Thanks to TV shows and movies, we tend to think of
private equity bidding wars as involving fast-growing
Silicon Valley companies. But when Oak Street Health,
a Chicago-based network of seven primary care clinics,
began looking for investors last year, more than a dozen
firms flew to Chicago to court the physicians and most of
them ended up bidding for the group of seven primary care clinics, according to a report in Modern Healthcare.
Oak Street is not alone — almost any independent
physician group of scale these days is likely to be an
attractive target for so-called “smart money,” investors
and their advisers.
Increased regulatory requirements and complexity has led
many independent small groups to “throw up their hands
and decide to sell to or join larger entities,” says Andrew
Kadar, a managing director in L.E.K. Consulting’s healthcare
services practice, which advises private equity groups.
While many such physicians sell to a health system and
become salaried employees, investor-backed practice management groups may have certain advantages, Kadar says. “Each private equity firm has its own approach, but in general they tend to give physicians a continued degree of independence and are willing to invest in new tools and technology.”
What is private equity up to? What attracts these
titans of capitalism to one of the most bureaucratic,
heavily regulated industries in the United States? And
what does the acquisition spree mean for physicians?
Here are five things to know about private equity and
healthcare in 2019.
1. The feeding frenzy is just ramping up
The driving force behind investors’ interest in healthcare
is the amount of “dry powder” in the industry — the term
market watchers use for funds sitting idle and ready to
invest, which McKinsey estimates at around $1.8 trillion
Investors are hungry for deals, and healthcare providers
are an attractive target for multiple reasons:
• The healthcare industry is growing faster than the
GDP. Healthcare is a relatively recession-proof industry
(demand remains constant even during downturns).
• Many providers are currently not professionally
managed, and many specialties remain fragmented.
• Investors see an opportunity to create value by
increasing efficiencies and consolidating market power.
Thus, with many independent providers still competing
on their own, there remains ample opportunity to
roll up practices into a single practice-management
organization owned by investors. “A lot of deals are
making the headlines, but when you look closely you’ll
see that most specialties aren’t highly penetrated yet by
investors,” says Bill Frack, a former managing director at
L.E.K. Consulting who is now leading a new healthcare
delivery venture. “We are still at the beginning.”
2. Investors have various strategies for creating value
Far from the leveraged-buyout days of the 1980s, which
relied primarily on financial engineering to generate
returns, almost all private equity deals today require
investors to find ways to add value to organizations over
the course of their holding period (typically around five
to seven years). By and large, in healthcare they follow
two strategies for doing so.
The most prevalent play is to buy high-volume, high margin specialist groups such as anesthesiologists,
dermatologists, and orthopedic surgeons. The PE
group then looks to maximize fee-for-service revenue
in the group by ensuring that the team is correctly
and exhaustively coding patient encounters (via ICD10) and encouraging physicians to see more patients.
Simultaneously, they work to improve revenue-cycle
management and drive efficiencies of scale into sales
and back-office administration.
Private equity firms may also look to vertically integrate
by acquiring providers of services for which their
specialists were previously referring out. For instance, oncologist groups might buy radiation treatment centers;
orthopedic surgeons might acquire rehab centers;
dermatologists might acquire pathology labs to process
biopsies, and so on.
Investors exit either through a sale to a larger PE group or,
for the largest groups, through an initial public offering.
Consolidating fee-for-service providers “is a very mature
strategy, and there’s not a single specialty you could
name where an investor wouldn’t have an incentive to
[form a roll-up],” says Brandon Hull, who serves on the
advisory council of New Mountain Capital, a private
equity firm that is investing in healthcare, and is a longtime board member at athenahealth.
Hull says investors are starting to take another approach
to creating value — which he argues “is more virtuous
and aligned with social goals.” In this strategy, investors buy up general medicine specialists — such as internal
medicine, pediatrics, or ob-gyns — and then negotiate
value-based contracts from payers.
To succeed under these contracts, investor-backed medical
groups identify the most cost-effective proceduralists
and diagnosticians in their network and instruct general
practitioners to refer only to them; and they work hard
to play a larger role in patients’ health and thus keep
healthcare utilization down. Groups that employ this
approach include Privia and Iora Health. In this strategy,
investors typically exit by selling the organization to a
larger PE group, a payer, or a health system.
Interestingly, groups that pursue the first strategy often
transition to the second – for instance, an efficiently run
orthopedic group might start with a focus on growing
revenue by maximizing fee-for-service opportunities,
but then consider pursuing bundled payments for hip
replacements. Or an investor-backed oncology group
confident in its treatment protocols and ability to keep
operational costs down might accept capitated payments
for treating patients recently diagnosed with cancer.
3. Private equity can be a great deal for physicians
How these deals are structured depends on whether a
specialty group is the first group acquired by investors —
what is known in private-equity lingo as “the platform”—
or whether it’s being added to an existing group, what is
known as a “tuck-in.”
Physicians in the platform practice are often offered
substantial equity and can benefit from the group’s
appreciation — while, of course, being exposed to the risk that
their share-value may decrease if the group fails to deliver on
its intended value proposition. Physicians in subsequent tuckin groups tend to have simpler contracts with a salary base
and added incentives tied to productivity and other measures.
L.E.K.’s Frack says both models can be attractive, but
that a more simple employment model is probably best
suited to most physicians. “I would tell docs that if they
have a strong group of doctors, they don’t have much to
lose. Even if the deal falls flat for investors, the doctors
will likely just be acquired by another investor, and they
won’t be left holding the bag.”
4. Technology underpins it all
A similar private-equity healthcare frenzy in the 1990s failed
spectacularly. One reason for the collapse was that the
technology did not exist for investors to realize back-office
efficiencies and handle the complexity of value-based contracts.
Today, cloud-based EHR and revenue-cycle management
systems harness the power of network effects to help
provider organizations handle complex and unique
payer contracts, improve back-office efficiency through
automation and machine-learning, implement best practices
for care, and quickly onboard the new practices they acquire.
Technology is particularly important for the general
medicine specialist groups looking to win under fee-for-value contracts. “The moment you start to care about
a patient’s entire episode of care, you need a massive
upgrade of your back-end systems, including full
visibility into what’s happening to your patient outside
your office. Now the technology exists to truly achieve
care coordination,” New Mountain Capital’s Hull says.
5. Public perception can be a problem
Even if physicians believe a private equity deal is their
best option, there’s a public relations risk in tying a medical practice to capitalists whose ultimate goal is to earn a return. Most coverage of private equity in mainstream media outlets questions whether investors’ profit motive is bad for patients. Physician associations and medical journals have also raised concerns in a very public way.
Such public skepticism should worry anyone who
remembers the crash of the first private-equity wave in
the 1990s, says New Mountain Capital’s Hull, who ties
that crash to the failure of managed care. “The American
consumer perceived that doctors were getting bonuses
for denying them care; this became the grim punchline
of late-night talk shows, and the whole thing fell apart.”
Frack advises investors and physicians to “monitor
quality data like a hawk, so that the group can counter
anecdotal accounts of bad care.”
Hull adds that savvy investors should take a page from
the many healthcare startups that are laser-focused on building trust with patients, particularly when it comes
to end-of-life decisions and hospice care. “They know
that success in healthcare depends on patients trusting
their doctors to help them make the best medical
decisions,” Hull says.
Positioned to accommodate uncertainty L.E.K.’s Kadar argues out that whatever direction Washington decides to take healthcare, an efficient, professionally managed group practice with advantages
of scale is well-positioned to succeed — and private
equity is one way for physician groups to reach that goal.
“These groups can adapt more quickly than smaller,
independent practices, whether progressives or
conservatives are in power,” he says. As an example,
Kadar imagines a scenario in which Medicare-for-all
comes to pass. “It turns out that most [PE-backed] groups
do very well on Medicare Advantage contracts. If your
group is focused on delivering more efficient, effective care, with strong operations, you’re in a good position no matter what happens.”