The story of 2022 was really a tale of two halves. The first half maintained the record pace of 2021, while the second saw macro challenges catch up. Even so, 2022 was a strong year, and there remain many pockets of opportunity in the current environment, which is critical because organizations that accelerated fastest out of prior downturns were those that invested throughout them.

In this newsletter, we explore six prominent trends, along with investment themes, areas of concern, and potential categories that are well insulated in light of current market conditions.

As we note above, 2022 results were a mixed bag. On one hand, disclosed deal value reached nearly $90 billion, making 2022 the second-highest year on record by value, and deal volume in North America and Europe was the second highest on record. On the other hand, the annual view masks a slowdown that occurred throughout the year. Buyout volumes fell by more than 50% during the second half of 2022 vs. the first half, and the fourth quarter saw the lowest quarterly healthcare private equity deal activity since 2017.

Some signals point to a global economic slowdown in 2023, which may prompt funds to update their downturn playbooks. We have more on that below. On the flip side, today’s uncertainty may prove advantageous for savvy investors. It’s a good time to find differentiated assets, and there are plenty of creative ways to get deals done.

In prior recessions, healthcare private equity has proven more resilient than the overall PE industry. That said, we face a unique set of macroeconomic challenges today. Even many of the most tenured PE investors have never seen inflation like this, and labor shortages have hit healthcare hard. Funds can take several proactive steps to navigate current market dynamics; they can target downturn-resistant investment themes, get more creative about how to make deals happen in a credit-constrained world, and dial in value creation playbooks for the current environment. Healthcare subsectors will feel the effects of recessionary and inflationary pressures differently, with providers likely to be hit harder and life sciences businesses being more insulated. Across all subsectors, however, pockets of opportunity remain.

Speaking of recession resistance, activity in biopharma and life sciences remained robust as participation in these sectors has become increasingly important for US and European funds. Most of the action has occurred in eight subsectors, each with its own unique dynamics. Meanwhile, a core of 50 funds account for about 65% of deals in this space, with leaders consistently demonstrating that they know where to play and how to win. The variance in returns among life sciences subsectors is wider than other healthcare investment areas, highlighting the value of specialization in mitigating current market risks. It’s a challenging space to navigate successfully, particularly given the intense competition.

The rising costs of care and the maturation of key enablers are converging to propel the growth of value-based care (VBC), which has long been touted as the next big thing. Our analysis suggests that it will take 15% to 20% of the market from traditional fee-for-service models in primary care environments by 2030. At the same time, we are seeing the uptake of VBC models expand beyond primary care into other payers and specialty segments. Investors should consider two ways to play: assets that participate directly in VBC models or services and technology that support the transition to VBC.

That said, it can be challenging to identify the best entry point amid the abundance of solutions and business models available. Investors also confront some critical questions about current valuations, whether business models are appropriately tailored to the audiences they serve, and how to assess the right point of departure.

Tough nuts to crack, to be sure, but worth the effort: 80% of physicians are interested in VBC but feel constrained by technology and administrative overhead. That may be your opportunity.

In the face of tight credit and depressed valuations, companies are changing their exit strategies. Adding to a general disenchantment with public markets, sponsor-to-public exits slowed to a trickle last year. Consider that:

• Total exit volumes fell from more than 240 in 2021 to around 230 in 2022
• After seeing 43 sponsor-to-public exits in 2021, there were only four public exits in 2022, none bigger than $1 billion
• Given the disappearance of public exits, sponsor-to-sponsor and sponsor-to-strategic exits stepped into the void. Both were up compared with last year.

The future remains unpredictable; continuation funds and partial exits triggered by a prolonged downturn could contribute to longer holding periods going forward.

Rising competition, higher interest rates, increased labor costs, and tighter credit—that’s the bad news. The good news is that ample dry powder and an impressive track record for returns should continue to attract healthcare-specific funds in 2023.

We expect each region to face specific challenges. In North America, questions about economic stability, interest rates, and post-pandemic changes to Medicaid eligibility are among the top concerns. Europe’s central banks may respond individually to different signals, and competition within life sciences seems poised to intensify. Asia-Pacific faces the same macro challenges as the rest of the world, but the nuances differ considerably by country; some healthcare private equity investors have been diversifying to markets such as Southeast Asia, India, and Japan in response to evolving trade policies and geopolitical dynamics.

Change is imminent, and while some will benefit from a new trajectory, others must adapt. Healthcare investors are accustomed to change and recognize its potential to create opportunities for backing future winners.