Investment Logic

Podcast 18.11: Ophthalmology From Private Equity’s Perspective ... Rationale, Risk And Reward


One question that physician owners often have is how private equity investors will further optimize the practices that they have spent years building. In episode 18.11, we reference our advisory resources article titled, “Ophthalmology From Private Equity’s Perspective, Rationale, Risk And Reward” to look at this question from PE’s perspective and explain how private equity makes money off of their investments.

  • We explain the investment logic behind private equity's investment in specialty practices and surgery centers and share insights about the financial power of roll-ups  1:47 - 4:44 
  • How the current economy is affecting PE’s ROI, projections moving forward, and examples of successful ROIs from conservative PE investments  4:40 - 7:00 
  • How supply and demand for ophthalmology practices will benefit PE investors  8:30 - 10:15 


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Eric:                          In ophthalmology, there's just a great, fundamental macroeconomic scenario, and that is that there are more people who need ophthalmic care, and at the same time, there are less physicians being trained to do that care. The supply and demand scenario in this space is great. If there's another recession, this whole thing isn't going to go away.

Narrator:                   Welcome to PF Insights, hosted by the leadership of PhysiciansFirst Healthcare Partners. If you're a physician practice owner, or an ambulatory surgery center owner, and you're wondering how to navigate the mergers and acquisitions ecosystem, this is the podcast for you.

Andy:                       Hello world, welcome to PF Insights. This is your host Andy Snyder. I'm a managing director at PhysiciansFirst Healthcare Partners. With me, as always, I have our managing partner, Eric Yetter.

Eric:                          Hello Andy.

Andy:                       Today we are kicking off Episode 11 by my count, and today we're going to go back and reference an article that you wrote, it's up on Ophthalmology From Private Equity's Perspective: Rationale, Risk and Reward. And the genesis of that article was really that we had so many physicians asking us, "How is private equity going to make money off of this investment? I have a well run practice. I've spent the last 10 or 20 years getting it as optimized as possible. Why do they think they can come in, acquire it, and then make even more money off ... I just don't understand how the numbers work, and why they see this as some conservative investment like you're telling me." And so, I'll kick it to you there.

Eric:                          Yeah. I mean, a lot of physicians, and I think a lot of people generally are saying, "Why is private equity doing this? Why do they want to put their money here? Don't they have other opportunities?" And some of that comes, to an extent, from a misconception about what private equity firms are doing. A lot of that is because what's publicized. We hear about PE firms coming in and acquiring companies, maybe they're public companies, and they're underperforming, or the stock is underperforming. They have management problems, and the PE firm comes in and acquires them, and reworks the business, makes the business better. Staples, Hertz, some of the big companies that people have heard about ... you know, PE firms coming and making big changes.

                                    That's a lot of what PE firms do, and they're very successful with that, but another thing that they do is they make more conservative investments. Particularly, they make more conservative investments when you're talking about something called a rollup. That's really what this is. At its core, the idea behind a rollup is that a lot of small things, put together, are worth more money than they are on their own. That doesn't just mean that they ... you know, one company makes 100,000, another company makes 100,000, a third company makes another 100,000, and the three of them make 300,000, that's A. But B is the multiple that's applied to that profitability. So, if $100,000 company is worth two times profit, a $300,000 company might be worth three times profit. People love to say one plus one equals three.

Andy:                       Which it doesn't, by the way.

Eric:                          Yeah. It doesn't but it's a ... PE ... private equity saying, and it's an investor saying, is you know, "We can put some things together and they're going to be worth more." That's what they're trying to do with ophthalmology. They're also going to make some improvements to their companies. They're not going to just let them sit there. They're going to try to create efficiencies in terms of better reimbursement contracts. They're going to try to drive more referrals. They're going to recruit more physicians so they can see more patients. They're going to try to save money on the cost side. They're going to improve their businesses.

                                    But, at the end of the day, that one plus one equals three thing is very powerful. And it's not a way to go out and make a 500% return on your investment. They're not going to do that. They're not going to, you know, buy Facebook in its infancy, and it goes to, you know, a billion dollars over time ... in its early stages. It's not going to be like that. This is a much more conservative investment play.

                                    And part of that, I think, is because of the current market. There aren't a lot of opportunities out there to make really good meaningful returns. And returns have been compressed, and they're going to be compressed more going forward, and that's just because of the way the economy is right now, and the market cycle.

                                    So, for a PE firm right now, getting a low double digit return, getting a 15% return isn't that bad. Even a 10% return isn't that bad. They'd rather have more, but that is a good, sound investment. When wealth managers and investment managers, who manage money for pension funds, and other institutions, and very wealthy individuals, et cetera, they're typically looking at single digit returns ... low single digit returns from blue-chip stocks, low single digit returns from particularly preferred stocks and bonds. The market's had great returns over the last several years, but they don't expect that to continue.

                                    So, when they're looking at alternative investments like private equity, the recent historic return on that has been 11%, and more ... probably going forward, it's going to be a little lower. I've seen some pretty smart people expecting 10% returns from private equity as an asset class. And PE firms, of course, have some costs to doing what they do, so for them, they need to get better than a 10% return. And they're going to have some failures, so they need to get better than a 10% return for that reason too, in order to balance out the failures. But, they don't need 100% return year over year. They don't need that. If they get a 30% return, year over year, that's going to be a huge win for them. That's a great scenario. That probably involves them getting a five times return on their money. If they put a dollar in, they get five dollars back at the end of this whole investment. If they get a 12% or 15% return, that's okay. It's not ... you know, it's not a total failure. It's fine. But, you know, I think they want 30.

                                    And some of the investors may disagree with me. This is me looking at it from a very high level, macroeconomic perspective. But that's really what they're trying to do. They're not going crazy with this. That's how it's a good conservative play.

Andy:                       Right. And I think the biggest chunk of the gains aren't going to be realized until there's a resale of the platform.

Eric:                          That's true.

Andy:                       You're not going to see ... I don't think you are. Maybe there are some ophthalmology portfolio companies out there that are just gaining 10% year over year in the bottom line, via organic growth. I'm not talking about acquisition ... maybe not. But, I think when you really talk about the complete ROI of the entire platform, it's really going to be realized during that second sale, and for the reasons that you said. Selling something ... something larger, it's going to sell for a higher multiple than something smaller.

Eric:                          Yeah. I mean, I think these investors ... and this is what I would be hoping for if I were them. I think what they're hoping for is single digit organic growth ... growth that comes from improving ... you know, from saving money on supplies, getting more money from reimbursements, recruiting more people, et cetera ... single digit growth there. Double digit growth, of course would be great, but single digit is probably more realistic. And then, double digit growth ... or value being added from the economies of having more practices, and the whole being worth more than the sum of its parts. That's where the value is going to come from.

                                    And, you know, there are some really good, fundamental things behind ophthalmology too, that are important to talk about. If you're an investor, you want a situation where you have a good opportunity to make money, but you also have some really good tailwinds that improve the stability of your investment, and help ensure that kind of single digit organic growth that we talked about.

                                    In ophthalmology, there's just a great, fundamental macroeconomic scenario, and that is that there are more people who need ophthalmic care, all the time, and we have some very sophisticated projections about that ... and at the same time, there are less physicians being trained to do that care. There's a large older population of physicians that will retire relatively soon, and there just aren't enough coming in to replace them, the way things are. We're going to have to figure out a way to solve that problem. It may involve having optometrists and other mid-levels doing more.

                                    But, in any event, the supply and demand scenario in this space is great, and PE investors can get really excited about that. It gives them a big margin of safety in this, that this isn't just ... if there's another recession, this whole thing isn't going to go away. It's going to keep growing at conservative rates, and we can probably count on that. If we can be successful doing some additional growth, we can be successful finding ... building a good company and selling it to the right next owner, at the right time, then we're going to be really successful and we might get that 30% return.

Andy:                       Great. If you have more questions about really how these private equity groups work, and their desired returns, I do encourage you to go back to the article we referenced. We're going to put a link to it in our show notes. It's also on our advisory resources blog on Again, the name of the article is Ophthalmology From Private Equity's Perspective: Rationale, Risk and Reward. It really does give you kind of real numbers that ... I mean, we made the numbers up, but it gives you kind of the real equation as to how this can work and it's not far-fetched for these ophthalmology platforms to be a great investment.

Eric:                          To be successful, yeah.

Andy:                       To be successful.

Eric:                          And you know, the analysis that we did is done at a high level. You know, there's probably some PE analyst out there who will read this and say this is terrible. We did it at a pretty high level because we wanted to make it simple and easy to understand. I think that the goal is to just demonstrate how you really can come to above a 30% return if you do this right. I hope that the people will take a look at that and just kind of see what we mean, and how we walk through that process.

Andy:                       Well, thank you for your time, Eric. That's a wrap for today. We hope everyone who's listening got some good information out of this one and we will talk to you next time.

Eric:                          Yeah. Thanks, Andy.


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