United States: PE Investment In Physician Practice Management ‒ What's To Come In 2019?

Private equity (PE) investors entered the physician practice management (PPM) market in 2011, and eight years later the PPM sector continues to be a ripe middle market for PE investors looking to diversify their portfolios. However, as the healthcare market continues to change in light of increasing vertical integration between payors and providers and disruption caused by new players such as Amazon, changes may be on the horizon for PE investment in the PPM space.

Current Landscape

The PPM sector is considered to be a stable investment space that promises the ability to withstand future market downturns, given an aging population in the United States that is set to balloon in the coming years. To date, PE investments in the PPM space follow a "multiple arbitrage" or "roll-up" model, where large physician practices with sufficient infrastructure and revenue are targeted for acquisition to serve as a platform practice. Once the platform practice is acquired, the PE investor adds smaller practices to its foothold in the market, with the goal of expanding regionally and potentially beyond.

The first wave of PE investment in the PPM sector targeted retail practices such as dermatology, eye care, dental subspecialties and pain management. While dermatology and other "first wave" PPM specialties continue to remain attractive investment options for PE investors, a second surge of PE investments are presenting themselves among previously untapped practice specialties – most notably orthopedics, urology and gastroenterology. This is in part because these specialties share the following characteristics, which are enticing to PE investors:

  • A high degree of market fragmentation.
  • Forecasts for high utilization based on a burgeoning aging population (the number of Americans over age 65 will double by 2030, according to the U.S. Census Bureau).
  • Lucrative ancillary services associated with these specialties, including surgery centers.
  • Higher reimbursement forecasts due, at least in part, to payor authorization of increasing services/procedures that may be conducted in an outpatient setting.

Case Study – Orthopedics

Based in part on the above factors, a flurry of PE investments in orthopedic practices is anticipated over the next three to five years. First, outpatient orthopedic procedures are on the rise – based on a Feb. 12, 2018, article from Becker's ASC Review, it is anticipated that 51 percent of total joint replacement surgeries will be performed in the outpatient setting by 2026. Second, reimbursement of orthopedic procedures continues to move toward bundled payments as these procedures shift into the outpatient setting. Total knee and total hip replacements were among the first orthopedic outpatient procedures to shift to bundled payments by the Centers for Medicare & Medicaid Services (CMS). Additionally, in 2018, CMS removed total knee arthroplasty from the hospital "inpatient only" list, making this procedure eligible to be performed in an outpatient surgical setting. While total hip replacements are still inpatient only procedures, it appears to be only a matter of time before CMS will reimburse for these procedures on an outpatient basis.

Further, orthopedic practices are highly fragmented. Only 30 orthopedic practices in the country have more than 20 physicians in a single practice, with few of the large practices spanning more than one state. These larger practices are well positioned to serve as platform practices for PE investors interested in pursuing a roll-up model of investment. Orthopedics has already seen some movement with PE investors, with the acquisition of Southeastern Spine Institute in South Carolina by Candescent Partners and the recapitalization of The Orthopaedic Institute by Varsity Health Partners. The changing reimbursement landscape, the shift into the outpatient setting, and the current fragmentation of orthopedic practices across the country make these practices prime "second wave" acquisition targets for PE investors.

The Lure of PE Investment for Physicians

The 2010 passage of the Affordable Care Act (ACA) spurred a significant amount of merger and acquisition activity in the healthcare space, in particular between hospitals and physician practices. However, as the healthcare landscape continues to shift further along the pay-for-performance spectrum, the remaining physician practices are finding it increasingly difficult to stay competitive. Investments by PE firms provide an attractive alternative to the traditional hospital-physician alignment models.

Most notably, PE firms are able to offer higher multiples of EBITDA – they are not as constrained as traditional healthcare providers by federal and state fraud and abuse laws, which require transactions among such providers to be "fair market value." PE firms also provide entrepreneurial physician practices with the following:

  • A platform for increasing in size and scale.
  • Additional opportunities for investment by practice owners.
  • Minimal administrative and management responsibilities, thereby allowing the physicians to engage in new opportunities while focusing on their medical practice.

The promise of increased size and scale also better positions physician practices to negotiate with payors, a significant factor in staying profitable and competitive in the current market.

However, PE investment in the PPM sector is not necessarily a panacea. PE firms typically have a three- to five-year exit strategy; as a result, the physician practice will see frequent turnover in its investment partner. Further to this point, the decision to sell to a PE investor is often driven by a practice's senior physicians who, with only a few years left to practice, are looking to "cash out" on their initial investment as they move into retirement. For these physicians, recapitalization through PE firms offering highly competitive EBITDA multiples is attractive. The goals of the senior physicians in a practice, though, are often different from those of a practice's younger physicians, who will not have the opportunity to cash out in connection with the initial PE transaction. Post-closing, they may be compensated at a lower rate than if the practice had otherwise remained independent. Further, to protect their interests and position themselves for a successful exit, PE investors will likely require all physicians to sign broader non-competes that will likely hinder a physician's ability to otherwise practice in the market.

Looking Ahead

The flurry of horizontal consolidation among hospitals and physicians, kick-started by the 2010 passage of the ACA, has been disrupted in recent years by the entrance of PE investors in the PPM sector. As the first wave of investors begin to exit, and the second wave of investments in different specialty practices commences, we will likely continue to see a shift away from traditional hospital-physician alignment. It will also not be surprising, in light of the vertical integration of the market between healthcare payors and providers, to see the next wave of exits result in sales to large healthcare payors – such as UnitedHealthcare, whose affiliate, Optum, has agreed to acquire DaVita Medical Group, one of the country's largest independent medical practices.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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