Private Equity Swallowing Ortho Practices

Connecticut-based Atlantic Street Capital, a private equity firm, has acquired Washington, D.C.’s OrthoBethesda. Terms or structure of the deal were not disclosed.

The sale of an orthopedic practice is not new. Hospitals, and in some cases, payers have been buying up independent orthopedic practices for some time. But private equity firms moving into the orthopedic space? That seems new.

So, we did some research.

MarketWatch reported this past June that investments by private equity and venture capital in private medical practices has been very active recently—but mostly in dermatology, a $14 billion and growing market. And, they report, many dermatologists “aren’t happy about it.” They worry about the effect on patient care, and even fear for the future of their profession if it continues to be dominated by business interests.

We reached out to Atlantic Street Capital and OrthoBethesda and asked about this “fear.” We asked how the transaction was structured to assure that patient care decisions were left to the providers, not “business interests.”

They declined to comment. Too bad. The acquisition of orthopedic practices by private equity interests is likely to continue.

OrthoBethesda

According to a September 5, 2018 press release from Atlantic Street announcing the acquisition, OrthoBethesda was founded in 1965 in the greater Washington, D.C. market. Just in time for Medicare.

The practice operates four Centers of Excellence: Washington Joint Institute, for patients with debilitating arthritic joint conditions; Washington Shoulder Institute, focusing on shoulder-related ailments; Washington Spine and Scoliosis Institute, for complex spinal conditions; and OrthoTraumaBethesda, providing advanced comprehensive care of orthopedic trauma cases.

Edward Bieber, M.D., of OrthoBethesda, said in the press release, that the practice “wanted a partner to not just provide capital but to also contribute strategic and operating value and we are enthusiastic to partner with Atlantic Street Capital to expand the breadth of services, enhance the patient experience, and continue to improve execution and operations as we grow within our region and beyond.”

Atlantic Street Capital

Atlantic Street invests in middle market companies with between $4 million and $15 million in EBITDA (earnings before interest, taxes, depreciation and amortization). “The firm invests in fundamentally sound companies that will benefit from capital investment and value-adding strategic and operational initiatives. Atlantic Street Capital’s investment team are hands-on investors who work closely with management to unlock their business’ underlying value and help them succeed,” stated the press release.

Since “Corporate Medicine” is illegal in 40 states, it’s that “hands-on” and “operating value” proposition we were interested to know more about and find out how the deal was structured.

Acquisition Trend

Acquisition activity hasn’t been limited to dermatology. Private equity investors have also been acquiring radiology practices. Just this past February Golub Capital provided a $270 million loan to support private equity-backed Radiology Partners’ expansion into California with the company’s acquisition of Renaissance Imaging Medical Associates, one of the largest independent radiology practices in the country as the largest hospital-based radiology practice in the U.S.

In describing the trend of acquisition of doctors’ practices, MarketWatch reported that buyers aren’t necessarily from the health care world. “In a growing and powerful trend, private equity and venture-capital groups have been swooping in with ever larger offers for all kinds of doctor’s practices.”

The private equity firms typically handle practices’ business operations and navigate complex regulatory requirements, so that doctors can focus on practice medicine. “They also say they can introduce efficiencies and leverage economies of scale in the process, a proposition that, backed by deals offering EBITDA multiples as high as 15 times, many doctors have found enticing.”

That sound great. Let doctors practice medicine and let investors run the business.

Skeptics

But there are skeptics.

Marni Jameson Carey, executive director of the Association of Independent Doctors, a nonprofit trade association that represents more than 1,000 doctors in 33 states, says the private equity folks “… don’t have medical licenses to lose; they didn’t take any Hippocratic oaths. They are in it for the profit. And Americans are going to pay for it, either with their health or their finances or both.”

The trend to acquire dermatology practices by private equity in the 1990s, reports MarketWatch, “sent valuations sky-high.” But some of the largest groups declared bankruptcy. Doctors today are seeing parallels. One private-equity-backed group, DermOne Dermatology, closed a number of offices earlier this year, selling others to another dermatology group.”

Sailesh Konda, M.D., an assistant clinical professor of dermatology at the University of Florida, said dermatologists “… are complaining of a constant pressure to see more patients with less resources, and that’s a constant overarching theme.”

Konda, an avowed opponent of equity firm acquisitions of medical practices, estimated that just under 1,000 dermatology offices are affiliated with private-equity-backed groups in the U.S., employing about 1,100 dermatologists and about 750 nonphysicians like nurse practitioners and physician assistants. Dermatologists make up just 1% of U.S. doctors, but have been the target of 15% of all recent medical practice acquisitions by private equity, according to Konda.

Dermatology practices, like orthopedic practices, have many attractive qualities for private equity investors. They can both provide a lot of ancillary services. They can also sell company-branded products to patients, offer new services, and refer to in-house specialists, all of which serve as revenue streams.

In one 2016 example, Omers PE paid over 13 times EBITDA for Forefront Dermatology, which had previously been owned by venture capital and private equity firm Varsity Healthcare Partners, and ABRY Partners paid about 15 times Dermatology Associates’ expected $20 million in earnings to buy it (the company is now called U.S. Dermatology Partners). The firms did not respond to MarketWatch’s requests for comment or declined to comment.

Seems like nobody wants to talk.

In a recent JAMA Dermatology research letter, Jack Resneck, M.D., a dermatologist and professor at the University of California, San Francisco, wrote about “risks to the specialty, the profession, and patients that could be irreversible as independent practices are rapidly replaced by investor-owned conglomerates, commoditizing the treatment of skin disease.”

MarketWatch cites unnamed sources who work or have worked for venture and private-equity-backed practices who told them that “financial firms’ emphasis on profitability results in corners being cut and patient care suffering.” There was no substantiation of those claims.

The report alleged that many doctors reported pressure to meet production numbers for procedures, sell products and refer patients to in-house adjunct services.

Corporate Practice of Medicine

Technically, when private equity firms invest in medical practices, they are actually buying the practice management or support companies affiliated with the practices because a company running a doctor’s office, or what’s called the “corporate practice of medicine,” is illegal in about 40 states, though how that’s defined and enforced varies considerably, said Ropes & Gray partners Deborah Gersh and Neill Jakobe.

“There is no bright line, and there is no bright line from state to state,” Gersh said.

Given these cautions, what should private physician practices keep their eyes on as they consider an investment or acquisition by a private equity firm?

Challenges of Acquisition

William Eck, a partner at Seyfarth Shaw LLP in Washington, D.C., wrote on April 20, 2018 that there’s been a resurgence in the acquisition of physician practices, both by hospitals and by private equity firms.

“Hospitals and health systems are increasingly looking for clinical integration. Private equity firms see the advantages of large, integrated groups. Independent physician groups are faced with significant challenges, including continued reimbursement rate pressure and reimbursement methodology challenges, such as the Medicare Access and CHIP Reauthorization Act of 2015, popularly known as MACRA, that demand implementation of sophisticated and expensive technology that small groups can ill afford.”

Structure and Legal Pitfalls

In view of the heavy regulation of the health care industry, Eck says acquiring a physician group carries special challenges. “Once it is decided to acquire a physician practice, among the questions the acquirer and its counsel must consider are the optimal structuring approaches and how to avoid the legal pitfalls that are particular to this sort of transaction.”

In those states that prohibit the corporate practice of medicine, Eck notes the transaction may take more complex forms, such as asset purchases followed by long-term management relationships. “In some states, hospitals may own practices, but private equity firms may not. In others, even hospitals may not own physician practices. In such states, it is common for the transaction to take the form of a purchase of assets other than goodwill, coupled with a practice management agreement.”

Attorneys performing diligence must also address the federal health care anti-kickback statute and its state counterparts. Those statutes prohibit direct or indirect remuneration in return for or to induce referrals for items or services for which federal health care program (i.e., Medicare or Medicaid) payment may be made.

Eck says the critical review consideration is “whether it appears that inappropriate remuneration in return for or to induce referrals is involved in the agreement.”

Then there is the Stark Law and its state counterparts. “With certain limited exceptions, the Stark Law prohibits physicians from making referrals for specified designated health services, where the physician or an immediate family member of the physician has a compensation relationship or investment interest in the provider or supplier of the designated health service.”

To this list, Eck adds, Compliance Policies and Procedures, Coding and Billing Practices, HIPAA and State Privacy Law Compliance, Licensing Regulations, and more.

Eck notes that private equity firms will become more specialty-oriented and will focus their investments in the dermatology, pain management, anesthesia and dental practice. And now, we note, orthopedics.

Greater Scrutiny

There will be greater scrutiny by Boards of Medical Examiners and other regulatory bodies regarding how the deals are structured. “This is especially true after last year’s Allstate v. Northfield decision, which essentially raised the spectre about how medical practices are owned and professionally managed by those outside the medical profession,” added Eck.

We were not able to read the terms of the Atlantic Street Capital/OrthoBethesda deal and have no reason to believe all legal and regulatory hurdles have not been met. But as further private equity deals with orthopedic practices are announced, William Eck’s prediction of greater scrutiny will undoubtedly follow along. We’ll keep an eye out.