The Next Stage of Evolution in Physician Practice Transactions: Can hospitals compete with private equity in attracting physician group deals?

There are many terms for it: alignment, physician integration, employment, practice acquisitions, hospital-physician joint ventures, strategic affiliations. The recent rise in transactions involving hospitals and physicians has been one of the most impactful trends in the nature of how both types of organizations are structured and how they function as enterprises. Regardless of the terminology used in referring to this trend, hospitals and practices continue to engage in transactions at steady volumes, and they entail a wide range of structures, provisions, and valuations. Considering the value that such transactions can generate for the parties involved, it should be no surprise that in recent years, we have seen a number of new types of participants attempt to compete for the potential downstream value that many perceive as available within the healthcare services landscape.

Perhaps the most significant new player to this “game of healthcare deal-making” is what we broadly refer to as private equity (PE).Now just a quick point on this—private equity is a broad term that can include a wide range of entities, individuals, and unique characteristics. When looking at physician practice transactions and for the sake of this discussion, PE primarily refers to entities—sometimes existing enterprises or also new entities—backed by investment firms, often referred to as financial sponsors. On a large scale, there are firms like KKR & Co.; Silverlake Capital; Welsh, Carson, Anderson & Stowe; Texas Pacific Group; Clayton Dubilier & Rice; etc., which are major institutional investors that manage hundreds of billions of dollars in capital and invest across many different industries and sectors. Like with most things, the overall PE player landscape varies widely. Thus, countless other firms manage comparatively smaller funds, along with a long list of firms that manage a few hundred million dollars in capital, but they target opportunities that fall more in the middle market.

In this domain, a significant amount of healthcare deal activity is taking place in the current market, particularly healthcare deals involving physician-owned entities. Enough indicators have emerged within the last few years to conclude that the impact of PE targeting physician practice transactions should not be underestimated or ignored. One can merely look at the number of newly created consortiums backed by financial sponsors today compared to how many of these companies were targeting this space 10+ years ago, and the significance of the trend becomes apparent. Moreover, we can look at the value that has emerged for many of these entities—either through growth in earnings or subsequent exit transactions--and it is easy to understand how attractive these deals could be for any firm trying to generate value for investors. The growth of PE in physician deals is not necessarily a revolutionary finding. However, perhaps one of the most interesting aspects of this trend is the question about the impact these deals are having on the healthcare market, which in the case of medical practices is something that is localized and somewhat unique for individual markets where these deals are occurring.

A PE firm entering a market by acquiring a physician group (or potentially consolidating multiple different groups to create and/or expand broader platforms) can significantly impact a local market’s healthcare services dynamic. This effect will also likely have some degree of influence on the hospitals and health systems operating in that market. Further, in some cases, we are now seeing PE deals—notably larger ones with significant market share impact—have major effects on the local hospital facilities through a shake-up in various matters such as service mix, ancillary referral trends, managed care contracting, and other variables that play key roles in shaping a local healthcare market.

There is a wide range of considerations entailed in PE/physician deals, all of which we cannot cover here. However, soon Coker will publish a series of articles, white papers, and podcasts on this topic, including some of the vital characteristics that market players should understand related to these transactions. One of the key bigger picture observations has to do with where we see the majority of these transactions take place. It is likely no surprise that PE would target those healthcare specialties that pose the highest potential for downstream value maximization, which can ultimately be realized through partnering in specialties that still enjoy higher reimbursement. Other targets include specialties that have significant opportunity for revenue from ancillaries (e.g., surgery centers, endoscopy centers, office-based ancillary services, outpatient facilities, etc.).As such, for many years we’ve seen deals in urgent care, physical therapy, dermatology, and gastroenterology. However, within the last couple of years, the focus is extending to other specialties, including orthopedics, ENT, oncology, OB/GYN, urology, and even neurosurgery. Attention has also increased in primary care, including both internal medicine and pediatrics. Essentially, any medical specialty services where an investor can show the potential to generate downstream value for investors would be strongly considered, and they are actively targeted. How a deal ultimately gets done and what it means for the different players within a given market is all over the board. This information will be addressed in the upcoming publications.

For now, the primary point we want to stress is that not only are these deals happening, but more importantly, these should be included on the list of possible alternatives for what could take place in your respective market. For example, if you are a medical group and are considering potential affiliation or full-scale sale scenarios, then private equity may be something you should explore. Chances are if you fall into the category of primary targets referenced above, then you likely have already been approached by at least one party indicating interest in engaging in a transaction with your group. If you are a hospital, then the prospect of having to compete with PE buyers entering your market—or expanding existing assets within your market—is something to take very seriously. The challenge here is that there are different rules for hospital buyers versus for-profit entities sponsored by institutional (i.e., private equity) capital. However, that does not mean hospital leaders should accept the assumption that if a group with whom you would like to affiliate is talking to PE firms, then you are automatically off the list of potential partners for that group.Finally, for the PE firms looking to expand their healthcare assets, the most significant recommendation I can provide is first to understand that healthcare is different and unique from other industries. Moreover, while deals typically do eventually come down to how value can be transferred between parties, the players within physician deals are varied and many.

Ultimately, healthcare is delivered locally by individual providers. Therefore, it is essential to understand that the physicians are the real value behind such deals. To ensure your partnership generates valid long-term value—both regarding investor ROI and in the form of quality medical care delivered within a community—these types of deals must go far beyond standard financial models and conventional deal assumptions.