Private Equity Is Hungry For Hospitals, But Managing Doctors is No Picnic
Private equity firms already own a bunch of hospitals and are on the prowl for more acquisitions as healthcare reform brightens hospitals' long-term prospects. But these investors also better pay attention to hospitals' increasing employment of physicians, if they don't want to repeat the mistakes of their predecessors.
Back in the '90s, investors lost many millions of dollars on the meltdown of what were then known as "physician practice management companies," or PPMCs. Fueled by private equity, these PPMCs based their business model on the assumption that they could create economies of scale by combining many small practices into large groups. But they overpaid for the practices, didn't know how to run them, and failed to recognize that employed doctors would be less productive than private entrepreneurs. In addition, the PPMCs didn't employ enough doctors in any given market to extract payment increases from health plans. As a result, physician salaries and management and infrastructure costs more than ate up the practice revenues.
Within a short time, most PPMCs went out of business or switched fields, in the process destroying many long-established physician groups. Among the overnight successes that bit the dust were Phycor, MedPartners, Phymatrix, and ProMedCo. Meanwhile, many hospitals -- which had made the same errors as the PPMCs -- divested their owned practices.
Fast forward a decade. Hospitals, preparing for a sea change in Medicare reimbursement methods, are employing physicians right and left. Then healthcare reform comes along, and it suddenly looks like hospitals are going to have a bonanza when 32 million additional people get insured. The consensus is that this will more than outweigh the Medicare cuts to which the hospitals acquiesced in negotiations over the reform legislation. They're going to come up smelling like roses.
Smelling roses in the distance, private equity folks come a-calling. Cerberus Capital Management agrees to acquire the six-hospital, Boston-based Caritas Christi chain for $830 million. Vanguard Health Systems, backed by the Blackstone Group, buys the Detroit Medical Center for $700 million and agrees to make additional investments later. And RegionalCare Hospital Partners, a Nashville startup with Warburg Pincus money, is nosing around for weak facilities in smaller markets.
According to Scott Mackesy, a general partner with Welsh Carson Anderson & Stowe, more private equity buyouts are coming in the hospital sector, although the good deals won't be around for long. There's no reason to doubt him, especially since some hospitals that have been capital-starved because of tight money are probably available at good prices.
However, I wonder what will happen a few years down the line, when the new equity-firm owners notice that their hospitals' physician practices are losing money. Will they conclude that these are duds and sell them off? Or will they realize that the patient referrals and test orders from these practices and the competitive advantage that their hospitals derive from them are worth more than the amount they lose?
A lot will depend on two factors: First, if the equity firms try to have the hospitals manage the practices, rather than leaving them under professional management, they will increase their losses. And second, if payment bundling and accountable care organizations become real factors in the market, the investors may find that owning a physician group can actually be quite profitable.
It really boils down to whether the finance guys learn the prime lesson of the PPMC debacle: Since they don't know anything about healthcare, they should leave the operational side to those who do.
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