Why Chicago is a deep pool of funding for health care innovators

Justin Ishbia - Manuel Martinez
“Justin Ishbia” Photo by Manuel Martinez
The disruption wrought by the Affordable Care Act and the aging population are creating opportunity in the health care sector—and Chicago is shaping up to be a surprisingly deep source of funding for companies looking to cash in on it.The city has the biggest cluster of private-equity firms focused on health care in the country and, lately, they’ve been on a tear, raising more than $2 billion to invest in the past two years alone while contributing to a surge in mergers and acquisitions.

Firms such as Linden Capital Partners, Cressey and Shore Capital Partners are eager to invest, and last year helped drive dealmaking in the sector to an all-time high; but a corresponding run-up in prices could undercut gains.

The clutch of Chicago firms focused on health care grew out of a confluence of finance pioneers from First Chicago Bank and executives spawned by local health care stalwarts like Abbott and Baxter. Over the past two decades, they have formed a clique unlike any in the country.

They’ve benefited from a host of opportunities in the biggest and fastest-growing segment of the economy, with about $3 trillion in annual health care spending, investing in everything from medical device companies to hospital staffing businesses to dental practices.

The rising number of people insured under Obamacare, as well as the aging baby boomer generation, technological advances and consumer demand for convenience and efficiency are triggering structural changes in the industry. That, in turn, is fueling consolidation through mergers in some areas, such as among hospital systems, and splintering in others, like the move by dermatologists and dentists to set up their own practices.

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“We’re fundamentally going through an ‘industrial revolution’ in this industry of becoming more efficient, delivering quality health care at a lower unit cost than in the past,” says Ken O’Keefe, CEO of Chicago-based Beecken Petty O’Keefe, which has specialized in health care private equity since 1996.

O’Keefe’s firm is preparing to raise another fund that he expects will be larger than the most recent $503 million fund it closed in 2013. Lake Forest-based RoundTable Healthcare Partners raised $650 million in September; Linden Capital raised $750 million last March; and Cressey raised $615 million in December 2014.
Aside from firms focused exclusively on health care, Chicago-based Waud Capital Partners, which invests in health care as well as business services, raised $1.06 billion last month. The city’s biggest private-equity firms, GTCR and Madison Dearborn Partners, also invest in health care as well as other sectors. “That dynamic landscape creates a lot of opportunities to invest in,” says Dean Mihas, the managing director who leads GTCR health care investing.

Returns for the firms focused exclusively on health care investments have been strong at Water Street Healthcare Partners and Cressey in the case of two funds, though others have sometimes underperformed their benchmarks, according to the limited return data available from Seattle-based Pitchbook Data, which tracks such investing. Nonetheless, “sector specialists,” including those in health care, tend to outperform private-equity generalists, according to a 2014 study by Boston-based industry consultant Cambridge Associates.

Some storied Chicago private-equity generalists, including Willis Stein and CHS Capital, unraveled in the wake of the recession, though none in the health care coterie folded. On the contrary, new health care specialists such as Shore Capital emerged.
It was founded in 2009 and did one-off deals until raising its first fund in 2014, attracting $112.5 million. It bought 10 companies last year and sold one, says Justin Ishbia, the firm’s founding partner. “There’s a lot of capital out there right now,” he says. Similarly, Water Street bought eight companies and sold two over the past year.

Private-equity firms last year engaged in a record 504 transactions, the highest in 10 years. The $66 billion spent was the third-highest amount in the same period, suggesting more deals in the middle-market range that is the sweet spot for the Chicago-area firms.

Still, Linden was often priced out of the market as competition and prices rose, leaving it with just two transactions last year, says Brian Miller, a managing partner at the firm. “2015 for many firms was tough,” he told attendees at a Transactions Advisors mergers and acquisitions conference in Chicago this month.

Flush with new funds, the firms will be eager for more stable conditions this year.