Why M&A Over IPO in Digital Health
2018 was a record year for startup exits. Whether M&A or IPO, exits in 2018 exceeded $120B, for the first time since 2012. For the top unicorns, the count of IPOs more than doubled the count of M&As. In digital health, however, one hundred and ten exits were a result of M&A, while IPOs in digital health remained a barren landscape. Though there hasn’t been a digital health IPO in the US since 2016, IPOs in the digital health space have performed comparably to their peers. Why has there been a heavy preference for M&A over IPO in Digital Health? A lot of it centers around the strategic vs. financial value of their proprietary data.
Digital health startups tend to accumulate a significant amount of valuable patient data. The value of this data tends to outweigh typical revenue multiple valuations. Flatiron Health, for example, was acquired by Roche in 2018 for $1.9B. A major factor in this valuation was Flatiron’s expansive oncology data sets which not only bolsters Roche’s existing oncology portfolio, but also helps more accurately forecast pipeline performance. A combination of the following factors has led to the exit landscape being more favorable for M&A than IPO:
1. Stagnating R&D. Large pharmaceutical companies have consistently returned poorly on R&D investments. This, in turn, has partially caused a reduction in the proportion of capital these companies invest in their R&D departments. One cause of this effect has been opaqueness in the metrics used to track return on research capital. As it is near impossible to track research budgets effectively, many new startups such as Alchemy are enabling companies to optimize research budgets and produce greater returns. These companies have the potential to be viewed as strategic acquisition targets to bolster the overall efficacy of pipeline products.
2. Expiring patents. 2018 saw a sweeping wave of expiring patents in the bio-pharma space. Once a drug goes off patent, it typically loses a large chunk of market share to generics, becoming a much smaller value driver for pharmaceutical companies. As these companies scramble to overcome this revenue loss, they may look for ways to cut costs by optimizing existing teams and processes. Early-stage SaaS products can be particularly valuable acquisitions as they provide extensive data sets to forecast from and streamline pipelines.
3. Jurassic infrastructure. Pharma has been among the slowest verticals to adapt to our digital age. Given that every industry that has adopted SaaS products has demonstrated improvements in productivity, it follows that pharma should follow the trend and adopt additional services to optimize their processes. As they are in a mature market, there is a need to explore additional digital health services in order to expand offerings and maintain a competitive edge.
4. Informed patients. Patients are becoming more informed about the options that exist for healthcare. It has become the norm to Google anything from a slight cough to splitting headaches, with sites such as WebMD providing quick and dirty diagnoses. With this new breed of patient comes a need for additional digital integration into the healthcare space. With sensitivity around patient data, and consolidation of healthcare services, it makes sense that these conglomerates would look to acquire a few digital health companies to augment their offerings.
5. Physician overload. The burden on physicians continues to increase as healthcare costs spiral ever higher into the stratosphere. Given that the number of hours in a day doesn’t seem to be increasing any time soon, optimizing and consolidating physician tasks is key to lowering physician burnout. With the number of startups focusing on streamlining administrative processes, it stands within reason that healthcare groups will consider adding one or more digital health startups to their team.
6. Long development cycles. Digital health companies tend to have long development cycles that are plagued by a multitude of misaligned stakeholders. These long cycles frequently inflate costs commensurately, which many startups may be unable to bear. As encroaching costs creep, and without sufficient revenue to raise a satisfactory venture round or IPO share value, many digital health companies will look to an acquisition in order to gain access to the deep pockets of established healthcare institutions and pharma companies.
M&A is poised to continue to be the preferred exit strategy for digital health companies. Though it appears that the digital health IPO drought is starting to show signs of breaking, it is unlikely that the number of IPOs will surpass the number of M&As in digital health in the foreseeable future. In fact, it is likely that large healthcare players that do not move on these acquisitions are likely to see their revenues decline over the next few years as their competitors’ stranglehold on patient data accelerates. This urgency is likely to drive up the median M&A value of digital health companies commensurately. As a result of this price imbalance, the strategic acquisition value tends to outweigh the actual financial valuation of a digital health company.
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