AlbionVentures

June 2010

Investing in Healthcare
ANDREW ELDER, PARTNER, ALBION VENTURES

Let’s face it, we all prefer doing something we are interested in, and when it comes to choice of sector for venture capital investment this rule continues to hold true. In terms of “interesting” sectors there are few that can touch healthcare and we have invested in healthcare for 15 years. So what makes the sector so interesting to us? From a commercial perspective, no sector can combine the breadth, complexity and strong underlying drivers for long-term growth as healthcare. As investors who invest in high-growth companies, but with a balanced approach to risk, these three things underpin its attraction:

• The breadth of sub-sectors, from care provision through life science services, to med tech
  and drug discovery, offers the ability to take a truly diversified approach within a single sector.


• The complexity creates sources of competitive advantage at both the investee company level
  and from an investor perspective.


• The strong underlying fundamentals of the sector, driven by demographics, rising expectations
  and technology-led innovation mean that there are plenty of sub-sectors with prospects of
  strong growth across investee company’s addressable markets.

That’s not to say that healthcare investing is easy. On the contrary, the complexity, driven by everything from its strong regulatory constraints, multiple un-aligned stakeholders and lack of uniformity across geographic markets, makes it one where sector experience is vital. However, together with the softer, but nevertheless “interesting”, factor that most healthcare companies provide such a tangible benefit to the people they touch, then all these factors make the sector one that in future we are looking to take an even bigger interest in and build on our success to date.

Choosing Sub Sectors
As we take a balanced approach to investing, we can invest in a wide array of differing sub-sectors, from care provision to medical technology that few investors can match. However, choosing which specific sub-sectors to focus on becomes the challenge.

At the lower-risk end, property-based care provision (hospitals, rehabilitation centres, care homes, etc.) has enjoyed immense growth in the past 10-20 years, driven by demographics, increasing demand and expectations, fuelled by large increases in both public and private expenditure. While some of these drivers remain, others are coming increasingly under threat, the obvious one being public expenditure that faces unprecedented pressures over the next five years.

Where care services are undifferentiated and an alternative exists, they will come under increasing fee / price pressure. For example, an increasing acceptance of care delivery in the home threatens to reduce the attractiveness of certain areas of residential care. Other areas, however, remain relatively immune to these pressures and so, on balance, remain attractive areas to invest. For example, conditions which in their very nature cannot be treated at home and require specialist input to treat, thus being more immune to fee pressure (certain categories of mental health and dementia for example) are areas of particular interest. Conversely the shift to care in the home and the community setting in general also provides areas of opportunity. In the UK at least, the increasing use of private providers in primary care is creating a fast-growing addressable market, even if the overall market size is unlikely to grow in real terms in the near future.

The overall mantra in healthcare in future, across the board from care provision to technology, is going to be “improving outcomes for lower cost”. It will simply be impossible to sell a new technology to a hospital or a new service to a healthcare purchaser, unless the economic case as well as the clinical case stacks up. Certain technologies will fulfil this mantra perfectly and it is these that may, ironically, have the potential to be adopted faster than might have been possible before the spending constraints were felt. By way of example, new diagnostic devices that enable earlier detection of disease at lower cost can enable improved and cheaper treatment outcomes. In addition, new technologies will enable care services to be delivered using innovative pathways, which are more efficient. Where technologies can demonstrate they can fulfil this mantra and where that is proven by customers parting with cash for it, we will be interested in investing. What do we avoid and why

Capital intensive investments will find it harder to attract investment as they have long times to market and/or exit. Drug discovery companies (or “biotechs”) and early-stage companies developing implantable medical devices, for example, are reliant upon buoyant finance markets to raise increasing amounts of capital as they progress along the development pathway. Progress along this path, in order to satisfy the increase in required exit value associated with increased capital investment, incurs continuing technical risk leading to high attrition. With returns in these sectors having proven to be less than attractive for the risk carried, investors in the UK have fled this area in droves, leaving the whole model vulnerable. Whilst not an area in which we invest, for both the reasons stated and the highly specialist nature of this sector, I will stick my neck out and say that this has to be an area ripe for change in how it is financed. Finding long-term financing models that match drug discovery timelines, off-loading commercial risks earlier to big pharma through licensing and taking advantage of more capital efficient models, seem to be just some of the ways that could be used more frequently in future to capture more value from a sector which has fundamentals as strong as any in healthcare. So with no shortage of attractive sub-sectors within healthcare, an experienced team able to navigate the inherent complexities, opportunities emerging from adversity and a series of strong long-term drivers of growth,