Why large physician groups should consider private equity: 5 thoughts with Todd Mello

Private equity firms continue to invest in healthcare as the industry moves toward greater consolidation.

In 2016, disclosed deal value for healthcare private equity reached $36.4 billion, according Bain & Co.'s Global Healthcare Private Equity and Corporate M&A Report released in 2017. That was the highest value recorded since 2007, when deal value for healthcare private equity reached $47 billion.

The report's authors attributed this growth to long-term industry trends, as well as megadeals such as New York City-based global asset manager Blackstone's $6.1 billion acquisition of Knoxville, Tenn.-based TeamHealth Holdings, a physician services organization.

"Powerful secular and demographic forces underpin this surge in healthcare PE investing," they wrote. "The global population is getting older, and people are demanding better and often more expensive treatments."

Todd Mello, senior vice president with The Bloom Organization's healthcare investment banking and consulting services divisions, says it remains to be seen how long the trend will last, but large physician groups of 50 or more can particularly benefit.

Here, Mr. Mello offers five thoughts on why large physician groups should consider private equity instead of hospital employment or the status quo.

1. Changing healthcare environment. Healthcare organizations are under increased pressures to improve quality while reducing costs as they move toward value-based care. Amid the changing healthcare landscape, it is important for physicians to consolidate and achieve scale to bring about cost efficiencies, and invest in health IT offerings designed for risk-based payment models, according to Mr. Mello. "Accessing capital in order to gain scale and prepare for these changes will be a challenge to most medical groups," he says. "Partnering with private equity allows access to such capital without [groups] sacrificing certain key elements."

2. Sale to hospital compared to private equity. Physicians often don't want to lose complete ownership in their practice or lose autonomy and control. However, those things can occur on some level when a hospital buys the practice, according to Mr. Mello. With a sale to a hospital, "you're taking a person who's not used to being an employee, and you try to fit the square peg into the round hole," he says. "Converting independent, entrepreneurial physicians to an employment model and mentality is oftentimes a difficult pill to swallow for the physician who is selling out." But he says private equity involves an initial sales transaction that is not constrained by fair market value scrutiny required of hospitals and health systems, and allows physicians to keep a significant degree of autonomy while at the same time preserving the group's culture. With private equity, he says physicians also gain ownership in a newly formed management services organization, with the private equity financial sponsor and the physicians as owners. Additionally, unlike sale to a hospital, which involves a single transaction, Mr. Mello says physicians, through their equity ownership in the MSO, can continue to participate in the upside of additional sales transaction(s) when the private equity investor sells the MSO. He estimates these transaction(s) would occur within three to five years of a private equity fund's initial investment. "So you have capital and attractive economics and the ability to maintain your autonomy and entrepreneurial spirit" in contrast to an employee-type model, says Mr. Mello.

3. Private equity opportunity. But private equity opportunities are not available to all interested physicians, according to Mr. Mello. "Typically private equity will be interested in building an initial platform, many times around a single specialty with significant ancillary revenue source opportunities, such as urology, orthopedics or GI," he says. He also contends the initial transaction will need to have a certain number of physicians and earnings level. Mr. Mello says scale with the initial private equity investment can be achieved by partnering with a group of 50-plus physicians or by combining multiple groups under one tax ID number simultaneously when the transaction occurs. "However, smaller groups will be added over time through subsequent acquisitions at multiples which are still attractive yet lower than the initial platform transaction," he says.

4. Economic return for shareholders. There are other ways to achieve size and scale with private equity deals other than acquisitions. According to Mr. Mello, some of those ways are growth and cost savings initiatives. "Organically, the new 'super group' can add a full complement of ancillaries, which may have not been an economically viable or affordable option for any one, single group prior to the transaction," he says. "Additional revenue sources include participation in clinical research studies on a significantly larger scale, as well as data licensing arrangements which are now possible given a significantly larger patient base and more sophisticated IT systems." Mr. Mello says the new group also saves money due to centralized billing and administrative services and a larger number of physicians absorbing what are predominantly fixed costs. He believes the setup can also draw in new physicians who are not interested in other employment options.

5. Management experience. Most medical practices fail to invest in appropriate management infrastructure, and, as a result, forego appropriate growth opportunities, revenue enhancement, and cost savings initiatives, as physicians are oftentimes too busy to focus on these areas. By combining with private equity, the group gains immediate access to experienced management who is able to focus on growing the practice, while the physicians are focusing on delivering care. "This is a different opportunity [compared to hospital employment] to get bigger, prepare for changes, preserve certain autonomies and also have an opportunity for a second, third 'bite of the apple' from subsequent sales transactions." He says groups that partner with private equity firms gain access to additional resources such as legal and financial expertise, as well as the ability to network with other groups the private equity partner is investing in.   


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