Episode 65 – Private Equity’s Impact on Healthcare

Welcome to the TRSA podcast. Providing interviews and insights from the linen, uniform, and facility services industry. Most Americans might not realize it, but they benefit at least once per week from the cleanliness and safety of laundered, reusable linens, uniforms, towels, mats, and other products provided by various businesses and organizations. TRSA represents the companies that supply, launder, and maintain linens and uniforms. And in this podcast, we will bring the thought leaders of the industry to you.

We’re back with another episode and a brand new year of the Linen Uniform and Facility Services podcast, interviews and insights by TRSA. I’m your host, Jason Risley. TRSA recently held one of its signature in person events, the 12th Annual Healthcare Conference and Exchange in Memphis, Tennessee. Thanks again to each and every TRSA member that joined us for the event. If you were unable to make it to the event in person, today’s episode is for you.

Several influential voices from the financial sector discussed the impact of private equity investments on the linen, uniform, and facility services industry, particularly companies serving the acute and non acute health care sectors. Andrew Kratke, the President and CEO of Emerald Textiles moderated the panel discussion, which included Ryan Camenti, the Managing Director for CIBC US Middle Market Investment Banking, Kieran Prasad, the Managing Director of Stephens Inc, and Matthew Snivas, group head and managing director of Piper Sandler and Company. Let’s get things off. Let’s start let’s talk about kind of what’s happened in the past. And, Matt, I’ll start off with you.

Has you know, I guess, how has the market changed over the past 10 years? And, Andy, your question is on the m and a market or on the health care services market? I think it’s the health care services market and, in turn, m and a and how that’s impacted, you know, the industry. So we’ve and and I’ll let the other panelists provide their perspective as well. I think we’ve seen a fair amount of consolidation over the past 10 years.

I think that’s in large part driven by your end customers consolidation and just the health care industry in general consolidating to be able to reap some efficiencies out of out of their operations and achieve some of the benefits of scale that they’re looking for. So we’ve seen a lot of consolidation, I think we would expect that to continue. We’ve seen it in within the healthcare linen space sector, industry and, would would not be surprised if that continues for the next decade to come as well. Yeah. You’re right.

Yeah. I mean, the other thing is, I mean, interest rate environment was very favorable the last, you know, many, many years, and so it made financing, acquisitions accretive in many ways. You know, folks like yourselves are are probably thinking about, you know, do I buy somebody? Do I build my own facility? And the buy made a lot of sense for a lot of reasons.

Volume was already there. Interest again, interest rates were low. We could finance it. And and so that drove a lot. And then, you know, there are a lot of sort of, you know, markets where there are adjacent markets that you that you aren’t in that said, hey.

This is much easier to to to grab the market share through an acquisition than to spend 6 to 12 months building something. And so that’s really spurred on. We like to think it was all strategic driven, but given the financing environment there was a huge component that was just, it made sense financially. Ryan, any thoughts? The only thing I’d I’d add is, you know, I’d say over the last decade, you know, we’ve seen buyers in, you know, both strategic and private equity groups go from, a rifle shot focus to a diversified focus back to a rifle shot focus.

From the healthcare side of it from being on the hospital foundation. They’re going again to a diversified focus and trying to find you know, players that can do, you know, more for them. Well and, you know, when I look at kind of what’s taken place, and and I guess some of you didn’t see several of these folks are are in the seat, you know, it seems like, you know, the consolidation has happened. There are these super regional players that are out there. There’s still independents that are out there.

Do you think that that was the strategy around private equity was to separate themselves out into super regionals, and if you think that was the strategy, why? Why would they deploy that? Yeah. So I think there’s I think there’s a couple things to understand there, so And there may be some private equity firms here in the audience, I’m not sure, so I think the in general, they’re looking to to create returns for their investors. Right?

And you create returns primarily by a couple different ways, but one is financial engineering. So if you do an LBO and you take out debt and you pay down the debt, you’re creating equity value, and Then the other big part of that is growth, and the growth is coming either organically by new customers increasing share with existing customers or inorganically by acquiring, another a competitor or someone else that’s adjacent to you. And so as they think about as a private equity firm thinks about their returns, they’re thinking about how do we grow along with the management team. So I think there’s there’s that aspect of it. I do think there are also for strategically, from some of the management teams that we’ve worked with and even from the private equity firms that are sponsoring some of these transactions, it’s thinking about how do we strategically grow, and there are certain benefits of scale that can be achieved, both scale and density that exist in particular markets, and if they can acquire if you all can acquire somebody who’s in your same geography and increase the density, the operational efficiencies can go way up.

And so there’s there’s multiple ways. I think there’s multiple reasons why that took place. Yep. Yeah. I mean, I yeah.

I mean, I I think it’s you know, they they probably think about and, again, you’re the operators, not not us, but you probably think about what’s most efficient for my business. Do I sort of jump a state and go here because it makes sense? And, again, certain operators can do that. They’re, you know, they’re world class in what they do. Or is it to make more sense just to grow concentric circles and, you know, you’re here, so find a location here and then find a location here, and so you can all connect the dots.

Obviously, it’s from an operation standpoint. There’s redundancy that you guys all have. And so it’s probably both I mean, I’m gonna repeat what Matt said. It it’s both. It’s it’s financial, but it also makes sense as you think about growing and backfilling markets.

You know? Is it easier to backfill existing markets and then keep growing out, or is it easier to kind of skip and then try to kind of, you know, backfill into the middle? And, you know, the the good news is for for many of the super regionals, there’s still room to grow, you know, for certain people. And so for so to us and that’s a thesis that I think we have is super regionals make sense because you can grow inorganically, but strategically. Let’s shift over into the next question.

The next question is gonna be the interactive piece, so we’ll ask the audience first. So in a word or phrase, why have we seen the shift in level of interest for a private bank? So the 2 biggest ones coming out of here are succession and stability. You have reoccurring revenue, it looks like. What are your guys’ thoughts on that from the audience?

For me, it’s if if you’re a private equity firm and you think about you know, you’re agnostic of the economic environment, and you think to yourself, what’s a really good business or an industry for for me and and our LPs to park 50, a 100, 200, 300, $400,000,000 of capital. Well, it’s in a business that has long term contracts. It’s in a business that has a, you know, very strong management team. It’s a business that has visibility, and it’s a business that really isn’t impacted, you know, certainly on the health care side, by the economic cycles. And it’s a business that in an in an economic downturn, if we were to have 1, you could actually have a a view that input costs would actually fall.

But in in good times, it doesn’t mean it it acts countercyclical. It, you know, in good times, it grows very nicely, but in bad times, it doesn’t it it it doesn’t fall. It’s acyclical. Yeah. There you go.

And then so in the investment committee discussions, again, I’m not gonna speak for private equity firms or in the audience. You you you can speak to this. But investment committees, it’s all about what not only what is the upside, but what is the downside. And when you think about businesses in your in your sector, the downside, you know, if you have a good management team, you have a well invested, set of facilities, they’re really it’s a it’s a wonderful place to to park capital for for the long term. And as long as you’re making a a good return on that and then you add on to that the acquisition opportunity.

We just talked about regionals becoming super regionals. There is a very strong inorganic acquisition play here in all markets, in all parts of the country, and then, candidly, the continent. And so you you have the predictability, you have strong management teams, and you have the m and a aspect. It it’s ripe really for for private equity, and you have the low interest rate environment of the last many years. Yeah.

The other the other just to maybe parse some things a little bit more finely, I’d say we’re talking about private equity holistically, but I think we’re talking about institutional capital. So I don’t know about you guys, but in the past, I’d say, couple of years, we’ve seen a lot more inquiries from what we would call infrastructure funds, which are different than what it’s a traditional private equity. And you also have interest from family offices, which are different than traditional private equity, but I’ll provide institutional capital to business owners. And when you think about stability and you think about an infrastructure fund, they like the contractual nature of your all’s business. They like the stability that Kieran just described, and it provides a return profile that fits for them, which is perhaps slightly different than a more traditional private equity firm.

And so I think you’re gonna I think you will start to see more genuine interest from multiple groups of institutional parties or investors really start to come into your industry, and some have already entered in. You have family offices that are significant investors and you have traditional private equity, But I think the infrastructure funds will likely make a play to enter into your market in the next, in the next 3 to 5 years, if not sooner. And maybe, you know, dig into that a little bit more because private equity, I think probably most people’s perspective out here is that it’s a 3 to 5 year hold. They’re going to turn in for, you know, ramp up results and get out and get their returns. I don’t think that’s everybody from a private equity fund standpoint.

But when you get into institutional capital, when you get into family offices and different options that are out there that are interested in the space, You know, give the give the group a view of, you know, how they are really different. What’s their hold period? What are their expectations? Everybody wants growth, but, you know, is it 2 times growth in 3 years, or is there longevity to it? Things like that, I think, you know, are are important as we look at who’s coming into the market and who is going to, you know, take the next step.

I’ll take it first. Yeah. In terms of the the health care market, I’d say, to to Matt’s point, it is it’s evolving in terms of who’s interested. You know, private equity is a 3 to 5 year hold, and I would say they’re they’d prefer 3. You know, hold periods have gone up coming out of out of COVID.

And as they think about it, whether they’re investing in organic growth and buying new contracts, you know, that money is the same pool of money that would go into acquisitions. So if they set, put a 100,000,000 in, they put a 100,000,000 on the side, you know, they wanna triple the business in 3 years. You know, can you do that, you know, with scale? I would say the private equity model is a little bit tougher to get the returns they’re looking for. The family offices that that I talked to, they I would say the ones that are sticking within healthcare are the ones that made their money in healthcare.

I would say others are are are getting out. We tried to to help a family office who invested in an imaging service business. So they bought the trucks, imaging equipment, rented it to the hospitals, and for each new contract they basically were spending a 100% of their EBITDA each year, and this was a massive company, 50 to 100,000,000 in EBITDA, and every capex spend was like $35,000,000 to get new trucks in regions. It was a deal that we had in market pre COVID and had a lot of interest. Then, unfortunately, we were under LOI, and March of 2020 deal broke and then relaunched it.

Second time around, nobody showed up because of the lack of immediate return on investment on the spend and the, and the, you know, kind of the the quick returns private equity were looking for and and strategics just weren’t at a position in their health to really do the deal. And, you know, to Matt’s point, infrastructure funds to me are the ones that are really emerging, and we’re seeing this kind of across it’s really in recurring revenue stability, industries. I say anything that kinda meets broadly a definition of infrastructure installed base, they’re underwriting it basically as a bond. So looking at 8, 9% returns, I don’t know, Matt, if you have a better perspective, but that’s kinda the math I’ve been been hearing from them. And thinking 50 years, not 3 to 5 like private equity.

Yeah, I think there’s a so not to get way off topic, but I think infrastructure, there’s there’s a a myriad of different, investors out there. You have like Core Infrastructure, which invests in bridges and things like that, which is non nonrelevant to this group. But I’d say that the folks that we see, the the infrastructure firms that we see that are linen or, other route based businesses tend to look for returns that are below where private equity is typically doing so. So they’re in the 12 to 15% range depending on the risk profile. I maybe they’re as low as you just described, but we haven’t seen that yet.

I hope to find those investors because it means they’re paying larger prices. Yeah. But, I’d say it’s probably low to mid teens is where we see most infrastructure funds under underwriting operating type businesses. I don’t know if you see something No. I think that’s right.

I I I think that’s right. The the one thing is in in any in whatever you’re underwriting, I go back to the m and a play, you’re able to underwrite more if you have an acquisition strategy or you’re able to to buy here and then do a bunch of add ons here. So then, basically, your your your weighted average purchase price is lower, and then your return threshold ultimately becomes, you know, higher even though you’re underwriting to to to a different rate. And so I I think whoever is the the pool of capital, whether it’s a strategic infrastructure fund and family office, traditional private equity firm, they’re the there there have different they have different return thresholds, but the playbook in many ways aside from the whole period should be the same, which is grow organically, grow through m and a, and grow grow grow strategically. So on the growth right?

So growth is is ultimately one of the more important things, you know, in in their thesis. But when you look at the difference between growth in m and a and the growth organically, you know, if you just kinda separate and let’s say you wanna grow $100,000,000,000, how would they view the growth in M and A? You can grow with M and A by $100,000,000,000, no problem. But the organic piece, I think, is important. And I’m interested to to understand, you know, what’s the separation kind of percentage wise?

Is it 50% growth periodically, 50% growth through m and a? Is it you know, is it dependent on fund? Was it dependent on business? I don’t know if I can quantify it, but if I’m if I’m sitting at the investment committee, I would say I would think it’s 80 20 organic m and a. It’s because you can’t predict m and a.

As much as we all think there’s a strong pipeline of m and a out there, and and I’m sure there is for for many of you, you you it’s hard to underwrite. Hey. I’m gonna do an m and a transaction on this date in this year. But, you know, over the next 3 to 5 years, you could probably underwrite 2 to 3 to 4 m and a transactions. Again, some companies, 2 to 3 to 4 are very easy to do.

Others, it takes longer. But I would think the the core the core organic growth is what many folks want on. They wanna make sure that the end that the the bins is growing. If you have an environment like we have today where interest rates are higher, it’s a little harder to get deals done. Maybe buyer seller expectations aren’t where they were a year or 2 ago.

You wanna have a you wanna have a business that’s just, you know, comping normally, you know, positively. And then the m and a, I wouldn’t call it the icing. It’s a it’s a very core thesis, but it’s not where you’re you’re counting on the m and a to get your return. You’re you’re counting on the m and a to enhance the return of the of the organic of the organic case. Yeah.

Mathematically, you need both to make the LBL LBL model or the leveraged bioanalysis work. So you you absolutely need both, but you also need the organic growth to to prove out that this is a growing sustainable business and to be able to reinvest in your core business, right, if you’re not growing. So I agree with everything you said, but the the, multiple arbitrage from in m from M and A is just very powerful in the in the ultimate model, and the the ability to potentially do that with primarily leverage is really powerful on the returns from the equity standpoint. Yeah. And then the the only thing I’d I’d add to it is that, you know, whether it’s private equity or strategic, if you you know, they they wanna underwrite management’s plan and hit the ground running, you know, 30 days before close, not 18 months after close.

So having an m and a pipeline teed up, having the organic growth plan teed up, those deals tend to be the ones that are the most successful, have the faster exits and the best returns, and have the most interest from buyers, but it’s usually backing the management’s vision, not you know, a new buyer coming in and, you know, and and kinda helping to lead that strategy. So jumping off from that, you know, one of the questions that I had revolve around what does private equity really look for in a business? And I think we’ve touched on some things from growth standpoint, good management team. But what else is there? If they’re looking at these deals, which there have been a lot of, you know, what else are they looking?

So I can start. I’d I’d say it depend it partially depends on the the size of transaction and size of deal, but I think industry size, industry structure does matter, and so having this industry that you all participate in is is multi is a multibillion dollar sized industry. I think several firms in this, in this audience that are on the stage have paid Parthenon, you know, a lot of money to size this industry about 20 times, and it’s it’s multiple billions of size. So I think you need a a an industry that’s large enough, I think that’s the kind of the first point. You need an industry that’s growing just organically and that they’re and whether that’s price, price and volume is more desirable so ultimately you’re you’re selling your customers more and you’re, they’re outsourcing more or whatever the case may be.

So I think you need some organic growth from an industry standpoint. I think both those are important, and then just sustainability. Right? There’s a reason for being. You guys provide a very essential service to your customers.

It’s not going away anytime soon, And so this the the ability to underwrite something that’s very repeatable, sustainable is is really important as a new investor looks at coming into the industry. What about some of, like, the fundamentals of the business? Right? You know, we talked we got it, you know, the growth and and the overarching, you know, umbrella of of the industry reoccurring revenue and whatnot. But, you know, fundamentally, when we get into the business, good management team, but there’s so many other things that, you know, me sitting in the sea a few years ago, as I was talking to private equity groups, that they were hitting on that was the basis of, you know, them moving forward or not moving forward.

So you guys could give some color on that too. So I I would say and with with the help of the Thielman here, we’ve educated the private equity market and the family office market on the space, right, with the transactions that have occurred over the last 5 plus years. And so folks are coming in here pretty on pretty well understanding of the business model of of of a health care and laundry business. And and while EBITDA is a very important metric, and it will always be a very important metric, free cash flow is a extremely important metric. It’s more important.

Yeah. And they and and they obviously, EBITDA was great, and that’s important. It’s important for them, you know, on their exit at some point down the road. The free cash flow pays the bills. Free cash flow allows you to reinvest in the business.

Peak free cash flow allows you to pay down debt. And so free cash flow is an extremely important metric, and they will dig down in the free cash flow right away. Obviously, the the the the the health and the well well-being of the facilities themselves, You know? We we you know, CapEx expenditures historically. Is is the business well invested?

Is the business poorly invested? Is there deferred CapEx that needs to be put in place immediately? How how how is the overall I mean, again, not even getting into the layouts of the facility, just the equipment health and just the overall overall, well-being of the facilities. But then CapEx goes right into free cash flow. And so and then return on invested capital.

I mean, ultimately, you you make a decision to build a facility or you make a decision to take on a customer, and, basically, that customer comes with a certain pricing dynamic, and you’re gonna have to fund that with with new linen spend. And it is the return on that new customer doesn’t make sense, which then gets back into a capital outlay for linen and then income coming back and what is the net free cash flow. And so, ultimately, while EBITDA and gross profit and revenue and margins are all very important, ultimately, it gets back down to free cash flow. And they look at it, obviously, maintenance as in what do you need to to operate day to day and and more growth, which is what do you need to to grow and and expand. Before getting into this question, you know, there’s been a lot that’s taken place over 10 years or so with, you know, you know, funds coming in here.

We talked about some, you know, additional options by way of capital coming in and being introduced. How saturated do you think our market is for them to continue down the path, and how aggressive do you think they’re gonna continue to be to put businesses together? So in your Andy, you’re asking how what’s the appetite for private equity to continue to invest in the industry? Is that the core of your question? Yep.

Yeah. So I think personally I think it’s it’s still very strong and the the fundamentals and dynamics of of the of this industry are really positive for some of the reasons that we’ve talked about. The stability, the contractual nature of the of your relationships with your customers, the ability to grow both organically and through acquisitions, the scale and size of the industry. I think it’s a very attractive market, and I think there will continue to be interest and investment from institutional investors across all size ranges within the industry, And if it’s any indication, this industry is a lot like a lot of other industries that private equity has an interest in where they can deploy significant dollars and continue to consolidate and reap the benefits of scale and putting, more capital to work. So I actually I believe that the outlook is bright for continued investment from private equity.

I don’t know if you all feel differently about that. Yeah. I’d agree with that. As you think about it, it’s what you guys are aiding and why private equity, strategics, everyone showing up is with this service, it’s about the customer experience and the hospitals and the employees’ experience. So having good, reliable, it’s safety, it’s prevention of disease, it’s kinda everything that you bring to the table, that whole service umbrella’s really important.

And from a private equity seat, you know, that’s not stopping. It’s actually each year, the bar is getting raised in terms of what the expectations are from, you know, hospital staff, and the consumer that the only problem is what are people willing to pay, and is there a ceiling you know, on pricing? But the money is gonna continue to come. There’s, you know, it’s software and tech and and health care is where the funds are getting raised, you know, for the next, you know, 5 to 10 years. Now for a brief message from TRSA.

Laundries are certified hygienically cleaned through third party inspection and quarterly testing that quantifies an established threshold of pathogens on textiles to levels that pose no threat of illness. Inspectors also verify employee training, safety standard compliance, and operational efficiencies. Certified laundries must maintain a quality assurance or QA manual that indicates their management, housekeeping, and training practices comply with the hygienically clean standard. Now back to the episode. You know, talking about pricing and what you think you can get for a business or not, with capital markets where they’re at, interest rates where they’re at, the ability to lever businesses, you know, previously higher, you know, and now that’s compressed because of interest rates, Where do you guys see kind of valuations and and things really kind of playing out for these businesses?

Kurent? There there has obviously been a multiple contraction, but that’s not a health care laundry specific phenomena. That’s an m and a phenomena. Right? You just you just described it.

It’s basically unless it’s a highly strategic asset and the strategic is funding it with cash on the balance sheet that’s earning a return that is much lower than the return on investment of buying that business. The fact is interest rates basically, the debt markets are are challenged. The interest rates are higher, and the quantum of debt in general is lower. You couple that with with the inflation, and and and many folks in this room have had, you know, conversations with their customer base to, right, make sure that the pricing is appropriate, and there’s a lag on that. And so then you have a a whole function of what is financeable EBITDA, what is the what is the EBITDA that a bank is gonna sign off on versus what is the EBITDA that a buyer is willing to is willing to underwrite.

Ultimately, I think across the board, there’s 2 things that are true. The really strong assets that have strong free cash flow, have organic growth, have an m and a pipeline, have a very strong management team, which is ultimately they’re partnering with management, have a, you know, a a a set of locations that they view. And, again, whether it’s regional, super regional, whatever, it it’s it’s strategic. Those assets will still command a premium valuation. We’ve seen it in other sectors.

Yep. We’ve seen I mean, the fact is the good in fact, more so now than before because of the scarcity value of really well performing businesses had you know, the the number of those businesses has gone down, so the scarcity value of those businesses has gone up. And so we firmly and, again, they’re nodding their heads. So Yeah. We firmly believe that for really strong assets, the valuations are still gonna be there, and I wouldn’t necessarily say there’s gonna be a a fundamental contraction.

I think for the businesses that are nice, that are, you know, financed with both debt and equity, I think in this environment, the math suggests that the valuation would be a little lower than it was a year or 2 ago. But, hopefully, with pricing going back and interest rates hopefully normalizing, if there’s a good story and a good pipeline and good growth, hopefully, the valuations come right back. But, again, for good businesses, the valuations will will hold because ultimately, there’s and somebody said it, there’s tremendous capital still on the sidelines ready to invest. Yeah. It’s a really it’s I would say I agree with everything you just said 100%, but I’d say it’s a really for those that are of us that are, like, dealing with valuations on a daily basis with M and A transactions, like it’s a really tricky time in the market right now both to buy and sell businesses, and I’d say there’s a bit of price expiration going on between buyers and sellers right now.

And so it’s a it’s a really tricky question to answer with any authority because every deal is a little bit different, and the market is is very dynamic. And I would say there’s more price pressure if you’re a seller than what there has been over the past 5 years where it’s clearly a very good seller’s market, and and buyers have more leverage than they perhaps had in the past. But it’s price exploration right now is is something we are we’re dealing with on every single transaction we are in the market with. And, one more thing to add just to to WASH as we go into ‘twenty four and be interested in the other guys’ perspective as well is that, and it’s more on practice management, multi location facility, private practice roll ups. That’s the biggest pocket of pain in the lending markets.

Most of those roll ups were done on forward pro formas, and what I’m hearing through our bank, and and then most of them were done by direct lenders, which are funds, is that there’s gonna be just with interest being now a true cost for those companies, they’re not being they can’t raise their prices. Interest is now 11% instead of 6%. They’re getting getting squeezed, and the expectation is there’s gonna be a number of bankruptcies, workouts or fire sales coming, or just the, private equity funds toss and the the, you know, the lenders the keys. So health care in the you know, and and I don’t know if that’s gonna trickle down to, you know, beyond the, you know, the multilocation facilities, you know, into other areas of health care within the banks. But right now, it’s, you know, I’d say there’s there is a little bit of a penal penalty box, you know, area within health care as people look to see what’s gonna happen with with rates and how that, you know, plays out with with renewals and other things coming.

So what is gonna happen with rates? What’s your guys’ perspective? You guys are living and breathing it. I don’t know. I’m not I’m not qualified to answer that question, Andy.

Yeah. I don’t know the answer to that question. If I did, I wouldn’t be sitting here. Yeah. Look, you know, I think that over you know, everybody reads news and kinda sees what’s happening in the world and, you know, there’s obviously different perspectives that, you know, end of q 1, end of q 2, rates could come down.

There’s perspectives that you know, could wait until, you know, the election takes place, and then, you know, we move from there. But, you know, do you guys see or have any perspective on, you know, kinda timing? Any thoughts around that? We have a, an economic forecasting team within Piper that we bought a couple years ago, and they their view is that the Fed is actually not done raising rates and that may be counter to what you read in the Wall Street Journal, but I think their their view is that the Fed has to continue to push unemployment up higher than what it is and I know we’ve seen some positive data over the past week or so on inflation and even unemployment claims, but I think their view is rates may not be done going up totally, but likely will start to recede some at some point next year. But I I I expect that or I should I will use their view because it’s not necessarily mine, but their view is there’s likely gonna be more economic pain before we get to the other side of this.

And the likelihood of a soft landing, despite what the Wall Street Journal reported today, their view of the likelihood of a soft landing is it’s unlikely. It’s just it’s too hard to navigate to get there, but economists are always wrong. So, you know, she probably is wrong as well, but that that’s their view. I guess so. I what I would what I would say, and and that’s really good perspective.

We’re not expecting a materially different economic or deal making environment, you know, certainly for the first half of next year versus where we are today. I mean, you could have the Fed go up. You could have the Fed stay the same. I’ve I’ve read also kind of maybe back half of next year, maybe a little down. But the the fact is what we’re telling clients, the conversations I’m sure these guys are having as as well, is that this is the environment, and, ultimately, let’s try to make a market.

Let’s try to you know, if you’re if if you wanted to go buy somebody, if you wanna, you know, monetize your your your asset, whatever that may be, This is the environment there that folks are gonna need to underwrite, and and there really isn’t going to be and, again, the the the headwinds or the backdrop of a recession depending on who you talk to. There are there are folks that are more confident, less confident. I think the consumer has been resilient, thus far. Obviously, their savings has taken a hit, but they have been resilient. I think the retail was poor, and so you might start seeing some of the resiliency fade away as we get into the holiday season.

But but, again, I think as we think about it or we think about it, this is the environment for the next 3 to 6 months. Yeah. And I’d say if we bridge bring it back to, like, the m and a world, what we see is the 2 biggest questions that buyers are trying to get their arms around today, independent of industry, is, 1, what’s the sustainable level of free cash flow or EBITDA depending on the sector? And that’s oftentimes really hard to figure out when you have all the crap that COVID and inflation and supply chain challenges have reeked in many, many businesses, and I’m sure including some of your all’s. That’s one, so sustainability and and what’s what’s the right underwritable level of EBITDA, which is more historical looking, and then prospectively, what does the economy hold and what how would this business perform in a recession?

And I think you all are very fortunate in that your businesses perform exceptionally well throughout different economic environments, so that’s an easier question to answer. But those are the 2 fundamental key questions that most buyers are trying to get their arms around right now because there’s there’s still uncertainty around both of those in many businesses. We’ve talked a little bit about, you know, kind of the past and obviously surprising economic environment and all that good stuff. Let’s get into kind of what the future outlook is. Where do you see this industry, and and I guess what are some of the things that are gonna impact the industry in the next 5, 10 years, give or take?

Kieran? You know, I I would say awareness from other pools of capital when we talked about infrastructure funds. There are other funds out there. I mean, obviously, you have a check size limitation if you start thinking about sort of some of the larger sovereign wealth funds. But, again, there is an awareness over in the future because you first had traditional private equity and strategics.

Family offices are obviously involved. Infrastructure funds. Other other institutional institutional capital is aware, likes the dynamics. And so there’s fundamentally as the the dry powder of investable capital will continue to go up, and that’s probably a fair statement across cycles. And so as as more people become aware of this industry and understand the cash flow dynamics, the reoccurring revenue dynamics, the m and a dynamics, that will drive up as sort of the the regionals become the super regionals, and the super regionals continue to grow.

You you you could have large consolidators that for them you know, I said 80 20 organic m and a. Maybe it’s closer to 6040 where m and a is a really important but it’s not it’s not transformative m and a. It’s sort of tuck in m and a. But when you’re a a super regional in a certain location, it’s a very it’s a very underwritable fact that you can you can do that. I would say the capital markets, we we would expect at some point a normalization or or or a a downward, trajectory on interest rates.

So that will obviously spur more more financing, more more, LBO type investments. And, you know, the the other thing is as these businesses become bigger, there are more exit opportunities we think that people could have. I mean, traditionally, it’s you sell to a strategic, you sell to an institutional investor. Maybe maybe the public markets down the road become a viable exit opportunity for more folks out there. And so as awareness grows, the pools of capital come in like the dynamics, and maybe there’s more ways to exit.

We we obviously think that all drives activity up. And the last thing I would say is there there’s probably a generational timing of folks that at some point are looking to either, you know, turn it over to a next generation or to exit. And that by definition is a tailwind to support future m and a activity. Yeah. And I’d say the other the other fact is just consolidation of your of your customer base in the channels.

And and if if that continues, which I think most people would expect that to continue, it would make sense that the entire supply chain, the entire service chain would also consolidate to be able service larger customers. And and some people may wanna do that for safety, in the sense that if if you, you wanna consolidate or need to consolidate to make sure you have, not all of your eggs in one basket with, certain customers that have become quite large. So I think that’s another factor that strategically may drive some consolidation within the sector. One one more thing to add. Just as you look forward over 10 years, and it I I don’t think it it doesn’t matter what industry you’re in, but, you know, the labor shortage is is gonna get worse and worse, and there’s a, you know, I think a big cliff coming with births in 2028 and people coming into the workforce, but anything you can do to support outsourcing, whether it’s in a manufacturing facility or within the hospital.

I know within the hospital that I’m on the board of, they can get anything approved for outsourcing without having to get board approval. If they’ve got if it’s a capital expenditure, they’ve gotta get board approval on everything. So, you know, as you think about the spends, if it’s on the p and l, it’s a lot easier, and they’re gonna be looking for every industry is gonna be looking for ways to to outsource more and take the labor that they have and use that labor more efficiently in whatever, you know, manner possible. But I think that trend is gonna be huge over the next decade. Yeah.

I wanted to dig deeper on something that you guys were talking about, and, you know, poignantly, when we look at what’s taken place in the past, there were a couple of big kind of players that reached across the map, right? And things have changed mightily. We have these super regionals, obviously, it’s the last of independence and and whatnot, and, you know, that dynamic has happened. When I think about what’s taking place with health care systems, and we heard about it, you know, earlier this morning. You know, health care systems are growing, and they’re carrying through, you know, a broader spectrum of the US.

And so when we look down the path 5 or 10 years, you know, do you guys think that there’s a movement, you know, from super regional to putting these together in order to grow with the customer base that’s also growing in the same way? I I think that’s likely, but I think there’s it’s it’s likely but maybe not necessary, right? There are certain there’s a regional density that exists, but you know don’t necessarily achieve that same benefit on a national scale in terms of localized localized density. So I think there’s some merit to that, but I and so and there are certain efficiencies, buying power, and other things that you can have as a larger, participant, national, super regional, whatever the case may be. So I think that’s likely, Andy, but not not necessary, is what I would say.

I don’t know if, Kieran, if you think one’s looking at it. Right? When it’s institutional you know, everybody has capital they wanna deploy. You know, how do they look at it? Do they is their strategy do you think their strategy 5, 10 years is, yeah, we’ll still stick with super regional, will chip around the edges and continue to grow organically.

Are they, you know, viewing it as let’s take a bigger swipe? Because what’s happening, you know, with, at the end of the day, the customer base that, you know, that the company services. Yeah. So from I I think what we’ve heard and seen and when we talk with private equity firms about the the industry, I think there is the desire to put more capital to work, and I think some of it’s a timing issue of of putting certain businesses together that line up with when owners wanna sell and and things along those lines. So I I do think there’s the the inertia from institutional capital to to put businesses together for some of these reasons that we’ve talked about.

And I I so I do think that’s one of the reasons why it will happen. I I think it’s the question is what do you from a return standpoint, if you put 2 super regional businesses together, what does that what does that mean from a return standpoint? And it’s not clear that that’s been proven out yet, that that’s a successful investment from the equities holder’s perspective. If you have any comments on today’s show or suggestions for future episodes, send an email to podcasts attrsa.org. That’s podcasts attrsa.org.

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