Obsidian Point Partners Commentary - Healthcare in the LMM - our view

Healthcare in the Lower Middle Market in the Covid Era: Opportunities & Pain amid the Goldrush.

Baba Akin-Aina Andrew Wenger

U.S. health care spending grew 4.6 percent in 2019, reaching $3.8 trillion or $11,582 per person. As a share of the nation's Gross Domestic Product, health spending accounted for 17.7 percent. However, despite large spending on absolute basis – US healthcare outcomes compared to other rich countries have been slipping for years. Industry experts blame wastage, incompatible Government and State policies and the lack of a coherent, national health care framework for these drawbacks. In addition, the Coronavirus Pandemic has laid bare some of the shortcomings of the US healthcare system in stark relief. However, amid these shortcomings has come a reckoning that healthcare investment needs to be better directed and health care delivery as a sector presents a variety of opportunities for the Lower Middle Market Investor. This opportunity set is further enhanced by the demographics of the US population, which is expected to age over time with adults outnumbering children by###-###-#### This greying of the population will shift healthcare priorities with an increased focus on quality of life and older age care. With this environment in mind, middle market investors are targeting the healthcare space with increased enthusiasm, driving up multiples that can only be justified by strong assumptions about growth in the sector relative to US GDP. At Obsidian Point Partners LLC – we generally favor Healthcare as a sector for its defensive characteristics; countercyclicality, inelastic consumer spending and strong lifetime demand. Like many other investors we are skeptical of high regulatory touch businesses with insufficient moats and expect any businesses we invest in to demonstrate strong and consistent levels of profitability on a margin basis. As a result, we focus on specific areas in the healthcare vertical, which we further segment internally in both geographic and demographic buckets.

2020 Healthcare Pipeline & Sub Sectors: In 2020, we reviewed over 50+ private, lower middle market healthcare companies across multiple sub-sectors as a part of our transaction pipeline. Most businesses fell into the following healthcare sub-sector buckets: • Contract Research Organizations • General Private Practices • Durable Medical Equipment Manufacturers (DMEs).
• Back office & Scheduling services • Collection Services • Treatment Centers • Niche Non-orthopedic Healthcare services • Outpatient Radiology • Outsourced Anesthesiology

Valuations Rising! As we’ve noted earlier – valuations started ticking up in the space in early 2020 and have remained elevated ever since as a broader universe of investors (including family offices and legacy Private Equity) chase a limited number of assets. From our internal data, which focuses mainly on the < $5MM range of the Lower Middle Market we have seen General Practice Assets that pre-covid would have traded somewhere between 4-6x EBITDA transact in the 7-9x range. We have seen similar multiple expansion for Healthcare adjacent services like Medical Answering and Billing services that now trade in the 5x-7x range, a 1-2x multiple premia to where they would normally transact pre-covid. It is important to note that large hospital chains for example – your classic healthcare public comps – currently trade at 6x-7x multiples on much larger and much more diversified earnings bases. However, this multiple expansion is to be expected given the dollars that will now be focused on the healthcare space for the foreseeable future as both governments, large payers and individual consumers take and apply the lessons learned from the mistakes of the pandemic and seek to prepare for future incidents. Whether it is sustainable for the long term is an entirely different question. At Obsidian we have successfully acquired Lower Middle Market businesses with strong legacy operations in their home markets. We continue to look for future businesses with these characteristics and believe we can be a strong resource for Owners and Families looking to transition their businesses and legacies going forward.

Obsidian Point Partners LLC (www.obsidianpointpartners.com) is a New York based Lower Middle Market Investment Firm with a focus on control acquisitions. Mr. Akin-Aina is Managing Partner and Chief Investment Officer. Mr. Wenger was a Senior Investment Associate.