Healthcare Investment Banking: The Best Place to Check In When Other Bankers are on Their Career Death Beds?
Tony Soprano once said to his shrink after a particularly grueling session:
“I came here today to tell you, in all seriousness, that I’m done.”
And maybe in this crazy economy you’re also done: you’re going to leave your current finance job to pursue sanity and stability.
So you’d better be thinking about healthcare investment banking.
“Healthcare?” you might say. “I don’t know anyone in healthcare who owns giant mansions lined with gold.”
But that’s OK – these “Healthcare Regular Joes” are the ones who have it easier in a rough economy, and access to plenty of other perks.
Here’s what you’ll learn from our healthcare IB interviewee today:
- How to tell your story and break into healthcare IB.
- What majors and backgrounds are common among healthcare bankers.
- Why deal flow is more stable than in other sectors, and the most common deal types.
- The industry sectors within healthcare and how valuation metrics and multiples differ.
- The all-important exit opportunities and where you can learn more about the sector.
Oh yeah, and as an added bonus you’ll get to advise companies that save lives rather than killing people and burning down villages as you normally do in finance. This post includes valuation and financial analysis commentary by Larry Chen.
Anyway, let’s get started:
Healthcare Investment Banking: Got Biology?
Q: Let’s start with your background – did you go through the typical on-campus interview route?
A: Yes – but I was a Biology major at Cornell and I went in with my parents telling me that I should become a brain surgeon or cardiologist.
Like most biology majors, I tried research but didn’t want my only friends to be the test tubes I used every day.
So I figured that a more well-rounded skill set would help me escape that fate.
I looked into healthcare consulting (ex: Triage) and healthcare investment banking as a way to get broad exposure to the sector and apply what I’d learned as a biology student.
Q: So was the Biology degree helpful for getting in?
A: Nope, haha, at least not on the technical side (I had to learn the finance part myself with your program actually).
But it really helped me with storytelling for the interview – you have to connect the dots on your personal/professional history for the interviewer both on the resume, and in the physical interview.
And as you’ve written about before, it’s all about your story.
I went in there and said, “I’m interested in the field but want to do more than research – I want a broad skill set that I can apply to business, and I want to be able to advise healthcare companies on strategic decisions” (see: the why investment banking question / answer).
Q: So do you see a lot of Biology majors in the group?
A: I wouldn’t say “a lot” and it’s certainly not necessary to break in, but it doesn’t hurt either.
There are a fair number of bio majors, a few MDs (Medical Doctors, not Managing Directors), and even some med school dropouts in my group.
As with any industry group, demonstrated interest in the sector is huge for getting in so if you haven’t done something bio or healthcare-related, you need to show that in some other way.
The Anatomy of a Healthcare Group
Q: It sounds like you have quite a few science geeks in the group.
How technical are the sectors you cover? Does a PhD or MD or two help?
A: Hah, not really, at least not more than certifications and degrees help anywhere else. Here are the major sectors:
Pharmaceuticals: A few of the big companies here are Pfizer, Novartis, Sanofi-Aventis, Merck, and Roche.
Pharmaceutical companies focus on different types of drugs, different segments of the market (e.g. over-the-counter vs. prescriptions), or even different R&D models.
For example, Valeant (NYSE: VRX) focuses on dermatology and neurotic therapeutics. Using a “leveraged research and development model,” a firm such as Valeant often takes on already-developed products and focuses on sales and marketing.
Pharmaceutical companies are completely dependent on their pipelines: a new drug might take 10-15 years to go from R&D to pharmacy counters due to the clinical trials that are required.
And then the firm only has a patent on the drug for so many years before generics start coming in and driving down the price.
So pharmaceutical companies spend a fortune on R&D (and on acquiring smaller companies) so they can constantly replenish their pipelines.
A company’s operations might also hinge on whether the products are paid for through reimbursement or out-of-pocket.
Clinical trials also have a huge impact on companies’ stocks, and positive results can send share prices to new highs while negative results can send share prices to their doom.
Biotechnology: Much like technology companies, biotech firms frequently have little-to-no revenue, and are evaluated by projecting future paydays.
Many of these companies are trying to get acquired by larger pharmaceutical companies who need to find promising new drugs and technologies for their pipelines.
Scientific / Technical Instrumentation: These companies focus on developing equipment, storage facilities, and chemicals / powders for use by academic and commercial customers. Examples include Illumina and Thermo Fisher.
Companies in this area tend to be very diverse, covering a wide range of clients with reputation, product availability, and active sales channels determining their potential top-line growth.
These companies grow by targeting new markets, combining divisions, and coming up with new ways to deploy existing products.
Hospital Management Firms: These companies operate hospitals mostly regionally, and sometimes nationally. Companies that come to mind include Community Health Systems, HCA Holdings, and Vanguard Health Systems.
Key drivers include current illness levels, the seasons, and geographic presence.
Healthcare Services: Sometimes you’ll find these firms in Business Services or Information Technology. These firms manage records for hospitals or develop ways to track incoming patients.
A prime example includes Vangent, which was acquired by General Dynamics.
Health Insurance: Since these firms operate with premiums and benefits, they are often classified under FIG.
Healthcare REITs: These firms are really funds that acquire, build, and operate hospitals; they are often classified under real estate.
Q: Great overview. What about valuation in the sector?
We’ve gotten lots of questions from readers wondering how healthcare multiples and methodologies are different.
A: I hate to disappoint, but they’re not that different.
You still see multiples like P / E, EV / EBITDA, EV / Revenue, and so on being used in healthcare.
Q: OK, I’m going to stop you right there because I think there are some valuation differences – but maybe not as much for huge companies.
Let’s say, for example, that you’re valuing a small pharmaceutical company with no revenue yet. How does that work?
A: That’s a good point, though at large banks we don’t work with those types of companies quite as much.
In that case, we would use a modified sum-of-the-parts analysis and attach a multiple to each phase of the company’s clinical trials.
So a Phase 1 pharmaceutical might be tagged with 4.0x or 5.0x, and you would assign increasing multiples as the probability of creating a marketable product goes up in each phase.
Then you would project revenue based on the estimated market size / number of patients and price for the drug, and value the company based on that.
Effectively you have to project revenue and expenses far into the future, which is always tricky, but if there are comparable drugs on the market then it’s a little easier to estimate.
For healthcare firms that don’t really work with clinical trials (ex: healthcare IT), you can use pure-play trading comparables and multiply your target’s EBITDA by the range of multiples.
It’s a pretty standard way to value a start-up or any other private company for that matter. You could even use a DCF analysis that works with far-into-the-future projections.
Q: Great, thanks for explaining that one. It sounds like there’s still a lot of guesswork involved, but that’s true of valuation with any early-stage company.
I noticed there are some methodologies we haven’t discussed much before in those two Fairness Opinions you pointed out – can you talk through those?
A: Sure. As I mentioned, you still use standard methodologies such as the DCF, public comps, precedent transactions, accretion / dilution, and LBO models (back-solving the latter two to determine valuation ranges).
For some industries such as hospital management, you’ll need to look at the number of beds, or the number of hospital locations (see page 5 of this merger agreement).
When it comes to benchmarking in this area, page 34 of this presentation has a good summary of the key metrics.
Some of the items listed sound like the ones you’d use for lodging – Average Length of Stay (ALOS) and Net Revenue per Adjusted Admission. Just don’t confuse staying in a hospital with staying in a resort…
The methodologies we haven’t discussed before include:
Pfizer / Wyeth: Morgan Stanley and Evercore
- Leveraged Recapitalization: The value of a company’s stock following a substantial repurchase of shares using debt. You might compare this value to the merger consideration to see which one is higher.
- Synergies Valuation: Premium Paid vs. Total Value of Annual Synergies. This tells us whether the price paid for the deal was really worth the value that’s “unlocked” as a result of the transaction (Think 1+1 = 3).
- Illustrative Future Stock Price Analysis: Future stock prices derived based on present values of the same. You can probably do this on a napkin actually (see page 91 of the Pfizer / Wyeth filing). You just take the current or prior year multiples, apply them to the projected financial figures, and discount the implied future share prices.
Roche / Illumina: Greenhill and Citi
- Trading Comparables: In addition to P / E, they’re also using PEG (P / E divided by Annual EPS Growth). The idea there is to look at more than just the simple P / E ratio to see whether a stock is overvalued or undervalued – you also factor in the company’s earnings growth, since higher-growth companies also trade at higher multiples.
- Premiums Paid: This is helpful to see if the acquirer is trying to lowball the target, because you see the premiums that all other buyers have paid for public sellers in recent deals.
Q: OK, that’s helpful – but just to clarify, these methodologies are not specific to healthcare, right?
A: That’s right, you see these methods across lots of industries – I’m just pointing them out here because you haven’t discussed them on the site as much.
And something like the Synergies Valuation can be really important when a big healthcare company is acquiring a smaller one and hoping to boost its pipeline in the process.
I didn’t discuss LBO analysis above because that provides a floor on the valuation – the seller would never agree to sell for the value implied by an LBO model unless they’re selling to a private equity firm.
And as with all valuation methodologies, you pay the most attention to ranges; no one says, “Aha! The DCF said the company is worth exactly $23.51, therefore we will do this deal!”
You use these methods to frame the discussion and negotiate for higher/lower prices, not to argue for one specific number.
Healthcare Diagnostics: Deals and Defensive Plays?
Q: Great, thanks for that overview of valuation.
People often say that healthcare is counter-cyclical and that it’s a great place to be when everything else is doing poorly – is that true?
A: Generally that’s true, at least if you’re looking at larger companies. If you created an index of healthcare stocks, it wouldn’t move too much with the market; the only similar sector is defense.
Go to Finviz.com and look at the Betas of healthcare stocks, and you’ll see that many of them are below 1.0… because people are always getting sick and in need of medical treatment, regardless of the economy.
This doesn’t apply as much to small-cap pharmaceutical and biotech startups – those are always risky and prone to failure because of the nature of clinical trials.
Q: So what deal types are most common? Do you focus more on M&A or capital markets?
Remember that it’s a broad sector, covering everything from pharmaceuticals to medical devices to services to sometimes healthcare REITs.
Companies in each of those sectors have different needs depending on where they are in the lifecycle and how they’re planning to expand.
Q: And I’m guessing that government regulations play a big role in M&A deals in the sector?
What else drives deal activity?
A: M&A deal flow is affected by legislative reforms that raise the cost of doing business (just like other sectors). Even the degree of regulation can be a factor in determining whether or not a deal will close.
Drug testing – and how far along a company is on tests and phases – determines acquisition prices for smaller companies and whether or not deals get done at all.
Capital market deal flow is much more cyclical. You might expect a company to raise capital in order to:
- Develop some transaction firepower
- Retire debt
- Engage in general corporate uses
For the biotech sector, financings for companies of all sizes are much more common – the volume of deals more than makes up for the size differences.
Q: Awesome. What about geography? Do focus on healthcare investment banking in any cities or regions?
A: It’s not quite as limited to one office as you see with other groups (e.g. energy in Houston) but in the US, most groups are based in New York or San Francisco.
I’ve also seen bankers travel to New Jersey quite a bit because many healthcare companies are based there (e.g. Johnson & Johnson and Merck).
Q: See? That Tony Soprano reference in the beginning did serve a purpose.
A: Yup, you got me on that one.
Checking In and Checking Out
Q: OK, so moving on… What other advice can you offer if you want to learn more about healthcare and the deals going on there?
A: To start with, I would read BioCentury if you’re interested in the biotechnology space.
You can also subscribe to Dealogic’s Deal Alerts and pay attention to the healthcare-related ones. So if you didn’t happen to catch a deal right in the healthcare section of the WSJ or FT, you can still get the news in your inbox.
The key is to be consistent in following ONE topic – the depth of your knowledge will be clearly reflected in your interviews.
When it comes to networking, you can look at Valuation in the Life Sciences on LinkedIn.
Q: Great, thanks. Moving back to the Tony Soprano point, let’s say it’s time for you to make a quick “exit” – what are your options?
A: Besides the usual business school route (depending on your performance/overall standing), you can work at a healthcare firm or move to a buy-side firm (private equity, hedge funds, asset management) with a healthcare theme – all pretty much common sense.
Some people argue that you get pigeonholed into healthcare-related opportunities, but keep in mind that you use standard accounting and valuation methodologies here.
To me, being in healthcare means you’ll have plenty of practice on transactions, which translates to a stronger applicant profile. Remember that you’re a banker first and a specialist second.
Q: Thanks so much for your time, this was really helpful.
A: I’m glad to help out. If you have any further questions, feel free to leave them in the comments section below!
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