Orthopedic Practice Consolidation Jumps 45% in 2018

Like it or not, healthcare industry consolidation is a fact of life for medical professionals.

What’s driving this trend? More complex and uncertain reimbursement practices, increasingly burdensome administrative duties inflicted on physicians and a deep and abiding desire to return to the practice of medicine.

Adding to these factors are changing models of care delivery that require financial resources and an investment of capital unavailable to most physician practices.

In the first six months of 2018, 94 physician groups elected to sell or merge their practices, up 45% from the record setting transaction volume of 2017. More are on the way.

The good news for orthopedic practices is that the specialty has become a very attractive investment for private equity (PE) firms that see value in the consolidation trend and will pay well to participate in this trend.

Benefits for Physician Owners

Private equity investors bring two important benefits for orthopedic practice owners:

1. The ability to cash out a portion of their practice equity at historically attractive valuations; and,
2. The ability to access additional capital and expertise to accelerate further practice growth.

Outside investor participation can accelerate growth in several ways, including providing capital and expertise for mergers and acquisitions, resources and relationships for market expansion, and capital for facility growth and information technology (IT) investment.

Mounting Capital Requirements and Operating Pressures in Orthopedics

Patients and commercial payors like ambulatory surgery centers (ASCs).

They offer lower costs per case, improved technology, patient preference, 23-hour stay programs, and significant improvements in anesthesia and postsurgical pain management.

If payors had their way, a significant portion of orthopedic procedure volume would move to outpatient settings. Centers for Medicare and Medicaid Services (CMS) is also changing incentives to favor ASCs.

Orthopedic groups interested in expanding and building a state-of-the art ASC however, require capital. The cost of building an ASC averaged $413 per square foot in 2013. It’s probably higher now. A small center with two surgical suites will range from $2 to $3 million, while a larger orthopedic ASC with integrated imaging, physical therapy (PT), and other ancillary capabilities can cost more than $10 million to develop.

Beyond the cost of facility expansion, orthopedic groups face several other demands for scarce capital and management time. CMS and other payers expect orthopedic physicians to practice medicine within a bundled reimbursement scheme. These programs typically employ pre-negotiated rates and fixed price services and shift risk and cost burdens to the orthopedic physician from pre-op through a post-op and the 60-90-day rehab period.

Successfully navigating this outcome-based reimbursement and population management requires a substantial investment in data analytics—to say nothing about a new IT infrastructure to control all the variables including post-op PT and outcome metrics.

The Merit-based Incentive Payment System (MIPS) reporting requirements create additional uncertainties and risk to future incomes (tying reimbursement levels to performance metrics on a relative scale). Costs are bound to rise.

Data from a recent survey of approximately 100 physician groups showed that most believe they must have at least 200 physicians to pay the $500,000 or more for IT required for MIPS participation. Only 19% of respondents told the survey that they are confident or very confident in their MIPS capabilities.

Further complicating this picture are the competing constituencies across the payor–provider continuum. Payers are rapidly consolidating and building negotiating leverage over physicians.

In the past 10 years, more than 500 hospitals have merged into larger health systems. More than $100 billion has been spent on hospital consolidation in the last six years alone.

The top three publicly traded payors now have a combined enterprise value of more than $350 billion, providing scale, negotiating leverage and almost unlimited access to capital.

All of these external pressures are putting the burden on physicians to decrease costs while improving outcomes.

No wonder physicians are, themselves, consolidating in order to also build scale to counter the emerging hospital and commercial payor behemoths.

Outside Investment Zeroes in on Orthopedics

Until recently, few outside private equity investors were interested in orthopedic practices. That is changing.

In January 2017 Frazier Healthcare Partners invested a reported $50 million in the CORE Institute. Several other practices, including The Orthopaedic Institute, followed suit shortly thereafter and partnered with private equity investors.

Today, there are at least a half-dozen large and mid-sized orthopedic groups in negotiations with private equity investors.

These groups understand that the orthopedics industry is exceptionally well positioned for investment and consolidation. Many conditions such as an aging population and joint damage caused by obesity are providing strong underlying demand for orthopedic services, give PE investors’ confidence in the market.

Other Reasons Capital is Flowing into Ortho Practices

Spine, orthopedics and sports medicine practices are poised to benefit from recent changes in reimbursement—including CMS’ focus on the relatively high cost of procedures in the inpatient setting compared with an ASC—which can only help to drive more patient volume to the outpatient centers. Spine, orthopedic and sports medicine practices with the resources and scale to take advantage of these trends should see attractive growth for many years to come.

The Formula for Growth

The faster growing practices are creating platforms with a broad array of services, such as PT, urgent care, MRI, and pain management, which create highly effective patient volume magnets.

Private equity can help to fund this growth.

Most private equity-based transactions are structured so that the investor group buys a majority or minority stake in the practice—generating significant cash proceeds for physician shareholders.

At the same time, the new capital creates a vehicle for growth—both by funding a platform of services and creating the potential for mergers with other orthopedic groups. Under these scenarios, selling physicians continue to own a significant stake in their practice and manage the day-to-day clinical operation while retaining the opportunity to benefit economically from accelerated growth in the practice, in terms of both increased income and equity appreciation.

Consolidation is happening on both a national and a regional level. As this occurs, it will place additional competitive pressures on smaller practices, and likely trigger more transactions. Radiologists, dermatologists, ophthalmologists, and other specialty groups are further down the road in this process and provide a road map for what orthopedics can expect.

There are multiple factors to consider when buying or selling a practice or joining with a private equity firm to grow in a consolidating environment. These include everything from practice valuations to taxes to real estate considerations. Most physicians will only go through this process once, so professional guidance is critical to maximizing value and avoiding potential issues.

If, and when, the decision is made to sell or pursue a strategic partnership/investor, understanding both the broad market dynamics, and your interests as an owner of an orthopedic practice, will be vital in maximizing value.

Jeff Swearingen is co-founder and Managing Director at Edgemont Capital, a leading healthcare investment banking firm. Edgemont Capital has represented dozens of independent physician practices in mergers, acquisitions, and private equity transactions.