In this podcast, Delphine O’Rourke, Partner, Duane Morris, talks to Chris McFadden, Managing Director, KKR, about investment in the health care industry and the impact of the COVID-19 pandemic. The podcast discusses what sorts of transactions are most and least likely to have been impacted by the pandemic, how telehealth will impact the future of health care, where firms are currently investing capital, and how PPP funds could be accounted for in transactions.
To learn more about AHLA and the educational resources available to the health law community, visit americanhealthlaw.org.
In this podcast, Delphine O’Rourke, Partner, Duane Morris, talks to Chris McFadden, Managing Director, KKR, about investment in the health care industry and the impact of the COVID-19 pandemic. The podcast discusses what sorts of transactions are most and least likely to have been impacted by the pandemic, how telehealth will impact the future of health care, where firms are currently investing capital, and how PPP funds could be accounted for in transactions.
To learn more about AHLA and the educational resources available to the health law community, visit americanhealthlaw.org.
Welcome. I'm Delfin o I'm a partner with Dwayne Morris, a healthcare attorney, and I have the privilege of working with PE clients and a variety of healthcare, uh, transactions. And today we're gonna talk about, uh, the state of private equity in the healthcare space, where we are now compared to where we thought we would be and what the future looks like. And I'm thrilled that, uh, joining me today is Chris McFadden from kkr, who's gonna introduce himself and the work that he does as well as KKR focus. Chris, thanks so much.
Speaker 2:Well, thanks for having me.
Speaker 1:So, Chris, could you tell us before we kick it off, just a little bit about your experience, which has been extensive, uh, deep and, and broad in the healthcare space, um, including on the telehealth side and, and also what, what you're currently focused on these days?
Speaker 2:Sure. Pleased to do it and pleased to be with you all. Uh, so my name is Chris McFadden. I'm a managing director with K K R based in San Francisco. I've been a healthcare investor for over 20 years, um, ranging from a public markets, uh, equity research analyst, uh, to private equity, uh, and today, uh, financing, uh, larger, more mature healthcare companies. Um, most of our focus has been on services, uh, infrastructure, health, information technology, and supply chain, uh, businesses. And we've put, uh, just under 2 billion, uh, to work, uh, in the healthcare sector, uh, over the past, uh, two years. Uh, prior to joining, uh, K K R in early, uh, 2018, I worked in a growth equity capacity where we made, uh, a number of telehealth investments, teleradiology, uh, telepsychiatry and general specialty physician services, and have liked that space for a long time. And obviously, as we all are, uh, seeing how the space is maturing very quickly, uh, as the covid impact really reshapes, uh, people's relationship to their positions both online, uh, and offline.
Speaker 1:Chris, thank you for that segue into the impact that Covid has had and, um, really from a macro perspective and the impact that we'll have going forward. Um, so, you know, just provide context. 2019 was already a record year, um, for investments in, in the health space, and was anticipated that 2020 would outpace 2019, and the first couple months of, of 2020 were going very strong. Um, and then we have this worldwide epidemic that has impacted, um, our economy and the way we see business significantly. Um, so last time, um, Chris and I started each other in person was in New York at mid to the end, end of February. And the impact of covid and the magnitude was not appreciated at the time, and so much has changed since. Um, so the initial thought was, well, pe activity's going to slow down, um, not just in healthcare, but overall. And, um, you know, we, we found that there has been, there was an initial, um, let's say little pause, um, by that it's coming back not necessarily to pre covid and crystal develop, uh, this point, uh, but really that it's going to see an uptick and that we've had some pretty significant transactions in the past couple months. And a lot of focus now is okay, even though the covid pandemic is not over looking, looking beyond. So, Chris, what, what's been your experience since, you know, since again, end of February, we've talked about some of the major deals that have closed. What are you seeing in the market? Cause you really have your, your pulse on, um, the larger transactions.
Speaker 2:Yeah, no, I, I think that's well, uh, summarized and it, you know, of course, you know, in the first weeks of March when, you know, the reality of this was, uh, being recognized by all segments of the economy, um, you saw private equity do what, you know, we typically do when, uh, there is an external disruption, whether that's nine 11 the great financial crisis or now, um, coronavirus, which is to, you know, I think very quickly pivot into an internally focused mode, or you're trying to assess the health, the liquidity, um, the stability of your portfolio companies. You're obviously being attentive to employees, customers, partners. You're trying to ver validate the integrity of supply chains. You know, all the things you do to make sure that, um, the investments you already have are as stable and as well cared for, uh, as the circumstances will permit. And I think you saw that reflective, uh, behavior across the industry at the same time that investment bankers and other intermediaries confronted with a no travel policy were largely putting processes that were in the market on hold. Uh, and I think that defined a lot of, of March and into early April. I think what's happened since then though, has been frankly, a stronger than foreseen recovery and activity, uh, both by financial sponsors in healthcare and also, uh, by strategics. Um, we saw, for example, Blackstone, uh, close the acquisition of Health Edge, which is a health information technology business. Uh, you've seen activity in the DME space with, uh, adapt health. Um, United Healthcare made an interesting acquisition of Navi Health from, uh, the sponsor, CD and R. Uh, and I think what we see in our own business, in the pipeline of new activities, uh, is that activity, to your point, is not returning, uh, to February levels. Uh, but the slope in which activity is really re uh, igniting is been impressive. And, uh, even with restrictions on travel and the like, um, clearly, uh, people are wanting to be, uh, forward-leaning when good opportunities, good assets are presenting themselves in the marketplace.
Speaker 1:Chris, what do you think were the factors that, um, sort of leaned against the, the, the, uh, the perception that things were just gonna slow down? Because, you know, whether, whether it's the Blackstone, UnitedHealthcare, these are significant transactions now, you know, I've heard folks say, well, it's because they were already underway, so these are just deals that they wanted to close, but not new deals. How do you, how do you explain this? Or is it because, um, combination of factors and they were saying, you know, the economy's gonna bounce back, um, Corona, we've shifted, it's gonna be a, a force that we can incorporate and manage and work around going forward. I mean, how do you explain it?
Speaker 2:Well, I think like so many circumstances, it's all very fact specific. So certainly there are parts of the healthcare ecosystem that are less impacted, at least at the moment. Uh, by covid 19, uh, healthcare insurers as a general matter, um, have been, uh, relatively modestly impacted, maybe even at the margin benefited at least, uh, momentarily because of much lower elective, uh, procedures. And yet, uh, in the case of nav health, which benefits from, you know, long-term, um, focus on post-acute care and how to be more efficient, those market forces aren't going away. So, you know, I think that's a specific circumstance to a business, a process that likely started before, uh, covid 19. Uh, but a strategic rationale and the absence of a financing risk, uh, that allows transactions to go forward. I would say by contrast, you've seen, uh, very little activity in the physician practice, uh, part of the healthcare, uh, ecosystem where we know practices both dental and medical, uh, have been severely impacted by, uh, the moratorium on elective procedures. Um, those have significant impacts on revenue. Uh, and therefore there's going to be probably a longer period of assessment to understand sort of what the, the new normal is, both in terms of volume and profitability as you take into account, uh, the health policy requirements for making sure that, uh, patient visits to these sites, uh, had the lowest potential, uh, infection risk.
Speaker 1:And Chris, you mentioned health policy and, you know, health and public policy has taken on, uh, a significance that is, is frankly unprecedented. And you talk about elective surgeries and, you know, providers around the country are trying to figure out how to, uh, start elective procedures and, and surgeries because it has been such a financial hit and, and causing, uh, certain systems to really hemorrhage, um, uh, you know, hemorrhage cash. And until the volumes can come back in it, it's a real, it's a real challenge. Yet at the same time, new York's one example, um, some of the requirements that the state has put in place for those reopenings, you know, for example, 90 days worth of ppe, um, providers are not able to satisfy and therefore, um, the closures continue. And that is until we have a, a sort of alignment of, um, what is operationally possible and compliance with the healthcare laws, it's gonna be a real challenge for those, uh, private practices for some of the larger providers for dental practices. Um, at the same time that I'm seeing, you know, with the regulatory expansion on telehealth, that area is just, just booming and, and, and folks are taking, um, advantage of those opportunities. So, you know, we talked, you talked about like new opportunities. You talked about focusing on strategic opportunities. So where are firms investing the new capital they have to work with in this, uh, uh, new normal?
Speaker 2:Yeah, no, those things are all important points. I think, you know, in, in, in one regard, um, you know, it's going to take, I think, a long time for certain segments of the provider community, uh, to get back to a more normalized rate of activity. I'll give you an example. I was on the phone, uh, with a legacy portfolio company this morning. Um, they're active in the ambulatory surgery center marketplace. Um, what used to be fairly standard cadence of 30 minute appointments, um, are now 60 minute appointments, because the additional time needed to sterilize the room to reset pp and e to take into account a different patient flow without large groups in waiting rooms, means that the effective capacity of that fixed cost facility is cut in half. Um, and so even as they ramp up to total number of hours, total number of patients, and therefore revenue and operating profit is going to be, uh, curtailed, and, you know, there'll be iterative improvements over time, of course, but I think, um, that, um, anecdote, that illustration, uh, is gonna run itself through a lot of provider-based businesses for some period of time. And that's all going to be factors that delay the ability of investors to set, uh, a new trajectory or a new, uh, forecast, if you will, for what the earnings power of these businesses are going to be. Some will be affected, less or more, all will be affected, uh, in some regard. Um, conversely, and as you reference, you know, what's happening with regards to liberalization of telehealth or virtual health policy is really dramatic. Um, you know, I think healthcare in general, um, is about slow evolutions in new modalities of care in new technologies, whether those be information technology, therapeutic or pharmaceutical. Um, to see this sort of rapid adoption, uh, across multiple stakeholders is, uh, is pretty uncommon. And yet, you know, pretty interesting to watch. And that is taking a couple of forms. Obviously CMS has taken real leadership here, um, and adjusted rules that allow providers, uh, to see patients on a so-called parody basis, um, same reimbursement as if the patient had been, uh, in their offices. That's really helped patients get access. It's helped practices maintain some stability. And I think, um, everyone I think agrees that has worked. Uh, well. Um, at the same time, state boards of medicine have temporarily relaxed a certain licensing requirements, uh, which can be a real barrier frankly, for, uh, telehealth organizations that are trying to work across state lines and yet still con conform to all of the appropriate, uh, licensure and, um, credentialing requirements that's helped, uh, in a large way. And I think both providers and physicians, excuse me, both providers and patients that have now been exposed to telehealth often for the first time are finding that they really prefer it, uh, and it's a really efficient and effective way, uh, for them to receive care. So I think the bundle of those elements together, in my opinion, you know, makes telehealth a much more now, uh, regular way element of how we deliver care for the foreseeable future. And I think that's gonna be, you know, good for our providers and good for the healthcare system, uh, in general.
Speaker 1:Uh, I, I, Chris, I agree with you, and we did a, a prior podcast on the, the waivers, the section 1135 waivers, the state waivers, what we've seen in telehealth and the relaxation is, is really where many people have been wanting to go for a while, but for a variety of reasons, um, we just weren't getting there. Um, so there's a lot of speculation as to, um, particularly as some of the states now are saying, you, you know, we're getting close to ending the emergency, which waivers, where's the pendulum gonna swing? Uh, part of it is obviously state based, and are we gonna go back to where we were? Or are we going to go back to, you know, maybe in the middle? Um, and, you know, relating that to your patient flow, um, I would predict that it's gonna be a large part of it. If, if you're in a high volume practice and you need to have patient intake and you need to, et cetera, et cetera, the more you can do, uh, via telehealth, the more that's gonna speed up. Um, you know, there, there are practices you mentioned, you know, particularly those are things like orthopedics where you can only do so much by telehealth. Um, and where predictability and volume is key, where we're seeing decreases in the ambulatory, uh, surgery center space, that, um, is gonna require some creative, um, creative, you know, creative, uh, approaches. Um, and, and just lastly, you know, we've been talking about, you know, a, the Affordable Care Act was supposed to be the trans transformative, um, you know, transformative phase in healthcare. And since then it's been, you know, we've gotta transform, we've gotta transform. This has been the sudden, you know, push for rapid transformation. Um, from a healthcare regulatory perspective, it's fascinating. Um, how, how much has changed in just a couple months and, and to your point, increasing patient access. Um, of course there's some very challenging and difficult aspects, uh, to this crisis, um, that your front and center need to be mindful of. Um, so how do you see, I mean, this relates to when you're talking about, you know, what the model looks like, what the revenue's going to look like when we look out into the future and say, okay, um, if we're going from a patient every 12 minutes to a patient every 60 minutes, how do you see due diligence changing in a post covid world?
Speaker 2:Well, I think diligence changing in a number of ways, right? First of all, you know, the capacity, uh, to have any type of in-person meetings, whether it's investment team to management team, whether it's third party diligence resource, Q of e, legal or otherwise, is substantially, uh, curtailed. Um, I do think people are, uh, increasingly getting as we all are more comfortable with other ways to have those sorts of meetings, but now that's gonna continue, uh, to be a challenge both in pacing, um, and I think also in, in conviction building. Uh, so, you know, that is a kind of a, a new, new world reality that everyone is still acclimating to. We're about to launch a sale process, uh, for a legacy portfolio company. Our expectation is all of the initial management presentation meetings will be virtual. And we've had all of of our interested parties sign up to that, you know, without qualification. Might we do in-person as we get into a, a more of a short list? We may. Um, but I think we, like others are still learning, uh, as we go. Um, I think we're all incredibly thankful that, you know, cloud-based, um, virtual data rooms have become such a normal standard integrated part of how all of us think about diligence as a, as a practical matter, obviously the reliance there, I is only going, uh, to increase. And likewise, you know, most private equity firms have become very active users of any number of different expert networks, uh, to really help accelerate their understanding of industry structure, risk factors, regulatory matters and the least. And I think none of that, uh, is inhibited, uh, with regards, uh, to, you know, the virtual, um, way that we're all, uh, approaching this. Um, I think the longer term impact, though, is going to be in part on the sourcing side. You know, a lot of sourcing by private equity firms is done, uh, a bit by, you know, being out in industry trade shows, customer events, uh, and the like. And obviously, uh, that sort of proprietary deal flow generation is gonna be hard to do virtually. And so, um, you know, there will be that effect that's probably not a 2020 effect on the complexion of pipelines, but it will have, uh, a more intermediate term effect as it will limit the ability of investors, particularly that has segment orientations, uh, to go out and build relationships with up and coming businesses. And you'll get that firsthand relationship and diligence intel that often, uh, makes a difference, uh, in terms of, uh, particularly more disruptive parts of the, uh, delivery system.
Speaker 1:And that's something that I'm hearing from clients in, in a variety of different sectors, including those who have nothing to do with healthcare. It's the way they have, you know, whether they've sourced the way they've entertain, the way they have, um, thinking about how to restructure it, um, and do so quickly cause some of their standards, just the way they have developed those relationships and maintain those relationships, um, they anticipate will be changing for a variety of reasons. Um, so interesting to, to think about that in due diligence. One area that I've been, I've been thinking quite a bit about is, you know, all the ACHs funding and, you know, tons of dollars have been poured in. We anticipate that there will be more, um, you know, when, when, um, when some of the funds have come out, they've done so very rapidly, very little notice. The guidelines have been, um, you know, vague frankly, and, and have contradicted some of the prior guidance that that was coming out from hhs. Um, again, you know, a lot of opportunities for, um, interpretation and, you know, they'll say, okay, well, it's not, it's not alone. Um, but you have to, to attest that you're eligible and that you're gonna comply and that you're gonna use all these funds for, for the appropriate, um, appropriate, you know, u uses. Um, part of my concern is, you know, again, both how rapid it was. Um, as, again, regulatory attorney, I never like it when the, when the regs are vague and, and subject to further, uh, retrospective interpretation, we know they're gonna audit. There's no way that kind of, um, cash came out without audit. And it's challenging when you talk about, you know, providers, um, in the midst of caring for covid patients to be managing the, the funds. Is that an area where you think in due diligence, you're gonna start focusing on, okay, what kind of funding did they receive and how did they track it? And are they prepared for a potential audit?
Speaker 2:Yeah, I, I think you're exactly right. Um, I think it is, uh, new ground to be covered. Uh, let's take the paycheck protection program, as you know, another illustration. Uh, you know, the, the funds come in, um, the audit trail will be there. Um, the submission for forgiveness isn't, uh, sub, uh, expected to be due until mid-July, and then there's gonna be a response period. So you have organizations that could have, uh, you know, millions of dollars of P P P monies that are now sitting on the balance sheet for, in the first instance. Of course, they have to be excluded from any revenue, uh, consideration with regards to operating performance. But then in addition, you know, one has to make account for whether, uh, something less than a hundred percent of those funds are gonna be forgiven under the outlines of the program, the contours of which, to your point, um, continue to move, right? Including legislation passed, I think just 10 days or so ago, uh, by Congress and signed, uh, by the president. What Medicare has done, uh, to push dollars out, um, into, uh, providers similarly, uh, is going to be subject, uh, to both adjustment and audit. Uh, and those are all the sorts of intricacies, you know, relative to purchase price adjustment and post close considerations. They're gonna have to be very carefully crafted. Um, and, uh, they're not great precedent for it. So, you know, it's gonna take time. Um, I would emphasize a lot of the deals that we've seen done thus far are non-providers, right? So you don't have as many of those, uh, complexities, but those are coming and it'll take good council and, and, and good stewardship to, to make sure people get to the appropriate landing spots.
Speaker 1:Yeah, no, I, I, I agree. Um, so let's shift from providers, um, because I think there's so much in the, in the health economy that is accelerating, that was a great interest already before pre covid. And now, um, particularly I'm thinking about, you know, the, the health IT space, um, mobile health, um, all these ways that, you know, we were already becoming used to that the public was, and because of some regulations. And we noticed, for example, you know, we were talking about the telehealth and the virtual care, um, that you could, you know, suddenly FaceTime with, with your provider. And, and, and there was a lot of positive feedback about that. So where do you see digital health, self diagnostics, that's whole sphere. I have this theory that we're all gonna have home clinics or, or just like you would have a, a home theater and, um, you know, a home office, um, that we're gonna get to that, that point. So I don't know if that's in five years or 15 years, but, but that's my theory. So, but going back to, to reality, at least for now, uh, what what's your, what's your take on, on health it? Cause I see it as, I see it as booming.
Speaker 2:Yeah. I, I think its, but I, to me, um, you know, the really important sort of nuance is does it live inside or does it live outside of a care delivery, um, framework, you know, going all the way back to the last great financial dislocation, uh, and the stimulus monies that came out of it, you know, meaningful use, right? Which was a federal program designed to help digitize provider organizations, both hospitals and physicians, uh, by providing financial incentives to adopt, uh, electronic medical records, uh, really contemplated that you would have, um, or move towards some single source of truth, uh, about a patient's longitudinal health status. And that's a really, uh, admirable objective. There are selective examples of that occurring, not as widespread as probably were forecasted when, uh, the original monies were allocated. But we have made huge infrastructure progress, particularly, uh, at large healthcare delivery systems around the country, thanks to the likes of Cerner and Epic, and obviously, uh, many others. Um, digital health is fascinating. All sorts of monitoring tools are fascinating. Even virtual care, um, is fascinating. Um, but I think the real impact is going to be most felt when it operates in as part of, not outside of where all your other health information on a HIPAA protected basis is residing. Um, and so that's a challenging integration question. Um, obviously there are, uh, congressional initiatives to make sure the interoperability functions in a way that allows that to occur. Uh, because cl clearly the technology, as we know from the non-healthcare elements of our lives, makes integration, uh, quite easy. We need to see that replicated so that when my continuous glucose monitor, which is taking, you know, uh, you know, consistent reads of my, uh, blood sugar, uh, is downloading it into my iPhone, it's ultimately being, um, captured by my medical record so that when my physician community is assessing my health status or we're meeting for checkups or the, like, um, all that information is able to be seen in a coordinated fashion. That's when I think we get the real ROI of digital health. Um, and while I love disruptive technology, it's gotta speak to, you know, a larger value-based proposition. And I think that's the value-based proposition we continue to, uh, navigate toward
Speaker 1:And that integration. Um, now I, I agree with you and a lot of the work that I've been doing in that space has been that integration between these products and, um, and providers and also, you know, counseling providers saying, well, which ones do I really wanna incorporate? My patients are bringing some of these to me and saying, I wanna download my medical record, or I wanna record you, et cetera. How do we integrate these, you know, again, whether it's monitoring, whether it is, um, you know, devices that, that help people, um, at home, whether it's even within the visit. I mean, you know, for example, that that app where you can record the, the visit and then send it to the patient's family members, that's been really marketed to an elderly population. Providers, understandably. They're saying, okay, so how do we incorporate that, not just from a technological perspective, but from a privacy perspective? Um, because once that data goes to a third party app, um, what are, if any, the HIPAA protection? So I, I agree with you, it's gonna be that that interconnectivity, which will be critical, and I think Covid is gonna push it a little saying, you know what? I don't necessarily wanna come in for some of this care. What can we do to monitor? And obviously, uh, the extent to which it's reimbursed. Um, one final, final question and just predictions. Um, so how do you see, what, what do you see in the next, um, you know, 12 months that, that, um, someone's listening to this podcast, um, should be thinking about as critical, either market forces or, or trends that you anticipate in the, in the private equity space?
Speaker 2:Yeah. Well, I think to, you know, paraphrase, uh, a concept that, that, you know, somebody smarter than I, you know, articulated, but I think captures it well, trends that we have been observing in many way, uh, C O V D has accelerated, whether that's, you know, the decay of the retail sector, the importance of e-commerce, right? These are trends which we've been monitoring for some time. Covid has just added new urgency and velocity, uh, to those trends. And I think you could apply that, uh, framework, uh, to the healthcare, uh, delivery system. Um, clearly the largest, most sophisticated, most well capitalized, uh, provider organizations, which in most markets are large hospital-based delivery systems, uh, are going to be beneficiaries, um, I would argue of, of the dislocation that we're seeing here. Um, they have the resources, they have the infrastructure, they have the access, uh, to capital to continue to be viewed as a very safe set of hands, uh, for how care gets delivered in a market. Likewise, physician groups which had already tilted past the 50% of all physicians in this country employed either by a hospital system, a health plan, or an investor group. Um, the willingness of physicians to leave private practice and join a larger entity, uh, likewise would seemingly be accelerating, uh, in this environment, not least of which is by some estimates, it's gonna cost between 50 and$200,000 per physician to reopen a practice, given they've gotta recapitalize working capital, um, as they now kind of reinitiate, uh, their practice environment. So, you know, for, for a physician who may have been within five years of retirement under any circumstances, that may be more than they're willing, uh, to contribute, just to get back to 80% of where they were, uh, before, uh, COVID started. And then finally, you know, all of these, uh, emerging technologies, virtual health, digital health, uh, the things that we've talked about here, um, are obviously all now, uh, table stakes, uh, for how we think about care delivered, uh, as an integral part of health systems and the relationship between patient and physician as opposed to something that lives, um, in a satellite outside. Um, and I think we've got the capacity to do it. Um, and I think now we've got the regulatory leadership and in many cases the reimbursement, uh, flexibility to accomplish it. And I think that's, uh, one of the few silver linings that may, uh, come out of this. The final thing that I would add is I think there will be, uh, a renewed respect for public health as a discipline within our healthcare system. Um, I'm in the private equity business, so we think a lot about for-profit healthcare, obviously enormous respect for non-profit and faith-based care organizations in this country. But public health, whether that's rural, urban, um, other, um, uh, cohorts of, of individuals that need special consideration, I hope and expect are going to get, uh, more resources, uh, more attention than recent years given. Uh, I think the new recognition we all have that public health is something that affects all of us, uh, and, and therefore warrants, uh, are continued support.
Speaker 1:Well, Chris, thanks for closing on that note. Um, I know the American Health Lawyers Association is very involved, um, with the public health space and advocates, um, and leading in that area. So it'll be, uh, pleased to hear that. I wanna thank you and thank a H L A for this opportunity and, uh, look forward to getting together in New York, uh, when, when, uh, social distancing has been restricted and, and comparing notes on where we are then compared to our conversation today. Uh, what we can be sure of is that it's gonna be an exciting time, um, and real opportunity for those of us who is reflect and think about the future of healthcare and how we can best deliver value and care, um, in this country to, to look at potential solutions and, and crafting a, a future that has improved on, on what we saw, uh, play out over the past several months. So thank you and, um, thank you to h l a,
Speaker 2:Thank you for having me. Have a great rest of your day.
Speaker 1:You too.