PE Recapitalizations and Formation of "Super Groups"

Uh, good morning, everybody. I'm Roger Stroden. Uh, I was almost a doctor there for just a second.

Uh, I only have like 12 minutes. Um, I'm a partner at Foley and Lardner, uh, in Chicago. We're about, um, 1200 lawyers across the country, uh, with a couple of offices, um, in Mexico, uh, and Asia.

Um, 12 minutes. I, I don't even bill in 12 minute increments, so I'm not entirely sure how I'm gonna get this done in 12 minutes. My partners won't let me bill in 12 minute increments. Uh, what I wanted to do, talk a little bit about private equity, um, in Spine and Orthopedics, as well as in kind of compare and contrast that a little bit to, uh, the formation of supergroups which you're seeing a lot of going on today.

Um, there's still a lot of private capital out there, uh, chasing deals in the healthcare space and specifically in the Spine and orthopedic space, and this is just a few of the deals that happened in the last year or so. There are about, uh, the last time I looked, there are about 15 or 16 major private equity sponsored Spine and, and or orthopedic platforms out there.

Um, so, as a general rule, uh,

What, um, private equity is doing is chasing what they call platform Practices, and a platform practice is generally a large practice, usually a fairly sophisticated practice, um, uh, with fairly high EBITA, um, usually, uh, quite a number of ancillaries, good hospital, um, relationships, and most importantly.

Very high end physicians physicians with good names, good solid brands in the communities they're in, and these are generally the larger Practices in whatever region they're in that's compared and contrasted to what you would call an add-on practice. We'll talk about that in just a minute and add-on Practices or bolt-on Practices tend to be smaller Practices that are then acquired by the platform after private equity comes in, um.

As you might guess, private equity and, uh, I'm sorry, Spine and Orthopedics is pretty highly sought after, and it's highly sought after for prob I would say three reasons. One is there's, there's still quite a bit of fragmentation, believe it or not, in the market in Spine and Orthopedics. The last time I looked, it was about 60 to 65 to 70% of the Practices in the country actually have less than 10 providers in.

So that's a great deal of fragmentation, and that fragmentation provides opportunity for private equity sponsors as well as physicians looking to aggregate.

You guys are all very highly productive physicians and as are, you know, straight orthopedic surgeons, very highly productive docs, and you also generally in the Practices tend to have a lot of ancillary revenues and a lot of, a lot of ancillary leverage, you have MR, you have DME orthotics, uh, in many cases you've got, uh, ownership in ASCs, etc.

So that's why you tend to see these are frankly your Practices, they're the holy grail anymore, Private equity. Private equity started with hospital-based Practices. They started with uh anesthesiology, they started with radiology, then they moved into more subspecialties. They moved into derm, they've moved into ophthalmology.

GI is also a pretty hot sector and has been, but you, you men and women, um, really truly are, you're the, you're the sought after Practices, and frankly it's they've had a difficult time consolidating your Practices because you tend to be, first of all, you're very high earners, um, you also tend to be very independent, um, and the idea of going to work for a private equity sponsor isn't always all that attractive for all of you. We still do see, um, the EBITDA multiples of the double digits.

In, in, um, healthcare and specifically in physician recapitalization transactions, um, there, there could be some softening of that as the economy grows weaker.

And it looks like it's continuing to grow weaker. Um, you're going to see some of the, I think you're gonna see some of the multiple trend down a little bit. It, it's just natural that they're going to trend down. But what's interesting with the rise in interest rates, we aren't necessarily seeing that the rise in interest rates is going to cause the softening of the markets because as a general rule in healthcare M&A, these are not heavily leveraged transactions. You only see about 3 to 4 times.

Um, uh, debt on these deals. So if you've got a, if you've got a well capitalized practice, only about maybe 30% to 40% of the capitalization is in debt, um.

We, we, so far in healthcare, we're starting to see what we call the second tier trades, and that is if you ever, people say, you know, the second bite at the apple.

So you will see second tier trades. We're seeing a lot of them in derham and ophthalmology and Pain. We haven't really yet seen that many in Orthopedics and Spine, and I think that's also, and I think one of the reasons we haven't seen that yet is still fairly young. You're the, the maturity of these trades, they're fairly young yet, and, and there's still a lot of consolidation to go on.

I am aware, without mentioning a name, I am aware of a fairly high profile group that did a first trade, and as I understand it, in the last 3 to 4 months they went out to the market again and didn't get any bites, and I, it, it, the trade didn't happen. I'm not entirely sure why it didn't happen. I have, I have my, I have my suspicions, but that, that does happen from time to time.

Uh, let me move on to this real quick, and by the way, I'm happy afterwards to take any questions. So let's look at private equity real quick. We got about 6 minutes left. Look at private equity. As I said before, when you're considering private equity, one of the things that you have to say to yourself, are we a platform practice? Are we an add-on? And there's a, there's a pretty significant difference between that. As I said before, if you're a platform practice, you're going to attract the highest multiple.

You're gonna track the double digit multiples. Your doctors are gonna get, you know, really, really the best price you can get for your practice. If you're an add-on, and this is what private equity does, they arbitrage, right?

So if you trade at 12, the next add-on, they're not going to trade at 12, you're going to trade at 8, you're going to trade at 7, and you and the private equity sponsor are going to at some point hopefully take advantage of that, that 5 turn multiple that you traded for over all of the add-ons that you traded on.

Uh, in terms of, of deciding though, these are a couple of things that, that you need to know, um, when, uh,

To create IATA in these deals.

They'll look at the cash flow that comes off of your ancillars, assuming that you have a fee, assuming that you have PT or MR, you have antsars, they'll trade off the whatever the cash flow and those are, but the big, the big money maker in these deals are what we call income scrapes, and the income scrape is essentially the monetization or the present valuing of the income, your go forward income.

So in many of these cases you'll see PE come in and say, OK, your comp is this now, this is what you're taking out of the practice. We'd like you to take 60 to 70% of that as on a go forward basis. We'll then monetize that that that money that we've scraped away. We'll monetize that and we'll apply the multiple to it.

And then what's often discussed is, OK, with this income scrape, don't worry because we're going to repair your income. That income eventually will trend back up. So, you know, what you'll get in the deal is you'll get cash and then you'll get rollover units in the, uh, in the newco or in the, in the management company. Those are the two things you'll get and, and your income scrape hopefully is repaired.

That happens a lot in smaller Practices. I, I have a tendency to believe that in larger Practices where you're already leveraged out into ancillaries, I, I have a hard time figuring out exactly how that income repair is gonna happen. We see it, the, the specialties we really see it in is, for example, Durm. Durham's a great place for you to, to repair your income because you can put in all kinds of cash-based, um, all kinds of cash-based businesses, bed spas you can put in.

Whatever you want to repair physician income. Again, I really wonder on a go forward basis how that's gonna happen in the Spine and orthopedic space. So that's something to take care, that's something to, to really watch. The Other thing you wanna think about is, is the group you're joining, are they aggregators or are they really good operators? And what we're seeing in private equity is there are private equity firms, they're great at buying things.

But they're not so good at operating things on a go-forward basis, and you have to be, I say, you know, my caution to you would be really be careful of that.

Do your diligence, do your reverse diligence on the folks you're talking to.

The Other thing you wanna do, and I really meant to, um, say this earlier, is don't get yourself caught up in a one-off conversation with a private equity sponsor. And by the way, I represent private equity as well. So I do both buy and sell site transactions. I'm not, I'm not telling any secrets here, but be careful about getting caught up in a one-off conversation with a private equity sponsor that wants you to get you under exclusivity right away so that no one else can talk to you.

Really, if you think you have a practice that that is a platform type practice, your best bet is to engage a banker and have someone out and do a process for you. That's where you're gonna get the highest value for your practice. The last thing is, and I mentioned before, in most of these deals, when you trade with private equity, you get two things you get cash, but then you get rollover equity in, in the new code. And when you get rollover equity in the new code, what, what is being held out there is.

When we we trade in 5 to 7 years or 6 or now it's 3 to 5, um, you're going to, you're gonna, you're going to receive a, you know, you've rolled over your equity, you're gonna get a big pop at the end. That does happen. It doesn't always happen. And one thing that you wanna be very, very careful of because we really don't see much of this in private equity is there's always the discussion of the holy grail is we're gonna go public.

Um, be very careful of that. There really have not been very many physicians. In fact, I don't know that there have been any successful, uh, physician recapitalizations that have gone public. So that's something you have to really, really think about.

Let me go here and we're just about done. Um, an alternative to private equity is the supergroup. We've seen a lot of formation of supergroups and frankly what this is is these are larger groups that have decided that they're going to come together and they're gonna pool their capital and they're going to cut costs and they're.

Do, you know, they're, they're gonna form these large groups and we've seen, I don't know, 5 or 6 of them around one in Texas, very famous, um, that we've seen, and, and that they are getting significant traction. Um, the, the difference between that and private equity is there's no monetization up front of your equity. You're just simply merging your groups. Nobody's getting paid in most of these deals. You're pushing the groups together, but what does that do for you? It makes you more relevant to payers, obviously.

It gives you market power. It gives you a little more leverage in the market when you're when you're approaching payers. It makes you relevant to hospitals in certain markets, you know, hospitals have an awful lot of sway and leverage over physicians, and when you do that, you become much more attractive to them, obviously then you become much more attractive to Other physicians that want to join the group, um, and one last thing is ultimately we do see these.

Come together and try to form themselves and uh and and and get themselves in a position to at some point in time make themselves a little more attractive to private investment um what does it do for you? It increases your access to debt obviously because you've got a larger borrowing base and if you've got groups that don't have a lot of um uh don't have a lot of answersars, they don't have ASC investments, they don't have MR, they don't have PT, etc. this gives you the opportunity to do that.

And cobble that together and if it's done and it has to be done, uh, you know, in a way that's regulatorily compliant under the Stark Law and the anti-kickback statute so that you can make cross referrals among practice lines. The, the hard part about these things, super expensive, super time intensive, um, you can imagine taking 3 or 4.

Uh, groups of physicians, especially orthopedic surgeons, and mushing them together, it's not easy. And the Other thing you gotta think about when you do all of this is the culture there, and you gotta do a lot of work on the culture when it comes to something like this.