the brave new world of healthcare private equity · private equity investment strategies...
TRANSCRIPT
Demystifying Private Equity
PE firms raise funds from institutional investors and wealthy individuals
Investors and funds that make direct equity investments in privately-owned
companies, called “portfolio companies”
PE funds usually have general and limited partners
General partners are managers that raise money for individual funds and
manage the funds and investments
Limited partners are passive investors
Private equity seeks to invest in high quality businesses that can be grown
organically and through acquisitions and provide financial resources for
acquisitions and internal investment while optimizing the performance of the
businesses
Private Equity Firm(General Partner)
Investors (Limited Partners)
Private Equity
Fund
PortfolioCompany #1
PortfolioCompany #2
PortfolioCompany #3
20% of “Gain”(Carried Interest)(Upon Sale/IPO of
Portfolio Company)
80% of “Gain”(Upon Sale/IPO of
Portfolio Company)
5-10% 90-95%
Private EquityFund
Typical Private Equity Fund Structure
Development Early Growth
Accelerated Growth
Maturity Decline
Private Equity Business Cycle Landscape
Revenue/Cash FlowOver Time
Venture CapitalGrowth Equity
Buyouts Distressed
Stage/Investment Strategies
Private Equity Investment Strategies
Venture Capital
> Early stage, pre-revenue companies
> Betting on success of new products and services
> High risk, BUT high reward
DevelopmentEarly
GrowthAccelerated
Growth Maturity Decline
Revenue/Cash FlowOver Time
Venture Capital Growth Equity Buyouts Distressed
Stage/Investment Strategies
Private Equity Investment Strategies (cont’d.)
Growth Equity
> In between Venture Capital and Buyout sectors
> Invests in products/services that work, but have not gained market acceptance
> Not cash-flow positive . . . Yet
DevelopmentEarly
GrowthAccelerated
Growth Maturity Decline
Revenue/Cash FlowOver Time
Venture Capital Growth Equity Buyouts Distressed
Stage/Investment Strategies
Private Equity Investment Strategies (cont’d.)
Buyouts
> Most popular strategy most $ / most funds
> PE fund acquires control of the portfolio company
> Invests in mature, cash flow stable companies
> Under-valued or under-performing, but significant growth potential
> Investment using a combination of equity (capital from the CPs and LPs) and debt (bank loans or mezzanine debt)
> Usually PE funds buy portfolio company using a little bit of their money and a lot of borrowed money
DevelopmentEarly
GrowthAccelerated
Growth Maturity Decline
Revenue/Cash FlowOver Time
Venture Capital Growth Equity Buyouts Distressed
Stage/Investment Strategies
Private Equity Investment Strategies (Cont’d.)
Distressed and Turnaround
> Buy debt
> Take borrowers through capital restructuring
> Benefit from an economic recovery
DevelopmentEarly
GrowthAccelerated
Growth Maturity Decline
Revenue/Cash FlowOver Time
Venture Capital Growth Equity Buyouts Distressed
Stage/Investment Strategies
Buyouts
PE Firm Acquires Controlling Or Minority Position In A Portfolio
Company And Seeks To Maximize Value By:
> Cutting costs and CapEx to increase profitability
> Improving management
> Streamlining working capital
> Forging new business partnerships
> Leverage technology
> Opening new customer channels
> Buying related companies and combining them together to add value
- Called “tuck-in” or “add-on” acquisitions
PE Firm Receives Management Fee And A Share Of The Profits
From Each PE Fund Managed
Buyouts (Cont’d.)
Investment Horizon:
> 3-7 year
Goal: Make Money For Its Investors
How: Maximize Value of Portfolio Company
> Sold for cash or shares in another company
> Initial Public Offering (IPO)
Large Leveraged Buyout PE Firms
Kohlberg, Kravis, Roberts & Co. (KKR)
Texas Pacific Group (TPG)
Goldman Sachs
Blackstone Group
Bain Capital
Carlyle Group
Apollo Global Management
Note: Most are active in the healthcare sector
Healthcare Target Sectors
SPECIALTY PRODUCTS
• Specialty Pharma
• OTC Drugs
• Nutraceuticals
• Personal Care Products
• Medical Foods
OUTSOURCING & DISTRIBUTION
• Contract Manufacturing
• CROs
• Formulations
• Outsourced Staffing
• Specialty Distribution
HEALTHCARE SERVICES
• Alternative Site Providers
• Physician Management
• Outsourced Hospital Services
• Labs
MEDICAL TECHNOLOGY
• Medical Devices
• Medical Equipment
• Diagnostics
• Specialty Supplies
HEALTHCARE IT
• Population Health
• Revenue Cycle Management
• Payor Technology
• Consumer-Driven Technology
• Telehealth
• Software
Types of Healthcare Services Portfolio Companies of Interest to PE
Long Term Care
Home Health
Rehab Centers
Urgent Care Centers
Ambulatory Surgery Centers
Dental Practices
Ophthalmology
Dermatology
Neurosurgery & Orthopedic
Practices
Behavioral Health
Major 2018 Healthcare PE DealsAquiline Capital Partners Aspirion Health Resources
(Revenue Cycle Management Company)
BlueMountain Capital Management KentuckyOne Health (Hospital System)
Clayton Dubilier & Rice naviHealth – 55% Stake From Cardinal Health (Manages Post-Acute Care In Value-Based Arrangements)
KKR & Co. Envision Healthcare (Physician Services Provider $9.9B – All Cash Transaction)
Platinum Equity Life Scan (J&J’s Diabetes Unit $2.2B)
Summit Partners & OptumHealth Sound Inpatient Physicians Holdings (Physician Staffing Company – Sale of Fresenius’ Majority Share $2.2B)
Veritas Capital General Electric Healthcare’s Value-Based Care Division $1.05B
Welsh, Carson, Anderson & Stowe, Kindred Healthcare’s Long-Term Acute Care TPG and Humana Hospitals and Rehabilitation Services
Businesses $4.1B
Curo Health Services (Hospice) $1.4B
Middle Market Healthcare PE Firms
Sterling Partners (Chicago)
HIG Capital (Miami)
Audax Private Equity (Boston)
RoundTable Healthcare Partners (Lake Forest, Illinois)
Pritzker Group Capital (Chicago & Los Angeles)
Harbor Point Capital (New York)
Sentinal Capital Partners (New York)
Private Equity’s Interest In Healthcare
FACT: U.S. healthcare private equity investments surged from$72 billion in 2016 to $83 billionin 2017 (American Investment Council’s 2017Q4 Industry Investment Report)
Why do private equity companies want to invest in healthcare?
> Unique Economics – Seen as a “safe haven” for money in economically turbulent times
> Scalable Models – Drive to make healthcare more “efficient” using money as an incentive for organizations
> Large Market – Historic fragmentation presents an opportunity for consolidation
> Best Practices – Provider organizations offer opportunity for immediate operational efficiency
Why Do Healthcare Targets Consider Investments From Private Equity?
Capital infusion for technology, additional management and increased growth
Strengthen leverage for negotiations with payors
Management expertise
Remove personal guarantees
Reduce economic risk
Large upfront cash payment
Participation in future growth
Possibility for additional liquidity events
Factors Healthcare Providers Should Consider In Choosing a Private Equity Partner
Hands-on management by the private equity firm vs. passive investor
Philosophy
Past healthcare experience and past experience within the target’s specialty
Past investment returns
Leverage
Additional potential acquisitions
References from current and past partners
The firm’s future plans for the target
Reverse due diligence
Factors PE Firms Consider In Choosing A Healthcare Provider
Unique market opportunity with strong market position
Strong revenue, earnings and cash flow with prospects for accelerated growth
Best-in-class management team with aligned economic (equity) interest
Scalable operating model and attractive growth strategy and growth
opportunities
Transition and acceptance of risk
Multiple avenues for growth (in market and new markets) and ability to
leverage core competencies
Scarcity value
Strong customer relationships and patient interactions
Straight Forward PE Equity Structure
Healthcare PortfolioCompany
(Licensed Healthcare Provider)
PE Firm
• Equity Stake• Liquidity Event
Original Owners
• Minority/Majority Equity Stake• Management• Capital
Management Agreement
Physician Practice PE Structure
Physician Practice
PE Firm
MSO
• Capital• Management• Liquidity Event
‹50% ›50%
• Clinical
Management Agreement
Deal Terms Depend On:• Business Dynamics• Negotiating Leverage• Advisors Knowing What They’re Doing
Management Fee
PE Joint Venture Structure
Healthcare Company
PE Firm
• Real Estate• Buildings• Clinical Staff
Joint VentureEntity
• Capital• Management
51% 49%
Management AgreementLeasesEmployment Agreements
New License Entity or
Service Line
Due Diligence Considerations
Preparing For A Private Equity Transaction
Provider should conduct an internal pre-transaction assessment to
identify any issues
Provider should identify and remedy any potential compliance issues
> Compliance audit
> Coding audit
> Overpayment liabilities and risks stemming from improper medical coding and billing practices
> Compliance with healthcare fraud and abuse laws, such as the “Stark Law,” the “Anti-Kickback Statute” and state laws
> Failure to implement appropriate corporate compliance programs and/or corporate governance practices
Provider should not conceal or avoid issues during due diligence
General Due Diligence
Non-Disclosure Agreement
Scope of requests
> Financial records
> Organizational documents
> Litigation, investigations and audits
> Contracts
Private equity analysis
> Successor liability
> Compliance and reimbursement
> Post-closing business and operations
Regulatory Due Diligence – What Private Equity Firms Want To Know About Their Target Markets
Jurisdictional Concerns
> Threshold Barriers To The Deal
> Corporate Practice Of Medicine (CPOM)?
• Will impact deal structure and agreements governing business decisions of the healthcare enterprise
> Private Equity Analysis
• Is government consent/approval required before the transaction?
• Often results in non-simultaneous sign/close transactions
• Important in deals involving not-for-profit healthcare entities
Regulatory Due Diligence – What Private Equity Firms Want To Know About Their Target Markets
Jurisdictional Concerns
> State insurance laws
• If the private equity model will include risk-based or shared savings arrangements with payors, may be subject to state insurance laws
• Registration, licensure or certification
> Fee-splitting
• Typically, state fee-splitting laws prohibit professionals from sharing the professional component of their fees with non-professionals
> Licensure
• If a medical entity holds any licenses, certifications or accreditations, the transaction with the private equity firm may trigger change of ownership (CHOW), notification or other filing requirements
Regulatory Due Diligence – What Private Equity Firms Want To Know About Their Targets
Enforcement Dangers
> How risky is the target?
> Private equity firms looking for high rewards may be
overlooking significant risks
> Examples:
• Providers who do a large volume of no-fault auto work
• Home health, nursing facilities, laboratories
• Hospitals and physician groups – higher Stark Law concerns
• Physician-owned hospitals
- ACA bars hospitals owned by physicians from expanding
- New physician-owned hospitals can’t be established unless they forego Medicare and Medicaid reimbursement
Regulatory Due Diligence – What Private Equity Firms Want To Know About Their Targets
Enforcement Dangers (cont.)
> Laws With Unique Bearing In Healthcare
• Fraud & Abuse – Stark Law, Anti-Kickback Statute
• Corporate Practice of Medicine
• Antitrust (add-ons or complimentary service lines)
• Privacy & Security – HIPAA et al.
• Tax
• Labor & Employment
> How to address non-compliance issues (depends on risk
aversion level of client)
• Investigation and Resolution (Self-Disclosures)
• Escrow
• Indemnification
Regulatory Due Diligence – What Private Equity Firms Want To Know About Their Targets
Reimbursement Complexities
> Potential ROI of the deal
> Preconditions involving licensure and enrollment issues can affect
reasonable timing of the deal’s completion
> Structure of the deal can greatly impact cash flow, particularly for
Medicare/Medicaid
> Sector-specific challenges (e.g., laboratories, surgical centers,
specialty pharmacies, etc.)
> Commercial payor contracts may require intensive credentialing
process – skepticism if a new private equity owner has limited
healthcare experience
Regulatory Due Diligence – What Private Equity Firms Want To Know About Their Targets
Policy Uncertainties
> How risky is the deal overall?
> Private equity firms generally focus on “short-term” risks (3-7 years),
but healthcare is fast-changing in current political environment
> Transitions to value-based payments reinforce private equity focus
on efficiencies, but usually are a longer-term improvement prospect
(e.g., ACOs, bundled payments, CINs)
> Regulatory changes may require additional unanticipated investments
to recover losses (e.g., 340B reductions)
Transactional Considerations
Letter of Intent Culture Differences
Private equity firms tend to include more terms in letters of intent than other types of acquirers (i.e., hospitals)
Firms tend to adhere very strictly to the letter of intent and deem an attempt to negotiate a deviation as an act of bad faith
Providers should spend more time than usual negotiating the letter of intent to see if there is a real fit with the PE firm
Make sure to include the right to terminate after expiration of a certain amount of time
Soliciting & Responding To Bids
Do on blind basis, or leverage offers against each other
Consider auction style
> Accelerates preparation of Purchase Agreement, but drives early comments that can factor into determinations
How distinguish between bids?
> Price
> Amount of equity rollover
> Amount of seller financing
> Tax implications
Make a decision and initiate “final” negotiations
The ValuationThe private equity firm will “value” the provider target and provide the target with its
determination
Values are usually between 3 to 8 multiples of EBITDA (Earnings Before Interest,
Taxes, Depreciation and Amortization), but can go higher for certain providers
Factors that may influence the multiple:
> Geography
> Growth
> Size
> Ancillaries
Roll Over Equity
> Physician owners of a practice target will typically be required to apply some of the valuation consideration to equity ownership in the entity holding the investment
Valuations are typically negotiable
Valuations may be negotiated higher if providers will take less guaranteed
compensation post-closing
Considerations For The Provider In Negotiating The Purchase Price
Different perspectives based upon stage in career and goals of
partners
Early and mid-career partners
> May want to put more into rollover equity
> May prefer more productivity-based compensation (higher risk, but higher reward)
> May look to strategies that would allow them to benefit in multiple transactions
Late career partners
> May want a higher upfront cash purchase price
> May prefer more fixed compensation
Deal RoadmapPE transaction typically follows one of two standard corporate transactional pathways:
> Asset Purchase – may occur if private equity can add to another practice• Pick and choose among assets to purchase• Means of limiting liabilities that are assumed, but presents challenges in getting operations
up and running• Use may be influenced by type of entity being acquired
> Equity Purchase – more common in healthcare because of enrollment and credentialing considerations• Regulatory considerations impact how private equity can acquire interest• Often need physician ownership to remain in place for practice/professional entity• Liabilities are assumed
Maintaining drive and interest of selling owners
> Results in “roll over” = selling owners being forced to retain equity interests> Private equity buyer often takes preferred distributions and gives “promise” of big future returns
Controlling or non-controlling interest?
Directors and officers
Management
Can deal be financed?
