A Discussion with Healthcare Private Equity Executives on Life with COVID

May 2020

This is Wyatt Ritchie, Managing Director with Cain Brothers. With me today is Greg Moerschel, Managing Partner at Beecken Petty O'Keefe & Company (Beecken), Ben Edmands who is a Managing Partner and Co-founder at Consonance Capital Partners and Marty Felsenthal, Partner and Co-founder of Health Velocity Capital.

What have we learned over the last eight weeks and how does that compare to your initial thoughts as we went into the Coronavirus. Pandemic?

Marty Felsenthal: It's obviously been a very interesting eight weeks. I would say that relative to our initial expectations, unfortunately we have not been surprised with how the situation has evolved. I was on a call with a Kaiser executive about a week and a half before San Francisco implemented its shelter in place regulations. Kaiser was on the front line dealing with the crisis in Seattle. What I heard was extraordinarily scary in terms of both the health impact and the impact on the healthcare community in Seattle. We shut our office down about a week before San Francisco did and very quickly started to prepare our portfolio, put the storm shutters on the windows of our portfolio companies and are glad we got on it early. In terms of the impact of the lockdown on portfolio companies, Health Velocity has a slightly different portfolio then Beecken and Consonance. Our portfolio is more growth oriented, and less direct care oriented. Last year, our average portfolio company grew 77%. Everything we're doing is geared towards a more affordable, sustainable consumer friendly healthcare system. The biggest impact that we have seen in our portfolio companies has to do with morale. It has been very hard on people with hiring freezes and job layoffs. At some of our portfolio companies, sales have ground to a halt over the course of the past six weeks, and the focus was on liquidity and scenario planning.

What I've noticed the most is the very high level of frustration and angst in the companies that we partner with, however there have been no real surprises when it comes to operating performance.

Wyatt Ritchie: Greg, how have Beecken Petty’s portfolio companies fared over the past two months?

Greg Moerschel: Frankly, the public health response has been both surprising and a little disappointing because it feels like we still don't have the handle on the mortality rate of this disease. It is a function of not having enough testing and bad data coming from the rest of the world that has caused the public health response to be so severe and, in some cases, arbitrary. I think when history is written about this period, you'll wonder if we could have addressed the economic consequences a little differently. Specifically, could we have shut our borders, quarantined the elderly and those in nursing homes, and focused just on the hotspots geographically?

Instead, we have a situation, where we shut down a $21 trillion economy. The long-term effects of that are painful, not only for those who were affected by the disease, but also for families, children and college kids who are missing experiences and have had their wealth destroyed.

My concern is related to the uncertainty of demand on the part of the consumer. Have we set a precedent for future breakouts of disease that may be difficult to break? This did not happen in H1N1 when 60 million people were infected. It was a much less contagious, deadly disease, but the government has really enabled this shutdown to occur by flooding the economy with capital.

Inevitably it will be politicized, but as we talk to our companies, I echo Marty's comments, there's a heck of a of frustration because the geographic response at a high level has been the same, but there's all kinds of little differences of how the executive orders are being implemented. A rancher in Nebraska is different than somebody living in New York City for example, yet many of the rules have been the same. We must figure this out because the long-term effects could be much worse than what we're going through today in my opinion.

Wyatt Ritchie: Ben, how about at Consonance?

Ben Edmands: Well, I think it's tough for me to answer that in terms of what we initially thought because being in New York City, we were closest from the beginning. We saw this coming but had no idea what to expect. Our answer to these questions was, we just don't know. We're reading the same things you are. We're talking to experts, but we don't really know.

The ability to completely reset expectations and adapt to new situations is amazing, particularly in the healthcare provider world. We've completely changed the way we live our lives and the way we work, at least for those of you who are still working. Yet there still seems to be a certain amount of calm in the country and amongst the people, which to me, has been surprising. I would have thought there could have been a lot more outbreaks of civil unrest.

What I also would have thought eight weeks ago, is that by now we would have had a much clearer national response. I've been underwhelmed by national testing and tracing. Having said that, I've been impressed by a lot of the actions happen at the state and local level. There's been some real cause for accolades for some heroes that have stepped up. However, I think we're largely grappling with how to get out of this. It feels like we're just missing some real true leadership on the national level.

Wyatt Ritchie: I have been impressed with how companies have been able to adapt and make changes to their business models. Are there changes that have been implemented as a result of necessity that will be longer lasting than what is just a COVID related activity?

Marty Felsenthal: We've seen a tremendous amount of creativity, particularly from a product development standpoint within our portfolio, as well as the speed with which those companies are innovating on the product side. Health Velocity’s portfolio is comprised of 11 companies. As I prepared for this call, five of our portfolio companies implemented impactful product development plans very quickly. MD Live, one of the nation's three largest telehealth platforms, saw volumes basically double in the span of a week. That creates a tremendous need for additional providers. You must credential those providers. We credentialed hundreds of additional providers faster, more reliably and better than we ever have in our history.

We work with Well Health, a company that developed a communications platform which converts any provider communication, clinical or administrative, into a unified bi-directional text chain. The thesis being automated telephone calls in healthcare create a ton of friction. Patients hate it and the staff is frustrated. Within the span of a week, Well Health implemented a new product that could be deployed within 48 hours and helped health systems convert in-person visits to virtual visits without all the telephonic back and forth. One of our clients used it for a virtual waiting room; they had patients wait in in the parking lot in their cars and when it was safe to come into the office, the patient would receive a text.

We also work with Contessa Health, a hospital-at-home company that partners with Mount Sinai in New York. Within a week of the crisis in New York, Contessa started providing hospital-at-home services to all of Mount Sinai's non-COVID related patients. Now Contessa is providing care for COVID patients in their homes where it's safer for everyone. Another one of our portfolio companies, Spero Health, provides medication-assisted therapy to individuals with substance use disorder. During the pandemic, they converted 50% of their visits to telehealth in the span of a week.

We've seen faster, better, stronger product development initiatives over the course of the past eight weeks than I'd say we've seen at any point over the course of our careers. On a more holistic level, we're going to see that continuing going forward. This has been a real wake up call for the entire healthcare system for payers and providers. This pandemic has exposed real flaws in our system.

Greg Moerschel: Several of our provider-facing businesses have adapted telehealth quickly, and it's been well received by patients. I've also been very impressed with both our Beecken team and our interaction with all our companies and between companies, at how flexible and resilient folks have been working from home. And I think the implication for the business world going forward is an opportunity to revisit its real estate footprint. There is a real economic opportunity that will be sustained over time.

Ben Edmands: The telemedicine question is going to be one that we're all thinking about because it's something that we've talked about for a while. There was a lot of resistance to it from the patient and provider base that I think in some ways felt threatened. Going back to resilience and flexibility, the speed with which CMS, state agencies and insurance companies have credentialed and authorized telemedicine for various services has been great.

One of our companies went to delivering 100% of its services through telemedicine despite not offering that service prior to the pandemic. Another company went from 2% to 70% in telemedicine visits. I'm not saying we're going to stay at that level, but clearly a patient who had a good experience with that type of doctor interaction realizes that they can have a fulsome visit.

The question that we're asking is, what does that do to the existing infrastructure? What does that do to real estate? What opportunities do you have to repurpose some of that space for other things? For example, where can people go if they want to get out of the hospital, but they are not ready to go home? Can you repurpose some of that real estate? The question that we're asking is, what are the implications of these changes for the healthcare system overall?

Wyatt Ritchie: Ben, do you see any other sectors or applications that have been positively influenced as a result of the healthcare crisis?

Ben Edmands: Urgent care has been improved as a result of COVID. City MD is one of the largest urgent care players in the New York metropolitan market. City MD partnered with Summit Medical Group, which is one of the largest outpatient physician groups. Unfortunately, we had to shut down 20 sites because we couldn't maintain staff due to people getting sick and childcare issues. As a result, we have been able to largely fix that issue with full scale PCR COVID testing. Last week we launched the ability to offer immunology testing. I don't know how sustainable that's going to be, but the volumes there have been up.

We also have a behavioral health assessment service company for the geriatric population in the rural communities that partner with critical access hospitals. Hospitals did not want elderly people showing up, nor did the elderly want to go there. We have now largely shifted to telemedicine for behavioral health group therapy. We think that the demand for those services will increase as well. One of our portfolio companies is a diagnostic lab that is not able to deliver telemedicine since you still need to take blood samples and the like. Two and half months ago, the R&D team shifted its focus to launching a PCR test for COVID. We launched that test two weeks ago.

Overall, the impact on healthcare demand has been significant. We have seen therapeutic practices like derm and others down 70 to 80%. It’s a question of when people are going to start funneling back into those areas.

Wyatt Ritchie: We are seeing states starting to slowly reopen their economies. and obviously there's geographic disparity around that. Within Beecken’s portfolio companies, are you starting to see activity returning?

Greg Moerschel: Elective procedures in some hospitals around the country have been scheduled imminently, and certainly into June. One of our businesses is also scheduling diagnostic procedures now.

Beecken has put the brakes on new site expansion in our provider businesses. But now there's enough visibility on opening dates state by state so we can start revisiting those plans. Potentially, the bigger challenge is whether we have enough workers, particularly lower wage workers willing to come back to the workforce when it's not completely safe. Unemployment benefits are affecting that decision in the short term. Labor is a big component of if you can open a provider-based business in the near term.

Marty Felsenthal: There are puts and takes in every company, but four of our 11 companies are either directly or indirectly related to telehealth. Telehealth companies have been net beneficiaries of this environment. You wish it didn't take a pandemic for telehealth to reach an inflection point, but these companies are fine. We have three provider-based services businesses which operate ambulatory infusion centers for patients on high cost drugs. Their volume really hasn't been impacted. These include patients with MS, rheumatoid arthritis, asthma, Crohn's and colitis who need these drugs to be well.

Hospitals have emptied out their hospital infusion suites for safety reasons and are sending their patients to us. Spero Health, a business that provides medication-assisted therapy to individuals with substance use disorder, has seen a 20 -25% impact. We also have four SaaS businesses. Our SaaS payer business actually sold a large new contract last week. Our three provider businesses have not seen a rebound yet, as their sales cycles have largely ground to a halt. The provider community is still heads down dealing with the pandemic, trying to understand what their budget is going to look like for the rest of the year. We've been fortunate in that we haven't seen any meaningful churn across any of our SaaS businesses.

Wyatt Ritchie: Ben, are there any sectors you’re concerned about or is it just more about weathering the storm?

Ben Edmands: Consumer oriented sectors which are more elective in nature, are going to take longer to come back. People are going to do the calculus of, do I really need to go see my dentist right now and risk getting COVID, or can I wait nine months for my teeth cleaning?

We are also trying to figure out what the second derivative impact is when you have this much of a shift. For every percentage point of unemployment, it's over three million people that are shifting out of employer-sponsored health insurance. We think about half of those go into Medicaid and pay 50% of what commercial typically pays. Other people are going to Affordable Care Act health exchanges which pay 25% to 35% less than traditional insurance. Self-insured is lucky to collect 15 or 20 cents on the dollar there.

Elective, non-essential sectors will take longer for people to do the calculus. The potential for significant benefit changes exists. After the 2008 financial crisis, we saw an acceleration of the push to high deductible health plans and it started to flatten out. I think once you have a soft labor market, and most employers are going to be under pressure for the foreseeable future, there's going to be more benefit buy-downs and that'll impact consumer behavior even more.

Marty Felsenthal: To that point, I think it'll be interesting to see if there's finally a move now towards a narrower network, the next phase of high deductible plans, reference-based pricing.

Wyatt Ritchie: What are the short-term and long-term implications of all the federal government’s COVID actions through the CARES Act, CMS accelerated payments and so forth?

Greg Moerschel: There is a potentially historic opportunity here. The Affordable Care Act was spawned virtually out of the financial crisis, and the cost for the government to implement ACA is $900 billion over 10 years. On a relative basis to what is being financed elsewhere, it's nothing. There's an opportunity to expand coverage in 2021 regardless of political party persuasion and leadership. And that benefits all of us and most importantly, the consumer and those who are uncovered.

However, you could revisit Medicaid expansion, even though there are barriers to that with the Supreme Court ruling several years ago. You could also revisit Medicare eligibility. I think, again on a relative basis, the dollars are going to be insignificant if we look in the recent rear-view mirror. There's going to be a near term opportunity of increase the span coverage and the number of paying customers to all of our provider-based businesses.

Ben Edmands: One comment I neglected to make earlier on is the fact that we maintained liquidity in the system over the past eight weeks. I think we all believed that there was at least a 20% chance of some type of liquidity problem. And the fact that there wasn't; I think it's impossible to overstate how important that was. A liquidity problem obviously completely changes the outlook for any sort of recovery on the overall economy.

In terms of CMS making changes and potential impacts, the federal government is going to be under massive budgetary pressures. We're already dealing with a massive deficit issue.

I continue to look at ways to get people to a low-cost setting. Medicare Advantage is going to be increasingly a great solution to control costs. Enabling telemedicine, making some of these changes that might've been temporary more permanent. I think service in the home is going to be another key initiative as well.

Wyatt Ritchie: Marty, does this cause you to rethink strategies from an investment point of view or still sticking in your general thesis?

Marty Felsenthal: Our broad thesis hasn't changed at all. As a result of the crisis, some of the more specific areas that we're interested in have been reprioritized as we've thought about areas to target. We are focused on telehealth, businesses that can help providers capture meaningful, immediate ROI, and anything that can help deal with COVID-19 over the next 18 to 24 months. I'm not sure the country realizes the economic pain that's been inflicted on our provider community as a result of shutting down elective procedures.

We were on a call with several health systems last week. One reported a loss of $80 million, and another reported a loss of $100 million in March. Another health system is expecting to lose $800 million this year, so we're going to have to find a lot of savings. We think the communications and the digital front door have become that much more important in healthcare. There has been community messaging, individual messaging about COVID, and canceling elective procedures. In an environment like this, communications have never been more important.

We're interested in businesses that can help seniors age at home. I think a quarter of all the nation's deaths as a result of COVID-19 have taken place in senior care facilities. Consumers are going to want alternative solutions to assisted living and because of the economic crisis, a lot of people aren't going to be able to afford it.

Remote patient monitoring is a trend that is going to be accelerated for cost and safety reasons. We're seeing a lot of interest from both payers and providers around analytics predicting who's at risk for COVID-19, localized surges, and what their staffing and labor needs both for the surge as well as for the eventual comeback of elective procedures.

My belief coming out of this crisis is going to be that innovation in healthcare will never be more important. I also believe that because of the crisis payers and providers are centralizing and speeding up decision making at a pace that we've never seen.

Wyatt Ritchie: I would like to conclude with your insights on the deal making landscape, including your views on when we return to normal and what private equity investing looks like until then.

Ben Edmands: The sectors that we like are largely intact and there are some new ideas that we think could be interesting in this market. These are preferred equity investments in good companies that have temporary liquidity or leverage issues. But to answer your question, my answer is I don't know. It's largely as a function of how long this crisis lasts. I think if we are back to normal in the fall, and it looks like we're going to pull out of this, existing GPs will say, "I'm going to bite the bullet. If it lasts longer, the ability of these companies will come under pressure and there will be a need for fresh capital. If it's a good company that got into an upside-down balance sheet, most people are going to support that. There is just going to be a large gap in the bid/ask between what someone coming in thinks the company's worth versus an existing investor.

Wyatt Ritchie: What is the state of play with lenders as they look at your portfolio companies?

Greg Moerschel: We have a distribution of companies that are accelerating and growing through this. Another subset of companies are treading water and just getting through it, and some consumer facing companies are struggling. Our lenders are not banks for the most part; they are largely unregulated finance companies. They are long-term relationships. However, I think Q2 will be the real test when covenants are breached or there are the liquidity needs in the industry. I am a little concerned as to the cost of capital of our lenders is going to go up, if their portfolios become troubled. These finance companies rely on banks. To the extent their ratios are impaired, or their cost of capital goes up, it could affect their behavior in amendments, and the quantum and costs of debt that they're offering to all of us going forward, at least temporarily.

We've implemented a rigorous communication strategy, which the lenders have asked for and are appreciative of. We're over-communicating, and hopefully getting ahead of any difficult discussions we may have in the second quarter, but I foresee a bit more resistance. There will be gradients of pushback or acceptance to change going forward.

Wyatt Ritchie: What do you think about transaction activity going forward both near term and long term and what do you think it's going to take to get back to “normal” levels? What does that do to valuations?

Marty Felsenthal: I don't know how we can get back to a normal pace of investments without being able to travel freely. Ultimately, we are all in the business of partnering very closely with management teams. We would all characterize partnerships like marriages. The prospect of investing in a company without meeting them in person is a little bit like a mail order bride.

The companies that we have been looking at over the course of the past eight weeks are businesses that need additional growth capital with management teams that we have known for the past 15-20 years. As an organization, we have not figured out how we feel about traveling even as some of the restrictions come off. Until there is a vaccine or herd immunity, we're putting ourselves at risk, and we're putting our community at risk. So, we're having a lot of interesting ethical debates inside of the partnership about what our return to normal is going to look like.

Wyatt Ritchie: Ben, what are your expectations?

Ben Edmands: I think it's going to be slow next quarter for deals. When we sold a company last week, the only reason that happened is because we were working on these things long before the crisis hit. The third quarter is going to be pretty slow. My guess is when the market comes back, we're going to see a bifurcation, such as companies with a Medicare Advantage plan, largely insulated from something like this.

My guess is, when we look back four years from now or five years from now, and look at where the outsize returns were, it's going to be like the people who made bets in 2008 - 2009. Ones that weren't really that obvious at the time, but they worked out. That was where the outsize returns were.

Greg Moerschel: The businesses Beecken buys are founder-owned so we are the first capital in. We are anticipating a bit more risk not only from a performance standpoint, but from a market multiple, they're going to look backwards. We're going to look forwards. Once that is resolved, I think there will be good activity. That's where you must get creative on structuring and perhaps, Ben, to your point about bifurcation. Paying for an asset for what you can look around the corner in the industry or getting comfortable with a high valuation on a company that's performing. I think the premium assets will continue to get premium multiples, notwithstanding the environment today.

There's still a ton of equity capital out there and I think the willingness to look through issues and over equitize in this environment is still going to be the instinct of most buyers. There's probably going to be less leverage available because lenders are less apt to accept the pro forma add backs. That was a bubble that was waiting to burst, and now it has. So potentially, it's a returns issue for all of us entering at those multiples. Certainly, activity is extremely slow now, and it's probably at least three months away from picking up measurably; Q4 I would say.

Join Wyatt Ritchie, Managing Director at Cain Brothers, as he interviews the following healthcare private equity executives to discuss life with COVID-19 and investment strategies moving forward:

  • Benjamin Edmands, Managing Partner & Co-Founder, Consonance Capital Partners
  • Marty Felsenthal, Partner, Health Velocity Capital
  • Gregory Moerschal, Managing Partner, Beecken Petty O'Keefe & Company

Benjamin EdmandsBenjamin Edmands is a Managing Partner and Co-Founder of Consonance Capital Partners. Prior to founding CCP, he was a Managing Director at JPMP, where he co-led the Healthcare Group. Ben joined JPMP in 1993 and served on numerous boards, including Big Rock, CareMore, DJO, LHP Hospital Group, MedQuest, National Surgical Care, and Warner Chilcott, Inc. He currently serves on the Board of Enclara Healthcare, Turn-Key Health, Bako Diagnostics, Orsini Pharmaceutical Services, CityMD and the Mount Sinai’s Children’s Environmental Health Center. Additionally, he is the Chairman of Harvard T. H. Chan School of Public Health’s Health Policy and Management Executive Council. Benjamin holds a BA from Colgate University and an MBA from Columbia Business School.

Marty FelsenthalMarty has worked exclusively with innovative, disruptive, and rapidly growing healthcare software and services companies for more than 20 years and has led investments in companies such as TelaDoc (NYSE: TDOC); Change Healthcare (acquired by Emdeon); Aperio (acquired by Leica Biosystems); Titan Health (acquired by United Surgical Partners); US Renal Care (acquired by Leonard Green); Payerpath (acquired by Misys/Allscripts); Vantage Oncology (acquired by McKesson); NovoLogix (acquired by CVS Health); VeriCare (acquired by MedOptions); OnShift; ClearData Networks; IVX Health; MDLIVE; and Well Health. Marty was previously a partner at two leading venture and growth capital firms focused on this sector - Salix Ventures and HLM Venture Partners - and also worked with Madison Dearborn Partners earlier in his career. He also serves as an adviser to the California Healthcare Foundation Innovation Fund. Marty received his AB from Princeton University and his MBA from the Stanford University Graduate School of Business.

Gregory MoerschalGreg is the Managing Partner of BPOC. He joined the firm as a Partner in 1997, commensurate with the closing of Fund I. Prior to that, Greg was a senior healthcare research analyst at ABN AMRO, after previously being a healthcare investment banker with Ken O’Keefe and David Beecken at First Chicago.

Greg serves or has served on the board of directors of Cranial Technologies, Inc., EMSI, Genezen Healthcare, Inc., Genoa Healthcare, Hospital Physician Partners, The Hygenic Corporation, Maxor National Pharmacy Services, Medical Solutions, Medicus Healthcare Solutions, NetRegulus, Inc., NeuroSource, Inc., Preferred Homecare, RSA Medical, Take Care Health Systems, TIDI Products and Zenith American Solutions, Inc.

Greg received a B.A. degree in economics from Northwestern University and an M.B.A. degree in finance and health services administration from the Northwestern University Kellogg Graduate School of Management.

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