M&A activity in the healthcare and life sciences space reached Covid-era lows in the first quarter due to concerns about debt and credit markets, lower valuations, and headwinds from rising interest rates and labor shortages persist. Nonetheless, industry experts are resoundingly optimistic in their forecasts of a bounce-back for the sector as private equity investors begin to channel their stockpiles of capital back into middle-market healthcare providers.

Healthcare in particular has emerged as a recession-resistant opportunity for gun-shy investors as a result of the collapse of Silicon Valley Bank and the global banking crisis that has followed in its wake, and has had negative implications for the debt financing of transactions.

“There’s no question that private equity is becoming more defensive,” says John Calcagnini, managing director and global head of healthcare investment banking at Stout. “Private equity, I think, is held back because they’re worried about going to market and not getting the valuation they expected because of the credit market conditions.”

M&A transaction volume across the healthcare and life science sector declined over 38 percent year-over-year in the first quarter of 2023, according to a report from Stout, a global investment bank and advisory firm. There were only 38 deals announced and 231 deals closed in Q1 2023 compared to 86 and 352 in Q1 2022, respectively — lower than Q2 2020.

Rising interest rates are also a headwind for firms in the healthcare space, says Roger Strode, a partner and healthcare M&A lawyer at Foley & Lardner. The Federal Reserve opted against an 11th consecutive rate hike on June 14 but the federal funds rate could see increases from its current target range of 5 percent-5.25 percent in July and/or September when the Fed meets again.

Consolidation of the sort demonstrated by Amazon in its acquisition of One Medical or CVSdeal to acquire Oak Street Health is also driving community-based hospitals to be scooped up, says John Washlick, a shareholder and lawyer at Buchanan Ingersoll & Rooney PC focusing on healthcare transactions and corporate compliance.

“They’re looking for opportunities to have a better platform for population health management, bigger market share, and they just sort of can’t do it alone,” Washlick says. So they’re looking for strategic partners. In most cases, they’re bigger health systems.”

And with funds drying up from the 2020 $2.2 trillion stimulus bill known as the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, some smaller health systems have struggled to remain viable, Strode adds.

“About 10 years ago, some of the healthcare futurists said they believe that the healthcare system, at least among large hospital systems, is going to tend to look more like the banking system,” Strode says. “Look what we have today — five or six very large banks. We’re beginning slowly but surely to see that happening in healthcare.”

Dealmaking demand remains robust in the healthcare sector, and is driven by patient growth and acquisition, scale and efficiency, and the emergence of new business models such as digital health and care management, says EY’s health leader Mallory Caldwell.

“There are transaction needs everywhere in health strategy today,” Caldwell says. “These transactions often change the boundaries of the traditional enterprise to incorporate new capabilities, ecosystem relationships and other-industry alliances.”

Lower valuations have made for a more attractive buyer’s market, says GSR VenturesJustin Norden, a partner and venture capital investor.

Analysts expect a resurgence in the second half of 2023 based on an abundance of dealmaking “firepower,” which EY defines as “companies’ capacity for conducting M&A deals” measured by their cash and equivalents, market value, and debt.

On the life sciences side, the biopharma sector has $1.4 trillion in its balance sheet, says Arda Ural, EY’s Americas industry markets leader in health sciences and wellness.

Acquisitions are also useful for biotech and life sciences firms building out their research and development pipelines, says Carter Caldwell, co-investment program director at Penn Medicine, a corporate venture firm that incubates spinouts from UPenn faculty.

“You have Company X developing Product Y and then they see that Product Y is going to be more effective if they have these other things that build into it,” Caldwell says. “Or they need to build up that pipeline with another set of products.”

Unlocking generative artificial intelligence tools can augment physicians and caretakers to reduce repetitive, rote tasks such as notetaking to focus on caregiving, says Sunny Kumar, a partner at GSR directing investments in companies specializing in applying machine learning and AI technologies in healthcare.

“That’s been the holy grail of artificial intelligence in healthcare for almost a decade now,” says Kumar. “And now, generative AI is getting us much closer to that than we’ve ever been before.”