It's been nine months since the COVID-19 outbreak sent shockwaves through the global economy. While the markets have recovered somewhat and early losses have been reversed, many industries continue to face deep financial hardship. Unprecedented in its global reach and impact, the pandemic has wiped out large swathes of the global economy. More resilient to economic downturns compared to cyclical industries, the pharmaceutical sector was not as badly hit, offering protection to investors in times of heightened uncertainty. Still, the destructive impact was felt.

Some healthcare sectors were sheltered from the economic shock brought by the virus outbreak, but many segments of the health and social care system felt the damaging effect much in the same way that it has been for a lot of cyclical sectors. As the health crisis placed hospitals in the spotlight, the healthcare sector found itself in a perfect storm. On one side, revenue was affected as all healthcare deemed nonessential was postponed. On the other side, healthcare providers faced growing cost pressure as wages and supply cost increased. In addition to the supply chain, workforce and financial disruption, the healthcare sector started to face longer-term challenges, including shifts in patient behaviour and demand, as well as adjustments to operating models required to better serve and manage populations in the post-COVID-19 world.

The impact of the virus outbreak and all it brought was multi-layered. The first-order impact of lockdowns and quarantine surfaced as business deterioration across the healthcare services spectrum — although to a varying degree. The economic fallout from COVID-19 was most evident among provider-based specialities, the elective segments of provider practice management, and social care settings, which faced the challenge of an immediate drop in private referrals coupled with the requirement to potentially accept patients with COVID-19 from hospitals.

And any time there is a disruption to business operations, there is a disruption in M&A activity that follows — and this time was no different. Markets quickly tightened up with most processes either put on hold or delayed until uncertainty subdued and more clarity about a future recovery was restored.

Indeed, as the country opened up and businesses resumed operations, more buyers engaged in deal-making activity, unlocking a massive backlog of the build-up of interrupted deals. As we approach the year-end, this pent up demand is expected to lead to high transaction volume and gradual deal-making recovery.

The latest numbers on M&A activity released by ONS support these findings documenting subdued activity until June, with a rebound in July and August.

Type of Deals That Saw Finish Line in 2020

Notwithstanding tight conditions and a hard environment in most of the current year, some deals were still able to get through to the finish line. However, a good bit of restructuring to address some of the Covid-19-related risks and financing issues was needed to achieve the deal closure. Here, risks and challenges faced by strategic buyers differed from those faced by private equity firms.

Having had to grapple with the negative impact of Covid-19 on their own businesses before considering acquiring other companies, strategic acquirers were mainly focused on their own operations. In times of heightened uncertainty, cash is king and conserving liquidity becomes a priority, which then makes it difficult to finance transactions with cash on hand.

With a subdued lending environment as banks tightened the credit reins during downturns to weather the storm and maintain financial resilience, private equity firms faced difficulties with financing new transactions - and among them especially platform transactions using the same level of third-party debt that they had previously used.

Innovative Deal Structures to Tackle Capital Tightening

As a result of the tighter market, different creative structures have emerged to allow previously initiated deals to move forward. These deals, with terms, negotiated pre-Covid closed at the same valuation albeit with some creative structuring such as.

• All equity transactions which eliminate the need for third-party financing
• Seller financed transactions where the seller defers a part of the purchase price, which is then treated as a debt-like item on the balance sheet. When the business stabilises, the business will refinance that debt out and pay the sellers.
• Deferred payment structures usually tied to productivity metrics of the business returning back to pre-Covid levels.

Different Positions of Strategic and Private Equity Buyers in COVID-19 Environment

In the current environment, strategic buyers likely have more readily available financing with larger revolving credit lines and easier access to the capital markets. As a result, we will likely see more activity from strategic investors than from private equity firms.

In addition, the nature of post-closing costs plays a role here. The private equity model leans heavily on investing in the infrastructure of a business that they can grow and scale — which adds substantially to the post-transaction costs. In contrast, strategic acquirers will have already built out corporate infrastructure, enabling them to realise immediate synergies from the get-go to offset costs.

For this reason, it is likely that more strategic deals were closed than new platforms. Nonetheless, private equity is sitting on record amounts of dry powder and firms will be looking at putting to work this massive amount of capital.

Key Long-Term Pressure Points Affecting UK Healthcare M&A Activity

Although Covid-19 wreaked havoc on the healthcare sector, not all pressure points are pandemic-related. Some of them are legacy issues carried over from previous years, such as:

Continued Pressure on Government-Funded Social Care Contracts

Spending on adult social care in England has fallen by 2% since 2009/10 despite growing demand. Demand for publicly funded social care is likely to continue to increase at a faster rate than funding. Unless local authorities can make further efficiency savings, the government will either have to increase spending or accept that local authorities will have to reduce the quality of or access to, care.

Increased Care Quality Commission Regulation

In 2013 the Care Quality Commission (CQC ) introduced a new regulatory model and a new approach to inspecting and rating NHS acute hospitals. It has since been adapted for use in other sectors that CQC regulates across the health and social care spectrum as it was recognised that NHS services and social care are interrelated and it is difficult to have a plan for the NHS without having a plan for social care.

Consequences of Brexit for the Healthcare Sector

Brexit is expected to have a profound impact on the UK healthcare sector, including staffing, access to treatments in the UK and abroad, regulation, cross-border co-operation, funding and finance.

It may present some opportunities for the UK, such as the chance to drive public health regulation and remove rules on competition hindering the integration of and collaboration between health services.

Still, Brexit also presents the NHS and social care with a number of significant challenges, including the impact on the health and social care staff who are EU nationals. Also, future trading relationships could affect the supply and affordability of drugs and other medical products. In addition, this event will have a profound impact on the broader economy, affecting future funding for health and social care.

Recruitment and Retention of Staff

Staff shortages are an ongoing challenge for the health and care system. Despite considerable rises in activity pressures, the full-time-equivalent number of registered nurses and health visitors employed in the NHS grew by under 0.5% between 2017 and 2018, according to the Health Foundation study. Although there has been very small overall registered staff growth, more than 100,000 vacancies were reported by trusts in 2019, a number projected to only rise over the coming years.

What to Expect Going Forward

However, it is not all bad news. Health and social care does continue to provide relatively secure shelter for investors and the activity seems to be bouncing back. The sector has seen transactions in dental, children's care, live-in care and diagnostics completed in recent months. As expected, in times of uncertainty, transaction timescales have lengthened as due diligence requirements increase. As we move closer to the year-end, we expect 2021 to be a very active year for healthcare M&A.

Until the vaccine is in broader use and business productivity resumes, M&A deal activity will likely remain soft when compared to the previous years. Still, for deals with a strong business case, it does not mean that they will not be executed or that announced deals will not be consummated. Deal planning will not cease and attractive and opportune strategic and financial transactions will continue. Deal benefits and risks will be watched more closely, and deal principals will be paying closer attention to emerging trends. As this happens, new deal structures will continue to emerge as new transactions are negotiated and structured.