This episode continues our three-part series on the outlook for private equity interest in 2018. We look at where things have been, where they are today, and where it is all going.
Importantly, we begin to focus on the fundamentals and the concerns. We drill-down into today's selling opportunity and discuss the value of investment bankers centered around two common question from physician-owners ... "When is the best time to sell?" and "How will my life change after the transaction?"
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As a physician, if you just take that first offer I'm very confident saying that you're probably leaving something pretty significant on the table.
Welcome to PF Insights, hosted by the leadership of Physicians First 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.
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Chris: Welcome to PF Insights episode two. We are in the middle of part two of a three part series on the private equity interests in physician practices in 2018. We’ve got a lot to talk about today so let's dive right in. I'm joined today by the leadership team of Physicians First Healthcare Partners Eric Yetter and Andy Snyder. Guys, good to see you again.
Eric: Thank you Chris happy to be here.
Chris: So this is part two of a three-part series we're doing titled 2018 and What Physician Owners Can Expect From Private Equity This Year. If you want to learn more about that there's a blog post on the website http://www.physiciansfirst.com and just hit the advisory resources section to view that blog post. We're gonna dive a little bit deeper into that actually for this episode. To kick it off guys there's been a lot of there's been a high level of activity in 2017 in terms of major acquisitions and physician practices. A lot of people listen to this, maybe they've got a letter in the mail or unsolicited phone call from private equity. This is kind of a new thing, this wasn't happening in the first decade of the 2000s so we're in a kind of a unique space. I’d like to hear from you guys, what is going on in this space and what does this mean in particular for small and medium practice medium-sized practices this year?
Eric: I think simply private equity firms and private investors have become very interested in investing in ophthalmology practices. It started in a smaller way in 2011 and accelerated over the past few years and it really accelerated in 2017. We saw seven major private equity firms enter the market in 2017. Currently there are about 15 PE firms that are investing actively in ophthalmology and have already made investments in ophthalmology practices and many many more are looking to get into this market. So we’re at a critical point where we have significant investments that have been made, those investors are looking to grow aggressively and there are also new investors trying to come into the market. We saw the same thing happened in dermatology, we saw this same type of acceleration at this point in that life cycle that now we're seeing in ophthalmology. This is a very exciting time because it means that great opportunities are available not just to huge 40-50 physician practices but are available to small and medium practices practices with 2, 4, 6, 8 physicians and that's what we're gonna see in 2018. It's a continued acceleration of deal volume for those practices and also some new big acquisitions as well.
Andy: Right and just to add a little bit of color to that, I think what a lot of physician owners don't realize is that all these outside investors these private equity groups they come in different shapes and sizes as well and so does their investment profile. You don't have to have 10+ physicians in a practice to be on the radar. There's a lot of there's a lot of investors out there that are kind of seeking that smaller range of 2 to 5 physicians, hopefully a surgery center is involved and that's actually their bread and butter and they're not even geographically focused. They're looking all across the country so there really are opportunities for everyone out there particularly in the ophthalmology space.
Chris: Andy I want to talk a little bit about multiples. If you've been in physician practice or ophthalmology or other specialties you've probably heard that term thrown around in terms of private equity deals but a lot of people might not even know what that means so why don't you unpack for the audience what that means and why it might matter to a physician practice owner.
Andy: Right, that is true we do use the term multiples a lot and that's something that really does need to be clarified. So when we talk about multiples we're really talking about acquisition multiples and that's the metric used by outside investors and private equity groups to get the valuation the practice. We're not selling houses here, the valuation isn't driven by zip code and square footage. It's really driven by the bottom-line cash flow of the company and of the practice. When we're talking about the bottom line we're really talking about EBITDA, a very common known term that's Earnings Before Interest Taxation Depreciation and Amortization. So when we take that number, a multiple is going to be applied to the EBITDA of the company, of the practice and that's going to get your acquisition price. So in professional services, in physician practices it's a little different because we're also adding something called normalized compensation back so once we have that EBITDA, we actually have to subtract what physician partners would be paid for their production going forward and then we get to the bottom line number and private equity firms will come in and they will apply a multiple. It could be four times, it could be six times, it could be up to ten times and once we multiply those two numbers together now we're talking about the acquisition price for physicians.
Eric: Yeah and I just want to stress that because a lot of people don't understand the importance of normalized compensation. They think that it's just about EBITDA and that is true for businesses that aren't professional services where a person isn't essential to produce revenue, but in physician practices, in law firms and investment banks like Physicians First, you have to have people, you have to have key people to produce revenue. So when you sell that business you have to take the cost of paying those people on an ongoing basis into account and that gets subtracted from the bottom-line. What we're doing when we're looking at valuing a practice and we do this by the way, physicians who are interested in this and they really want to look at these opportunities closely, you can reach out to us, talk to us, we can look at their financial information and give them an idea of what a transaction might look like for them. But in a very big picture way what we're doing is we're taking your financial statement, we're adding back all the compensation that the owners get, we're making some other important adjustments that the PE firms also make for operation issues and other things that we just have experience doing, getting to that bottom line EBITDA which is the total profitability including all the compensation of the owners and then we're pulling the go forward compensation back out. That's how we get to that saleable EBITDA which is what the multiple is applied to and it's what drives the sale price so importantly. You can have a practice that's creating a ton of revenue and it's creating a ton of money on the bottom line but it takes so many physicians to do that work that there's no money left to sell, you have to pay all those people. So we're really looking for practices and the investors are really looking for practices that have profitability beyond what it would take to pay a replacement physician to replace the owner or owners and that's really what drives these transactions.
Chris: Right and Andy why don't you talk about just the overall trend in the past ten years of the actual multiple is that staying the same or is is that does that fluctuate at all what are you seeing out there in the market?
Andy: I think the easiest answer that question is it increases with competition right. So in the past five years we've seen an explosion of investors entering the ophthalmology space and that's created competition that's led to multiples that really haven't been seen before. Right now we are kind of at this crest of this wave where ophthalmologists have the best opportunity that they've had in decades, possibly ever to look into this type of investment. As more and more investors enter into the space, Physicians First Healthcare Partners is constantly in conversation with private equity firms that have yet to make an investment in the space, we have probably another ten to twenty that will enter the space in the next year and that competition is going to keep the multiples high where they are now so it really is a good time to look into this type of investment.
Eric: It's funny, one of the questions that we get asked the most is “What's the best time to sell? Is this the best time to sell?” and asking that question is something that we spend a lot of time thinking about and we like to talk about with people but it's also kind of like asking when is the next recession gonna be.
Chris: When is the best time to sell your Bitcoin?
Eric: Yeah it's pretty hard to know because just like those things this is a market driven opportunity and right now we have we definitely have a critical mass of investors in the market and we have a lot of competition that's driving high prices. We're seeing multiples of anywhere from four to above ten times EBITDA which is which is tremendous. Compared to most businesses compared to what the guy down the street who owns a small manufacturing company or even the guy who owns a Mercedes dealership, these are great multiples compared to that. Physicians should take advantage of them, they should they should be interested in them and what's helping that again is this competition. Now as we see more investors enter the market there's a couple of competing forces that are gonna happen and this is what happened in dermatology. As more investors come in and as the the wave continues to crest and continues to mature there's going to be some consolidation among the consolidators. People are going to sort of stake claims to certain regions of the country, so at the same time even though there are more investors in the market things may become less competitive because things become more established. That's happened in ambulatory surgery centers, it's happened in dermatology and it will eventually happen in ophthalmology and some of our contacts in the ambulatory surgery center side who have been around this for a while say things to us “we’re gonna wait until the prices come down because it's crazy right now”. They know the prices are eventually going to come back down to earth but right now they're at a great spot and that's why we're we don't ever push physicians to do this now. That's not something we want to do, but we do want people to know that this is a pretty good time. If you're at a point in your career, you're at a point in your life where this could make sense and I think that the prices we're looking at it makes sense for people, this is a good time to look at it.
PF Insights is sponsored by Physicians First Healthcare Partners, the investment bank for physicians. If you’re a physician and curious about the market value of your practice give us a call for a personalized valuation. Reach out at 615-647-6885
Chris: I'm gonna play the part of a physician owner here and say I hear you, the multiples are great, the markets heating up, there's a lot of competition interest that's driving up offers but I don't want to sell to private equity firm because they're just going to come in, they're gonna try to cut costs, they're gonna centralize operations, they're gonna lay off staff and they're gonna do a lot of things they're gonna affect patient care I don't want that I would rather just not sell and not participate in that revenue if it's gonna mean my patient care is gonna get affected and my staff is gonna be unhappy. Talk a little bit about those concerns because I think that might be what holds people back for even considering something like a sale to private equity.
Eric: I want Andy answer this but I want to add something first I think it's important and those are extremely valid concerns. Those are concerns that we understand and that we have seen in our past experience as buyers and operators of physician practice and surgery centers having worked with doctors every day to make sure that they're satisfied. We know that's important and quite frankly we don't want to work with physicians that don't care about that stuff. We don't want to work with physicians that are just trying to get as much money out of this as possible and the investors don't want to work with them either. So those are extremely valid concerns, this is about the total deal and that's a concept that we have we call it the complete deal. It's very important to us to make sure that this works for physicians financially, it works for them clinically, it works with them operationally, it respects the relationships and the reputation they've built and invested in their community. We're interested in all of that and the investors are interested in all of that so those are extremely valid concerns but I think we're in a really good spot for those. I think we address those concerns and the investors have learned how to address those concerns. Andy I know you were about to answer that sorry to interrupt you but please.
Andy: No that's fine, those are all very good points brought out by Eric but Chris what you're talking about is saying that as a physician owner who's had control over the practice for the maybe the past 10, 20, 30 years, they're entering to a situation where they feel like they can have a complete loss of control and that's worrisome. Those are valid concerns and I think there's a couple parts of this, one being mostly all if not all the investors, they're not going to come in and take over any clinical control of the practice. That is left in the hands of the physicians. Investors understand that they need happy physicians with thriving practices for this to continue to be a good investment. So there they are going to leave the control for the clinical decisions obviously in the control of the physicians but even on the operational control we're talking about you know keeping the the staff happy and making sure that the best patient care is brought there and so the physicians are going to be, they're going to be leaned on to make sure that the practice continues to thrive while the investor is really going out and saying how can I help this? How can I help this practice grow through a further acquisition? How can we take this great practice and introduce some of the best concepts into the other practices that we're going in? I do agree with Eric that every physician should have that mindset and they do need to vet any potential buyer and maybe talk to past physicians that have gone through this experience. How did those concerns get addressed? It's something that at Physicians First we advise all our clients to make sure that, we'll walk them through it, that those concerns are met..
Eric: This is gonna work for them. It's a huge part of the consideration and I think that we and the investors that we work with have put a lot of effort and thought into making sure those things are there. You can hear it from them but like Andy said ultimately if you hear from another physician that's that's the way to go and there already are opportunities to do that, to get a first-hand account from someone who's done this and there are going to be more and more physicians are going to start hearing about more people who have done this in their communities, friends and colleagues, people they know from their training, from medical school. I think that as more and more of that builds momentum this is just going to continue to be validated something that's very physician friendly.
Andy: That's what makes 2018 a very special part of this acquisition cycle is on one side you have the investors that are seeing other private equity firms have success in the space, both in ophthalmology and in other practices but now physicians can talk to each other. They can have trusted allies in there that they know are going to tell them “this has gone well, it's been everything that we hoped it would be and you know you should really consider this for your practice”. So it's a good combination for both sides.
Chris: Thanks Andy and another thing I want to cover is all this business development activity that's happening with these PE firms. A lot of physician practice owners might be experiencing repeated phone calls, unsolicited letters from PE firms looking to do an acquisition and they might be thinking if I've got these. I'm already maybe semi interested in selling and playing with the idea and I've got these PE firms contacting me directly what's the harm in just going with the guy that keeps calling me and trying to see if I can get a deal. What should physician practices know about this kind of stuff?
Eric: That's that's something that they can do, there's no reason why a physician can't do a deal with somebody who approaches them and just get it done that way. But my question to physicians is why would you want to limit yourself that way? The buyers are great people, the people that they have working for them, the business development guys. Andy and I work with them every day. They're nice people who we respect and we want to make sure that we help, that we give good service on behalf of our clients where they feel like we have good information we answer their questions, we bring them good opportunities and we help them do their job better, so those people are really important to us and they're important part of this ecosystem. But as a physician if you just take that first offer I'm very confident in saying that you're probably leaving something pretty significant on the table. The competition that comes from using a broker is just so significant, from using an investment bank like us to represent you and our experience shows that. Our past clients would say that and the academic research that has been done on this topic shows a significant premium in the purchase price for people that use an advisor versus who do it on their own and that's just established. I think that in this space too there are a lot of other considerations beyond just price. You're not just trying to get the best price, you're trying to do something that's going to work for you going forward. There are a lot of legal problems to solve, a lot of operational problems to solve, what are you agreeing to do? What is your life going to look like going forward? That's a component that makes these transactions so much more complicated than a lot of physicians think at the outset because the initial communications they get are simple. “We're willing to buy your practice, we'll pay you this amount of money” but there are a plethora of additional items that don't get addressed and that really you need an expert to help you address, both a bank like us but also an attorney.
Chris: Yeah and Andy I wonder if you could flesh out to flesh that out a little more for me what are some things that maybe a physician practice owner might miss because they're not doing these deals all the time, that's actually really important to them that it might be good to have an outside party to come in and make sure is included in a deal that they might miss.
Andy: Alright I think it's just the fact that not every investor is the perfect fit for each practice right. There's just going to be different factors, it could be the acquisition structure, how much is in cash and how much retained equity would a physician, maybe a younger physician keep in the practice moving forward? Is there a rollover equity opportunity? Is there an opportunity to get to get equity in the global parent company of the platform company that's being built? So there's there's obviously those factors and then there's just kind of cultural factors as to what it does look like post transaction and it's just some some investment portfolio companies will be a better fit than others. We just don't want the physician our physician clients to limit themselves, to say that is enticing, should I go there? Why wouldn't you check behind door number two and door number three? What Physicians First Healthcare Partners is, we spend all of our time making sure we do know all the options and we can put you in contact with the right fit.
Eric: I would never mean to scare people but there are scary components to this too there are pitfalls and that's one of the reasons why it's really important to have a good advisor both on the financial side but also a good attorney. It’s very important that physicians be well represented there so we work with our clients to make sure if they do already have an attorney if they're qualified to represent them in this and if they don't, we have many attorneys we can recommend who've done this before multiple multiple times. They protect them from things basically agreeing to do things that they don't want to agree to do. There are going to be non-competes involved, there are going to be representations involved about your practice and you want to make sure that none of these things can be used against you in a negative way, in an unfair way in the future. So this is a big deal, there's a lot of money involved, there's a professional life after the fact involved. You only get one chance to do it and you've got to make sure that you do it right and one of the things that I like to say that's you know almost a little silly is that people use Realtors to sell their house almost all the time and this is incredibly more complicated than selling a home. There are implications for you now and in the future and you can't just put a sign up. You have to know who to call about this, so not using an advisor for this and using a realtor is crazy. This is a really important and critical thing and we want physicians to invest in a good advisor but we also think too and this is important we're confident that we pay for ourselves every time. I don't ever want to broadcast how we get paid and what our fees are but anybody who wants to talk about that can call me and we'll explain how we do that. It's really a win-win for physicians to use us or to use a qualified advisor like us who knows this space.
Chris: So the bottom line there I'm hearing is you can do it yourself certainly but you’re doing yourself a disservice in terms of the offer, in terms of operational things, in terms of clinical things to really bring in a partner that can advocate for you and make sure everything's working out to the best possible outcome.
Eric: We think so, we just don't think there's anything to lose in working with us. This is another component of how we work and we talk to all our prospective clients about this. We set up our services so the physicians have nothing to lose, they can explore these opportunities with us, see what they look like, talk to the buyers and if they decide to walk away after doing all that that's fine. They don't owe us anything. We really want to give them the opportunity to do that. Now we want to work with people who are committed and who are seriously interested but we create opportunities for people without a downside and I think that's a really important part of our value offering.
Chris: Thanks Eric, well that's all the time we have for this episode thanks for listening be sure to visit the website http://www.physiciansfirst.com to get more information, articles and podcasts about investment in physician practices and surgery centers. Eric, Andy good to see you guys again we'll see you next time.