By BERT ORLOV and AYESHA MEDINA
As consultants in health care/PE, we foresee a dramatic upturn in activity in 2021 and beyond for provider acquisitions (e.g., hospitals, physician practices, homecare, telehealth). While COVID temporarily slowed PE activity, the market has rebounded, based on 2020 Q4 published data and anecdotal data for early 2021. The COVID slowdown has created pent-up demand, and COVID itself will likely drive volume due to financial distress. Bain & Co reports that as new innovations are made, volumes rise and assets become available, investor interest will return stronger than ever. In addition, for providers and entrepreneurs on the older side, the aftermath of COVID stress will likely drive more to seek exit/monetization strategies.
Beyond COVID, the underlying drivers of consolidation, and thus PE activity, remain constant, if not stronger. Consolidation will accelerate across all segments due to needs for market power, economies of scale and stronger management to address increasing demands in technology and care management. Value-based purchasing will continue to expand, as CMS designs and implements new models of payment. Furthermore, integration of new technologies, such as telehealth, will require a move from the COVID ad hoc approach to a more strategic positioning of patient care and operations to integrate these new tools. Finally, long simmering issues, such as management of chronic disease and addressing behavioral health needs, will create new markets and management demands.
In short, sellers and buyers both see opportunity. On the sell side, we foresee a strong market, hence the need to rejuvenate assets to secure best prices. Critical is thinking carefully about transitions: the short-term challenges and, for younger practitioners/entrepreneurs, the long-term implications of sale. A study of the past decade shows that larger entities (by revenue or EBITDA) drive higher purchase multiples, potentially prompting intra-sector mergers in advance of PE deals. On the buy side, we also foresee a strong market and strong interest will require attention to detail. Defining a truly value-added strategy to support a liquidity event in 3-5 years (the common target timeline) and selecting the right partners will prove critical.
Across nearly all market segments, providers have seen declines in overall volumes, especially lucrative elective procedures, historically supported by strong commercial insurance payment. This loss of revenue, combined with increased costs for staffing and PPE has damaged the balance sheets of many providers. By mid-June of 2020, 26 percent of hospital systems had used more than 50 percent of their reserves, and another 41 percent of hospital systems had expended between 21 percent and 50 percent of their reserves, per a Waller and Kaufman Hall report. Furthermore, data remains unclear regarding whether volumes will return to pre-COVID levels or whether a lower baseline will emerge. Finally, new costs in telehealth and other new approaches to patient care delivery may drive up costs. All these factors put many providers at risk.
With vaccination accelerating (NYT estimate of 70 percent by July), the move back to some form of normal has begun. However, financial, emotional PTSD is emerging, with many providers seeking a post-COVID exit. By 2030, inpatient hospital revenue falls 35 percent compared to today, and demand for hospital beds will be 44 percent lower. Thus, hospitals are likely to be fewer in number and smaller in size, advancing industry consolidation, with smaller players particularly vulnerable. According to Healthcare Finance, M&A activity will surge as independent health systems look for partners. While deal flow has slowed due to the inability to meet in person, the rise in vaccinations should allow a return to some semblance of normal. We expect to see deal flow grow materially as vaccination progresses in 2021.
Secular Trends: Hospitals
Movement toward consolidation that is not directly related to COVID will advance industry-wide. Deloitte modeled the potential, yielding an estimate that 50 percent of current health systems will likely remain in 10 years. Deloitte also reported the consensus amongst CFOs that the pandemic will increase consolidation within the industry. Organizations that were weak pre-pandemic will emerge even weaker. The survey also found that only 27 percent of organizations had more than 60 days cash on hand. Health care merger and acquisition activity has shifted to more large-scale deals in which both organizations each have at least $1 billion in annual revenues. The third quarter of 2020 saw four such deals announced, according to consulting firm Kaufman Hall. This result should not come as a surprise, given that similar waves of consolidation have occurred in other industries (e.g., banking, airlines, retail) where market, regulatory and financial pressures led to M&As and other partnering arrangements. And with hospital consolidation inevitably comes growth in size/scale of physician and ancillary service networks where more and more practices are owned/controlled by hospital systems.
Secular Trends: Physician Practices
For physician practices, increased consolidation is due to acquisition by hospitals, thereby laying a foundation for PE firms as alternatives. Primary care practices owned by a hospital/health system grew from 28 percent in 2010 to 44 percent in 2016. By 2018, data from the American Medical Association shows that 35 percent of all practicing physicians worked either directly for a hospital or in a practice partly owned by a system. Furthermore, big insurance companies are also venturing into the provider space. For example, UnitedHealth Group uses its Optum division, which recently acquired Surgical Care Affiliates for $2.3 billion, setting the base for OptumCare’s primary and specialty care division, which focuses on acquiring or partnering with private medical practices.
Independent medical practices are now increasingly looking to private equity, which is responding, fueling health care consolidation. The Journal of the American Medical Association found that the number of private equity deals with physician practices across specialties more than doubled between 2013 and 2016. According to EY, $32.9 billion in private equity was invested in 647 health care transactions in 2018, double the investments made in 2014. Furthermore, an aging provider base—especially among PCPs and other areas—will drive exit strategies via PE. A “2018 Survey of America’s Physicians” found that 45.8 percent of 8,700-plus responding doctors plan to retire, merge or sell their practices), and that number has likely risen as a result of COVID. In terms of pricing, that potential rush to market will not likely dampen purchase prices because of the accelerating physician shortage. The Association of American Medical Colleges projects that the U.S. will face a shortage of between 54,100 and 139,000 physicians by 2033. Thus, we see more and bigger PE deal in the primary care space. For example, the private equity firm Carlyle Group invested $350 million in One Medical, a national primary care clinic operator with offices in San Francisco and New York City.
Secular Trends: Homecare
Historically, the homecare industry has included a large number of smaller entities. In the context of an emergent, post-COVID market, many of these players will likely seek exits. Overall, the last two years have seen more than 100 in-home related transactions. In 2018, private equity accounted for 57 of the 129 transactions; in 2019, private equity accounted for 46 of the 101 transactions. Overall, Q2 2020 saw a drop in M&A activity as prospective home health buyers had to navigate both the impacts of the COVID-19 emergency and the Patient-Driven Groupings Model (PDGM). However, we see heightened interest in the homecare segments, as well as its associated services of hospice and physician-at-home. For example, Amedisys deals pair home health and hospice with the overarching strategy of most of the large providers, which is to provide care for their patients across the post-acute continuum.
Secular Trends: Telehealth
We anticipate similar trends in telehealth as a distinct line of business. Anecdotally, we are seeing significant interest in freestanding telehealth businesses, as well as traditional businesses that incorporate telehealth. This interest stems from the twin beliefs that telehealth has long been poised for explosive growth and that its moment has arrived. This year has already started to see multi-billion-dollar mergers as Grand Rounds and Doctor On Demand look to merge to offer coordinated care and support, representing the latest consolidation within telehealth and virtual care (Cohen, 2021). CMS will likely extend reimbursement for these services as NY State has done for Medicaid (Adams, 2021). Areas of focus will likely include routine care and chronic care management, behavioral health and ancillaries, such as PT and at-home diagnostics, as well as the potential for “hospital at home.”
Bert Orlov is a Managing Director in the Health Care Consulting Group of EisnerAmper, a top 20 Consulting, Audit and Tax firm in the U.S. With 25 years of experience as a management consultant in the industry, he specializes in strategy, transactions, operations and project management for physician groups and hospital systems, as well as not-for-profits. He also has experience with ambulatory surgery centers (ASCs) and in evaluating investment opportunities for individuals and firms. Visit https://www.eisneramper.com/healthcare/