Rush ortho group scopes out private-equity infusion

As physician practices have consolidated in recent years, outside investment money from private equity and venture capital has been instrumental in quickening the pace. But one specialty, orthopedic surgery—viewed by experts as a potential gold mine for its ties to income-producing ancillary services such as physical therapy, X-rays, MRI and pain management—has been notable in resisting the urge to merge.

That resistance appears to be wearing thin right now. Several sizable healthcare investment groups have swooped in and acquired orthopedic practices in the past year around the country. One of the biggest local practices, the 50 doctors who make up Midwest Orthopaedics at Rush, is fielding proposals from multiple private-equity suitors and could make a deal to be acquired soon. More consolidation around the state would be likely to follow.

Crain's has learned that the Rush group has hired Cain Brothers, a New York-based boutique healthcare investment banking firm with offices in Chicago, as an adviser in sorting out its capital needs. While a big investment from a private-equity dealmaker is most likely, Chicago-based Rush could decide to recapitalize its ongoing business or continue to grow piecemeal by acquiring small practices.

Rush executives concede that they face important decisions in coming months. "We've been approached by a number of private-equity groups interested in duplicating or mirroring the experience they've already had in consolidating anesthesiologists, ophthalmologists, dermatologists and emergency room doctors," declares Dr. Brian Cole, a Rush doctor who works on knees and shoulders while also holding an MBA from the University of Chicago. He is the team physician for the Chicago Bulls and co-team physician for the White Sox, and also trains young residents in sports medicine at Rush University Medical Center.

"We've grown slowly and methodically here until now, with a lot of emphasis on research and education," Cole adds. "But the cost of business is very high. So scale is important, and leveraging scale can be important in controlling costs. But the question is how big do we need to be? I can't answer that exactly."

Joshua Jacobs, a professor and chairman of the department of orthopedic surgery at Rush, says that "we will be sitting down and sorting through our options. We are feeling some pressure to grow to be economically viable in the marketplace of the future."

Healthcare investors say a deal could be lucrative for the Rush doctors. One healthcare investor estimates private equity might be willing to pay each Rush doctor between $2 million and $5 million to acquire their practice, though there would be a trade-off as the doctors would henceforth be working for salaries that would amount to less than what they now net each year. Nevertheless, these estimates suggest the Rush practice could be worth as much as $250 million currently.

Dr. Jack Bert, a St. Paul, Minn.-based orthopedic surgeon who is chairman of the Rosemont-based American Academy of Orthopaedic Surgeons' practice management and rehabilitation program committee, says small practices are having more and more difficulty in negotiating reimbursements from ever-larger health insurers.

"Nobody cares about a five-man group of orthopedists," Bert says. "But if you are Rush and you have 40 or 50 doctors, the insurers have to listen to you. And if you get even bigger from there, your negotiating leverage keeps growing."

One group likely to go after Rush is Healthcare Outcomes Performance Co. of Phoenix, Ariz., known as HOPCo. With the backing of Frazier Healthcare Partners of Seattle and Princeton Ventures in New Jersey, it has amassed the Core Institute in Arizona with 78 doctors and an offshoot in suburban Detroit with 10 doctors so far.

Dr. David Jacofsky, chairman and CEO of HOPCo, says orthopedists are being driven to outside investors as once-dependable income from ancillary services such as imaging has begun to shrink. "Just getting approval for an MRI now for a patient's back pain has become a challenge as insurance companies are clamping down on testing and other services," Jacofsky says. "To do something like a knee replacement today requires a massive amount of documentation. Doctors have become overburdened by the administrative work. And outside investors can take that burden away from them."

But if income from ancillary services has been falling off, what's in it for private equity? Some doctors are pondering that. "Opportunistic outside investors can come in and skim off the lucrative pieces of healthcare practices," says Daniel Post, executive vice president of the Loyola University Health System in Chicago. "But I'm not sure these investments will be long term and sustainable."

And yet the larger trend seems unmistakable. In 1983, according to a study by the American Medical Association in Chicago, 41% of physicians practiced solo, though by 2014 just 17% were on their own. In the same period, the doctors who were part of groups of 25 or more rose from 5% to 20%.

Jeff Swearingen, a managing director at Edgemont Capital Partners in New York, a healthcare investment banker, predicts practices with 40 or 50 doctors, like that at Rush, will eventually be rolled up into consortiums of 250 and even 500 doctors. He explains that investors count on acquiring a practice priced at 10 times its earnings before interest, taxes, depreciation and amortization, then boost profits and flip it in a few years to another investor for a multiple of 15.

"There is also a tax arbitrage doctors can take advantage of," Swearingen says. "They can sell their practices for a lump sum and be taxed at a lower capital gains tax rate rather than taking more in pay and facing higher regular income tax rates each year."

No matter how attractive that might be, it appears that private equity doesn't appeal to all doctors. The 120 physicians working in 23 offices who make up the biggest ortho group in the state, the Illinois Bone & Joint Institute, appear to be lukewarm for now on accepting outside investment.

"Doctors have had mergers with hospitals and investment groups in the past, and not all of them saw their hopes and promises fulfilled," says Andre Blom, IBJI's CEO. "From what we've been learning the advantages in accepting private equity may be overblown right now."

"Rush ortho group scopes out private-equity infusion" originally appeared in Crain's Chicago Business.