January 12, 2023

Gibbins Advisors, a leading healthcare restructuring advisory firm, has followed up its August 2022 analysis of Large Healthcare Bankruptcies (Chapter 11 cases with greater than $10 million in liabilities) with a total snapshot of 2022, which showed a sharp acceleration of bankruptcy filings in the healthcare sector including an increase of 84% from 2021 to 2022.

There were 46 Large Healthcare Bankruptcies in 2022 included in the study.

As evidence of the stark trend, the number of Large Healthcare Bankruptcy filings in Q4 2022 was almost 3 times the number of filings in Q1 2022.

Cases in the senior care sector dominated the first half of 2022, whereas the pharmaceutical sector dominated the second half of 2022, driven by a large spike in Q4 2022.

While Large Healthcare Bankruptcy filings in 2022 returned to levels at or above those seen 2019/2020 for most subsectors, the exception was the hospital sector, with just two large bankruptcy filings in 2022 compared to ten cases in 2019.

Gibbins Advisors believes that market conditions indicate the acceleration in bankruptcy activity could continue through 2023.

What’s driving the increase in financial distress of healthcare organizations?

As Gibbins Advisors previously reported, the biggest drivers can be distilled down to a “COVID hangover” which has led to:

• Skyrocketing labor and supply costs driven by a nursing shortage and ongoing supply chain issues;
• COVID-related government funding exhausted;
• Limited ability to pass through cost increases;
• Low returns on invested assets (S&P declined by ~20% in 2022); and
• Interest rate increases (the Federal Reserve raised rates seven times during 2022).

“All these factors place a strain on cash flow and access to capital, and without a strong balance sheet such constraints are typically the reason behind companies filing Chapter 11 bankruptcy,” said Ronald Winters, Principal at Gibbins Advisors.

Winters continued, “The hospital sector was particularly insulated from financial distress during the pandemic however those protections have ended and we are now seeing a lot of struggling hospitals, particularly rural and community hospitals.”

What’s driving the uptick in pharmaceutical bankruptcy filings in Q4 2022?

Pharmaceutical and biotech sectors rely heavily on capital markets to fund significant R&D and product launch costs. Companies can incur heavy losses for consecutive years before reaching profitability and/or developing assets that deliver an attractive return.

For early-stage companies, equity (sometimes publicly traded) is usually the primary funding source, though some also have debt capital.

“The poor performance of the stock market in 2022 coupled with interest rate increases and high inflation have resulted in a tightening of access to capital, particularly for higher risk biopharma businesses” said Clare Moylan, Principal at Gibbins Advisors.

To survive, companies need significant reserves or pre-arranged access to capital to fund their operations. Those with good clinical data, lean operations and a strategically balanced portfolio will set themselves apart and stand a better chance of attracting the funding they need. Closely managing cost and cash flow in preparation for the long haul will be key to success.

Added Moylan, “Many will need to find a partner to access needed capital in order to avoid failure, so we expect to see continued consolidation in the next 12 months. There may be some good opportunities for savvy investors.”

Outlook for the year ahead

As the key drivers persist, financial distress in healthcare is expected to continue for the following reasons according to Gibbins Advisors.

Recession fears: Heading into 2023, fears of a recession continue to weigh on sentiment. The capital market constraints seen in late 2022 are expected to continue.

New baseline on labor cost: While there appears to be some relief on labor cost pressure, potentially due to a shift away from more expensive contract labor (see Kaufman Hall Hospital Flash report, December 2022), increases in pay and benefits awarded to attract and retain staff are expected to set a new baseline on expenses for healthcare organizations.

Pre-COVID macroeconomic factors remain unchanged: The impact of technology and the shift from inpatient to outpatient/community-based delivery of healthcare started decades ago, with COVID arguably accelerating the trend. While this creates challenges, it also creates opportunities for those who invest in the necessary transformation to remain relevant and efficient.

Market returns: Healthcare providers that rely on investment returns to supplement operating losses may not have that lifeline in 2023, and instead may need to sell such assets (possibly at a loss) to provide necessary cash flow.

Rate increases from payors will not likely meet cost inflation: The “margin squeeze” on healthcare providers is expected to continue, with those more reliant on government payors expected to be most challenged.

“Financial distress will persist if not worsen in 2023 as financial buffers wear thin” said Winters. “COVID-related support deferred this process, but margin squeeze and macroeconomic forces are driving the healthcare market toward consolidation given the enormous scale and depth of expertise you need to compete effectively”.

“Healthcare organizations need to be future-focused and looking at their operations and services with a critical lens,” said Moylan. “If the board pays attention and acts early there’s a lot more that can be done, but by the time you’re tight on cash the options for the organization become much more limited.”
—–
For questions, comments or more information please contact Clare Moylan; cmoylan@gibbinsadvisors.com.