Entering 2017, there was a certain level of trepidation that existed amongst providers, payors, operators, and financiers within healthcare, as uncertainty loomed in regards to the new administration and a potential repeal of the Affordable Care Act. While these uncertainties still largely remain, the healthcare markets have maintained their position as an attractive sector for growth and investment.
Despite the risks, the market fragmentation that exists throughout healthcare, combined with its favorable macroeconomic backdrop, still presents the sector as a stable candidate for investment and future growth. Because of this, throughout the first few months of 2017, meaningful investment dollars were deployed across a variety of healthcare subsectors, including a substantial interest in physicians services -- both by strategic consolidators seeking to expand their market footprint, and most notably by private equity investors that continue to demonstrate their bullish outlook on the sector.
Driven largely by the regulatory environment, reimbursement pressures, extreme fragmentation, and the need for advanced EMR systems and data analytics to succeed in value-based payment and population health programs, physician service organizations across a wide range of specialties have found that the best way to stay competitive in the modern healthcare environment is to gain size and scale.
Private equity has been a key driver of the consolidation occurring within physician services through implementing a “buy and build” or “roll-up” investment strategy where fragmentation exists. This article highlights five sectors that present significant opportunity to the private equity community. Two of these sectors (dermatology and eye care) have been deemed ‘Hot Sectors’ for a while, as they have experienced significant private equity investment throughout the last 12 months and will likely continue to be two of the most active specialties for the foreseeable future. The final three sectors are highlighted as ‘emerging’. These sectors, orthopedics, gastroenterology, and urology, have seen their first private equity investment within the last 12 months and will inevitably become the next ‘hot’ sectors.
Hot Sectors Within Physician Services
Dermatology:
Dating back to the earliest investments in 2011, dermatology has long been one of the most active specialties within physician services in pursuing strategic transactions. The combination of a growing elderly patient base, reimbursement tailwinds, pathology, surgical procedures and robust over-the-counter/ancillary offerings, have made dermatology a target for nearly every healthcare focused private equity group.
Dermatology has continued to be a highly active market in terms of consolidation as private equity-backed platforms aggressively execute add-on acquisitions to increase geographic density and expand into new markets. Add-on acquisitions will continue to be a focal point in the industry moving forward given the highly fragmented nature of the sector combined with the very significant amount of private equity capital that is being invested into the industry. As a result of widespread buyer demand coupled with few independent platform practices that have size and scale, valuations within dermatology will remain amongst the highest within physician services throughout the balance of 2017, pending any unfavorable regulatory shifts from the new administration.
Eye Care:
We have already seen a number of transactions in the eye care space in 2017, indicating that the period of significant investment and consolidation in ophthalmology is in full swing. Private equity-backed groups such as EyeCare Partners (FFL Partners) and EyeCare Services Partners (Varsity Healthcare Partners) have benefitted from first-mover advantage as the initial consolidators in the optometry and ophthalmology industries. However, with private equity firms Shore Capital, H.I.G., Flexpoint Ford, Sterling Partners, and Waud Capital all closing on platform transactions early in 2017, the market for sizeable add-on opportunities will become increasingly competitive given the buyer demand.
Moving forward, the ophthalmology industry should follow a similar pattern to the investment and consolidation that has been ongoing within the dermatology sector since 2011. New private equity platform transactions will be coupled with an increasing number of add-on acquisitions as private equity firms with investments in the sector will look to leverage the infrastructure and management from their platforms to partner with other providers in their region and nationally.
Emerging Sectors Within Physician Services
As private equity groups look to replicate investment successes across physician services, investment activity is occurring in emerging growth subsectors of healthcare that have yet to undergo considerable consolidation. The last 12 months have seen initial investments into orthopedics, gastroenterology, and urology, among others. The genesis of these transactions was to create an alignment between clinically leading physician groups and private equity firms that bring both the capital and strategic expertise to position the organizations for growth and success in this ever-changing healthcare environment. This initial wave of investment within these specialties is expected to result in additional consolidation within the orthopedic, gastroenterology, and urology spaces. Even as we look ahead toward an ambiguous regulatory and reimbursement environment, these transactions demonstrate that private equity firms are identifying new areas of healthcare for platform investment.
Orthopedics:
The orthopedic space represents one of the few physician specialties to remain relatively untouched by outside investment. While the space has seen a number of mergers over the last 24 months, it remains the most fragmented specialty on this list.
The industry saw its first majority recapitalization by a private equity group when Southeastern Spine Institute effectuated a recapitalization transaction with Candescent Partners in April of this year. Given the wide breadth of ancillary services offerings, increasing outpatient surgical volume, aging population, and the growing importance of orthopedics to overall healthcare, there is significant opportunity in this space for private equity led consolidation. There are a number of similarities in orthopedics to other specialties that have seen considerable private equity investment. Due to these factors and the favorable industry tailwinds, the orthopedic space likely will be the next sector to experience a considerable amount of outside investment.
Gastroenterology:
The gastroenterology space shares a number of similar market dynamics to both dermatology and eye care, such as increasing elderly demographics, medical procedures and pathology. The market remains fragmented with few multi-state providers. Gastro Health was the first organization to formalize a private equity partnership through its deal with the Audax Group in 2016. Since closing the deal with Audax, Gastro Health has already grown from approximately 60 providers to 100 providers through several add-on acquisitions of smaller organizations looking to align with a team that can provide management support. The Association of American Medical Colleges estimates that there are approximately 14,000 gastroenterologists in the United States, and the vast majority of gastroenterology groups operate with less than 30 providers. Over the years, groups have recognized the need to create economies of scale and this is evident by the trend of smaller independent gastroenterology groups merging together to form regional providers. A private equity partner can allow an organization to realize the same benefits that result from a merger, while also providing the opportunity to leverage the private equity firm’s capital resources and expertise in growth. These market dynamics have created an environment aptly positioned for a private equity backed platform to consolidate the industry.
Urology:
Comprised of roughly 50 regional ‘super groups’, urology, while still significantly fragmented, has a history of even more internal consolidation. Although mergers have created regionally dominant groups, very few groups operate in more than one state.
Like Gastroenterology, Urology saw its first private equity investment in 2016 by the Audax Group with their majority acquisition of Chesapeake Urology. As seen in several other physician specialties, this will undoubtedly lead to additional investments in the industry as others look to replicate a similar growth model to Audax/Chesapeake. Audax will look to leverage it’s first-mover advantage and begin consolidating the market before additional private equity competitors enter the industry. This will lead to a number of add-on acquisitions of smaller practices in the region and across the country.
With a breadth of ancillary service offerings similar to eye care, and the current fragmentation in the market, the Audax/Chesapeake transaction will be the first of many private equity investments in this space as investor groups look to leverage the industry dynamics to build national platforms.
Concluding Thoughts:
While it is impossible to predict the future, based on trends and past experience within other specialties, mergers, acquisitions and other strategic transactions will become increasingly prevalent within orthopedics, gastroenterology, and urology. The private equity community is aggressively looking for platform-ready groups in these spaces to capitalize on fragmentation and industry tailwinds. Macro trends within healthcare services will continue to favor large providers with scale, strong management, strategic vision, and access to capital; increasing the willingness of private medical groups to partner with private equity groups.
Robert Aprill is an Analyst at Provident Healthcare Partners; Gary W. Herschman, Esq., is a Partner at Epstein Becker & Green, P.C.; and Anjana D. Patel, Esq., is a Partner at Epstein Becker & Green, P.C.
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