Waking up to the consolidating anesthesia marketplace

In recent years, independent anesthesia practice groups across the country have seen remarkable shifts in the competitive landscape of their industry as numerous practice groups have partnered with regional or national strategic players, sold to private equity investment firms or merged with other independent practice groups in their own geographic market.

The trends are staggering – nearly 100 transactions have occurred in the past five years, with transaction volumes increasing each year since 2009. The momentum is likely to continue for the foreseeable future. As a result of this activity, independent practice groups are increasingly waking up to the concept of a transaction, as well as the benefits of the financial and business opportunity that lies before them.

Today there are over 80,000 anesthesiologists and nurse anesthetists in the U.S., administering 40-plus million anesthetics annually and driving the fundamentals behind the $19 billion U.S. anesthesia industry. As a necessary practice for a hospital's most profitable service line – surgery – anesthesia allows clinical facilities to add new surgical lines and thus capture market share. And with a growing number of patients undergoing additional procedures like plastic surgery, demand for anesthesia services is expected to rise considerably.

Even more, with the Affordable Care Act mandating insurance coverage for an additional 32 million Americans and an aging Baby Boomer population creating greater demand for healthcare services, the U.S. anesthesia industry is primed to continue its rapid scale for the long haul.

Markets with significant long-term growth potential and dynamic competitive forces naturally attract attention from investors who see an opportunity to build a strong presence within the market. The anesthesia industry has long been a highly fragmented market of independent groups, but the recent consolidation trends are changing that, and quickly. The nearly 100 acquisitions of anesthesia practice groups over the last five years have been the result of billions being spent by private equity firms and other major strategic players. The activity has been partially led by investment firms such as Welsh, Carson, Anderson & Stowe (U.S. Anesthesia Partners), Moelis Capital Partners (North American Partners in Anesthesia), Goldman Sachs Private Capital Investing (Resolute Anesthesia), and TPG Growth (NorthStar Anesthesia).

In parallel, major strategic players have upped their ante in this anesthesia acquisition spree, seeking out groups who have strong relationships with payers and exclusive contracts with hospitals. MEDNAX/American Anesthesiology (NYSE:MD) has acquired approximately 20 practice groups since 2012, and Team Health Holdings (NYSE:TMH) channeled $188 million towards 11 anesthesia acquisitions in 2013. In 2014, the largest transaction in the anesthesia industry was consummated not by a pure-play anesthesia provider, but by AmSurg Corp., a publicly traded operator of ambulatory surgery centers, when it acquired Sheridan Healthcare for $2.4 billion in July. Through just the first three quarters of 2014, the nation's largest anesthesia providers – MEDNAX, NAPA, Sheridan Healthcare, USAP and TeamHealth – have partnered with nearly 20 regional or local groups.

Another factor in the consolidation trend is hospitals seeking to partner with large, diversified providers that can offer reduced reliance on stipends / subsidies due to the breadth of services they offer (i.e. emergency medicine, radiology, anesthesia, neonatology, etc.) and the economic synergies that exist among their national networks.
So, what drives owners of independent anesthesia practice groups to explore a potential sale or recapitalization with a private equity investment firm or one of the major strategic players? First and foremost, transactions typically involve a significant upfront cash (and/or stock) payment to owner physicians in exchange for an ownership stake in the group going forward. In addition, recapitalization transactions provide an added benefit of participation in the future growth of the practice group (in the form of profit-sharing or related structures) and/or synergies (created as a result of a transaction with a strategic acquirer who may have more favorable payer contracts or more efficient back office operations). Given additional benefits beyond the monetary aspect of a sale or recapitalization – e.g. access to an expanded physician network, tech-enabled back office resources, growth capital, and key leadership positions in a larger organization – both the seller and the acquirer can reap the rewards of a synergistic transaction.

How to value your anesthesia practice

Acquisitions of anesthesia practice groups are often valued using a standard earnings before interest, tax, depreciation and amortization ("EBITDA") multiple approach.

An increasingly common structure that seeks to mimic the EBITDA multiple approach and often benefits both the buyer and seller is sometimes referred to as the "sell-down" method. For example, imagine the partners of a group each earn an average of $550,000 in total annual compensation (including benefits). Each partner decides to "sell-down" $150,000 to the acquirer in exchange for the acquirer's ownership stake in the practice group going forward. The market EBITDA multiple (typically in the range of 5.0 to 8.0x) is applied to the amount each partner will "sell-down". Using a 7.0x EBITDA multiple, the acquirer pays each partner 7.0 times $150,000, for a total transaction consideration of $1,050,000 per partner. After the transaction, each partner then receives $400,000 as his or her annual compensation on an ongoing basis (equal to his or her original compensation of $550,000 less the "sell-down" amount of $150,000). This approach creates valuable flexibility for partners' compensation objectives, as a greater "sell-down" amount results in more upfront liquidity but lesser ongoing compensation post-transaction, and vice versa. In effect, each partner receives consideration today for compensation he or she would have earned in the future – a very attractive proposal.

The personal tax implications of a transaction can also create a key benefit to selling partners. Partners receive capital gains treatment on the upfront cash consideration of the transaction, whereas ordinary income tax rates would apply to ongoing compensation received in exchange for services over time. On a post-tax basis, the net result is typically an upfront cash payment to physicians equal to more than 10 years of any foregone compensation – an opportunity that many would call a "financial no-brainer."

For some, it may not sound appealing to "sell-down," but partners often retain substantial and very attractive opportunities post-transaction to grow their new base salary over time – or "repair" their income. This is accomplished through specific profit-sharing arrangements or other opportunities that contribute to improved profitability of the practice, such as increases in unit volume, improved payer rates or new facility contracts. More often than not, these growth strategies are not as achievable when operating as an independent practice group, and may only become available by partnering with a larger strategic player (who can offer greater negotiating power with payers/hospitals and back-office synergies) or the private equity investment firm (who can offer substantial capital for executing growth strategies such as add-on acquisitions).

Transactions may also take the form of a "split percentage" structure, where each partner sells a percentage of the practice group's future earnings (for example, 25 percent) in exchange for an upfront payment equal to the multiple of the corresponding dollar value sold. Post-transaction, the partners collectively retain 75 percent of the profitability of the practice group on a standalone basis, while also sharing (often equally) in any improvements in profitability that are achieved as a result of synergies with the acquirer.

Regardless of structure, selling partners must consider and negotiate other common, yet important facets of a transaction including: employment agreements, non-compete and non-solicitation agreements, the percentage of purchase price consideration that will be paid in the form of stock (in the case of a private acquirer), rights to corporate governance and control over clinical programs, among others.

The overall goal of any transaction is for both sides (acquirer and seller) to experience the proverbial "win-win" situation.

Independent practice groups can gain leverage in the industry by joining larger organizations, uniting with other physicians and realizing the power in numbers versus allowing hospitals and payers to dictate market conditions. Selling a portion of the practice also reduces the immediate risk and exposure to the shifting healthcare regulatory environment, by electing the opportunity to take some "chips off the table" while still providing opportunities to participate in the long-term growth potential of the anesthesia industry.

Acquirers benefit from transactions through gaining additional scale, which in turn fuels future growth and drives the value of their business.

Mutually beneficial situations like this are something independent anesthesia groups across the country should continue to take advantage of, whether the group is currently operating from a position of strength or facing headwinds. It is rare to be in the middle of such a shift in any market, and physician leaders can go a long way to securing the future of their group by acting now.

Matthew DiCanio is a Principal at MHT MidSpan, an investment bank focused on the middle market. Mr. DiCanio who is based in Dallas, is currently leading sellside and buyside engagements in the anesthesia market.

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