Physician Practice Trends
The healthcare marketplace has observed a marked rise in the prevalence of private equity (“PE”) firm investment activity since 2012. The following observable trends have emerged in healthcare over the past decade:
- Increased Healthcare M&A activity overall;
- Increased private equity investments in physician practices;
- Changing and evolving deal structures of private equity acquired physician practices;
- Shifting Incentives, benefits, and challenges for each side of the transaction; and
- Pending regulatory scrutiny on the horizon.
Healthcare M&A Activity
Healthcare transactions have picked up in 2018. Merger & acquisition activity demonstrated sustained strength throughout the first half of 2018, increasing quarter over quarter from 2017.
As the flow of ‘easy money’ continues, with relatively low interest rates as compared to historical periods and high levels of dry powder in the private sector, PE firms have turned to healthcare to fuel investment returns and overall firm performance.
In particular, physician practices remain a top priority as acquisition targets, especially in the private equity sector.
The Private Equity Model
PE firms generally employ similar templates in rolling up physician practices. This model typically includes an initial “platform” acquisition of one larger, multi-location physician practice in the targeted specialty (usually commanding a higher acquisition multiple), followed by continued expansion through acquisitions of smaller, add-on physician practices (usually acquired at lower multiples than that of the ‘platform’ practice).
As the portfolio pieces itself together, the physician practices usually re-brand under a centralized trade name. For example:
Why Target Physician Practices?
Physician Practices are Highly Fragmented
Private equity firms have the ability to rapidly deploy capital in order to consolidate physician practices by offering attractive buy-out and partnership options. This strategy, if implemented effectively, purports itself to accelerated returns for the firm through an economies of scale effect associated with consolidation, as well as increased market presence.
The economies of scale effects allow practices to share resources across the platform of physicians, leading to superior cost control. Increased market share improves the ability to leverage with payor reimbursement, and increases awareness of the practice’s brand. These effects can result in higher growth/profitability.
Physician Practices Provide Interesting Value Propositions
Most physician practices treat common, recurring procedures, which provide the practice with consistent cash flows. On top of these regular procedures, certain practices also performed more specialized procedures, which reimburse either at higher rates by insurance, or are paid out-of-pocket by patients (i.e., voluntary procedures).
Specialties containing the traits listed above tend to attract private equity firms, as these specialties deliver lucrative, higher margin financial performances and tend to maintain substantial earnings power. Specifically, specialties that have piqued investment interest in the past include the following:
- Dermatology Common procedures include Mohs surgery and general procedures
- Specialized procedures include cosmetic operations
- Radiology Professional services agreements with multiple outpatient centers and hospitals leads to the diversification of revenues
- Higher reimbursed scans such as CT, MRI, PET
Physician Scarcity
Based on various studies conducted in recent years, there is an expected shortage of physicians in the following specialties over the coming years:
The pending shortage of physicians in several of the above high-demand specialties may result in higher patient volumes, productivity, and therefore higher potential for revenue growth per physician/practice.
In anticipation of this potential event, private equity firms will commonly structure the acquisition of a physician practice with a combination of cash and equity. Typically, cash will comprise a more significant portion of the deal offer, while equity will encompass the remaining portion to ensure that physicians still maintain some “skin in the game.”
This transaction structure benefits both sides, as physicians cash out by monetizing a large portion of their future compensation in addition to receiving equity in the new platform company. Likewise, private equity firms stand to generate returns through the aforementioned economies of scale, industry consolidation, and future projected demand for physicians in the U.S.
Aging Demographics & Healthcare Demand
The aging national population demographics are favorable & healthcare demand is projected to increase substantially:
Physicians Have Their Reasons, Too:
Instead of dealing with the day to day operations involved with running their own practices, physicians may choose to partner with private equity firms. In doing so, they also find themselves with greater access to capital and infrastructure building capabilities, including, but not limited to:
- No longer having to worry about costly capital expenditures, debt services, equipment repairs, administrative tasks, information technology fees, regulatory requirements, or marketing needs;
- Being less prone to macro-economic effects; and/or
- Expanding the practice’s geographical footprint through acquisitions or recruitment of other physicians, attracting talented employees, and working with industry experts and consultants.
For physicians who are looking for an exit strategy, they may view private equity as the catalyst to a potentially quicker, hassle-free acquisition compared to other potential models. For instance, physicians may be dissuaded from working for hospitals, as no equity component exists in this deal structure (although hospital employment typically involves a lift in compensation). Another exit strategy includes self-consolidation with other local physician practices in their area, in more of an entrepreneurial approach.
Ramifications to the Private Equity Model
While there exist plenty of benefits to the private equity model, physicians also exercise caution when approached by investment firms. Physician consolidation was previously attempted in the 1990s and collapsed under unsustainable business models.
Furthermore, a private equity firm’s typical investment exit strategy generally involves some form of sale after 5 – 7 years of enhanced growth. Knowing that an exit sale is imminent, a firm with controlling interests has the potential to exercise poor operational measures for the purpose of spurring growth, which may leave physicians “in the dust” to rebuild their over-extended practice operation. Longer investment horizon strategies, which have recently emerged, could mitigate these issues.
Post-transaction compensation for acquired physicians complicate operating situations, as physicians may earn less than they were accustomed to before the transaction occurred. Furthermore, physicians may find themselves with a bad taste in their mouths as their investing partners demand arbitrarily high hurdle rates and preferred distributions.
Finally, regulatory scrutiny is appearing on the horizon. As the prevalence of these investment relationships increase, studies will consider whether the arrangements are ultimately benefiting the patient and increasing quality of care, or if they exist mainly for monetary gain.
Looking Forward
Private equity deal-making continues to ramp up in 2018. Transactions have ranged from the consolidation of industries (as exemplified in physician practice consolidation) to major buyouts of large healthcare players (Envision, Kindred, and now LifePoint) in public-to-private acquisitions. Future public buy-out targets may include Acadia Healthcare and Surgery Partners.
How transactions evolve moving forward into the second half of the year will be interesting to observe. Growth is expected to cool off and pressures stemming from potential regulatory scrutiny, along with other media sources, increase. We look forward to following the healthcare marketplace as 2019 emerges.
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