Deal flow to increase with clarity on Fed policy and valuation convergence

Private markets are primed for health care. The expected start of the interest rate cut cycle will spur meaningful deal activity, despite longer due diligence cycles and a general market complaint about a lack of quality assets. The health care sector remains too large and too fragmented to avoid investment.

We expect 700 to 800 deals in private equity-backed health care services deal volume for 2024, in line with industry transactions from 2017 to 2019. While this number is significantly below the nearly 1,400 deals in 2021, it isn’t quite the dearth many market participants are proclaiming.

Investors want exposure to the health care sector, and this will continue to drive volume. Health care dry powder—capital that has been contributed to private equity funds but not yet invested—remains high, signifying investor optimism for the sector.

According to data from Bloomberg, private equity and debt funds have accumulated $238 billion as well as $14 billion of dry powder, respectively. Bloomberg further estimates that $125 billion of health care buyout funds are currently raising money and expects at least $45 billion of new funds to begin fundraising in 2025. However, firms will continue to face a challenging fundraising environment, as limited partners—the investors in private funds—are scrutinizing sponsor performance and raising expectations for returns.

Much of this capital is being held on the sidelines as sponsors, sellers and other market participants wait for the Federal Reserve to begin a much-anticipated cycle of rate cuts. This will make capital less expensive, and more deals will be attractive to more buyers and sellers. Additionally, sellers who have been waiting for more favorable conditions and valuations will be motivated to sell, boosting supply.

Despite the Fed’s policy of holding rates steady, we have seen some reductions in the rates of leveraged loan yields. These loans are a primary way private equity sponsors finance their investments. Leveraged loan spreads have fallen compared to the second half of 2023, when 81% of loans were issued at 600 or more basis points above the secured overnight financing rate; only 17% of loans were issued at that level in the first half of 2024. Over the same period, the proportion of loans issued at premiums of 500 to 549 basis points increased to 48% of volume, from 10%. Reduced financing rates will continue to drive deal volume.

One caveat is that much of the debt financing activity in the first half of 2024 was related to refinancing and not new issuances. However, when excluding refinancings, the first half of 2024 saw $40 billion of total leveraged loan issuance compared to $13.4 billion in the second half of 2023. As financing becomes less expensive—and the timing of future rate cuts becomes clearer—debt will become more available and drive more financing.

The takeaway

Private investors are eager to invest in health care. Despite declines in deal volume, the sky is not falling, and volume has nearly returned to prepandemic averages. The fundraising and deal-making environments have challenges, but the mechanisms are working and we expect headwinds to ease, particularly once the Fed embarks on its anticipated rate cut campaign. This will drive deal-making throughout the next macro cycle.