Revenue Growth Prospects Appear Solid

In 2024, S&P Global Ratings expects healthy, organic revenue growth of mid-single-digit percentages or higher for most health care information technology (IT) issuers. This is primarily due to the essential and high value nature of their services, improving forecasts among hospital and provider clients, and the return of patient volumes and acuity.

Health care IT firms typically provide services via recurring subscription models, creating revenue stability, and they are relatively insulated from macroeconomic concerns. We also expect them to expand via annual price increases and selling of additional capabilities and services to current customers. Health care software vendors provide productivity gains and lower operational costs for labor-intensive and low-margin health care providers. While supply chain and labor related pressures are easing somewhat, labor costs will likely remain heightened and continue to exert operating pressure.

We expect cost-cutting and efficiency initiatives among health care providers, as well as a focus on ensuring cyber security and exploring artificial intelligence (AI) use cases, to make for generous IT budgets. We think IT will also be a key lever in managing through persistent doctor and nurse shortages, allowing medical staff to spend more time treating patients and less time on administrative tasks.

Software sales were mostly resistant to macroeconomic concerns in 2023, reflecting the essential role they play in health care providers' operations, storing and transmitting customers' proprietary information and protected health, financial, and other personal patient information. Last year's persistent growth also reflects the procedure volume normalizing as well as the strength and stability of the recurring subscription model and high switching costs.

Timing Of Demand May Be Volatile

While these dynamics support solid long-term growth prospects for IT vendors, a combination of economic and industry specific factors could constrain or delay demand for individual providers or the sector as a whole. Health care providers' increasing IT budgets may face challenges in worsening economic conditions, leading to deferred large projects and resistance to upselling. Even with stable macroeconomic conditions, we expect health care providers to become increasingly selective in IT budget allocation, pushing decision-making up the chain of command and elongating decision cycles as they look to rationalize vendors and manage costs. Customers will likely be increasingly discriminating with their investments, raising the bar for expected value, requiring additional revenue capture or lower costs.

Perhaps equally important, customers must hire and retain talent in a persistently tight labor market to ensure the proper internal governance and change management structures necessary to support deployments and upgrades. A lack of talent to implement new systems and processes could hold up IT investments or the efficiencies they promise. We also expect health care providers will continue to seek to consolidate software spending with fewer vendors and that constrained staffing will lengthen implementation times.

Finally, while we expect providers to invest in technological advancements, some have reported lower customer churn than usual, associating it with economic uncertainty. Churn is generally unusual in this industry, given the hesitance of health care providers due to the sensitive nature of data. Changing vendors is expensive and time-consuming, though not unusual when providers switch from legacy vendors to those with greater capabilities. Low churn could pressure the ratings on companies that are relying on market share expansion to expand into their capital structures.

We expect providers to continue to move their workloads to the cloud, with software vendors encouraging on-premises customers to transition to software-as-a-service (SaaS) delivery. In doing so, providers can more easily scale applications, get quicker access to the latest updates, and have more predictable software expenditure. Upfront costs are lower and implementations less complex with SaaS, making future purchase decisions easier.

RCM Companies May Be Set For Higher Growth

While electronic health records software companies may have predictable revenue streams with subscription-based contracts, there may be upside in 2024 for revenue cycle management (RCM) companies with contracts based on a percentage of collections. In addition to being increasingly essential for providers facing financial pressures, we expect RCM vendors with contracts tied to collections to benefit from medical inflation, increasing utilization, and reimbursement rate increases. According to an annual KFF survey, medical care prices and overall health spending, which typically outpace growth in the rest of the economy, increased slower than for many consumer goods and services, which have increased unusually fast. We expect medical costs to rise more rapidly in 2024.

Additionally, in recent earnings calls, insurers emphasized that in addition to the unprecedented increases in medical cost trends, they assume a significant uptick in the utilization trend will persist throughout 2024. According to Humana Inc., the increase was predominantly driven by inpatient utilization and outpatient trends, especially for physician office visits and surgeries. UnitedHealth Group Inc. stated elevated activity was led by outpatient care for seniors. We expect vendors operating in these settings with contracts tied to collections or percentage of savings for their customers will benefit from the increasing utilization. We expect the increase in reimbursement and procedure volume should outpace the growth of expenses at RCM firms. The continued migration of procedures to outpatient settings and ambulatory surgical centers will also provide tailwinds to health care IT providers serving those markets.

While many RCM companies have a percentage-of-collection fee structure, some have contracts structured on a fixed-fee basis, thus not tied to a dollar amount or transaction volume. We expect fixed-fee models may be more difficult to sell during economic uncertainty than the percentage-of-collections alternative, which advertises its risk-sharing nature.

The Feb. 21, 2024, cyber attack on Change Healthcare Holdings Inc. could have a mixed impact for RCM peers. While some providers may reenter the RCM market and seek new vendors for certain products, Change maintains a strong market share causing a widespread backlog of claims to be sent to payors. Many RCM vendors have customers that also utilize Change, so we expect that as payers eventually start working through the backlog of claims from Change and providers enter the normal cycle of getting paid, cash for providers and their IT vendors could be moving between quarters. Longer term, we also expect providers that have been consolidating vendors may opt to retain some diversification of vendors in case one is affected by a cyber event. We expect vendors to continue to invest in cyber security, which hospitals will likely scrutinize.

AI tools could contribute to revenue growth in the next three to five years, but can be expensive to develop. We expect AI capabilities to support the growth of the industry and stimulate mergers and acquisitions (M&A). IT vendors are looking for opportunities to enhance health care providers' worker productivity for physician notes, coding and billing, and over time, patient clinical outcomes. We expect them to also look to AI for their own cost optimization through greater automation. Overall, we expect an increase in AI-related investments by vendors and health care providers over the coming years to tackle labor pressures and other challenges.

Cash Flow Turns A Corner, But Rating Downside Pressure Persists For Some

Higher interest rates have significantly pressured the free cash flow of and ratings on many health care IT companies, which in general is a very highly leveraged group. Many of these issuers have significant variable-rate term loan structures that made them ill-prepared for the rapid and significant interest cost increases over the past 18 months. Health care is often viewed as a less cyclical, less risky sector, and many of these companies were capitalized in a different interest rate environment with strong growth expectations. As such, leverage is especially high and the burden of higher interest expense is more pronounced.

While we expect the onerous interest burden to ease over time, many companies will need to execute their growth strategies to expand into their highly leveraged capital structures or face restructuring. We expect several to not produce cash flow in 2024 and only minimal cash flow in 2025. With negative outlooks on 40% of the portfolio, we expect further downgrades if companies have difficulty executing their growth strategies. See the Appendix for our downside and upside triggers (table 1).

For others with lower leverage, financial policy will play a more important role in determining ratings and outlooks. With competition remaining fierce and providers gaining more interest in worker productivity, consumer engagement, monetization of data, and use cases of AI, we believe there is pent-up demand for deal-making after a quiet year. An end to interest rate hikes will likely increase M&A through 2024 and sellers slowly conceding to lower market valuations. We expect more debt-funded acquisitions will likely limit the sector rating upside.

Chart 1

IT Providers Have Pushed Off Maturities

Many issuers have been quick to take advantage of the recent capital markets access to refinance and push off maturities, despite many generating cash flow deficits in 2023. This has differentiated the companies with cash flow deficits that are likely to turn positive in the next two years versus companies which may take longer.

Chart 2

For those that have not yet pushed off maturities, some with material cash flow deficits, near-term revenue growth and cost-cutting becomes essential to allow for capital market access, and sufficient liquidity will become increasingly important. If elevated borrowing costs are more prolonged, refinancing risk will increase, potentially leading to more debt restructuring, defaults, or exchanges, repurchases, or term amendments that could be considered tantamount to default.

Appendix

Table 1