Specialty physician groups attracting private equity investment

The 18 physician shareholders at Beacon Orthopaedics in Cincinnati decided last year they needed an outside investor to help them grow and compete more effectively in the rapidly consolidating healthcare market.

After interviewing about 15 private equity firms, the Beacon orthopedists selected Denver-based Revelstoke Capital Partners to help them launch a management services organization that takes over the business functions of the practice. That structure sidesteps rules in most states barring nonphysicians from formally owning medical practices.

The MSO, which started in July, will serve as the foundation for a new network of orthopedic groups across the region and perhaps even nationally that would share management, billing, staffing, credentialing, accounting, and other services. The 26-physician group says it’s already in talks with more than a dozen other orthopedic practices interested in joining the MSO.

Orthopedists, along with gastroenterologists and urologists, are among the newest targets in the rush of private equity firms investing in physician specialty groups over the past few years. These firms are attracted to specialties that promise rich revenue from ambulatory surgery centers, lab, imaging and other ancillary services. The trend is already far along in dermatology, ophthalmology and dentistry.

Other orthopedic and gastroenterology groups acquired by private equity firms over the past two years include the Phoenix-based Core Institute, the Orthopaedic Institute in Gainesville, Fla., Atlanta Gastroenterology Associates, and Texas Digestive Disease Consultants in Dallas-Fort Worth.

The proliferation of these deals has raised alarm about whether ownership of physician practices by investors eyeing a 400% return on their cash investment within a few years will affect overall healthcare spending and quality of care. It’s set off an emotional debate within medicine about potential pressure to provide unnecessary care and loss of professional autonomy.

“It’s appropriate to be wary of new people coming in and gobbling up practices,” said Dr. Arash Mostaghimi, co-author of a recent JAMA Dermatology study on private equity acquisitions of dermatology practices. “If you promote care that’s focused only on money, humanity is lost,” he continued. “But there’s a lot to be gained from good business practices and consolidation that produce better, more efficient care. Probably both things will happen.”

Revelstoke paid the Beacon shareholders an undisclosed amount for a majority share of the management services organization, with the physician group keeping ownership of the practice itself and paying the management services organization a fee.

“The key to our decision to go with Revelstoke was the ability of physician leadership to continue to manage and be advocates for the care of our patients,” said Dr. Peter Cha, Beacon’s president. “Time will tell whether we can take this into national markets.”

The big potential payday for both the doctors and Revelstoke comes three to seven years down the line, when Revelstoke sells the expanded business to another investor, most likely another private equity firm but possibly an insurer, hospital system or another physician company. Then the orthopedists will find themselves working with a new managing partner.

“We’re not speculating as to who would take over from Revelstoke,” said Cha, whose group also serves Dayton, Ohio, and northern Kentucky. “We’re simply focused on growing the business and consolidating the market in orthopedic surgery in the best interests of our patients.”

Despite the concerns, medical groups are rushing into the arms of private equity investors. They see this as an alternative to ownership by hospital systems or insurers that they believe will preserve their professional autonomy and enable them to serve a much larger market.

There were 181 private equity deals for all types of physician practices last year, according to an analysis published in Bloomberg Law. In dermatology alone, there were nearly 200 practices acquired by private equity firms over the past six years, according to the JAMA Dermatology study.

In these deals, the shareholder physicians receive a large cash payment upfront—which is particularly attractive to older doctors near retirement—with the prospect of a much larger bonanza when the private equity firm sells to another buyer. The initial payment is based on a multiple of the practice’s earnings before interest, taxes, depreciation and amortization, ranging from low single digits to as much as 12 times EBITDA.

The doctors generally pay for their equity interest by taking up to a 30% cut in their compensation, said James Heidbreder, managing director of Coker Capital Advisors, which has brokered nearly a dozen of these deals. They also contribute valuable practice assets such as ancillary services to the new management firm.

A number of medical groups, particularly in dermatology and ophthalmology, are already on their second private equity owner, following a “liquidity event” in which the first owner cashed out. There is little public information on how lucrative these transactions have been for investors and physicians.

In one deal, Varsity Healthcare Partners sold its ownership interest in Forefront Dermatology to OMERS Private Equity in 2016 for a reported $450 million, 15 times the medical group’s EBITDA, according to PitchBook. Forefront now has 130 clinics in 16 states.

Private equity firms say these deals are proving successful financially, and the proof is that many are eager to keep investing in medical groups.

Advocates say private equity partners can help physician groups grow and improve their efficiency and quality of care through better management and technology, as well as readying them for new value-based payment models. They also can help the practices become one-stop shops for all needed services, and speed the shift to lower-cost outpatient settings.

“We’re not in the business of telling doctors how to practice medicine; we’re in the business of taking away roadblocks and making the practice easier and better for providers,” said Andrew Welch, Revelstoke’s managing director. “The experience is better for patients, and payers like it as well.”

On the other hand, private equity investors like Welch structure the deals to ensure the physicians have a strong stake in the business’ profitability. “We don’t want a situation where the doctors just run clinical and we run the business and we’re not aligned on the overall strategic direction,” he said. “We try to keep the physician leadership very active on the business side as well.”

With their improved quality, larger size, and expanded services and locations, the private equity-backed groups also have more clout to negotiate better deals with payers, though they downplay this to avoid attracting attention from antitrust regulators.

“The goal is to develop market leverage,” said Bill Brown, a healthcare strategist with Nashville-based A2B Advisors. “It’s a war of who can get big enough in any area to get payers to treat you with respect.”

Some observers say private equity-backed management firms also bring practice standards that protect patients from lesser-quality practitioners.

“In small practices, if one doctor is a bad apple, it’s almost impossible for the others to do anything about it,” said Dr. Lawrence Casalino, a health policy professor at the Weill Cornell Medical College who’s studying private equity deals with physicians. “Whereas (the private equity firm) can get rid of the bad apple or make him behave.”

There are few published studies so far on the impact of these deals, though researchers are gathering data and promising results within the next year.

Some early studies, however, already have raised concerns about private equity ownership of dermatology groups leading to loss of physician autonomy, conflicts of interest, increased utilization of high-cost services and inadequate supervision of midlevel clinicians.

A recent editorial in JAMA Dermatology urged a halt to private equity acquisitions of dermatology practices until more data is available on cost and quality outcomes.

“This does not seem to be a step in the direction of value-based, lower-cost care,” said Dr. Joshua Sharfstein, vice dean for public health practice at Johns Hopkins University who co-wrote the editorial.

A study by Yale University researchers published last year found that two large, private equity-owned medical groups, TeamHealth and EmCare, aggressively used out-of-network billing tactics to boost revenue. Insurers and other groups have pointed to private equity ownership as a culprit in the current congressional battle over legislation to end surprise out-of-network medical bills.

“My biggest concern is private equity firms aren’t focused on making healthcare better,” said Zack Cooper, an associate professor of health policy at Yale who co-authored that study. “They are focused on hunting out narrow slivers of the healthcare system where they can make significant amounts of money by exploiting loopholes.”

Another looming question is whether the private equity business model is sustainable for medical practices, particularly after the first buyer cashes out. Observers wonder how much growth and greater efficiency can be achieved to enable subsequent investors to continue to pull large profits out of the practices.

“Who’s going to be the ultimate buyer?” Casalino asked. “If there is no ultimate buyer, then things don’t turn out so well.”

Buyers and sellers say they’re acutely aware of the disastrous experience with the wave of investor-owned physician management companies in the 1990s. A number of those companies, along with the physician practices they acquired, went bankrupt. Some have called those ventures Ponzi schemes.

But today’s environment and deals are sharply different from the ’90s in key ways, private equity investors and consultants say. “Everyone is positioning for value-based payment initiatives and population health, and smaller medical groups see they need capital and expertise to succeed in that,” said Gary Herschman, an attorney at Epstein Becker & Green who advises clients in these transactions.

Instead of putting physicians on salary as earlier management companies did—and as some hospital systems still do—smart private equity firms now structure deals to make physicians business partners with strong financial incentives to boost productivity and revenue, said Nader Naini, managing partner at Seattle-based Frazier Healthcare Partners. His firm closed a deal with Atlanta Gastroenterology Associates last December to form a management services organization platform called United Digestive.

Also unlike before, investors are bringing in experienced medical executives to provide management and technology help in integrating practices.

Still, Naini worries some private equity investors continue to see this as a pure financial play, with the goal of acquiring more and more practices rather than building high-quality, integrated medical groups. “If you don’t integrate, you are slapping s*** on top of s***,” he said. “There are still people in the market who have that mentality of the ’90s, and we’ll have circumstances that don’t work out.”

Chris Gordon, managing director at Bain Capital Private Equity, who also lived through the 1990s fiasco, wonders whether private equity investments in medical practices are moving too far and fast. He’s particularly skeptical about orthopedic group deals because market power in that specialty depends on specific physicians and referral patterns.

“People are deciding every specialty should be rolled up into a physician practice management platform,” he said. “I wouldn’t say it’s a bubble but it’s probably a little euphoria. It’s still not obvious that the whole world of physicians should be moving toward” practice management companies.

He’s one of many observers who see the rapid growth of these deals as a risky national experiment that could produce both successes and disasters.

Even so, Weill Cornell’s Casalino said many physicians believe they have no good alternative to accepting the uncertain outcome of private equity investment, given doctors’ often-negative experiences with hospital ownership of practices.

“Once you do it, you don’t know what life will be like in five years, because you’ve given up control of your destiny,” he said. “But that may be fine with some doctors, as opposed to selling to their local hospital, where they know all too well what their destiny is and they may not like it much.”