The Invasion of Private Equity into Healthcare- Are we experiencing a new era of efficiency or a 1990s disaster sequel?
by David H. Fater

There is a marked invasion of private equity into healthcare (again) and a day does not go by without reading about another physician practice acquisition or some other combination of healthcare providers being ushered along with private equity dollars and financial backing. There were 181 private equity deals for all types of physician practices last year and this year there will be even more.  In dermatology alone, there have been 200 practices acquired by private equity groups over the past six years. Orthopedists, along with gastroenterologists and urologists are among the newest targets in the current gold rush. The attraction with these types of groups are the rich revenue that can be generated from ancillary services such as ambulatory surgery centers, lab, imaging and other such services. This rapid proliferation of private equity deals has raised alarms about whether investor ownership of physician practices will negatively affect healthcare costs and quality. The other $64,000 question is whether this rash of deals will implode, crash and burn much like they did in the late 1990s.

Three Card Monte or the Shell Game
 

The big potential payday for both the doctors and the private equity groups comes three to seven years down the road when the private equity group sells the “expanded” business to another private equity group, insurer, hospital system or another physician company. In some respects, it is like a large chain letter and hopefully you are not the one that is left holding the bag. Of course, the song the private equity groups sing is “We are simply focused on growing the business and consolidating the market in orthopedic surgery [dermatology or whatever the specialty is] in the best interests of our patients”. Sure, and the moon is made of green cheese if you think there is not a real profit motive here. And when there is a profit motive, someone has to come up with the short end of the stick.

Despite the experience of the 1990s and many of the deals of this decade, physicians are still running into the arms of private equity groups because they see this route as their only and best alternative to ownership by hospital systems or insurers and that they will be able to preserve their professional autonomy. Because of the prohibitions in many states against the corporate practice of medicine, the practice itself is not “acquired” but a Management Services Organization (“MSO”) is formed that takes over the administrative non-clinical functions freeing up the physicians to focus on medicine and patient care.

Typically, the shareholder physicians receive a large cash payment upfront (this is particularly attractive to the older physicians near retirement) with the golden carrot being the bonanza that will be realized when the private equity firm sells to another buyer. The initial payment is calculated with rocket science and differential calculus and is based on a multiple of the practice’s EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). The multiple can be as high as 12; HOWEVER, since the EBITDA of a typical practice is 0 because the physicians pay all that out to themselves, the physicians have to take as much as a 30% decrease in compensation. This plus any valuable practice assets turned over to the Private Equity Group “pays” for the physician ownership in the MSO. Naturally a year later, the physicians forget about that and just start grousing about how their personal income has gone down.This could lead to inevitable friction that will ultimately lead to a meltdown of the entity leaving everyone unhappy.

 
The Pot of Gold at the End of the Rainbow
 

Advocates contend that private equity groups can help physician groups grow and improve their efficiency and quality of care through investments in management and technology as well as facilitate the transition to value-based payment models which are being mandated by the Centers for Medicare and Medicaid Services (“CMS”). The transition to one-stop shops for all needed services helps speed the shift to lower-cost outpatient settings. Additionally, the improved quality, larger size and expanded services and locations enables the group to negotiate better deals with payers.  This fact is often kept quiet to avoid attracting the attention of the antitrust regulators.

Not all is rosy, however, and there are naysayers besides the unhappy physicians. Those that develop health policy are concerned that private equity firms are not focused on making healthcare better. The belief is that they are rather focused on hunting out narrow slivers of the healthcare system where they can make significant amounts of money by exploiting loopholes. Two examples, determined by a study at Yale University, found that two large hospital-based medical groups (Team Health and EmCare) owned by private equity groups aggressively used out-of-network billing tactics to boost revenue. In fact, insurers have pointed to private equity ownership as a factor in the current battle over legislation to end surprise out-of-network medical bills.

Is the Business Model Sustainable?
 

A looming question is whether the private equity business model is sustainable for medical practices, particularly after the first buyer cashes out. Who is going to be the ultimate buyer? If there is no ultimate buyer, then things don’t turn out so pretty. Today’s buyers and sellers say they are acutely aware of the disastrous experience with the wave of investor- owned physician management companies in the 1990s. (And I was one who lived through those wars from the beginning in 1992 through the meltdown in 1999). Several of those companies, along with the physician practices they acquired, went bankrupt and have been called Ponzi schemes.

Today’s buyers seem to have learned that putting physicians on salary is not productive or beneficial. Physicians are intelligent, self-select and are autonomous in nature. So smart private equity firms now structure deals to allow physicians to be “partners” with strong financial incentives to boost productivity and revenue.  Unfortunately, some investors continue to see this trend as a pure financial play spurred on to acquire, acquire and grow. The caveat is that if you don’t integrate what you buy, you have a mess on your hands.

So Who Really Benefits from Private Equity Buyouts?
 

One could argue that if the policymakers really want to expand value-based care, then someone needs to hit the pause button and take a closer look at this private equity buyout activity. The trend that may have started with dermatology, ophthalmology and dentistry (which is interesting because each of these have an element of retail plus healthcare) are spreading to the costliest areas of medicine-orthopedics, gastroenterology and urology. As stated above most of the balance billing surprises from being “out-of-network" arise from the large emergency departments who are staffed by physicians that work for private equity owned firms.

This business model in healthcare parallels other industries by using highly leveraged private capital to roll up small companies into a larger one with the private equity firm providing the management. They charge hefty fees for arranging the deal and a 20% annual return on its investment after paying the interest on the debt related to the transaction. After three to seven years, the private equity firm and the physicians earn a windfall with the first flip and by this time, the private equity firm has taken all its money off the table. If things don’t go as planned, there is always a bankruptcy which cuts the private equity firm loose with no loss. As to how to achieve the financial targets, there can either be sharp cost reductions or ways to increase revenue. Since those specialty physicians took a pay cut to play the game, they have a powerful incentive to ignore cost controls or value-based treatment.  While we give lip service to value-based payments, the majority of revenue (which pays those physician salaries) still comes from fee-for-service medicine. It’s hard to see how this cycle is going to help the United States achieve a less-costly and higher-quality healthcare system. And let’s not even go near “Medicare for All”. We need to make sure that physician practices are allowed/mandated to practice medicine and still achieve the Triple Aims of High Quality, Low Cost and Patient Satisfaction.

*******************************************************

To explore ways in which we can provide assistance in assisting with your merger and acquisition strategy or decipher the changing reimbursement rules being promulgated by CMS in this evolving health care environment, please contact David H. Fater at dfater@alda-associates.com or Richard M. Cohen at rcohen@alda-associates.com

Is International Business Right For You?  by Richard M. Cohen, Ph.D.

(This is the second part of a three part series on whether internationalization is right for your business)

Having briefly sketched the global marketplace, we now address the question of when a company should consider an international venture.  What factors make doing business abroad worthwhile?  And when does a company have insufficient reason to proceed overseas?

 
THE WRONG REASONS FOR GOING INTERNATIONAL
 

Going international can have many benefits, but far too many companies make this potentially good move for bad – or, more often, insufficient – reasons.  Many executives misunderstand the real promise of international ventures.  Instead of analyzing the advantages and disadvantages of specific options in carefully chosen markets, they press ahead impulsively, often basing their reasons on misconceptions about doing business overseas.  The result is often disappointment, or even financial disaster.

The commonly held but wrong or insufficient reasons for undertaking international ventures are the following:

Wrong Reason 1:  Tax-Free Status
 

To attract foreign investment, many nations offer a “tax holiday” to certain companies, most often those that are either capital-or labor-intensive.  A tax holiday generally lasts from five to twenty-five years.  Tax holidays tend to increase in length the farther a company moves from urban centers that have adequate infrastructure and skilled labor.  So far so good.

The problem is that tax-free status often blinds American business people to all other considerations.  Executives look at their profit-and-loss statement at headquarters; they cringe at the sight of what U.S. taxes take out of their bottom line; they fall for the easy temptation of tax-free status overseas.  “If we didn’t have to pay taxes”, they rejoice, “just think of our profits!”

 Unfortunately, most people forget the drawbacks.

• The farther from an overseas urban center (and hence from adequate infrastructure and skilled labor) a company establishes itself, the harder doing  business is.  In remote areas of many countries, electrical power fails frequently; telephone communications are sporadic; bad weather can delay delivery of raw materials, and shipping costs can be exorbitant.
• The time the company takes to fill an order can increase significantly as a consequence of manufacturing problems and unreliable transportation.  For many reasons just listed, delays and expense in acquiring raw materials and shipping finished products may exceed your wildest nightmares.
• Finding even unskilled labor can prove difficult.  The more remote the location, the less likely it is that local workers will have had any experience – or will even have interest – in working in a factory environment.
• All overseas ventures – even when tax-free – necessitate additional accounting and reporting procedures.  The cost of accountancy and legal advice may ultimately exceed the value of an enterprise if tax-free status in the only benefit.

Some executives attempt to circumvent the risky aspects of this situation by limiting their venture to assembly operations overseas.  They transfer finished components at a low transfer price to an overseas location, thus showing a loss in the United States and avoiding U.S. taxes; then they assemble the products and transfer them back at an unreasonably high transfer price, once again showing no profit in the United States.  This method allows the foreign operations to show maximum profits that are tax-free.  However, the arrangement violates IRS regulations and frequently results in a net loss anyway.

 If your reason for going international is chiefly to reap tax benefits, you should consider seeking a similar advantage in the United States.  Many areas of the country offer tax incentives.  By taking advantage of them here, you will enjoy a similar benefit without taking such a high degree of risk.  Moreover, both acquiring raw materials and shipping finished products will cost you less.

Wrong Reason 2:  Cheap Labor
 

With certain exceptions (such as Korea and Hong Kong), you should carefully and skeptically investigate countries notable for cheap labor.  A production worker who costs twelve dollars per hour in the United Stats may cost only one dollar per hour elsewhere in the world.  However, one well-trained, experienced American worker may produce more than several workers overseas.  In addition, some countries have government regulations that virtually require management to hire a large number of workers to do the job that one worker could have handled in the United States.  In China, for example, the government used to provide a foreign company with a factory and a full team of employees.  The output of that factory, however, may resemble what you could have attained with a smaller staff of American workers.  Other countries, such as Singapore, dictate benefits and wages, thus raising personnel costs.

Productivity statistics that are tempting area also often deceptive.  Government ministry figures are especially suspect.  Even those supplied by international companies deserve close scrutiny.  How have these agencies and companies acquired their data?  What are their sources of information?  Few (if any) companies publishing such statistics run operations either for manufacturing or for assembly in the countries under study.  Often their reports are derived from government surveys.  The result, unfortunately, tends to be data with little or not foundation in reality.

Wrong Reason 3:  Serving Existing Clientele
 

Some American businesses unexpectedly begin to acquire clients in a particular country or region.  These clients many come about as a consequence of foreign business people visiting the United States or from advertisements in trade publications that have caught someone’s attention overseas.  In other instances, a U.S. customer establishes operations overseas and turns to his American supplier to continue meeting his needs.  One way or another, these unexpected foreign orders provide a pleasant surprise.  A potentially dangerous result, however, is that management may conclude that a market exists for their products overseas when in fact no such distinct market exists.

This situation often leads to sloppy thinking – and, worse yet, to sloppy decision making.  The illusion of an easy initial success can tempt management to proceed as if every subsequent choice will be successful as well.

Wrong Reason 4:  Acquiring a Vacation Spot
 

As unlikely as it sounds, some companies undertake international ventures chiefly to acquire a tax-deductible corporate vacation spot.  The usual sequence of events is that someone from top management visits a foreign country on business and, finding the locale attractive, inexpensive, and relaxing, suggest to fellow executives that they start a small operation there.  “The beaches are nice, the shrimp are cheap,” he tells them, “and – who knows? – we might even turn a profit some day.”  His colleagues make their own visits and concur.  The company opens a facility that, if nothing else, provides the excuse for tax-deductible junkets.  Unfortunately, the ill-planned enterprise flops after one year, costing the firm several million dollars.

 Absurd?  Of course.  But all too common.
 
To summarize:  international ventures often prove worthwhile, but companies sometimes undertake them for the wrong reasons.  Tax-free status, cheap labor, preexisting clientele, and suitability as a vacation spot are insufficient justification for going international in the absence of other, better reasons.
           
However, good reasons do exist and we will explore those in Part 3.

****************************************************************

If you are interested in exploring the benefits of becoming an international company, please contact Richard M. Cohen at rcohen@alda-associates.com or David H. Fater at dfater@alda-associates.com.

Representative Engagements

• Initiated and developed a de novo Accountable Care Organization to participate in the Medicare Shared Savings Program which grew to over 250 physicians over three years which successfully generated savings.
• Financial advisor to large physician practice in connection with a potential acquisition transaction where engagement includes determination of strategic and fair value and assisting in negotiations for closing the acquisition and in post acquisition integration.
• Review and in-depth analysis of new Medicare Reimbursement rules for subsidiary of Fortune 50 insurance company and assistance in developing a business model enabling the capture of a new revenue stream for both physician practices and affiliated providers.
• Acquisition due diligence and integration assistance for a public healthcare staffing company involved in numerous acquisitions. Retained by parent company to manage acquired company for 22 weeks through ALDA developed integration plan.
• Turnaround assistance for a near bankrupt client company, including tax and financial restructuring, and ultimate sale at a significant cash price.
• Leadership of development of client company's strategic plan for the next decade and assistance in repositioning the company.
• Determination of strategic value of a client company, packaging for sale and assisting in negotiations.
• Providing the entire management team for several life science and healthcare companies from early stage through obtaining additional patent protection, guiding clinical development plans, navigating the pathway through the FDA, establishing the manufacturing processes, initiating commercial sales and eventually transforming the Company into a publicly traded Company.
• Determination of strategic implications of a line of business with weak performance; development of strategies to maximize profitability contribution.
• Turnaround assistance for a troubled venture-backed company, including raising additional debt and equity capital.
• Acquisition and financing assistance for a public, international railroad in connection with a $300 million cross-border acquisition and refinancing.

Our experienced professionals are dedicated to helping clients unlock inherent value and create new value.

The ALDA Team includes, among others:

David H. Fater - Chief Executive Officer

Strategy, capital markets, restructuring, and mergers and acquisitions experience with public healthcare companies focused on physician management, rural healthcare, nursing homes, HMO's, diagnostic imaging and medical devices. Deeply involved in the implementation of the Affordable Care Act with Accountable Care Organizations, Independent Practice Associations and Management Services Organizations. 

Richard M. Cohen - Senior Operations and Business Development Executive

Healthcare operations and worldwide sourcing experience. Skilled in healthcare (physician management, clinical trials, medical and patient process flow, diagnostic imaging and life science) operations as well as in issues dealing with importing, exporting and manufacturing operations in South America, Far East and Europe. 

Thomas J. Bohannon - Senior Financial Executive

Accomplished, creative CPA, outstanding analytical and technical abilities. Has experience for over 40 years in public accounting and private industry including nursing homes, medical device companies,  hospitals, not-for-profits, retail, manufacturing, import/export and natural resources.

A. Ronald Turner - Senior Healthcare Executive

Senior healthcare industry executive with strong entrepreneurial focus including CEO and COO positions with start-up hospital companies and a publicly-traded hospital company. Extensive and successful operations experience for more than 50 hospitals and 9 nursing homes, and senior reimbursement experience for a major publicly-traded hospital company and a national accounting firm. Experienced in mergers and acquisitions, led operational turnarounds and debt restructurings that created significant value.

Mark W. Caton – Senior Healthcare Executive

Senior hospital executive with over 30 years experience in operating not-for-profit and investor-owned rural/community hospitals as CEO or COO, and Regional COO with several national hospital companies.  Skilled in strategic planning and business development, operations management, revenue cycle management, medical staff development, and quality/resource management.

Daniel N. Weiss, M.D., F.A.C.C. - Chief Medical Officer

Medical devices and healthcare practice experience, engaged in a private medical electrophysiology practice where he performs numerous invasive cardiac procedures and has served as a consultant for several Fortune 500 Medical Device Companies including Philips, Boston Scientific/Guidant, St. Jude and Medtronic, as well as for several medical device and drug start-up companies. 

David Bott - Senior Information Technology Executive

Systems and network support solutions experience, proviedes analyis of strategic business needs and assessment of business models and their integration with technology.  

Santiago Guzman - International Executive

Experienced in new project development for companies in a variety of industries from start-up to Fortune 500. Client relations management, fluent in English and Spanish. Skilled facilitator for introductions with influential leaders in South America including those in the health care industry. 

With offices in:

• Delray Beach/Boca Raton, FL
• Atlanta
• New York
• Quito, Ecuador

For additional information, please contact:
David H. Fater, Chief Executive Officer
ALDA & Associates International, Inc.
751 Park of Commerce Drive; Suite 128
Boca Raton, FL 33487
(877) 845-4657
dfater@alda-associates.com