This article appeared on The Deal Pipeline on February 28, 2018. It is reprinted here with permission.

In late January, three giant corporations — Amazon, Berkshire Hathaway and JPMorgan Chase — announced they would form a new and independent healthcare alliance to service their hundreds of thousands of employees. It was widely seen as reflective of mounting frustration over the ever-rising costs and inefficiencies of healthcare in the US.

A move of this kind could also create opportunities for healthcare services-related deals, said John Jones, a Philadelphia-based partner and chair of the health care transactions, regulatory and supply chain practices at Pepper Hamilton LLP. It more generally underscores a growing use of mergers, acquisitions and alliances as a way to combat healthcare challenges.

Those in the field anticipate 2018 will be a banner year in healthcare services-related M&A. This follows an especially active year in healthcare services deals, which, according to a PwC study, rose 88 percent globally in 2017 to $32.2 billion, a marked contrast to pharmaceuticals- and medical devices-related transactions, which fell sharply last year in both number and value.

“M&A was really strong last year in the healthcare services side, and I think it’s going to be equally strong this year,” Jones said. “These mega deals are an example of how those in the industry are touched by healthcare and are forced to be creative to bring solutions to solve problems,” said Solomon Hunter Jr., a Philadelphia-based corporate partner at Pepper Hamilton LLP and a member of the health sciences department. “Often, when people are being creative, it leads to more mergers and acquisitions and affiliations and strategic transaction opportunities. We think that creativity is part of the reason why 2018 will be so strong for healthcare services-related M&A,” he said.

The deal flow in 2017 took place despite some insecurity that stemmed from the Trump administration’s efforts to repeal and replace the Affordable Care Act. That sense of uncertainty has probably ended, and with it “there’s a lot more confidence in where reimbursement is headed, although still some uncertainty on how the tax cuts may impact Medicare and Medicaid,” said Jones. Greater certitude “on the reimbursement side and with government programs gives you confidence in the M&A activity,” he said.

However, “there are always regulatory risks in a deal,” Jones added. “That’s something buyers always consider.”

Both strategics and private equity are in what has become an aggressive marketplace for deals.

“We’re seeing strategic consolidators remain very active and executing on their M&A initiatives, while also thinking outside the box of their core businesses to diversify, to innovate, and overall, to continue to improve the delivery of care,” said Dan Gofman, a director in Cain Brothers’ M&A advisory practice. He added that financial sponsors “are looking to deploy an abundant amount of liquidity and in many instances, they’re outpacing and outbidding strategics in a pretty hot market.”

Justin Marquardt, a Chicago-based vice president at New Harbor Capital, said that aging demographics and a lack of supply give the sector a leg up. He then added a further impetus for his private equity firm’s investment in healthcare: “We really are attracted to businesses where we’re working with passionate people, not just about their business, but the constituency they serve. They are driven by making a difference and helping people,” Marquardt said. “We love investing behind those people because we feel the same, because it’s just more enjoyable and you’re dealing with people who are more motivated because they care. It’s just better.”

Jones made a further distinction between these two sources of investment: “Historically, the strategic buyers dominated the healthcare services industry in M&A,” he said. “Private equity has materially increased its activity and was probably on record pace last year. I think the financial sponsors are going to continue with their investments and their desire to spend and it’s really based on sizeable growth expectations and their confidence in assets that will support strong enterprise values and EBITDA multiples.”

That level of private equity action has led to far quicker exits for financial sponsors with healthcare-related portfolios, Gofman said. “The financial sponsors’ holding period has shortened in this market. We’re seeing many monetize their investments in as short as 12 months, on the outside 36 months,” Gofman said. “Founders and closely held organizations are recognizing the success and opportunity to grow with new partners in this ever-changing landscape.”

The middle market continues to drive healthcare-related M&A. “That’s where most of the deals are,” said Hunter.

Several subsectors could be especially active in the months ahead, deal advisors believe. Gofman noted three subsectors: physician practice management, behavioral health and healthcare information technology. Jones added long-term care, including assisted living and home health (given the demographics of the populations served with healthier people living longer) to the list.

Marquardt cited New Harbor’s majority stake investment in Fyzical, a franchisor and operator of physical rehabilitation centers specializing in balance, a particular concern among the aged. “Balance is very, very important, and it’s not being addressed,” he said. “It’s a market that’s very exciting to us, but untapped to some degree, and it’s very effective to the patients, the elderly patients.” Existing facilities linking up to Fyzical can make use not just of the brand, Marquardt said, but “more importantly our equipment, our ongoing R&D, our knowledge doing these different procedures…It’s a great social good as well as a great business.”

IT demands particular focus because technology is so transformative for the industry. “Everyone is looking for opportunities to control costs and create efficiencies in the healthcare system,” Jones said. “That is done today primarily through technology.”

Take, for example, the $1.1 billion acquisition last year by McKesson Corp. of CoverMyMeds. McKesson is a healthcare giant, primarily in drug distribution, but investing increasingly in related IT. CoverMyMeds is a leader in an area of healthcare technology called electronic prior authorization, software that automates the process for healthcare providers, as well as pharmacies, health plans and health records systems.

For many healthcare-services companies, IT has become a huge cost. Some companies are attempting to temper this expense through acquisition, converting a recurring expense into income. “One area where it’s going to be very active in 2018 is these healthcare service organizations acquiring the IT platforms that support their core businesses,” said Jones. “In some cases, they represent one of the largest expenses of the company, and senior management turns it into a revenue stream.”

Jones and Hunter cited a current deal in which a healthcare services company is acquiring a Canadian-based software concern. The acquirer is the IT company’s biggest client. “Its software is important; it makes sense to buy the vendor,” said Jones and Hunter.

In the arena of physician practice management, Gofman, for one, highlighted value-based care, practices in which physicians take on some of the risk while transitioning to payment for quality- and outcomes-driven care. He cited as an example Chicago-based VillageMD, which in January announced it had closed on an $80 million growth financing funding round led by Athyrium Capital Management.

Ophthalmology is another physician practice management specialty that should see accelerated M&A, Jones believes. “It’s just an industry that’s ripe for acquisition. It’s founder owned and highly fragmented. It’s growing, and it has new technology supporting it,” he said.

That kind of fragmentation extends to behavioral healthcare as well, Jones said.

With regard to behavioral healthcare, Gofman, for one, pointed to mental health treatment, addiction and substance abuse as areas where deals may be particularly active. Autism treatment is one specialty in which Gofman and colleague Todd Rudsenske have experienced a number of transactions. In December 2016, Cain Brothers advised on the sale of Invo HealthCare Associates, a Pennsylvania-based provider of autism-related therapeutic services to The Wicks Group and The Jordan Co. A year later, the investment bank advised on the sale of the Stepping Stones Group, which provides schools and communities nationally with clinicians to service children with autism and special needs, to Five Arrows Capital Partners. In both cases, the buyers were private equity, with prior owners retaining a minority stake.

Hospital-related M&A is one area that might not see the same level of growth this year as last. That’s largely because there was an enormous level of consolidation, especially among community hospitals, in past years. It probably peaked during the second quarter of last year, Jones said. “I just don’t think you’ll see an uptick there,” he said. “It plateaued and will probably just continue along those lines.”

However, he added, that doesn’t mean that hospital groups will stay away from deals altogether. He cited a Pennsylvania-based group. “They’re looking for different kinds of strategic transactions, for example, rollup of ancillary services, such as ASCs, in an attempt to increase their bottom line. Some are now looking at strategic transactions and affiliations rather than a merger or full-blown member substitution.”

Healthcare services in general should remain attractive for the foreseeable future. “Certain areas have become extremely pricey, so we have to navigate that and try to pick our spots,” said Marquardt. But he was quick to add: “We think there’s definitely a long-term need and a long-term demand, and those drivers that are promoting our interest from a social good as well as a business standpoint are not going away any time soon.”