Orthopedic practices offer a compelling opportunity for private equity investment and are likely to see significant interest from funds in the near future, according to experts who spoke on a panel titled “Investor Interest and Experience in Orthopedics” at the 16th Annual Healthcare and Life Sciences Private Equity & Finance Conference, held in Chicago on February 20 and 21, 2019.
Experts included Larry Barr, Senior Vice President at Kinsella Group, Kevin Becker, Vice President at LLR Partners, Mike Horrell, Principal at Foundation Surgical Affiliates, Michael J. Milne, M.D., Founder and Former Chief Executive Officer at Motion Orthopaedics, and John C. Riddle, Managing Director and Principal at Brown Gibbons Lang & Company. The panel was moderated by Amanda Roenius, an attorney at McGuireWoods LLP.
Here are five key points from the panel discussion.
1. Investments in orthopedic practices may be the next major wave in private equity; however, this space poses unique challenges for investors. Private equity firms have experience investing in the orthopedic medical device space and are starting to see the opportunities in orthopedic practices with more clarity. This space is highly fragmented, offering significant opportunity for profit generation, but it also presents unique challenges not seen in other medical specialties. For example, the panelists noted that orthopedic practices typically rely on a more complicated and diverse payor mix than other healthcare sectors. Furthermore, orthopedic practices have not historically relied on outside investment for growth, utilizing their own capital to expand and develop practices. Accordingly, while the orthopedic space may be an especially desirable specialty from a revenue perspective, private equity investors will need to adapt to this sector’s unique characteristics to succeed.
2. Competition is healthy and steadily increasing. Private equity firms are not the only groups with an eye on the profitability potential associated with investment in orthopedic practices. Hospitals have long tried to break into this space, with orthopedic physician groups having long resisted outside investment. Reception to private equity investment will require firms to bring innovation and value to orthopedic groups beyond mere capital infusion. Panelists believe competition for investment in profitable practices will continue to strengthen as down-stream revenue, largely evidenced through increasing ancillary services, continues to grow.
3. Investments are costly. As investors look toward orthopedic practices as potential targets, the price for investments of scale reflects the demand. Market EBITDA multiples in the orthopedic space are in double digits, with multiples increasing from tens to high teens as auction rounds progress. These higher multiples are rationalized by the organic growth possibilities associated with orthopedic practices as well as the opportunities for strategic tuck-in transactions.
4. Orthopedic compensation models and team structures present unique challenges for investment. As the experts explained, orthopedic practice groups have entrenched “eat-what-you-kill” compensation models, and the introduction of RVU-sharing models have been met with resistance by senior partners. To achieve profitability, private equity firms will need to strategically navigate transitioning these compensation and incentive models toward structures that are both effective in creating revenue growth and feasible to implement within established orthopedic practice teams.
5. Inorganic growth opportunities are untested. The probable success of tuck-in or bolt-on acquisitions to established orthopedic platforms is substantially unknown. Historically, orthopedic groups have generally grown organically. As discussed amongst the panelists, the current theory held among investors is that target practices should be geographically dense. The key to tuck-in or bolt-on success will be dependent on a firm’s ability to infiltrate markets where such regional density can be built. While exit strategies and future sales are also largely untested, the panelists noted that continued consolidation of orthopedic practices looks promising.