The Future Of Private Equity In Healthcare

Private-equity investments in hospitals and physician practices, which have been building for several years, will continue to grow for the foreseeable future — on this point, there is consensus. But whether private equity’s influence on physicians, their patients, and the healthcare sector overall will ultimately prove to be good or bad is up for debate.

Private-equity firms, investing capital from pension funds, university endowments, high-wealth individuals, and other sources, are intensely interested in healthcare providers, according to research conducted by the Medical Group Management Association (MGMA). Globally, more than 10 percent of the $560 billion in private-equity investments in 2018 occurred in the healthcare sector — and more than half of that was invested in the provider sector.

“That’s double from the level of investment in 2017,” according to Halee Fischer-Wright, MD, MMM, FAAP, FACMPE, president and CEO of MGMA. “We are seeing more deals and we’re also seeing bigger deals at the global level,” she says.

In the United States, private-equity investment reached $29.6 billion in 2018, with $23.2 billion invested in the provider sector. That includes medical practices and hospitals, but also a much broader range of providers, such as home health care companies, Fischer-Wright says.

PwC’s Health Research Institute named private-equity investment as one of its top healthcare trends in 2019. This year, PwC forecasts private equity will continue its healthcare focus for four reasons(1):

1. With a U.S. stock market correction widely forecast, healthcare is considered one of the safer sectors in which to be invested. “Healthcare is not necessarily 100 percent recession-proof, but it is at least a bit recession-resistant,” says Ben Isgur, who leads PwC’s Health Research Institute.

2. Consumers are looking for better access to healthcare, which requires investment and willingness to change. “There is some consumer power behind this,” Isgur says. “They are wanting more connection points and more convenience.”

3. The private-equity industry, having unprecedented success in the past five years, has a lot of money to invest, and the healthcare sector, representing more than 18 percent of the U.S. gross domestic product, is a logical target.(2)

4. Because the healthcare industry is fragmented, it offers opportunities to create value by consolidating multiple entities and addressing inefficiencies to lower costs and increase profits, says James Prutow, principal in PwC Private Equity Value Creation.

Certain specialties, such as dermatology, ophthalmology, anesthesiology, and gastroenterology, have been attractive to private-equity firms in recent years, but PwC trend watchers see that list expanding. Prutow and Isgur predict all specialties, including family practice and pediatrics, will be private-equity targets going forward.

Isgur points to behavioral health, where the need for services outstrips the supply, as a logical opportunity for private-equity investment. “Any type of investment in technology or operations that could make existing behavioral health networks more efficient and able to see more people will be an area of real growth going forward,” he says.

How Deals Work

Lawrence P. Casalino, MD, PhD, chief of the Division of Health Policy and Economics at Weill Cornell Medicine in New York, led a group of researchers who interviewed consultants, attorneys, investment bankers, and leaders of private-equity firms, physician practices, and health insurance companies to document how private-equity investments of physician practices work. Their findings, published early last year in the Annals of Internal Medicine, include(3):

• Private-equity firms typically acquire 60 percent to 80 percent ownership stake in practices. They want physicians to remain as investors so they are incentivized to grow the practice.

• Deals generally are anchored on the acquisition of a large, well-managed practice that has a good reputation in the market. The investors typically pay eight to 12 times EBITDA (earnings before interest, taxes, depreciation, and amortization) for the platform practice, but much less — typically two to four times EBITDA — for the smaller practices that are merged into it.

• Investors expect an average annual return on their investment of at least 20 percent. Private-equity firms try to reach this goal by assembling independent practices in the hope that they can share fixed costs, find synergies among the practices, increase efficiency, increase leverage when negotiating prices with insurers, and sell the assembled practices within three to five years for much more than the private-equity firm’s initial investment.

• Practice owners may receive as much as $1 million or more per physician but, after the acquisition, they receive market rate salaries and little or no revenue from ancillary services.

Private-equity investors typically hold investments for about five years, says PwC’s Prutow, although he sees some variability when it comes to physician practice investments.

“It wouldn’t surprise me at all if we saw more situations where the hold periods are approaching 10-plus years,” he says.

There are three exit options:

1. The practice is sold to a larger company, perhaps one connected with an insurer.

2. The practice is sold to another private-equity fund that may own another practice in the market and sees opportunities for further consolidation.

3. The investors cash out through a stock offering, although initial public offerings (IPOs) are less common for physician practices than some other healthcare investments.

Physician Perspective

Private-equity investments can be a lifeline for physician practices that need an infusion of capital and leadership or administrative support during a challenging time, says Byron C. Scott, MD, MBA, CPE, FACEP, FAAPL, deputy chief health officer with Simpler Consulting, IBM Watson Health.

Fischer-Wright of MGMA agrees. “This can provide the resources to compete in a business environment they were never trained to go into, so it has the potential to do greater good,” she says. “But the burden is on the physician to know that the entity that you’re doing business with has the values that are aligned with your values.”

She cautions physician leaders to consider that their autonomy and independence — two attributes that private-practice physicians have traditionally valued highly — will change when an outside investor buys controlling interest in the practice.

They also should consider the long-term financial consequences for practice partners at various stages of their careers. Once it acquires control of the practice, the investment firm is likely to pay physicians the median compensation for their specialty in their market. While all partners may get a big payout when the deal closes, that payout is likely worth more to a partner who is near retirement than to a mid-career partner.

“One thing I think physicians don’t recognize is that, by and large, they’ll get a permanent decrease in salary,” Fischer-Wright says. “Say, if you have been making 40 percent above median compensation, you will be going to the median compensation. People think ‘Well, I’m going to get a million-dollar payout’ rather than ‘If I take a $150,000 hit to my salary for 20 years, what does that mean to me?’ ”

Healthcare Perspective

Some observers worry that private-equity firms, whose primary goal is to make money for their investors, are not aligned with the primary mission of healthcare, which is to help patients. That argument gained traction in 2019 when the private company that owned Hahnemann University Hospital, the main safety-net hospital in Philadelphia, filed for bankruptcy and announced the hospital was closing.(4) Critics say the owner of the private equity-backed company that bought Hahnemann and a sister hospital in 2018 will ultimately benefit by Hahnemann’s demise because its valuable real estate will be freed up for a more profitable use.(5)

Physician practices may also present profit-making opportunities that private-equity firms find more palatable than most healthcare providers would. Writing in the Harvard Business Review, Commonwealth Fund President David Blumenthal, MD, and two colleagues said investors’ business model is “cause for concern” in the healthcare sector.(6) “...[A]t least in some cases, the investors’ strategy appears to be to increase revenues by price-gouging patients when they are most vulnerable,” the authors wrote.

They point to the problem of “surprise” medical bills in which patients are charged for “out-of-network” services provided by physicians working at an in-network facility. “Private-equity firms have been buying and growing the specialties that generate a disproportionate share of surprise bills: emergency room physicians, hospitalists, anesthesiologists, and radiologists,” Blumenthal and his co-authors wrote. “Patients are often unaware that they need these particular services in advance and have little choice of physician when they use them.”

Thomas L. Higgins, MD, MBA, CPE, FACP, MCCM, FAAPL, chief medical officer at the Center for Case Management in Natick, Mass., worries that private-equity investments support the continued deterioration of America’s healthcare delivery system.

“In the traditional model, the hospital made a lot of money on things like orthopedic surgery and open heart surgery and used that surplus to pay for the things that were not as well reimbursed, like behavioral health, and just simply the care of old, poor, and complex patients,” says Higgins, a member of the AAPL board of directors. “And we always felt that we had a responsibility to do the most good for the most number of people, and that included care of those who had no resources to receive that care.”

That healthcare delivery model is challenged, he says, when some stakeholders put a priority on profit over caring for patients, some of whom will never be profitable.

“What I worry about is that patients will be getting the equivalent of a coach seat on an airline designed to cram in as many patients as possible to drive corporate profit,” he says.

Tips and Advice

Fischer-Wright urges physician leaders to recognize that they have options. If one private-equity company is interested in investing in their practice, others will be as well. Physician leaders don’t need to accept terms with which they are uncomfortable.

Take the time needed to negotiate the right deal, she advises.

“I tell people it takes about 18–24 months to truly do an acquisition or investment with private equity because that time should be spent doing due-diligence,” she explains. “Be really clear about your goal. It is every bit as important for the physicians to have clarity and to be a champion for their end goal in three to five years as it is for the private-equity company.”

Scott, a member of the AAPL board of directors, spent 20 years in leadership positions at EmCare, now Envision Healthcare, a physician practice management company that went through a series of equity investments and an IPO during his tenure. He advises physician leaders negotiating with private-equity companies to think through success factors upfront.

The most important thing, he advises, is to make sure the physician practice has a strong advocate for patients.

“If you are contemplating a deal with a private-equity group, the hope is that the CEO or president of the practice will continue managing the practice,” he says. “That’s one way to make sure you have the right person in the room doing the right thing.”

Other advice:

• Honor your reputation. The name of a practice may change after an acquisition, but the brand associated with the platform practice must not. “You don’t want the transaction to impact your patients or the physicians you consult with,” Scott says. “Who you decide to sell to is important, and you have to make sure you have some say about what happens going forward.”

• Pay attention to details. The private-equity firm will have extensive experience with acquisitions, but physicians in the practice may be new to the process. Don’t make any assumptions about the contract or the working relationship after an acquisition; ask questions and make sure all parties are clear on every detail.

• Have board representation. The practice will have a new board of directors after the equity investment. “The most important thing is that the practice have the appropriate representation and leadership on the board,” Scott says. “That is a must-have to make sure the interests of the practice partners and the patients are being heard.”

• Be transparent. An acquisition affects practice partners differently from how it affects non-partner physicians and others in the practice. “Make sure you’re very transparent with everyone involved so they understand the potential benefit of doing this,” he advises.

• Lead. Help the practice’s new investors understand what is best for patients. “If you feel a decision is being made that is not completely right for patient care, stand your ground and make sure your voice is heard,” Scott says. “In the end, that is the most important thing.”

Looking Ahead

The Commonwealth Fund authors wrote their commentary in the Harvard Business Review as a way to reach private-equity leaders, says co-author Lovisa Gustafsson, assistant vice president of The Commonwealth Fund. Their message: The healthcare sector can benefit from fresh thinking and new sources of capital to solve longstanding problems, but private investors should not misuse patients.

“Solve those problems and make money doing it — that’s great,” she says. “Just don’t try to price-gouge or take advantage of things in the short term.”

She points out that several states have already passed legislation to protect patients from surprise out-of-network bills, and media attention to egregious bills continues unabated.

Although an advertising campaign primarily funded by private-equity investors that own physician practices appears to have forestalled congressional action so far, growing public outcry continues to put pressure on policymakers and may lead to regulation, Gustafsson says. President Trump has said he supports such legislation.

“As this is impacting more people, Congress or regulators at the state level or the federal level are going to start asking: Is this a practice that we really think is appropriate for people when they’re sick and trying to get care?” she says.

Higgins worries that society will eventually come to see private-equity’s foray into healthcare has done more harm than good.

“I think this horse is out of the barn already, and we are not seeing the downstream consequences yet,” he says. “For the next three to five years, it’s going to be huge. It will be lucrative in the short run, but it’s not likely to perform well financially in the long-term. And then we’re going to be left with a broken system.”

References

1. PwC Health Research Institute. Top Health Industry Issues of 2020: Will Digital Start to Show an ROI? PwC Health Research Institute, 2019. www.pwc.com/us/en/industries/health-industries/top-health-industry-issues.html

2. Bain & Company. Global Private Equity Report 2019. Bain & Company, 2019. www.bain.com/contentassets/875a49e26e9c4775942ec5b86084df0a/bain_report_private_equity_report_2019.pdf

3. Casalino LP, Saiani R, Bhidya S, et al. Private Equity Acquisition of Physician Practices. Ann Intern Med. 2019;170:114–15. [Epub ahead of print 8 January 2019]. doi: https://doi.org/10.7326/M18-2363 .

4. Feldman N. Many Fear Hahnemann’s Story Will Send a Message: Buying a Failing Hospital Pays. WHYY.org. July 31, 2019. https://whyy.org/articles/many-fear-hahnemanns-story-will-send-a-message-buying-a-failing-hospital-pays/

5. DePillis L. Rich Investors May Have Let a Hospital Go Bankrupt. Now, They Could Profit from the Land. CNN Business. cnn.com. July 29, 2019. www.cnn.com/2019/07/29/economy/hahnemann-hospital-closing-philadelphia/index.html

6. Gustafsson L, Seervai S, Blumenthal D. The Role of Private Equity in Driving Up Health Care Prices. Harvard Business Review. October 29, 2019. https://hbr.org/2019/10/the-role-of-private-equity-in-driving-up-health-care-prices