Healthcare Roll-Ups
Over the weekend, I came across a couple of interesting reads about consolidation plays in the medical space (doctors in the U.S., dentists, veterinarians, pharmacies in Canada).
This article in particular by Chris Hannay goes deep on the various roll-ups in Canada and how corporate ownership in privately-owned medical professions is growing at a rapid rate.
The goal (quite similar to roll-ups in many other industries) goes something like this:
"Fuelled by international private equity funds, consolidating firms have been on a tear in other health-professional fields as well, buying up practices in fields such as veterinary medicine, dental care, optometry, and pharmacies and assembling them into chains. Practitioners who sell to corporate owners typically get back-office support through the firm’s technology and staff, help with marketing, and reduced management responsibilities. The buyers, meanwhile, get businesses with steady streams of revenue, and profits that can be boosted by centralizing equipment and administrative functions, and ordering supplies in bulk. In the vast majority of cases, the old branding remains intact after a purchase happens, so patients and customers have no idea their once-independent practice has been taken over by corporate ownership."
The idea is to ultimately centralize/consolidate back-end functions (creating efficiencies) while sharing 'best practices’ that are designed to improve the value of individual customers. Some of which provide value to customers (e.g. perhaps better access to equipment) and others are more geared toward adding value to the investors (e.g. higher pricing).
Here are a couple of examples in Canada that are worth calling out:
Dentalcorp Holdings Ltd., which launched in 2011, has amassed nearly 500 dental practices (about 3 percent of Canada’s practices) by offering dentists six-to-eight times their office’s annual earnings – about double what had once been the industry’s standard. The dentists are paid out 80 percent in cash and 20 percent in Dentalcorp shares.
Neighbourly Pharmacy Inc., another roll-up company backed by private equity that went public last year, expects to have 271 pharmaceutical locations across Canada once a $435-million acquisition of Regina-based Rubicon Pharmacies is completed. The merger triggered an automatic review by the Competition Bureau because of its size.
These roll-ups speak to a broader trend where the share of corporate ownership in Canada is growing fast with significant opportunities ahead (corporates currently own ~5% of dental offices, 25% of veterinary clinics, and 50% pharmacies).
The idea of rolling up medical clinics isn't necessarily a new idea - here's an article on the 'rush to buy doctors' in the U.S. back in 1993.
This is a story that didn't end well as doctors who ended up selling to these roll-ups retired in a relatively short period. Younger, salaried doctors who were then brought on to manage the clinics and were ultimately underpaid as investors got most of the financial upside associated with the clinic's growth. "This churn (among doctors), along with declining insurance reimbursements and rising malpractice insurance rates, ended the run of PPMs (physician practice management companies). PhyCor ended up shuttering and doing a “fire sale” of practices back to doctors for 15-20 cents on the dollar."
Here's a pretty good read on the history of PhyCor covering its ascent and decline over the course of 1991 to 2000. At its peak, the company had managed 40 medical groups with more than 2,500 doctors in 21 states and nearly 26,000 physicians through networks in 29 healthcare markets.
There's a lot to like about medical clinics as a business - it's fairly recession-proof, customers tend to stick with one provider for an extremely long period of time and the growth tends to built-in depending on the location of the clinic.
However, the desirability of this business model has led to the use of debt to improve overall returns and prices paid by these consolidators. Advantages that should have allowed investors to pay a slight premium vs. industry averages have now been magnified via debt.
In an environment where debt was cheap and always available, this wasn't a bad strategy. However, the pressure to service the debt when debt gets more expensive and isn't always available will likely change certain policies that are ultimately designed to:
Growing top-line revenue
Raising prices
Improve the 'throughput' of patients by decreasing service times
Add new patients (e.g. increasing incentives to join a new clinic)
Cutting costs
Investment in virtual-only options
Offshoring/automating non-essential functions
Delay technology/equipment updates and other capital expenditures
In a more extreme scenario, you could see a couple of roll-ups doing a 'Phycor-type' firesale - not because it's a bad business but largely due to not being able to manage leverage as growth slows down. Time will tell whether these PE-backed roll-ups can manage to navigate the current environment without having to scale back.