A $14 Billion Private Equity Firm Plunges into Health Care

The blackstone group-its coffers fortified with $8 billion in uninvested capital-recently chose to buy out something unique: health care operating expertise.

Because the health care segment is fragmented, growing, large in size, and is characterized by rapid technological and regulatory change, it represents a particularly viable industry for "opportunistic investors like ourselves," explains vice chairman Tony James, formerly head of global investment banking and private equity for Credit Suisse First Boston LLC who was hired by Blackstone in November 2002.

So to better position the firm to invest more in pharmaceutical and medical device companies—and make use of its outstanding funds—Blackstone created a new group in April: Blackstone Healthcare Partners LLC, which boasts two health care industry veterans and one long-time health care financier. "Our expertise is late-stage investing," notes James, and since this is an area "where operating skills make more of a difference," he continues, Blackstone wanted to acquire "world-class operating executives" to take full advantage of opportunities in the health care industry.

Joining Blackstone is retired Warner-Lambert Co. president and COO Lodewijk de Vink, who also spent 20 years at Schering-Plough Corp. and was in contention for the top spot there, and former chairman and CEO of RP Scherer Corp., Alex Erdeljan. Also coming on is former Donaldson Lufkin & Jenrette Securities Corp.'s managing director of health care merchant banking, Doug Rogers. The group brings not only operating skills, but also financial skills, a combination James values and hopes will distinguish Blackstone from other private equity players vying for deals.

De Vink, Erdeljan, and Rogers are not new to structuring health care deals together—or to working with Blackstone. In October 2002, they originated a buyout of Nycomed Holding AS —a pharmaceutical in-licensing and development firm—as lead investors for CSFB Private Equity. Blackstone Capital Partners and NIB Capital Private Equity participated in this $1.1 billion buyout [See Deal].

While the group will not have its own fund, it will be supported by the overall fundraising efforts of Blackstone, currently one of the largest private equity firms with $14 billion raised for private equity investing since its inception. (Blackstone recently raised the largest institutional private equity fund ever at $6.45 billion.) And right now, Blackstone's president and CEO, Stephen Schwarzman, is keeping his options open, stating that it is "unclear how much [in total] will go into health care" because "it will be a function of the opportunities themselves."

Whatever the opportunities, though, each investment will be large: upwards of $200-$300 million. And there will be a distinctly global focus in considering potential target investments. "This group will spend lots of time in Europe and Asia," notes James, as these areas offer "a lot of cross-border opportunities" to take pieces of established companies and combine them into one global entity with better distribution, better technology, and more efficiency.

Besides cross-border consolidation opportunities, future deals from the Blackstone Healthcare Partners will likely resemble the Nycomed opportunity—with public markets closed, private equity firms want to find opportunities to engage large amounts of capital in companies that will thrive without continually needing new infusions. (See "Nycomed: Changing (Private) Hands," In Vivo Europe Rx, December 2002 (Also see "Nycomed: Changing (Private) Hands" - In Vivo, 1 Dec, 2002.).) Before forming the group, Blackstone recently expressed interest in, but did not ultimately pursue, similar buyouts for Quintiles Transnational Corp. , the clinical research company based in Research Triangle Park, NC recently bought out by its founder, Dennis Gillings; and ElderCare, a Genesis Health Ventures Inc. nursing home care business. The bids for both of these opportunities approached $1 billion.

The other likely buyout targets for the group: pharmaceutical spin-offs. The stimulus for spin-offs will come from anti-trust concerns as the industry consolidates. In addition, cost-cutting measures will offer new buyout candidates as Big Pharmas may opt to get out of less attractive, but still profitable businesses. "As the size of an organization grows, the hurdle rates associated with product opportunities become higher," explains Michael Lytton, general partner, Oxford Bioscience Partners, "so there are more and more product opportunities that aren't big enough for the pharma companies and they are spun off."

Blackstone's move into health care reflects a broader trend, notes Lytton. "The investment community today is far more interested in development and marketing than they are in discovery," he comments. And since the Blackstone team's name specifies health care, not biopharmaceuticals or biotech, it "clearly indicates the emphasis is on operating businesses."

The move also continues an ongoing trend in private equity itself—away from highly networked deals based on a few key names bringing a company idea to a specific venture fund and towards a more traditional view of private investing, in which an existing property is shopped to a variety of deep-pocketed investors. The winner is the one which pays the most for the property—but which can also add the most in value through operational understanding.

The research-intensive drug industry has historically resisted such investing, which is dependent on the generation of a target company's current earnings. But as more and more Big Pharmas either focus on fewer, larger drugs while mid-sized firms like Akzo Nobel NV no longer feel adequate to the investment requirements, opportunities for creating new operating businesses multiply. With their deep operating expertise, and huge resources, it is firms like Blackstone, as much as traditional health care VCs, that will define the future of medical investing.