Opportunities and challenges in an evolving market

The healthcare and life sciences industry and subsectors have weathered the most difficult economic year in modern history. However, despite the massive financial and social disruption caused by the global pandemic, many companies in the industry fared better in 2020 than other sectors of the economy, and companies in several subsectors maintained unprecedented momentum in the deal market.

Clearly, COVID-19 has been and will continue to be a dominant concern and focus across healthcare and life sciences, although the impact varies by subsector. In a recent KPMG survey, 71 percent of healthcare respondents ranked COVID-19 as one of the top two factors impacting deal activity in 2020, and 53 percent expect it will continue to be a major factor in 2021. For example, hospitals and certain specialty physician practices continue to struggle with fluctuating volumes due to patient reluctance to resume planned or unplanned elective procedures during viral surges.

On the other hand, healthcare IT and risk-based physician practices have sustained less of a negative impact from the pandemic, and many of the assets in these subsectors are experiencing tailwinds. For example, the pandemic has highlighted the advantages of telehealth as a safe and cost-effective mode of care. And there is now a high level of both public and private equity interest in companies in the risk-based physician subsector, which represents a resilient business model that has benefitted from the shift to value.

At the same time, the global life sciences sector continues to play a central role in helping the world move past the pandemic. In 2020, companies that pivoted to COVID-19-related products and services bounced back rapidly and are now attracting more investment interest than those that carried on with business as usual. Given the need for diagnostics, vaccines, and treatments for COVID-19 and a continuing focus on breakthrough innovations, organizations in the biopharma subsector, in particular, had a stellar year financially, which promises to carry over into 2021.

DIAGNOSTICS MANUFACTURERS
While the demand for routine diagnostic test platforms and reagents was depressed for months in 2020, diagnostics manufacturers that pivoted to COVID-19 testing thrived. These companies enjoyed rising revenue and valuations since last March, helping revive their interest in M&A. COVID-19 also created the need for more near-to-patient testing methods as people were advised to (or preferred to) stay home. In addition, companies that offer innovations such as point-of care testing, direct-to-consumer testing, and liquid biopsy, as well as other less-invasive sampling options for COVID-19 and other diseases, all had higher valuations.

How global diagnostics manufacturers fared in 2020
Pivot to COVID-19 testing. Diagnostics manufacturers that were able to pivot and fill testing demand – with molecular-, antigen-, and antibody-based COVID-19 tests – are flourishing. Between March and early December, approximately 270 million molecular COVID-19 tests were shipped, including ~200 million commercial tests and ~70 million extraction reagents. According to AdvaMed’s COVID-19 Dx registry, 90-95 percent of COVID PCR and serology testing was manufactured by a small group of companies, including Becton Dickinson, Bio-Merieux, Bio-Rad Laboratories, Danaher (encompassing Beckman Coulter and Cepheid), Hologic, Ortho Clinical Diagnostics, Roche, Sekisui Diagnostics, Siemens Healthineers, and Thermo Fisher Scientific, among others.

Hundreds of other companies have introduced COVID-19 test offerings, with new innovations rapidly emerging to allow more patients to get tested in whatever way is most convenient for them, including direct-to-consumer methods. Options now include at-home COVID-19 tests, several of which were authorized by the FDA in November and December of 2020.

Although point-of-care and direct-to-consumer testing are not new trends in diagnostics and have struggled in the past due to higher costs and access challenges, COVID-19 has forced their uptake, and the subsector is responding. Indeed, diagnostics manufacturers that have not already added point-of-care to their offerings are now looking at options to expand to meet this new normal, which is not likely to abate in the near term.

Increase in deals, shift in structures. Due in part to the demand for COVID-19 products and the influx of cash into the subsector, the volume of announced or closed acquisitions of diagnostics manufacturers picked up in 2020, with 46 deals through the first week of November 2020, which represents twice the volume of deals in 2019 and a 45 percent increase over 2018. According to the survey, 63 percent of diagnostic-manufacturer respondents said that the revenues they have realized from COVID-19 testing has allowed them to make more deals in 2020. And looking forward to 2021, 90 percent of our survey respondents say that they expect the number of deals in the subsector to increase.

The historic focus on deals involving molecular diagnostic and genetic testing, as well as drug discovery tools, has intensified this year.

Notable molecular diagnostic and genetic testing deals included: The ~USD 2.15 billion acquisition of liquid biopsy test kit manufacturer Thrive Earlier Detection by clinical reference lab Exact Sciences and the USD 1.4 billion acquisition of cancer test kit manufacturer ArcherDx by clinical reference lab Invitae. The valuations of these companies were given a boost by patients’ desire for non-invasive testing that can be conducted at home, as well as labs looking to both reference lab and kit options to diversify their offerings.

Notable drug discovery tool deals included: Life sciences analytics company Bruker’s acquisition of Canopy Biosciences, which specializes in biomarker imaging technologies for cancer; PerkinElmer’s USD 383 million acquisition of Horizon Discovery, a deal designed to bring gene-editing CRISPR technology for therapeutic research and clinical applications to the life sciences company, and gene-sequencing company Illumina’s ~USD 8 billion buy-back of liquid biopsy cancer-screening startup Grail.96

The latter will help Illumina expand its offerings beyond sequencing technology and increase the company’s focus on cancer-screening, diagnostics, and cancer-monitoring products.

Outlook and investment considerations for 2021
Balancing the need for COVID-19 and non-COVID-19 testing. Although the need for molecular PCR tests will likely fall once vaccines are fully disseminated, diagnostics manufacturers have found a lasting addition to their portfolios in COVID-19 testing. It is expected to take years for vaccines to be distributed worldwide and, in the meantime, there will still be demand for COVID-19 molecular and antigen testing kits and solutions.Additionally, vaccine clinical trials and post-vaccine tracking of patients’ antibody titer levels will continue to drive the need for serology antibody tests.

Deal trends. The trend toward more deals related to molecular diagnostic and genetic testing in 2021 is likely to continue and perhaps accelerate. In fact, survey respondents said that the top three areas for M&A activity in the subsector in 2021 are likely to be: point-of-care testing, driven by the pandemic; liquid biopsy, driven primarily by manufacturers desire to have a robust pipeline in key therapeutic areas (e.g., oncology), and next-generation sequencing (NGS), driven equally by enhancing the pipeline and a continuing push for innovation. Of the three, the liquid biopsy segment is expected to have the largest increase in valuation, according to 90 percent of survey respondents.

Investors find these assets particularly attractive because they provide a platform, rather than a one-dimensional product. These platforms enable a more seamless expansion into adjacent indications and give management teams more options for driving growth. Drug discovery assets also have opportunities to move downstream with their biopharma customers to applications in the clinical setting, fueling additional value in biopharma services deals.

Finally, diagnostics manufacturers that moved into COVID-19 testing now have more financial flexibility, which allows them to be more patient with new acquisitions. Instead of looking for an immediate payoff, some companies are now willing to give acquisitions several years to show value for innovations still in development. This trend is supported by our survey, in which 26 percent of respondents said that moving into COVID-19 testing has increased their revenues and allowed them to make non-accretive deals.

The take-away
We expect investment in the diagnostics-manufacturer subsector to center on a couple of major themes in 2021: platform-based assets that have clear applicability to adjacent indications and partnerships or acquisitions that enhance data and analytics capabilities. Diagnostics players will increasingly evaluate assets based on whether they are pursuing partnerships or acquisitions that can expand data and analytics capabilities. Another trend: companies will be reviewing their portfolios for products that could transition to home testing.

Diagnostics manufacturers, always the steady mainstay of the life sciences industry, will be in the spotlight for investors in 2021.

MEDICAL DEVICES
Although the COVID-19 pandemic drove high demand for ventilators and other respiratory devices in 2020, we expect companies in the medical devices subsector to be on a bit of a rollercoaster in 2021. The continuing surge in COVID-19 cases in many geographies across the globe impacts the demand for devices used in elective surgeries. On the other hand, many medical-device companies may be less vulnerable to economic downturns than companies in other subsectors, so demand could quickly rebound to pre-COVID-19 levels as the industry move beyond the pandemic. Longer term, the aging baby boomer population ensures rising demand for devices, particularly those used in cardiovascular, neurological, and orthopedic treatments.

How they fared in 2020
Medical device manufacturer global revenue rose at an annualized rate of 2.7 percent to USD 47.1 billion from 2015 to 2020, even though revenue fell approximately 4.4 percent in 2020 due to COVID-19. This impacted valuations of device manufacturers that rely on elective procedures: 69 percent of medical device survey respondents said that they believed valuation of such companies had decreased between 10 percent and 20 percent or more this year.

Outlook and investment considerations for 2021 globally
Over the next five years, medical device markets will likely return to normal growth, with revenue expected to increase at an annualized rate of 3 percent to USD 54.5 billion by 2025. Medical devices and services deal volume was strong toward the end of 2020 with 82 deals in Q4-20.134 This subsector had 247 announced or closed deals in 2020, which was a 106 percent increase from 2019 and gives the subsector the third highest deal volume for the year, behind biopharmaceuticals and healthcare IT. In 2021, 53 percent of respondents said they expect that small strategic tuck-in deals will be the most popular, followed by 30 percent who expect to see strategic partnerships and 17 percent who anticipate large consolidation deals.

One example of internal growth that will likely be of note to investors: Continuous glucose monitor (CGM) manufacturer Dexcom saw significant growth this year with 2020 revenues expected to be up by ~25 percent to reach around USD 1.85 billion. As we look forward to 2021 and beyond, the company’s growth could be given an additional boost by a five-year collaboration agreement with the University of Virginia to test its CGM technology for use among people with Type 2 and gestational diabetes.

Return of elective surgeries. Revenue growth – and investor interest – will vary widely across medical device segments and depend upon prioritization of elective surgeries. Faster recovery is expected in demand for devices used in less deferrable procedures, e.g., trauma, cardiac surgery, oncology, TAVR, diabetes management, and dialysis. The recovery may take longer for devices used in more deferrable procedures, e.g., hip & knee, ortho extremities, aesthetics, spine surgery, cataract LASIK, and LAAC. A lot depends on COVID-19: there was a resurgence of procedures requiring major inpatient hospital stays in the second half of 2020, but these fell off again during the recent surge of COVID-19 cases, as did outpatient procedures in specialty physician offices.

More than half of medical-device survey respondents said that they would target elective procedure medical device manufacturers based on the underlying technology, and they are likely motivated by currently depressed prices as well. Therefore, we anticipate significant activity in this subsector in 2021. Further, since ambulatory surgery centers (ASCs) could recover faster than hospitals, device makers whose products are used in those settings may recover more quickly.

The take-away
From a global device perspective, various regions of the world are in different phases of their first or second surge of COVID-19, making pinpointed predictions on return to elective procedures more difficult. Although the medical device subsector will only be watching from the sidelines, the pace of recovery in the subsector is dependent on successful and swift vaccine distribution paired with vigilant testing to keep populations safe and able to undergo surgeries.

HOSPITALS AND HEALTH SYSTEMS
COVID-19 disrupted the entire healthcare industry, but 2020 was particularly challenging for hospitals and health systems. From the first elective surgery suspensions in the spring to the overwhelming surge in virus cases across the country in late 2020, the pandemic has been severely taxing on hospitals from both operational and financial perspectives. Nursing and support staff shortages, provider burnout, and a dramatic decline in non-emergency and elective procedures have strained many hospitals in ways impossible to imagine a year ago. That said, when it comes to the longer-term impact of the pandemic, large, sophisticated health systems are expected to rebound financially, while a growing number of small and rural institutions may not survive on their own.

How they fared in 2020
In the hospital subsector overall, revenue had already been decreasing at an annualized rate of 1.6 percent to USD 934.8 billion from 2015 to 2020, and, in 2020, the subsector experienced a revenue decline of 18.4 percent. Loss of revenue and high operating expenses are expected to result in full-year operating losses of at least USD 323.1 billion in 2020, according to a June analysis by the American Hospital Association (AHA), even after accounting for the emergency funding provided under the CARES Act, the Paycheck Protection Program and the Health Care Enhancement Act.

As the industry moved into the second half of 2020, stronger hospitals, often located in larger metro areas, saw their elective surgery volumes return to near normal levels. However, that progress was interrupted by the year-end COVID-19 surge. Hospitals received CARES Act Provider Relief Funds and rural hospitals received targeted bailout funds through CMS’s Community Health Access and Rural Transformation model – which helped many institutions, stay afloat and deal with the surge. However, the path to financial recovery will be a long one for countless hospitals across the country. A significant number of rural hospitals may not survive without being acquired by less distressed hospitals.

Outlook and investment considerations for 2021
The challenges related to COVID-19, as well as reimbursement pressures and the trend toward providing more services on an outpatient basis, will lead to continued financial challenges for hospitals and health systems, especially ones that just barely survived the initial waves of COVID-19. Many may turn to horizontal consolidation and partnerships, as well as vertical integration. Others will rely on new business models to build scale, gain share of wallet, and access new revenue streams. Across the board, hospitals will explore the possibility of investing in telehealth and other technologies to help them compete with alternative modes of care.

Horizontal consolidation opportunities and obstacles. Hospital/health system deal volume of closed or announced deals was down 14 percent from 2019 to 2020 but the subsector had a strong Q4-20 with 36 deals. As we look toward a Biden administration, which has already stated its intent to focus on ensuring high-value care, it is likely that there will be increased scrutiny of those hospital deals that could create anti-competitive market power and higher prices, as well as those that are large and cross state lines. In regard to the latter, interstate mergers are more likely to be successful if they entail deal theses based on expanding best practices, adding digital capabilities, transforming chronic care, and ensuring service-line excellence, as opposed to pursuing scale and better negotiating power with payers and/or streamlining corporate functions and supply chain. It should be noted that any antitrust review is based on a complex rubric that involves service-line market share in hospital service geographies as well as variations in specific market analyses, which may impact the outcome.

Vertical integration. In 2021, we expect to continue to see vertical integrations that align services across the continuum of care—for example, hospitals forging deals with physician practices, ambulatory surgery centers, urgent care clinics, post-acute care providers, and behavioral health providers. It should be noted; however, that antitrust scrutiny of vertical combinations will likely grow, based upon a likely focus on market concentration by the FTC and the Biden administration.

Partnerships as an alternative to mergers. As antitrust scrutiny of hospital mergers continues to increase, partnerships, joint operating agreements, and service-line joint ventures are becoming more common and are expected to increase in 2021. These arrangements are attractive because of lower capital requirements, less regulatory scrutiny, and faster implementation – all of which can lead to value sooner. At the same time, we expect divestitures to continue as some providers shed lower-performing assets and allocate scarce resources to higher-performing ones.

In contrast to full integration achieved via merger, joint operating agreements can provide quick wins in areas like branding and service reconfiguration to optimize profitability. For example, Virginia Mason finalized a joint operating agreement with CHI Franciscan (part of CommonSpirit Health) in January 2021. The deal will build upon existing collaboration between the two legacy organizations, including a radiation oncology center and a joint venture obstetrics unit. Service-line joint ventures allow a more experienced operator with an esteemed brand to add another hospital’s service line to garner market share or stem migration away from a specific market. Service-line joint ventures are particularly popular in pediatrics and oncology.

New business models. Health systems, particularly those with the financial wherewithal and full penetration of existing markets, continue to explore new business models to diversify and access new revenue streams. This includes launching health plans; commercializing capabilities and assets; selling or partnering on the commercialization of retail products in providers’ offices or big-box retail stores; expanding the scope of research, general medical education (GME), and associated clinical programming; expanding into cash-pay adjacencies (e.g., senior living, hotels); and forming technology/healthcare innovation partnerships.

Investments in telehealth. With or without COVID-19, demand will continue to grow for alternative modes of care, including urgent care clinics, retail health, and, of course, telehealth. Telehealth services will likely continue to be an important adjunct to outpatient visits for the remainder of the pandemic and even longer if CMS continues to provide reimbursement for a variety of services that can be provided remotely. At the same time, hospitals are continuing to invest heavily in telehealth capabilities. In fact, healthcare IT and telehealth are the top two areas of investment interest among hospital survey respondents for 2021.

The take-away
Even as hospitals seek to make up for volume lost during COVID-19 and face continuing competition from alternative service providers, the increasing number of aging patients with Medicare coverage and multiple chronic conditions will likely drive a resurgence of demand for hospital services over the longer term. These factors will support the expected increase in hospital revenue of 2.4 percent annually to reach USD 1.1 trillion over the five years to 2025.

OUTLOOK
As the industry look forward to the end of the COVID-19 pandemic and brighter days ahead, the daily counts of new coronavirus cases, hospitalizations and deaths – as well as the economic dislocation and disruption to our lives, families and businesses – will remain seared in our consciousness for many years to come.

Healthcare and life sciences have been at the center of the pandemic response – from hospitals and physician practices providing life-saving patient care, often without PPE, to diagnostic manufacturers innovating to provide accurate testing capabilities, to biopharmaceutical companies developing effective treatments and vaccines in record time. However, this does not mean that the public will expect anything less than high value and higher quality from healthcare providers, or breakthrough innovations from life sciences for diseases and conditions unrelated to COVID-19. In fact, it is likely that the public will demand even more from the healthcare and life sciences industry and subsectors as we move beyond the pandemic and adapt to the new reality that will follow.

While the pandemic has exposed many of the vulnerabilities of the healthcare industry, it has also been an impetus for advancing the connective technologies, interoperability, and commitment to data sharing that will allow the digitalization of the entire healthcare and life sciences ecosystem, as well as the seamless, convenient, and immediate patient experiences healthcare consumers demand. The industry’s flexibility, as well as its ability to quickly adapt to a rapidly changing pandemic environment and respond to patients’ needs and demands, bodes well for this continued transformation.

Investors have clearly recognized the resilience and innovative thinking of many organizations across the healthcare and life sciences industry as they responded to COVID-19. In many subsectors, 2020 deal-making volumes exceeded initial estimates at the start of last year, despite the pandemic. And at least two subsectors had record years in 2020: Biopharma experienced the most active deal market in history, and the telehealth segment of healthcare IT broke investment records in the first two quarters of 2020.

As research shows, investment plans – and valuations – for 2021 promise to be robust. Looking forward to 2021 and beyond, healthcare and life sciences organizations have an opportunity to play a pivotal role in shaping the new reality – even beyond the parameters of their industry and subsectors. The degree to which organizations can continue to evolve and innovate will be key drivers of success, as well as indicators of worthwhile investment opportunities. As healthcare and life sciences investors map out their plans for 2021, analysis of the subsectors covered in this report should serve as a catalyst for thinking about where viable opportunities will lie.

This article is based on a report by KPMG.