Healthcare Remains an Attractive Asset Class for Private Equity
With a rate of return of 220%, healthcare continues to be a target asset class for private equity investing. In 2018, 63.1 billion dollars of private equity funding was pumped into healthcare – a 50% spike globally.
The following eight buyouts in 2018 were valued above $2 billion:
2019 Outlook
The pace looks to continue moving quickly in 2019, with projections of nearly 750 deals involving private equity buyers and sellers. Following market trends, private-equity firms are shifting their investments from the large, already consolidated acute care settings to more consumer-friendly, alternative care models. Investors have been looking for ways to build scale in fragmented categories and geographies. Private-equity firms are accelerating their investments into physician practices and expanding their portfolios into new specialty areas, such as orthopedics, urology, and gastroenterology. There were 45 physician practice transactions announced or closed in the first quarter, which is on pace to surpass 2018.
The healthcare environment continues to change. While compliance and regulation are increasing, reimbursement is decreasing, making physician practice more complex and burdensome to manage. Physician groups, to increase profitability, are looking to expand to serve additional patients and recruit more physicians. With inpatient margins decreasing, large physician group systems are shifting their focus to outpatient and ancillary service areas, which requires significant capital investment for IT, personnel, new infrastructure and dedicated standalone assets, and potentially third parties to service the systems.
Looking ahead, the likelihood of a recession will be palpable throughout 2019 and into 2020, and sociopolitical uncertainty may prevail. Returns in healthcare private equity markets have proven resilient through such storms. However, there is a wide-held belief in the market that investor demand for these fundamentally strong, recession-resistant assets will endure. Buyers with a robust healthcare acquisition playbook are best positioned to make smart investment decisions that will generate strong returns in the years ahead.
Making Your Practice Attractive
Many physician groups fail to invest in the areas mentioned above, and forego growth opportunities, revenue enhancement, and cost savings initiatives, as physicians are often too busy to focus on these areas. Entrepreneurial physicians (most often) do not want to lose ownership, lose autonomy and control, nor become an employee of a large hospital system.
To fuel growth, physician groups need funding and find that private equity is a ready and capable capital partner to share the financial burden without ceding clinical and economic control over critical areas. By partnering with private equity, physician groups gain immediate access to experienced management, and legal and financial expertise, with a focus on growing the practice and increasing profitability. The infusion of management services allows physician practice members and employees to remain focused on delivering care. Another significant benefit of this management expertise if the data collection to show what works and what doesn’t, which helps fill the assumptions in underwriting and show the insurance companies these groups do things better than others.
The common goal among investors is lowering the total cost of healthcare while enhancing outcomes. However, not all physician groups are an attractive asset for private equity investing. The funding appears to be available to physicians in lucrative specialties already profitable, while doctors needing capital because they’re losing money are less likely to find a partner in private equity. Private equity firms also look for the ability to scale up operations, and firms like to invest for a three-to-seven-year period and anticipate returns of over 20% annually.
Despite these profitability concerns, there remains significant interest in primary care because when done right, it can immediately affect the cost curve because it can directly affect downstream referrals. However, where deals have gone wrong is when the management team has underestimated the operational complexity of scaling a business across multiple regions or markets. As a result, private equity will continue paying a premium on organizations that manage their revenue cycle function efficiently.
Given the capital demands, there has been more willingness by private equity firms to structure capital in creative ways either as joint ventures or through structural capital “stack” models, enabling beneficial relationships between primary care and specialists and ancillary services. These financial arrangements, coupled with specific exit and governance rights, make private equity a valuable and indispensable player in the evolving healthcare ecosystem. Private equity firms are getting creative in two dimensions: the breadth of clinical areas and the maturity of the deals (more investors buying into early-stage concepts).
Key Takeaways
Long-term trends, such as an aging population, the rising prevalence of chronic disease, and expanding demand for quality and efficiency, have driven domestic investment activity for several years.
Firms typically invest for a three-to-seven-year period and anticipate returns of over 20% annually.
Private equity investment will analyze the following factors in determining the value of a deal:
(a) Attractive target investments can reduce costs of care without impairing quality;
(b) Capital intensive investments, involving information technology systems, will require significant scaling to achieve a level of profitability to warrant the initial investment;
(c) Structuring investments either as joint ventures or through structural capital “stack” models coupled with specific exit and governance rights is a trend that will continue to grow, as it provides the benefits of private equity without sacrificing clinical and other strategic control;
(d) There is a premium on organizations better equipped to handle new payment models;
(e) Ability to scale up operations is vital;
(f) Deals will fail (and have failed) when the management team underestimates the operational complexity of scaling a business across multiple regions or markets;
(g) Continued interest in primary care because when done right, it can immediately affect the cost curve because it can directly affect downstream referrals; and,
(h) Funding is available to physicians in lucrative specialties already profitable, while doctors needing capital because they’re losing money are less likely to find a partner in private equity.