: Okay. So, let’s say the uncertainty plays out for a longer period and then you have investors on one side who have capital, it’s not like private equity players don’t have capital, they are sitting on a lot of capital but then they want to look for the perfect deal or the right kind of deal they’re conservative, they’re gun shy right now and they want to wait and watch for the economy to turn around and let’s say the economy takes it time to turn around what happens in that scenario? As far as these private equity transactions are concerned. Are they going to continue to sit on the money or are they going to begin to take more risk than they usually would in such a scenario?
Abe M’Bodj: Yeah. There’s just so much of capital that has been raised and there is so much dry powder and you are absolutely right there is… they have pools of capital. Frankly that capital has to be deployed. If they don’t deploy that capital, they don’t get paid for managing that money and that’s what they are in business to do, right? So, they need to find a way to deploy that capital.
Albeit they certainly don’t get paid if they deploy that capital and then lose it because they made a terrible investment. If we are in the current state where we are in quarantine, we are 24 months from now then I don’t see transactions happening at that point because now we’re past the narrative that is keeping transactions and M&A work alive then things are going to recover and return to a sense of normalcy at least to a point where these physicians can sustain themselves.
Praveen Suthrum: Yeah. I would think Abe, that if there is capital and if this is a long-term situation, then you’ll use the capital to figure a way out. Like you now, if private equity can wear that hat and help businesses get digital like you know, GI groups or physician practices, that’ll be interesting. While it’s not what they might have signed up for, but it will be an interesting way to deploy capital and see practices and the healthcare industry out of this situation.
Abe M’Bodj: I agree, I think there is… I think it’s actually a great point to meet. It’s going to shift what they are making investments into. There are areas of healthcare that haven’t been as impacted. So, I was more so speaking about the current private equity initiatives that… where investments have been made in things like that. They will stick with their portfolio companies as long as possible but we’re still seeing valuations for businesses that haven’t been impacted by this and you have a financial track record to show that you haven’t been impacted by COVID. You know, actually private equity firms have shown a lot of interest in those types of models.
Hospices is an example of industries that haven’t been as impacted, interventional pain management is another space where we have certainly seen a reduction in volume but they haven’t seen the same reduction in volume as say the GI industry has so, that has found a lot of private equity interest. People think that on the other side of this, women’s health is going to see a lot of activity as well in the short-term, coming out of this. So, certainly there are spaces going to see investments and you’ll see private equity firms transition towards that.
Another interesting space would be the healthcare IT space as you referenced, in terms of moving a lot of the stuff to the digital realm and helping practices or helping businesses do that you are certainly going to see private equity and venture capitals chasing those investments because those are going to be big businesses. So, private equity firms are smart people, smart individuals, they are in-charge of billions of dollars for a reason and have been good stewards of that money. They are going to find creative ways to invest their capital but if we are sitting here 24 months from now, I just don’t think it will necessarily be in the GI practice space, but they’ll find ways to invest those dollars.
Praveen Suthrum: From the lens of a mid-size GI practice, or a small GI practice and if you were to see it from their lens, not the super large groups and so on that have already created the platforms. But the mid-sized and the smaller groups, when you see it from their lens, what the pros and cons of considering private equity at this point of time, what advice would you have for them?
Abe M’Bodj: I don’t think I’ve ever told you this Praveen, my parents are gastroenterologists, a small GI practice with about five doctors. So, this is the type of conversation I’m having with them on a regular basis. And they have certainly been impacted in a big way by this whole thing. For them...Just speaking specifically for them, I think they will be benefited, they feel like they would benefit by partnering to a large organization that can help them navigate something like this, right? As everyone would, instead they’re like a lot of these other practices that are scrambling to figure out where they can get some funding from, some government programs to meet payroll, they are having to furlough their employees and lay people off which a lot of practices are doing, big or small, and it’s a challenging environment.
So, certainly one of the benefits could be that it wouldn’t be all on their shoulders, handling those decisions, and figuring out what to do so that they can keep their livelihood same as it is today. Now, the cons of that obviously, specifically related to COVID, you know, one of the things that came out with some of the government funding acts was that private equity owned companies were actually not able to participate in some of those, in some of the funding. So, certainly that is an angle on the other side of the spectrum of medicine where the government is kind of taking the stance , ‘hey you have millions of dollars of capital, it shouldn’t necessarily be on the taxpayers to help you get through a crisis like that’ and whether you like it or not is for another conversation.
Similar cons that you have pre-transaction, there’s a certain level of autonomy that you’re giving up in joining a large organization and assimilating with a larger group. Like I said, there’s benefit to that in terms of… you’re not bearing the whole risk you’re not having to face the consequences of making the decisions at that point in time but on the flip side you’ve given up a lot of autonomy to be in that position. So, for physicians I know it’s always the biggest concern with any of these transactions. So, same cons really still exist.
Praveen Suthrum: Okay. Well Abe, thank you so much for your extremely insightful comments, I learnt a lot and I’m sure people who watch this interview would also be learning a lot. Do stay safe and I will talk to you soon. Thank you so much.
Abe M’Bodj: Absolutely. You too stay safe Praveen. Thank you for having me. I appreciate it.
By Praveen Suthrum, President & Co-Founder, NextServices.