What the Heck is going on Heading into 3Q20

Understandably the headlines this past quarter have been consumed by pandemic updates or the financial crisis, both inextricably linked. On April 1, there were sadly 3,746 deaths in the U.S.; on June 30 there were 119,761. Heading into the second quarter, analysts expected a wave of bankruptcies unlike anything experienced before, and surprisingly, that did not occur–yet. While the default rate on high yield bonds was estimated to be 5 percent at the end of 2Q20 (up from 2.3 percent a year ago), the level of Federal Reserve intervention allowed the capital markets to function relatively well. And in the background the digital health sector recorded a terrific quarter, keeping the sector on pace for 2020 to be a record year for new investment.

It is worth pausing for a moment to put the level of intervention into some context as it will inform how the remainder of the year may play out. Just over 1.02 trillion dollars of debt was issued by Corporate America in 1H20, more than double any previous first-half year ever before according to Dealogic. And while S&P Global Ratings projects default rates to be 12.5 percent by March 2021, with a range of 6.0 percent–15.5 percent (optimistic to downside cases), it certainly appears that for much of the rest of this year access to capital will not be as dire as was feared this spring.

Of course, the pandemic (and perhaps the distraction of the election) will dictate how quickly healthcare technology companies will scale and how predictably they will be able to raise funds. Even in light of the devastating progression of Covid, according to Rock Health nearly 100 healthcare technology companies raised approximately 2.4 billion dollars in 2Q20; eleven of those financings were more than 100 million dollars in size. For 1H20, this sector saw 5.4 billion dollars invested, putting it on pace to likely be more than 10 billion dollars for the year. While this would be a high-water mark, it also reverses the trend where 2019 was slightly lower than the activity of 2018.

One potential telltale sign to assess the balance of the year is and how venture investors have recalibrated to an all-virtual investment model is the 2Q20 monthly activity.  

In April, as the shock/heartbreak/interruption of the pandemic set in, investment activity was only 500 million dollars; by May it spiked to nearly 1.1 billion dollars, but notably had dropped to 800 million dollars in June. Arguably, 2Q20 was a time when investors shored up existing portfolio companies and closed on in-process new investments. Tough decisions were made as to reserve assumptions for existing portfolio companies. By the end of 2Q20, most venture firms were making investment decisions based largely on Zoom interactions–expect there to be some moderation in activity as everyone gets adjusted to the new “abnormal.”

Obviously, there were some powerful tailwinds that developed last quarter: Centers for Medicare & Medicaid Services (CMS) expanded reimbursement, reduction (hopefully to be permanent) of state licensure barriers, and the lock-down requiring dramatic adoption of virtual on-demand care. Consumers and employers are scrambling to utilize novel modalities to engage with providers.

While the dramatic reduction of service revenues to providers will undoubtedly compromise technology budgets, there is a market momentum that traditional care delivery models must change in response to current conditions. A recent American Hospital Association report estimates the four-month total through June 30 for lost revenues to be 202.6 billion dollars. Research analysts at The Chartis Center for Rural Health estimates over 450 of the 2,000 rural hospitals in America are now at risk of closing. Tragically, this past week only 14 percent of adult ICU beds were available in Florida given the resurgence of Covid cases due to idiotic state re-opening pressures.