Digital health poised for consolidation

2022 has been a rough year for the digital health space. While $6 billion of new capital was invested in the industry during the first quarter of 2022, capital is becoming more expensive, and the macro environment is becoming less certain. As a result, many digital health companies are increasingly evaluating M&A strategies as a way to gain market share and achieve synergies not possible as a stand-alone company. With over 10,000 digital health companies in the US, consolidation is inevitable, and the recent market correction has led many investors and CEOs to reconsider growth, financing and exit strategies.

The pandemic has revolutionized the healthcare industry by forcing innovation, a more supportive regulatory environment and the adoption of digital health tools by all stakeholders. Digital health companies are providing numerous benefits in delivering quality healthcare, including increased patient empowerment, better disease management, convenience, less burden on healthcare professionals, and improved access to affordable healthcare. The sector has fundamentally altered nearly every aspect of healthcare. But after an unprecedented period of growth, largely fueled by COVID, the industry appears to be entering a new phase, characterized by consolidation and an increased focus on scale and profitability.

The two years leading up to today have been extraordinary by all measures. Over $40 billion of capital poured into the space in 2020 and 2021, while market valuations of publicly traded healthtech companies have declined dramatically over the past year. Public telehealth companies have seen their forward revenue multiples decline by 90% since the beginning of 2021. In addition, the macroeconomic outlook is cloudy, given inflation, rising interest rates, persistent supply chain challenges, labor shortages, and geopolitical tensions. Prominent venture capital firms are telling their portfolio companies to start cutting costs and looking for ways to cushion their cash position. What a difference a year makes.

The massive rise in telehealth volumes led to remarkable estimates of future growth in telehealth volumes and revenues. In July 2020, McKinsey estimated a total addressable market of $250 billion for virtual care services. The pace of activity in both the public and private markets broke all records, with dozens of healthcare companies going public, almost half through SPACs. By the fourth quarter of 2021 inflation and rising interest rates led to a significant decline in public market valuations, particularly in the tech space, not only digital health but also fintech, biotech, cryptocurrency, and big tech companies, including Microsoft, Facebook (Meta Platforms), and Google (Alphabet).

The rapid proliferation of digital health solutions is now resulting in the creation of “app stores” designed to assist payers, providers and employers in assessing digital health companies. Intermountain Healthcare (along with Kaiser and other leading health systems) recently formed Graphite to function as an “app store” for digital health solutions. Graphite will provide independent validations based on user experience and clinical validation of efficacy. CVS and Cigna’s Evernorth subsidiary are offering similar marketplaces for employers evaluating digital health platforms. When customers begin creating app stores to deal with the overwhelming number of options, it’s likely time for some degree of industry consolidation.

Sustaining growth and financial standing will increasingly be driven by M&A that expands market share and results in valuation creation for shareholders. Not only will there be consolidation among competitors, but horizontal and vertical mergers will be increasingly common. The continued growth in “platforms” that integrate multiple related solutions will continue, and there will be consolidation among incumbents, which will likely result in more megamergers and blockbuster deals. Net, we expect to see larger investments in fewer companies that are solving bigger problems.