Crucial Questions

Podcast 18.4: Is My Practice A Candidate For Acquisition?

podcast_GEORGIA ARIAL18.4This episode of PF Insights kicks off our Crucial Questions series - a five-part series aimed at answering the most common questions we receive from potential physician clients regarding ophthalmology practice acquisition. We start  with our most common first question, "Is my practice a candidate for acquisition?" 

Behind that question, our physician clients have related beliefs or assumptions that we address with the market's reality. 

    • How many physicians are required in a practice in order to be considered an attractive candidate for acquisition?  0:59 - 5:34
    • The market has opened up for almost all practice sizes
    • What exactly are private equity investors buying?  5:35 - 8:25
    • EBITDA and the physician-owner as an employed physician
    • What about the real estate? 8:26 - 11:30
    • Post-sale real estate options and requirements


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 Transcript

Eric Yetter:

A lot of people on the outside of this see a physician practice with 50 doctors in it and just think, “that has got to be worth so much money,” and it's not necessarily.

 

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 Snyder:

Welcome to PF Insights, episode four, the podcast brought to you by the leadership of PhysiciansFirst Healthcare Partners. I'm your host, Andy Snyder, partner at PhysiciansFirst, and with me today I have our managing partner, Eric Yetter. Welcome, Eric.

Eric Yetter:

Good morning, Andy. Good to be here.

Andy Snyder:

Good to be here as well. Today in the podcast, we're continuing our focus on the ophthalmology practice acquisitions happening across the country, and we're going to start a series called Crucial Questions, which answers the questions that we most likely get from our prospective physician clients when introducing the ophthalmology acquisition landscape.

 

First question we're going to answer in this episode is, “Is my practice a candidate for acquisition?” Now, Eric, in previous episodes, we talked about how 2017 was really the wave of platform investments happening across the country, and subsequently now in 2018 we have a lot more opportunity for the smaller and medium-size practices to be add-on acquisitions, and we have more platform acquisitions going on from new investors. I think to start off that question, let's just start with how many physicians need to be in a practice for it to be a candidate for acquisition?

Eric Yetter:

At this point, it's really any number works. When we were starting out, probably prior to 2017, in most parts of the country, this was really only an option for very large practices, practices that probably had 10 physicians or more. There were some that were lower than that, but really this was for the big boys. Now that we have a lot more people in this space, we have a lot more investors who have acquired platform practices and are now looking to grow those either in the immediate vicinity or elsewhere throughout the country, and we have some big names that are partnering with practices nationally, not really geographically focused. The market has opened up for practices of almost all sizes. I say almost because there are still very small practices, maybe with a single physician or just a couple of physicians. Depending on their profitability, they may not have an opportunity yet.

 

It's more a matter of time than it is anything else, so in some parts of the country, very small practices need to wait for the market to develop a little bit, need to wait for an investor to come in nearby and have an interest in growing within that region. Those are probably the places that you might imagine. A lot of the Mountain West is still undeveloped. A lot of the West, period, is undeveloped still, and so are parts of the East. But that's going to change in 2018. It's already changing. It will continue to change by the end of this year, and I think it's really a case-by-case basis. What we do when we have people reach out to us who kind of fit that profile is we talk to them about their situation. We research what's going on in that area if we don't know already, and sometimes the answer is it's good to look at this now. Sometimes the answer is let's wait and see what happens over the next couple months.

Andy Snyder:

Yeah, I agree with that answer, and from our past experience with all the practices that we've spoken to, and, Eric, we've gone around the country and given 25+ of these presentations to physician groups of all sizes and all parts of the country. I would say our typical client ranges from anywhere with two physician partners all the way up to 10 physicians in the group, even more.

Eric Yetter:

Yeah. Those are the people we talk to the most, for sure.

Andy Snyder:

Right. I think the answer is that it doesn't really matter as much how many physicians are a part of the group. It matters more about the profitability of the practice.

Eric Yetter:

Yeah.

Andy Snyder:

And the variation within those different sizes is quite remarkable, actually.

Eric Yetter:

Yeah, it's tremendous. That's one of the things that I think has been the most interesting about being in this space is how different profitability among practices is, and it's not just driven by size of physicians. A lot of people on the outside of this, particularly consumers or just people who are reading about this, see a physician practice with 50 doctors in it and just think, “That has got to be the most valuable thing I've ever heard of. That has got to be worth so much money,” and it's not necessarily.

 

You can have a lot of physicians who are relatively low producers and have very high overhead, and there's not a lot of value there to an investor. There's still a lot of value there in a lot of other ways. There's a lot of value to patients. There's a lot of value to the physicians and the staff and a lot of other things that probably matter, frankly, more than the value to an investor in the scheme of things. But to an investor, what matters is profitability, and we've seen some extremely profitable small practices in unremarkable areas, and we've seen some very big unprofitable practices in very busy, very attractive areas. It's more than what meets the eye, for sure.

Andy Snyder:

It's a little bit counterintuitive. I agree. And I think the next question that we'll get into based on that lead-in is, “What exactly are these private equity investors, other types of investors, what are they buying?” If you have three owners, they're not buying Doctor Number One, buying Doctor Number Two, buying Doctor Number Three and putting a price tag on them. They're really buying the profitability of the practice as it is now and also what the profitability will look like after the owners are converted to employed physicians. Now, I want you to go into that more, because that right there is a concept that so many of the physician partners don't exactly think of first when they're valuing the bottom line of their practice, but it's very important to know and understand.

Eric Yetter:

Yeah. The way that these transactions are structured is that the buyer is investing and acquiring the assets of the practice typically, and that includes non-clinical assets, importantly, but it includes things like equipment. Also, probably the most importantly, it includes goodwill, which is really profitability. They acquire those things, and it's based on monetary factors. The way these things are valued is based on profitability. It's based on a multiple of EBITA, and what EBITA really means is earnings before interest, taxes, depreciation and amortization. It's a common financial term, but the point is it's the profitability. What's different in a physician practice or any professional services organization is that EBITA has another wrinkle to it. It's not just how much profit is the practice making because the profit has to be split among the owners and they have to be paid something after the deal.

 

What happens in these transactions is that the owners convert from being paid as an owner to being paid based on their productivity, and it's a different thing and there's some money that's going to be given up in that conversion. There just is. And in a very shorthand, non-elegant way to think about it, that's what the investors are buying is that difference. So you have to have some margin there between what you're earning now as an owner and what you would be earning go forward on a normalized basis, basically what it would cost to pay an associate to replace you. That's what you're going to be paid after the deal.

Andy Snyder:

Right. That right there answers a little bit of the question of ... You just talked about rural practices versus more of the urban practice and the overhead and having more offices and how sometimes that doesn't always lead to profitability because the increased staff, the increased rent, all that goes straight down to the bottom line, detracts from it and it gives you a less saleable entity, so to speak.

 

Speaking of offices and practice sizes, a lot of the times our physician clients ask us, "What about my real estate?" Oftentimes, the physicians of the practice also own the physical building and they want to know, “Is that part of the deal?” What would you say to that?

Eric Yetter:

It's variable. I think it's always an option. Physicians always have the option to sell the real estate as part of one of these transactions, but importantly, it's not necessarily the same buyer, same investor entity. Some of the groups that are partnering and acquiring ophthalmology practices are also interested in a transaction for the real estate, and that's fine. Usually when they are, it's at the option of the physician. The physician can or can't sell the real estate. It's up to them.

 

If the physician wants to sell the real estate and the investor is not interested, they will certainly have an opportunity to sell the real estate to a third party. There are a lot of healthcare real estate investors, healthcare rates, sometimes other types of organizations that are interested in acquiring medical office real estate, particularly stuff like this that has a private equity-backed company or some other large company as the tenant, and that's how it will be after the transaction. So, the value of the real estate, it can go up in one of these transactions and it makes sense sometimes for the physicians to monetize that as well.

Andy Snyder:

But they certainly don't have to sell-

Eric Yetter:

No.

Andy Snyder:

... the real estate.

Eric Yetter:

A lot of our clients don't. A lot of them want to keep it because it's a great investment for them. It's a great way to keep some cash flow coming in. It appreciates. There are a lot of reasons for a physician to hold onto the real estate, probably the same reasons that they bought it in the first place. And now they have usually a long-term, very stable tenant post-transaction.

Andy Snyder:

But they will have to set their rent at a fair market value going forward.

Eric Yetter:

Correct. There is a restriction on this, and I think it's the right thing to do. I think that the buyers are smart to require this, is that the physicians change their rent to market rate. It's just a legal problem to have rent that's outside of a normal market rate, and there are a lot of ways to figure out what that is. There are firms that specialize in that, but I think in most instances, the physicians that own real estate are paying themselves above-market for it.

 

There's nothing wrong with that. But after a transaction, it needs to be normalized to a market rate, and the physicians will get credit for that in the value of the practice. Let's say that the rent going forward will be lower than the rent is now. That would be adjusted in the financials of the practice, and the value of the practice would go up in terms of the price paid by the investor. And it makes sense to do that for a lot of reasons because of how much it can move the needle on the total value.

Andy Snyder:

Right. In summary, the answer to the real estate question is you can sell if you want to. You certainly don't have to sell. Either way, I think the value of that asset increases after a transaction like we're talking about.

 

I think that's going to wrap it up for today. We talked about all the practices that are candidates for acquisition, what it takes, how many physicians there need to be, what exactly these investors are buying, the bottom line profitability and your options with real estate post-transaction. That, in summary, is our podcast today. In our next episode, episode five, we're going to talk about how life changes for physician partners after a transaction. I think you'd be a little surprised at the answers there, because I think a lot of physicians out there have maybe a biased or wrong impression of what that is [inaudible 00:12:06].

Eric Yetter:

They have concerns. They've heard things, and I think it's important to clear it up as much as we can.

Andy Snyder:

All right. That's all the time we have for today. Thank you for listening to our PF Insights podcast. See you next time.

 

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