By almost any measure, 1Q21 was an extraordinary 90 days, from the political turmoil, progress on the pandemic, and to the “devil-may-care” financial markets. At the intersection of all of those forces sits the healthcare technology sector, which witnessed a record quarter for investment activity. According to a recent Rock Health report, $6.7 billion was invested in 147 companies in the digital health sector, absolutely crushing the prior quarterly high of $4.1 billion in 3Q20. MobiHealthNews pegged the activity this past quarter at $7.1 billion invested in 99 companies.
The start of the year mapped to 2020’s trendline until March, when $4.0 billion was invested in 74 companies in that month alone – average round size in March was $53.6 million. There were 25 “mega” deals of greater than $100 million in 1Q21, ten of which closed in March. For the quarter overall, average deal size was $45.9 million, a marked step-up from the 2020 average deal size of $31.7 million. Arguably, we have entered a phase when investors appear to be “anointing the winner” in particular categories. The average duration from company inception to the close of the “mega round” for this cohort was a mere six years. The annual investment pace six years ago (2014, 2015) for all of digital health was approximately $4.5 billion in ~300 companies. This coincided with the implementation of the Affordable Care Act (as well as the founding of Flare Capital Partners), laying the foundation for the number of break-out companies seen today.
Interestingly, round sizes for later stage digital health financings have meaningfully increased. While the size of the average Series A round modestly moved from $12 million to $15 million (~1.3x) between 2018 – 2021 YTD, Series B and C round sizes increased from $24 million to $49 million (~2x) and $39 million to $77 million (~2x), respectively.
Why are these metrics important? The healthcare technology sector is now operating with a great sense of urgency, in part due to the demands/opportunities created by the pandemic. The next two years will determine what will happen over the next five years; the next five years will set the stage for the next twenty years. While multiple winners can co-exist given the extraordinary size of the healthcare market, those with first-mover advantages will enjoy a valuation premium. Investors today are debating how enduring are these increased valuation benchmarks. Have we fundamentally reset valuation multiples in healthcare?
Rock Health highlighted three sub-sectors within digital health which saw the most activity: (i) on-demand services ($1.2 billion); (ii) drug R&D solutions ($1.1 billion); and (iii) population health management ($850 million). The next most active categories included “treatment of disease,” consumer health information, and fitness/wellness. Of the numerous specific conditions, behavioral health was the leading category – likely in response to issues compounded by the pandemic.
The broader context is also quite informative when looking at the healthcare technology sector. Global venture funding recorded all-time highs with $125 billion invested in 1Q21, according to Crunchbase. According to Refinitiv data, global M&A activity hit $1.3 trillion, a quarterly record, which was nearly 100% ahead of the 1Q20 level (although only a 9% increase in the number of deals). And while unemployment levels continue to decline (improving from 6.2% to 6.0% in March), admittedly in fits and starts with a long way still to go, there is recent evidence that investor cupidity may now be somewhat in check. The number of new SPACs (special purpose acquisition company) formed has declined precipitously from a ridiculous pace of 5 – 10 per day earlier in the quarter. Some recent high profile IPOs have either struggled out of the gates or have been downsized.
The “mega round” financing phenomenon is not at all limited to the healthcare technology sector. According to PricewaterhouseCoopers and CB Insights, there were 184 “mega rounds” in 1Q21 (of which 25 were digital health) raising approximately $40 billion (average deal size of $217 million). As shown below, this past quarter saw a remarkable step-up in late stage venture investing, highlighting continued crossover investor enthusiasm. It also helps that preliminary 4Q20 venture capital IRR data from Cambridge Associates shows early stage and late stage returns to be 30.8% and 20.0%, respectively. For some context, the S&P 500 Index is up 9.9% year-to-date, while the S&P Healthcare Index has advanced 3.9% in that same period (although the NASDAQ Biotechnology Index is down 1.8%, perhaps reflecting some risk aversion). The Leerink Healthcare Tech/Service Index increased 3.0% in 1Q21 (the Provider sub-sector increased a dazzling 18.4%).
Data: PwC/CB Insights MoneyTree report; Chart: Axios Visuals
The volatility index (VIX), a barometer of expected volatility in the next 30 days, traded below 17 this past week, near a 52-week low and down from a 52-week high of just under 48 at the outset of the pandemic last spring. One starts to get nervous with professional investor complacency. Oh, and unsustainable levels of debt: according to the Financial Industry Regulatory Authority, investors had a record $814 billion of margin debt at the end of February 2021 (see Archegos Capital for what can go wrong). At least the Citi Panic – Euphoria Index is settling down, now at a still-elevated 0.98 versus the wobbly 2.01 from earlier this year.
As was mentioned earlier, driving much of this activity has been extraordinary levels of liquidity and M&A volume. In the healthcare technology sector, there were ten SPAC offerings in 1Q21 in addition to 57 M&A transactions. While there were only two traditional IPOs in this sector, Rock Health is tracking 43 private companies which have each raised in excess of $220 million and stand as strong candidates to be public companies. Underlying all of this is the realization that, notwithstanding it may well take a few extra years and an additional round or two of private capital, healthcare technology companies that are able to both reduce costs (clinical or administrative) and improve outcomes with credible and defensible claims of attribution, significant economic value will be created.
Unfortunately, now SPACs are so yesterday…NFTs are where it’s at. When Jack Dorsey of Twitter and Square fame can sell his first ever tweet for $2.9 million as a non-fungible token, investors are left slack-jawed trying to understand is this the next big thing. SPAC investor sentiment has cooled significantly toward the end of 1Q21 (red line below), after arguably getting way ahead of itself over the winter. Average first trading day gains were a miniscule 0.1% in March after seeing opening trading increases of 5% in January and February. Year-to-date SPACs have raised $95 billion versus $80 billion in all of 2020, and yet since 2019 only 25% of listed SPACs have actually gone on to acquire a company.
Investor activity was not the only thing to get out-of-hand during the pandemic. According to the American Psychological Association, 42% of all adults in the United States have reported “undesired weight gain” on average of 29 pounds due to Covid. We might expect to see the “Fitness/Wellness” category move up the league tables next quarter. Good thing that the best performing asset class in 1Q21 was something called “Lean Hogs,” which while sounding entirely oxymoronic, traded up 43.8%.