Washington, D.C. — There aren't many crystal balls in today's healthcare economy, so when providers get a chance to hear what private investors think about healthcare and where they are placing their dollars, it can serve as a barometer of the health of the industry. That was the backdrop to “Private Equity's Bracing New Environment,” a concurrent session at this year's HCap Conference in early December in Washington D.C., where a panel of investment consultants and private equity firms shared their insights into healthcare trends and strategies for investment.

Before a packed room of providers, lenders and financial service companies, panelists painted a picture of healthcare investment driven by specialization, due diligence, and above all a keen understanding of future trends and legislation.

According to Tony Davis, Managing Partner at Chicago-based Linden LLC, the most important investment consideration is to understand what's on the minds of a firm's potential investment partners. “The big thing is that industry specialization is viewed by limited partners as a sustainable competitive advantage for private equity firms, and should lead to higher returns,” said Davis, whose current portfolio includes medical device manufacturers, pathology labs and mental health clinics, among several others.

Which specific areas of specialization they advise their partners to invest in is another question altogether. Davis identified labs, dental practices and life sciences in general as having good growth potential, yet he and other panelists were quick to caution against investing in sectors with too much exposure to government reimbursement.

“In the areas that touch Medicaid, depending on the state, and also Medicare, you have to be extremely careful on whether or not you want to expose your investors to that kind of risk,” Davis said.

Andrew Paul, Managing General Partner for Enhanced Equity Fund echoed Davis' cautionary words. “There's still a way to build good businesses in these types of reimbursement environments, but you have to work extra hard,” said Paul, who acknowledged that Medicare was overpaying for services like nursing over the last few years. “Some companies were hitting 20 to 25 percent margins on that business, and Medicare doesn't like to pay margins of that level, so it's coming down. But it still can be a very good business. It just has to be managed properly.”

When it comes to home care and hospice in general, Davis said his general pitch to investors is that the sector is here to stay. “It's not going away, . . . and the winners are going to the companies with great management, both internally and on the PE side, including a great compliance officer, terrific IT, and make sure you've got great attorneys.”

The theme of strong management and a close attention to compliance was high on all panelists' radar.

“Regardless of what you think of this Administration, we are looking at some of the most aggressive fraud and abuse enforcement we've ever seen,” said Barry Alexander, a partner in the law firm of Nelson Mullins in Raleigh, N.C. “In this environment, [non-compliance] creates significant problems.” So Alexander's message to providers looking for investment partners is to make sure their books are clean and their due diligence is done.

Another piece of advice from the panel is to pay attention to industry trends and understand how macro changes affect one's investment opportunities.

“What you try to do in healthcare investing is to be smart with where the government seems to be headed,” Paul said. “And if you're careful, you can read the tea leaves and understand the areas that are under pressure and the areas that aren't.