Once the darlings of Wall Street, physician practice management companies have become pariahs. Since January the industry has lost about one-third of its value in public equity markets after several big players missed earnings targets.
So new stock issues are hardly a hot commodity, and prospects for new offerings appeared to worsen with last week's Chapter 11 bankruptcy filing by San Diego-based FPA Medical Management.
"I think the window is tightly closed right now for public offerings," says Brooks O'Neil, an analyst with Piper Jaffray in Minneapolis.
Four public offerings occurred since the first of the year, but five other PPMs canceled or postponed offerings during that period, according to MODERN HEALTHCARE research (See chart).
While most observers believe investor confidence will return, they also agree it's going to take some time. O'Neil says it could take a year for the industry leaders, Nashville-based PhyCor and Birmingham, Ala.-based MedPartners, to work through operational problems and produce strong earnings.
In the meantime, the industry is looking for alternate sources of capital. So far, at least, there appears to be no shortage.
Filling the void are banks, which extended credit totaling nearly $1.5 billion to public PPMs in the first half of the year. Unlike stockholders, banks get paid first should a company go bankrupt. Less popular was financing from private investors such as venture capital.
In June, Hollywood, Fla.-based Sheridan Healthcare canceled plans for a public offering, citing unfavorable market conditions. Instead, it increased its bank credit facility to $75 million from $50 million to fund capital requirements.
Sheridan Chief Financial Officer Michael Shundler says the company might have to adjust its business strategy further, focusing more on internal growth, such as adding physicians to existing practices and investing in ancillary services.
"It depends on how long the market remains in a slump," Shundler says. "If the sector recovers, it makes no difference. If the sector doesn't recover, it can slow down the (acquisition) rate."
Another option is accounts-receivable financing, which is being promoted to the PPM industry by firms such as Boca Raton, Fla.-based Capital Healthcare Financing. It's a division of Capital Factors, a bank-backed accounts-receivable financing company. Started two years ago, Capital Healthcare has three private PPM clients and expects to close on a fourth late this month. It also finances hospital acquisitions.
While physicians were content to accept stock for their practices a few months ago, many now demand cash. Accounts-receivable financing allows PPM companies to generate quick cash to buy a practice by collateralizing the practice's unpaid third-party claims.
"We believe it's an attractive alternative until Wall Street likes these types of deals again," says John Apgar, senior vice president of Capital Healthcare Financing.
But he admits accounts-receivable financing has not been quick to catch on with PPMs, which have long enjoyed cheaper forms of financing. Accounts-receivable financing is more expensive than bank debt, because the lender charges a fee, which typically amounts to less than 1% annually of the loan amount, to monitor a company's books and verify claims on a weekly or monthly basis.
New York-based Complete Management is one PPM company that opted for the strategy this year. In May it closed on a facility with an undisclosed firm that will allow it to borrow up to $40 million. Complete Management says it will use the proceeds to add specialty practices and install information systems. Terms of the deal were not available by deadline.
A few companies have proceeded with public offerings despite the sour market, but they took a beating on price. Fort Worth, Texas-based ProMedCo Management Co. priced stock for its secondary public offering in May at $11, the low end of its filing range. Boca Raton, Fla.-based BMJ Medical Management made an IPO in February priced at $7 per share, below its anticipated range of $9 to $11.
"Investors were extremely concerned about the industry. It was not easy to convince them," says ProMedCo President and Chief Executive Officer H. Wayne Posey. He stressed to potential investors that his company has a conservative strategy of investing only in medical groups in secondary markets with little managed care.
Sadly for investors, though, both ProMedCo and BMJ have since seen their stock drop below those offering prices.
Despite what appeared to be a low price at the time, Posey says, as a result of the offering, "we're probably one of the best-capitalized companies in the industry right now."
Also as a result of the market downturn, some observers say, the number of start-up PPMs could diminish as investors become pickier. Companies with inexperienced management teams and questionable strategies might not make it out of the starting gate.
Ted Paff, a general partner with San Francisco-based Acacia Venture Partners, says he expects private PPMs to keep public offerings on the back burner and instead focus on building value by solidifying alliances with managed-care plans, adding ancillary services and enhancing the franchise value of their practices.
Investors "are increasingly focused on the `Where's the beef?' question," Paff says. "They're looking for businesses with value creation beyond simple arbitrage."
While investors appear to be cautious, there's still a strong conviction that physicians need to be in larger groups with sophisticated management systems-hence the need for PPMs.
"I think for the strongly managed, well-positioned companies, there is still a lot of capital out there," O'Neil says. But he adds, "Having a great deal of focus and discipline in your acquisition strategy is absolutely critical. We see many companies in the marketplace that don't have that."
Ultimately, observers say, the industry could be helped if potential investors demand solid management and business strategies-qualities still lacking in many PPMs. The experience of FPA, which encountered disaster after buying unprofitable practices in far-flung markets, serves as a stern warning.
Says Ira Coleman, an attorney with McDermott, Will & Emery in Miami who assists PPM firms in arranging financing: "Some people look at it as a tremendous opportunity for PPMs to stay private and develop what they need, which is an operational infrastructure."