Medical Practice Buyouts- Are We In A Bubble?

Physicians have been slow to catch on, but we are finally learning about the new marketplace. Wall Street and private equity financed companies; hospitals and large physician groups are competing for physician practices. Our past articles have explained why the market has changed. There is still a lot of confusion, however. The number one question I continue to get asked is, “Are we in a bubble?”. The number two question is, “What happens to me when it pops?”.   In this short article, I’ll give my opinion on the excitement in the market and what may happen if/when sentiment changes.

 

Despite growing financial pressures on practices, many colleagues are cashing in by selling.   Many of us are accustomed to the periodic irrational exuberance of the stock market and worry about something similar happening in medical practice valuations. The answer, as always, is a very personal assessment of risk and benefit.

 

Confused? Start with the concept of the bubble itself. Many economists have attempted to answer this question. There is never a straightforward answer. The basic idea is that when excitement leads to an increase in asset prices or valuations beyond traditional metrics, you may be in a bubble. Notice I used the word “may”. There is no accepted straightforward definition of a bubble. More important: on an individual basis, as a famous investor once said, “the market can be irrational much longer than we can stay solvent“.

 

Getting beyond the “bubble” really changes things around. The question becomes an individual one rather than a macroeconomic one.   Is the price someone is willing to pay for my practice high enough now that I am willing to accept future risk to my practice? What are the opportunity costs of not selling now?

 

What are the future practice risks? This is somewhat nebulous. Let’s look at one scenario. The large entity you sell to may be better at managing expenses and risk in an era of health reform. For some time, you may benefit from practice efficiency, technology and income stability/repair that the new entity provides (see previous articles for more details). Is there a point at which they maximize efficiency? What point will growth cease to impress the capital markets and multiples (price above earnings the market will pay) start to come down? What affect will that have on operations? When companies leave the rapid growth cycle, it creates pressure to decrease costs. Salaries and staff are reduced.

 

In our past articles, we argued that corporations are buying practices at earnings multiples of 3-9 and “reselling” them to the capital markets at multiples of 15-30. They use the money raised to purchase more practices. As corporate valuations go up, they can easily fund more practice acquisitions (of note, they also use the free cash flow of the practices to fund acquisitions as well). This means that practice valuations can be subject to the whims of Wall Street. Here is the 52-week chart of Envision Healthcare (EVHC), Team Health Holdings (TMH) and Mednax (MD). Notice the volatility. If their access to capital is decreased due to a declining valuation, that could mean decreased prices for practice acquisitions in the future.

envision

The recent buyout offer by Amsurg for TeamHealth underscores that this is a dynamic marketplace. Consolidation will reduce the number of potential acquirers.

 

We must also consider macroeconomic pressures. Eventually, rising interest rates will make acquisitions more costly and reduce prices. The lending market is still tight because of the financial crisis of 2008.

 

The uncertainty raised in the previous paragraphs explains the dilemma but also points to the solution for those worried about a bubble. Our best guess is that most providers/owners are better off now with the investment and efficiency of a large entity. If the underlying business of anesthesia deteriorates, the smaller groups will be hurt more than the bigger ones. Even if the business falls apart, you will likely have fared better in a large company than on your own during a downturn (“popped bubble”).

 

In the end, I cannot say with certainty that we are in a practice valuation bubble. Bubbles tend to be impossible to predict. Are we saying you should sell now? Not necessarily. Just that you should think about it systematically and not run away because of fear. Start with a practice and risk assessment. Then you can choose among several options, which may or may not involve a sale of your practice.

How To Get The Maximum Price For The Sale Of Your Anesthesiology Practice

The biggest mistake that anesthesiologists make is that they wait until negative trends or catastrophic events occur in their groups before they decide to sell.  In the article, Should I Sell My Anesthesia Practice, I demonstrated that timing is the most important factor when considering whether to sell your anesthesia practice. The first step is to calculate the current and future value of your group; otherwise,  you will get the timing wrong and you will be underpaid by a strategic buyer.

Money is one motivating factor why anesthesiologists are selling their practices and Wall Street backed companies are buying these practices.  It is not unheard of for partners to earn up $1-2 million each on a transaction and continue working for compensations that exceed the national averages.  But the reason why buyers are interested in purchasing your group is because they can make considerably more money than you can while providing the same exact services. You need to know how much before you ever consider selling your group.

Here is an example:

Considering the example we used in our previous article:

Our Client’s Current Revenues

Our Client’s Future Revenues with the AMC

Increase

Revenues

$25,046,566

$48,089,407

$23,042,841

Units

932,862

932,862

Percent Private Insurance

59.6%

59.6%

Average Units Collected

$25

$48

$23 per unit more per case

 Numbers were multiplied by a factor to comply with Non-Disclosure Agreement

Assuming that each partner earns $650,000 per year, the partners would agree to a future compensation and assign a profit he/she is willing to sell to the buyer.  So, let’s assume in our example that the partners agree to a future compensation of $350,000.  Thus $650,000 (current compensation) = $350,000 (future compensation) + $300,000 (profit). The buyer offers a purchasing price that is a multiple of 7 times the profit (EBITDA) and agrees to keep the partners employed for at least 5 years. Thus, the partners are offered $2.1 million cash each. Sound great, but not so fast.

In this example, Anesthesiastat calculated that the buyer’s existing third party payer contracts (Aetna, Cigna, Blue Cross Blue Shields, United Health Care, and Cigna) would double the group’s revenues.  That’s right, the buyer was so much larger than the groups they were buying that they negotiated lucrative third party insurance contracts; we’ve seen rates 250% higher. If nothing changes with staffing, the increased contract rates would be in the form of profits for the buyer.  Furthermore, in some cases the buyer improves staffing ratios, reduces the cost of benefits and billing expenses.  Thus, profits grow even further.

Here is what would happen: The buyer purchase the group for 7x EBITDA. However, in terms of their lucrative insurance contracts, they could potentially afford up to 14x EBITDA. That’s just the beginning.  Looking at current stock prices, many publicly traded anesthesia management companies are trading for as much as 40 times earnings.  In essence, they buy the groups for 7x and sell it to the public for 40x.  So, would a multiple of 7 be such a great deal if this was your group and you had multiple potential buyers?

Beyond money, groups have many reasons to sell.  As we have discussed at length before, they may wish to reduce future management, billing and reimbursement risk.  The cost of investments in updated billing, compliance and quality reporting software may be too big a burden for small groups.  Many simply wish to offload the business side of anesthesia and focus on patient care.

At Anesthesiastat we are anesthesiologists first and consultants second.  We want our colleagues to get the maximum possible sales price and compensation package in a transaction.  So, we help you assess your value to the buyer, determine the right timing for a sale and work with you for the highest value possible in the transaction.  Contact us today so we can provide you further details.