Reading the VC Tea Leaves – Predictions for 2018

I started off the year with an interview with Oliver Wyman Health, one of the top global healthcare consulting firms. They asked me to offer some healthcare investment predictions for 2018.  I figure this is a good way to start off the year so have reprinted a mildly expanded version of the article, which first appeared HERE. 

 

Oliver Wyman Health (OWH): What will 2018’s VC landscape look like? Which healthcare sectors will be the clear winners and sleepers?

Me: Two areas that will garner much attention in 2018 are areas that support precision health (by which I mean something much broader than precision medicine) and technology-enabled services, with an emphasis on services.

There is a great deal of interesting innovation on the precision health side, particularly around the discovery and delivery of new drugs. And this innovation is likely to continue, particularly given the expanding immunology opportunity. We will see expansion around integration of genomics and the core healthcare system (EMR/clinical, phenotypic info) as the data can be combined to find better and more appropriate treatment for people.  We are seeing many interesting evolving platforms to aid in more rapid discovery, better clinical trial recruitment and management, and more effective patient identification.  Yes, artificial intelligence is a part of it to be sure, as well as its friends, machine learning and neural networks.

We are also starting to see a serious commitment to expanding funding for social determinants of health that make a real difference in clinical outcomes — things like nutrition, housing, transportation, loneliness, cultural sensitivity, and the array of functions that make us human, and make us healthy. By looking at people as whole beings, we can serve them far better on the healthcare front. This is finally being recognized in the form of for-profit entrepreneurship.

Lastly, there is finally a growing recognition that most money that flows through healthcare flows through services. Technology is great, but in healthcare there is a need for technology to integrate well, mostly through the delivery of clinical and administrative services. Companies are finding they can capture more of the value chain when they provide integrated tech-enabled services that customers can more readily adopt; it is very challenging for many of the customers to adopt technology alone when they are not equipped to use it in their workflow. So although many tech investors have shunned services, when you’re in healthcare, the path to nirvana runs through services.

OWH: News of mergers and acquisitions (M&A) flooded the headlines in 2017. Will M&A activity continue to increase in 2018?

Me: Given how companies are having a tougher time getting financed, we will see a lot more M&A, both the “good” kind, where investors and entrepreneurs realize good ROI, and the “bad” kind, where asset sales dominate and invested capital is washed away.

As some of the interesting health tech companies reach a meaningful size, they are much more attractive acquisitions for larger entities that can provide the distribution reach that small companies simply can’t support on their own. Therefore, I expect M&A will be up compared to 2017. It will be interesting to see how the IPO market plays out.  The market has had a very mixed reception when it comes to health tech –  a few high fliers and a lot of ground-dwellers. It’s going to take real growth and a commitment to traditional financial metrics to make these stocks fly.

OWH: Is 2018 the year the Amazon re-shapes healthcare? 

Me: Amazon has certainly re-shaped what keeps some in healthcare up at night. We are seeing wholesale changing of who our industry leaders are. The traditional companies that could not (or would not) embrace technology, or did not want to acknowledge that the consumer experience matters, are getting a reckoning.

There is room for new market leaders, and we are beginning to see them emerge. I am not sure if the new leader will be Amazon, Apple, Google, CVS, or another company (or all of them), but traditional players wanting to keep their leadership role will have to embrace the importance of consumer experience, understand how to deliver efficiently in a technology-laden world, and stop relying on how things have always been done. Also, we are seeing more strange bedfellow partnerships, which will re-shape the industry. There is a new game of musical chairs underway and it is picking up speed.

OWH: How has the current Administration’s reform efforts impacted VC in 2017? What can we expect in 2018?

Me: Although “reform” is not how I would characterize it, the Administration’s activities around health insurance policy, combined with the strong pullback from value-based initiatives, have put a bit of a chill on the sales process for young companies trying to sell into a value-based world that doesn’t exist yet. The majority of healthcare services are still delivered through fee-for-service mechanisms, and that is clearly not speeding up with CMS’ rollback of initiatives like bundled payments.

I don’t see how this will change in 2018.  As a result, there is likely to be a slowdown in investments in companies that had raised earlier money with a focus on delivering in a world that would achieve financial alignment much sooner. As a result, they will not find the revenues they had hoped for so quickly, and will thus suffer in the next rounds of financing.

We may have reached a peak in digital health investing. It’s pretty clear that the number of deals is dropping and the best are getting larger amounts of money.  There is, thank goodness, a growing drumbeat around the importance of evidence and proof that a company’s purported value proposition is real. We will likely see many young companies falter and many larger companies adjust strategy for the very long march to a value-based world. In either case, there is an appropriately increasing demand for evidence of cost-savings, efficacy, and value for dollars spent, as there should be for a customer of any product.

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And a few additions that didn’t end up in the Oliver Wyman interview:

• In 2016 it was big data, in 2017 it was AI, in 2018 it’s blockchain. Every year has its fad and, even when the fad has some reality to it, too much money ends up backing buzzwords with no clear path to market adoption.  Just watch – this year we will see money flowing into blockchain like never before and this may well be a great technology to solve some key problems in healthcare.  But with health systems still figuring out their EMRs and with payers saddled with dozens of non-interoperable and antiquated systems, it’s not going to take off like wildfire on the adoption side.  Pants first, then shoes, as the saying goes.
• Valuations? I think they will start heading down. You can only measure company’s success by how much money they have raised for so long.  At some point, someone is going to do the math and realize that the average healthcare software company that raises $300mm plus at a $1B valuation (or numbers in those ranges) tends not to be a good investment.  Yeah, yeah, there are always exceptions, but not a lot of them (except in therapeutics, always an exception). In a market where adoption is faster than a speeding bullet, sure, you need to throw dollars on the fire to keep the engine revving.  But in a market, like healthcare, where the adoption curve has the longest possible up front flat line, you eventually run out of gas playing this game.  Repeat after me: capital efficiency is our friend.  Valuations need to be rational for investors to make good returns.  And what goes up, always comes down.  I predict a lot of flat and down rounds in 2018 as good companies with sky-high valuations that are out of sync with their adoption curve are going to become reacquainted with gravity.

So I guess we will all see how on or off the mark I am next holiday season.  In the meantime, I wish there were more entrepreneurs working on real problems, like the impending extinction of chocolate by 2050 (due to global warming killing off hospitable environments to grow cacao).  Thank God someone thought to use CRISPR to begin to address this unimaginable nightmare.  We can only hope and pray that a meaningful proportion of venture dollars are targeted to prevent the worst imaginable crisis of our lifetime.  Time to start hoarding M&Ms.  Maybe they are the next bitcoin!