Consolidation continues despite hurdles in private equity
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Private equity firms have continuously invested in, acquired and consolidated health care facilities and medical groups during the past decade.
A report from the Physicians Advocacy Institute and Avalere Health showed the percentage of physicians employed by corporate entities, including insurers, private equity firms and other corporate entities with a controlling interest in the medical practice, increased from 15.3% in January 2019 to 22.5% in January 2024. The report also showed practices owned by corporate entities increased from 14.6% in January 2019 to 30.1% in January 2024, which surpassed practices owned by hospitals (28.4%).
Source: Eduardo Manteca HOPCo
While private equity deals in dermatology, ophthalmology and dental have been prevalent for 10 to 20 years, Gary W. Herschman, Esq., said private equity has begun to invest in other areas of medicine, including orthopedics, spine and pain practices.
“Private equity interest in orthopedics started around 7 years ago and has increased each year. An even newer specialty area of focus for private equity investors has been cardiology groups,” Herschman, co-chair of the health care transactions group of Epstein Becker & Green, told Healio | Orthopedics Today. “With regard to cardiology, around 2 years ago, Medicare changed its rules to allow cardiac catheterization and other advanced procedures ... to be done in an ASC. That has accelerated the cardiology deals.”
He added plastic surgery and medical spas are also “new hot areas in the last 2 to 3 years.”
“A lot of plastic surgery practices and med spas are small, and they are coming together in platforms,” Herschman said. “Further, a wide variety of behavioral health companies — physicians and facilities — are also active and have been for 5 to 8 years now.”
Regulation of private equity
Due to this expansion of private equity investments in health care, the Department of Justice, HHS and the Federal Trade Commission issued a request for information for “public comment on deals conducted by health systems, private payers, private equity funds and other alternative asset managers that involve health care providers, facilities or ancillary products or services,” according to a press release from the HHS.
In addition, publications from the law firm Morgan Lewis showed several states, including California, Connecticut, Massachusetts, Minnesota, Nevada, New York, Oregon and Washington, have proposed or enacted premerger notification laws, known as “mini-Hart-Scott-Rodino Acts,” which target health care transactions involving private equity firms or sponsors.
The recent interest among federal and state government in regulating private equity in health care comes from concerns for the health of patients, the safety of health care workers, quality of care and affordable health care for patients and taxpayers, according to the HHS.
“The reason why states are getting involved in reviewing these types of transactions is for the same reason many state attorneys general offices have been looking at any mergers and acquisitions. If the sole purpose of a merger or an acquisition is to increase your [reimbursement] rates, that is a problem,” Wael K. Barsoum, MD, president and chief transformation officer at Healthcare Outcomes Performance Company and professor of surgery at the Cleveland Clinic Lerner College of Medicine, told Healio | Orthopedics Today.
Extra diligence
When specifically focusing on the orthopedics specialty, sources said the “extra layer of diligence” that has come with these regulations may have slowed the process of private equity investments in orthopedic practices.
“In some states, a deal now has to go to a higher governing body to be approved over a certain amount of money,” Dana L. Jacoby, founder and CEO of Vector Medical Group LLC, told Healio | Orthopedics Today. “If you have over a certain percentage of doctors or revenues in a certain state, you have now one more layer of diligence to clear the hurdle to make sure it gets that stamp of approval.”
Increased debt and changes in interest rates have also slowed private equity transactions, according to Barsoum.
“As interest rates have gone up, borrowing has gotten a little more difficult and the traditional private equity deal is usually leveraged fairly significantly,” Barsoum said. “The interest rates are high, so people have done fewer deals.”
Michael J. McCaslin, CPA, of CBIZ Somerset and The OrthoForum, said high interest rates have also impacted “second bites,” which have impacted the orthopedic market and specifically “second bite” valuations.
“Now that interest rates are almost two times what they were back when the original transactions were taking place, not only have additional acquisitions slowed down, but the so-called ‘second bite of the apple,’ where some of the initial aggregators would sell to a larger enterprise, only one of those has occurred in the orthopedic space so far,” McCaslin, a Healio | Orthopedics Today Editorial Board Member, said. “Even with recent reductions in interest rates, it is unlikely we will return to pandemic level interest rates, so it is unlikely we return to original platform and bolt on practice interest rates and, thus, reduced valuations. The comparison to use here to understand the impact of interest rates is home values. When interest rates are low, the value one can sell their home rises. When interest rates are high, the value one can sell their home decreases. This same thing has happened to private equity-owned practices.”
Consolidation continues
Despite the slowdown of private equity investments, Joshua Paul, vice president of Hyde Park Capital, said physician-owned orthopedic businesses have continued to see rapid consolidation.
“2023 was a good year [for private equity investments]. 2024 slowed down a little bit, but still many physician-owned deals [are] getting done [with] new platforms being invested in again from the physician-owned side and then also numerous add-ons being done by current platforms,” Paul told Healio | Orthopedics Today.
According to Paul, there are still bigger institutional capital companies looking for “attractive investment opportunities in orthopedics,” such as surgery centers, pain management and physical therapy.
“We compare [private equity investments] to a baseball game,” he said. “[There are] nine innings, and we think we are in the fourth or fifth inning in orthopedics.”
Jacoby said four private equity platforms are entering orthopedics for the first time, and four additional private equity platforms are out on market for a second bite for orthopedic practices, which has not been seen previously due to orthopedics only entering private equity investments in 2017. In addition, she said hospitals and health systems are creating partnerships with orthopedic groups and platforms.
“You might have a hospital health system, a strategic surgical group and an orthopedic group,” Jacoby said. “You are seeing other new parties come in, not just private equity, but you are seeing Optum come into orthopedics. You are seeing Surgery Partners and [United Surgical Partners International] USPI, which are two surgery companies, coming into orthopedics. You might start to see some joint ventures across all of the broader companies.”
More capital
With yearly decreases in reimbursement and increases in expenses, Herschman said that “bigger is better from the perspective of trying to compete with larger, well-capitalized players.”
“Some people might think that there is an advantage to being small but, in the end, in medicine I think that is not the case unless it is the most prestigious surgeon where people come and pay out of pocket,” Herschman said.
One reason orthopedic practices may be interested in partnering with private equity is for institutional capital, which can help with physician recruitment, new facilities and better compliance standards, according to Paul.
But practices that went through a private equity transaction may find physician recruiting to be challenging, as new physicians to the practice would not be a beneficiary of the private equity transaction and would not become a partner in the traditional way, according to McCaslin. He added practices may experience a loss of key staff — physicians and non-physicians — with private equity transactions.
“You probably have the potential for loss of key staff under a new set of rules and maybe a stricter business model with more earnings pressure than the practice might have had,” McCaslin told Healio | Orthopedics Today. “That could be the loss of long-term employees with incredible legacy knowledge, operational knowledge, etc.”
New revenue streams
In terms of new facilities, Jacoby said this includes providing orthopedic surgeons with the capital to build an ASC or other ancillary revenue streams.
“A lot of doctors would love to build their own ASCs, but it is expensive,” Jacoby said. “You have to personally guarantee funds, [and] you have to take out a loan. This is a way private equity is able to fund and capitalize growth and allow doctors to move faster and more efficiently into ancillary revenue streams.”
McCaslin said many existing orthopedic practices have an ASC already and, in many cases, multiple ASCs. With the rapid transition from inpatient to outpatient care, he said the ASC is the primary attractive asset the practice has and most practice acquisitions by private equity include the ASCs, which are typically owned in a separate entity by the orthopedic practice.
Capital can also be used for acquiring better technology and more C-suite talent, according to McCaslin. He added private equity will promote being able to help with income repair through payer contract negotiations. This will depend on the practices involved and location of the practices involved.
“When you have a collection of practices in the same state, you may have a chance for some successful payer contract negotiations,” McCaslin said. “When you get into a multi-state structure, the payers and rates are different state by state, even with the same payer. Thus, what you negotiate with Blue Cross Blue Shield, UnitedHealthcare, Cigna, Anthem or Aetna in one state may not be able to be negotiated for the same results in another state.”
‘Keep an open mind’
However, Barsoum said bigger does not always contribute to more worth.
“You have to be better to be worth more and just bigger does not get you there,” he said.
According to Barsoum, orthopedic practices need to look beyond receiving high reimbursement rates and use private equity to provide “true value creation” and take meaningful risks in patient care.
“Simply putting a bunch of practices together and then asking for higher rates, there is no value added,” Barsoum said. “If you are a patient, does it help that your practice is any bigger? It does not help you. But if your practice is run better, if your practice uses clinical care paths that are value driven and peer reviewed and your outcome is better, that benefits you. But just because a practice is bigger, just because a practice gets higher reimbursement for taking care of you, does not help you as a patient.”
When it comes to partnering with private equity, Herschman said it cannot be about the money, but about a combination of strategic positioning for the future and cultural fit.
Jacoby said this includes keeping an open mind regarding the themes and trends occurring in private equity and exploring all options.
“Do they want to partner with private equity? Do they want to partner with a hospital? Do they want to partner with a surgical roll up?” Jacoby said. “Just saying you are going to stay independent ... is not a good strategy for the future with the number of private equity deals that have happened.”
But Paul said it is important for a practice to find a private equity group that fits its culture, especially for groups with younger physicians.
“At the end of the day, physicians are the assets in these deals and there is no business without them,” Paul said. “Making sure that you find a group with the correct fit, the correct model [and] making sure that there is alignment between all of the physicians and the acquirer is extremely important. It matters, in my opinion, more than the purchase price you are getting up front.”
Be educated
If a practice decides to partner with a private equity firm, Jacoby said the physicians should become educated in terms of the deal.
“Even if they are not going to do a deal, [physicians] need to have good advisors around them, educating them about how these deals work and why now might not be the time or how to structure a deal if they are interested in creating a good partnership,” Jacoby said.
Herschman said practices can also benefit with seasoned advisers, including investment bankers, lawyers and accountants who have extensive experience in private equity deals.
“Some groups do [private equity deals] without an investment banker. It may not make sense for smaller groups to hire an investment banker, but private equity platforms could take advantage of groups that do not have financial advisors, investment bankers and seasoned legal counsel,” Herschman said.
But because health care is a human capital business it is hard to leverage or scale. McCaslin said private equity does not necessarily work in the physician health care space the way it does with a technology or manufacturing business.
“There is a place for private equity in some industries. I just do not know that it belongs in a human capital industry and, especially, in a health care industry where patients have to be at the center of the universe, not economics,” McCaslin said. “In the private practice world, economics generally follow with a patient-centered care approach. The reason the regulators get involved in private equity is when it appears there is only an ‘economic-centered’ approach. This poses the threat of over utilization of services and facilities to achieve the economic results desired by private equity.”
With the current state of increased interest rates, even with some decreases on the horizon, McCaslin said it “does not look like the promises made early on ... are going to be able to be met.”
“I do not know that we will see growth in [private equity] in orthopedics,” McCaslin said. “We may see people holding on longer and/or we may see people exiting and saying they tried it, it did not work like they thought and they will take a gain less than they expected but it is time to move on.”
- References:
- Borsa A, et al. BMJ. 2023;doi:10.1136/bmj-2023-075244.
- Brenneman DR, et al. California, Illinois, Minnesota: Latest states to enact ‘mini-HSR acts’ for health care deals. https://www.morganlewis.com/pubs/2023/08/california-illinois-minnesota-latest-states-to-enact-mini-hsr-acts-for-healthcare-deals. Published Aug. 28, 2023. Accessed Oct. 24, 2024.
- Herschman G, et al. J Orthopaedic Experience & Innovation. 2023;doi:10.60118/001c.70249.
- HHS, DOJ and FTC issue request for public input as part of inquiry into impacts of corporate ownership trend in health care. https://www.hhs.gov/about/news/2024/03/05/issue-request-for-public-input-as-part-of-inquiry-into-impacts-of-corporate-ownership-trend-in-health-care.html. Published March 5, 2024. Accessed Oct. 24, 2024.
- Johns ZM, et al. New York State: Health care entities must disclose certain material transactions. https://www.morganlewis.com/pubs/2023/05/new-york-state-healthcare-entities-must-disclose-certain-material-transactions. Published May 9, 2023. Accessed Oct. 24, 2024.
- Lachiewicz PF, et al. J Bone Joint Surg Am. 2024;doi:10.2106/JBJS.23.01298.
- Naranjo ML, et al. Growing number of U.S. states target private equity transactions in health care. https://www.morganlewis.com/pubs/2024/08/growing-number-of-us-states-target-private-equity-transactions-in-healthcare?hash=_ftn1. Published Aug. 28, 2024. Accessed Oct. 24, 2024.
- PAI-Avalere report on physician employment trends and acquisitions of medical practices: 2019-2023. https://www.physiciansadvocacyinstitute.org/PAI-Research/PAI-Avalere-Study-on-Physician-Employment-Practice-Ownership-Trends-2019-2023. Published April 2024. Accessed Oct. 23, 2024.
- Private equity investments in health care: Selected enforcement issues. https://crsreports.congress.gov/product/pdf/LSB/LSB11215. Published Aug. 8, 2024. Accessed Oct. 24, 2024.
- Sievers MT, et al. Ann Surg. 2024;doi:10.1097/SLA.0000000000006238.
- For more information:
- Wael K. Barsoum, MD, of Healthcare Outcomes Performance Company, can be reached at david.lozano@hopco.com.
- Gary W. Herschman, Esq., of Epstein Becker & Green, can be reached at gherschman@ebglaw.com.
- Dana Jacoby, of Vector Medical Group LLC, can be reached at djacoby@vectormedicalgroup.com.
- Michael J. McCaslin, CPA, of CBIZ Somerset, can be reached at mike.mccaslin@cbiz.com.
- Joshua Paul, of Hyde Park Capital, can be reached at jpaul@hydeparkcapital.com.
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