Private equity puts brakes on healthcare roll-ups after government scrutiny

This year there have been 180 private-equity add-on deals—transactions in which a buyout firm acquires a company to combine with one the firm already owns—in the U.S. healthcare sector through May 28, just 23% of last year’s full-year total, according to data-tracking firm PitchBook Data.

While all private-equity activity is down this year, healthcare roll-ups are down more sharply. All private-equity investment by deal value stands at 34% of last year’s total through May 28, while add-on deals in all industries are running at 33% of last year’s total as of the same date, according to the PitchBook data.

Biden administration regulators have for the past year sought to curtail healthcare roll-ups, arguing that they can lead to less competition, higher medical costs for patients and lower quality of medical care.

The Federal Trade Commission and Justice Department on May 23 began a formal inquiry to identify harmful effects of roll-ups in the U.S. economy. Other steps the antitrust enforcers have recently taken to curtail these types of deals include launching an investigation into healthcare profiteering, writing new merger guidelines to scrutinize more buyout roll-up deals and suing a buyout firm for allegedly seeking to fix prices through a healthcare roll-up.

These two federal agencies “have been very vocal about their concerns with regard to private equity and private-equity roll-ups," said Tim Cornell, an antitrust partner at law firm Debevoise & Plimpton who advises firms on deals.

This scrutiny has made it more expensive and slower—but not impossible—to get such deals to the finish line, Cornell said. “I am not sure it has created the uncrossable ravine in the marketplace that the government hopes to create," he said.

Roll-ups are perhaps the most fundamental strategy in the private-equity playbook. Add-on transactions made up 76% of total U.S. buyouts as of the end of 2022, up from 60% a decade earlier, according to law firm Goodwin Procter.

The business logic for these deals is simple. Creating one big company from many small ones can improve profit margins through economies of scale. And larger companies typically command higher prices in the merger market, so buyout firms have an easy arbitrage opportunity when they combine several small companies into a big one, and then sell it.

For many years roll-ups were not a big priority for antitrust regulators, say attorneys who work with buyout firms. The government focused on large transactions, not ones for relatively small businesses like individual physician practices or medical labs.

But under Lina Khan, who has chaired the FTC since 2021, the agency has become concerned about the cumulative effect of these series of acquisitions even if the individual companies being bought are small.

“By consolidating power gradually and incrementally, through a series of smaller deals, firms have sometimes sidestepped antitrust review," Khan said in March. “In the aggregate, these roll-up plays can eliminate meaningful competition and allow new owners to jack up prices, degrade quality and neutralize rivals without competitive checks."

Last September, the FTC sued private-equity firm Welsh, Carson, Anderson, & Stowe and an anesthesiology business it backs for allegedly trying to monopolize the Texas market and raise prices. A federal judge last month dismissed the charges against Welsh Carson, but let the case against the anesthesiology provider continue.

In December, antitrust authorities changed merger guidelines to let them review more small roll-up transactions that would have skated through in the past. In March, the FTC and Justice Department announced a federal probe into private-equity conduct in the medical sector, including the effect of roll-ups.

The private-equity industry and its lobbyists have pushed back against antitrust enforcers’ efforts to slow roll-ups, also called “buy-and-build" strategies.

“The ongoing attacks against buy-and-build will make it harder for entrepreneurs across our country to achieve the American dream, create jobs, and provide opportunities in their communities for workers and families," said Drew Maloney, president and chief executive of private-equity trade group the American Investment Council, in response to the probe started in May by the Justice Department and FTC.

Some people who work on these deals say regulatory pressure has so far had little effect. Healthcare roll-ups have declined, but so have all buyout deals. Private-equity dealmaking last year was 41% lower by total value than in the peak year of 2021, according to PitchBook data, largely because of higher interest rates and reduced asset values.

Nathan Ray, head of healthcare mergers and acquisitions at consulting firm West Monroe, thinks the decline in deal volume is entirely due to macroeconomic factors such as high rates, and not government scrutiny.

Private-equity firms “are paying for more advisers to do more market analysis, but I don’t believe that anyone has failed to consummate a [private-equity healthcare transaction] because of this scrutiny," Ray said.

Britton Costa, head of healthcare and pharma at credit-analysis company Fitch Ratings, says the government crackdown on private-equity roll-ups in the healthcare sector could be a short-term positive for credit quality. Roll-ups often use high leverage levels, and government scrutiny could force firms to moderate their use of debt.

Costa doesn’t see a “dramatic slowdown" in healthcare roll-ups yet but said it could happen if regulators start winning more court challenges to mergers. He notes that the FTC has had a mixed record in these cases so far, with several attempts to block deals on antitrust grounds tossed out by judges.

For others in the industry, the FTC’s mixed record is cold comfort. That healthcare roll-ups have slowed so much despite several FTC court losses demonstrates how much power the regulator has to influence the market.

“Despite the fact the FTC has lost lawsuits, it has cast a pall" on private-equity healthcare roll-ups, said one private-equity adviser.

A few wins for the FTC could turn the healthcare roll-up strategy into a virtual “no-fly zone" for buyout firms, the adviser added.

Write to Chris Cumming at chris.cumming@wsj.com