Physicians considering their next steps in the business have an emerging alternative to consider that would allow them to remain independent.
Rather than sell to a health system and become employees, an ongoing trend in recent years, doctors in independent practices increasingly are finding potential suitors in private equity investors, according to health care industry experts.
The trend began to unfold in West Michigan last spring with Chicago-based private equity firm Sterling Partners’ acquisition of a majority stake in Grand Rapids Ophthalmology PC. With the deal, Sterling Partners formed a medical services organization, Great Lakes MSO, that looks to acquire complementary practices in the state and across the Midwest.
Scott Alfree, chairman of the health care practice group at Grand Rapids-based law firm Varnum LLP, expects to see more deals in West Michigan during 2018 involving private equity groups acquiring medical practices, especially specialists.
“This, to me, is a real fascinating dynamic,” Alfree said. “There are some hurdles about who’s ultimately responsible for the delivery of care that make it more complicated for private equity, but they’re starting to figure it out and accept and tolerate the risk. Plus, there are very few options for those independent folks.”
Alfree calls the trend the “potential Wall Street-ization” of physician practices. That includes deals similar to one from mid 2015 in which Muskegon-based Lakeshore Anesthesia Services PC, with 31 anesthesiologists and 10 anesthetists, sold to MEDNAX Inc., a Fort Lauderdale, Fla.-based national medical group that’s publicly traded and has physicians and facilities in 40 states.
The increased interest from private investors is a direct result of independent physicians believing they need to secure a partner to better navigate the difficult economics of health care today, but not wanting to come under the control of a health system, Alfree said.
Selling to a private equity group gives independent physicians capital and a partner to support business operations. Physicians also get some semblance of autonomy for day-to-day care delivery, or at least more than they generally might if they sold and went to work for a health system, he added.
“It’s obviously a song worth listening to,” Alfree said. “It’s not as good as being independent, but it’s a half measure. They gain some financial stability without having to … ‘sell your soul’ to the system, whatever system that is.”
Although investment amounts are down, private equity deal flow in health care has been on the upswing in recent years.
S&P Global Market Intelligence reports 217 private equity investments in health care last year, accounting for 7.2 percent of all deals. That compares with 172 investments five years earlier, or 4.8 percent of all deals.
Driving the trend is the growing interest among private equity groups in buying medical practices, especially specialties, combined with many of the forces that have pushed doctors toward an employment model and going to work for health systems.
That coincides with independent physicians now facing increased competition from health system-owned medical groups, as well as a tightening reimbursement environment and the pressure to gather and report quality data that will determine payments by insurers.
Potential cuts to Medicaid funding by Congress in 2018 may accelerate the trend nationally and regionally and force more independent practice to weigh their options, Alfree said.
“The operational pressure on independent groups continues to mount. You either have to double down on maintaining your independence and engaging in strategic activity, or you’re running out of options and runway,” Alfree said.
FOCUSING ON THE BUSINESS
As an investment category, health care offers a number of lures for private equity firms. In particular, physician practices are fragmented, “relatively inefficient” and can benefit from economies of scale, said Rajesh Kothari, managing partner at Southfield-based Cascade Partners LLC, an investment banking firm.
Another part of the equation is the comparative non-cyclical nature of health care, Kothari said. Even in a down economy, people are generally still going to a doctor when needed.
“Health care isn’t going anywhere. This is a non-cyclical industry that has all of the dynamics that suit well to private equity,” said Kothari, who sees activity “definitely getting more vigorous.”
Doctors today also are “more open and understanding” of the thought processes to running the business, he said. That creates an opportunity for private equity groups to invest in practices that want a partner, but prefer not to go with a health system, Kothari said.
“(Physicians) are looking for ways to continue to practice effectively. The cost of running a practice is so high, they’re starting to see the benefits of scale, but most don’t necessarily know how to execute that scale,” he said. “I joke all the time with physicians and say, ‘Being a physician is a full-time job. So is being a CEO.’ Physicians can’t be growing and driving a successful organization while they’re being good doctors. They have to hire a team. Some have done that very successfully, and some are not interested in doing that.”
As private equity groups consider more investment opportunities in health care, they’re more apt to seek a deal with specialists than primary care providers. Specialists typically have better operating margins than their primary care counterparts, offering a better value to an investor, according to both Kothari and Alfree.
Ophthalmology, dermatology and anesthesiology are areas “that are very active,” Kothari said, adding that the ear, nose and throat practice area may soon join the trend.
On top of the business forces driving the trend are social and economic issues as well, he said.
For example, younger doctors have far more debt than ever before and may not have the ability and willingness to take on more debt to buy into a practice. That may lead practices led by older physicians looking to retire to examine a sale, Kothari said.
Even as private equity groups become more active in the industry, health systems remain in the market, although “most of the acquisitions that are going to happen by systems have already happened” in West Michigan, Alfree said.
One prospective buyer in West Michigan is Metro Health-University of Michigan Health System, which is “very interested in employing and potentially acquiring practices,” especially in primary care, said Chief Medical Officer Peter Hahn.
Since merging into the University of Michigan Health System a year ago, Metro Health has acquired three primary care practices and an OB/GYN practice.
The Wyoming-based Metro Health also has received a number of inquiries from independent practices in the region interested in a deal or forging some form of affiliation, Hahn said. Inquiries have come from as far away as Kalamazoo and the lakeshore, he said.
“We’re trying to really sort of work through what makes sense around some of those,” Hahn said.