WMBA 6602 Week 7 Private Equity Deal Analysis Example

Where the Money Changes Hands When Private Equity Buys a Gastroenterology Group: The Deal Structure, the Revenue Moves That Follow and What a Two-Hospital System Should Do Before the Endoscopy Volume Leaves

Student Name

Walden University

WMBA 6602: Contemporary Topics in the U.S. Healthcare Delivery System

Instructor Name

Month Day, Year

Where the Money Changes Hands When Private Equity Buys a Gastroenterology Group: The Deal Structure, the Revenue Moves That Follow and What a Two-Hospital System Should Do Before the Endoscopy Volume Leaves

The Issue

Private equity firms have bought physician practices in growing numbers over the past decade, with acquisitions documented across many specialties (Zhu et al., 2020). For Laurel Valley Health, the imaginary east Tennessee hospital pair used all term, the issue became concrete this year when a private equity-backed gastroenterology platform agreed to acquire the region's largest independent gastroenterology group, eleven physicians who perform most of their colonoscopies and other endoscopies in Laurel Valley's hospital outpatient department. This paper follows the money through the transaction and the years after it, then argues what Laurel Valley should do.

How the Deal Is Structured

Most states, Tennessee among them, restrict who may own a medical practice, so the platform does not buy the practice outright. Instead it buys the practice's non-clinical assets and signs a long-term agreement with a management services organization that it controls. The physicians' professional corporation remains physician-owned on paper, but the management company provides billing, staff, space, equipment and contracting, and charges a management fee that captures most of the practice's profit.

Money changes hands at four points. First, at closing, the physicians receive a large upfront payment for the practice's future earnings, part in cash and part as equity in the platform company, known as rollover equity. Second, after closing, the physicians' own compensation is reduced, because the earnings they sold now flow to the management company as its fee. Third, the platform finances the purchase partly with debt held at the holding company, which must be serviced from the practice's earnings. Fourth, after several years the private equity fund sells the platform to a larger buyer, and the physicians' rollover equity is paid out at that sale.

The Revenue Moves That Follow

The structure creates strong pressure to raise the practice's earnings quickly, both to service the debt and to raise the price at the eventual sale. The evidence on what follows is now substantial. Singh et al. (2022) compared 578 gastroenterology, dermatology and ophthalmology practices acquired by private equity between 2016 and 2020 with matched practices that were not. Relative to the controls, the acquired practices increased the charge per claim by about 20 percent and the allowed amount, what insurers actually paid, by about 11 percent. The number of distinct patients they treated grew about 26 percent, mostly because new-patient visits rose 38 percent, and a bigger fraction of their return visits were coded as lasting more than thirty minutes.

Table 1

Revenue Changes After Acquisition, Relative to Matched Practices

Figures from Singh et al. (2022), comparing private equity-acquired practices with matched controls through two years after acquisition.

For the gastroenterology group, one more revenue move matters most to Laurel Valley. Platforms typically build or buy ambulatory surgery centers and move endoscopies out of hospital outpatient departments into centers they own, capturing the facility fee that the hospital now collects. They may also add ancillary services, such as anesthesia for sedation and pathology for biopsies, inside the platform. Post et al. (2018), reviewing research on hospital-physician integration, found evidence that integration can be used to steer referrals and raise prices, and a platform that owns the physicians, the surgery center and the ancillary services has the same ability from the physician side.

The Effect on Laurel Valley

Laurel Valley's outpatient department performs about 6,800 endoscopies a year for the group's physicians. At an average facility payment across payers of about $1,150, that is roughly $7.8 million in annual revenue, with a contribution after variable costs of about $3.1 million. If the platform opens its own surgery center within two years, as similar platforms have done elsewhere, most of that volume could move. The hospital would keep the equipment, space and nursing staff sized for volume it no longer has.

The commercial insurers in the region face a different effect. Higher prices negotiated by a larger, consolidated gastroenterology group raise their costs, which feeds back into the premiums paid by self-insured employers in the region.

What Laurel Valley Should Do

Laurel Valley can respond in one of three ways.

One is to stand pat and plan to shrink the endoscopy suite. That accepts a loss of about $3 million a year in contribution and leaves the hospital without gastroenterology coverage for inpatients if the group's physicians stop taking hospital call.

The second is to compete for the physicians not joining the platform, about four independent gastroenterologists in the region, by employing them or offering professional services agreements. That preserves some volume and inpatient coverage but cannot replace eleven physicians.

The third is to propose a joint venture surgery center with the platform, in which Laurel Valley owns a minority share, provides anesthesia and pathology under contract and secures a call agreement for inpatient coverage. Laurel Valley would give up part of the facility fee but keep a share of it, and it would keep the physicians in its referral network.

Risks in the Recommendation

A minority stake gives Laurel Valley a share of the surgery center's earnings but little control over how it operates, and the platform may decline the offer if it expects to capture the volume anyway. The joint venture would also need legal review for referral and ownership rules before any terms are signed.

Conclusion

Laurel Valley should pursue the joint venture while making the second option ready as a fallback. The mechanics show that the platform's incentive is to move endoscopy volume to a center it controls; resisting that move outright is unlikely to succeed, and the platform needs local partners for anesthesia, pathology and hospital privileges. A minority stake converts a likely loss of about $3 million a year into a smaller, shared stream, and a written call agreement protects inpatient care. The analysis also suggests that Laurel Valley should monitor the platform's commercial prices, because higher regional prices fall eventually on the same employers whose workers fill its beds.

References

Post, B., Buchmueller, T., & Ryan, A. M. (2018). Vertical integration of hospitals and physicians: Economic theory and empirical evidence on spending and quality. Medical Care Research and Review, 75(4), 399-433. https://doi.org/10.1177/1077558717727834

Singh, Y., Song, Z., Polsky, D., Bruch, J. D., & Zhu, J. M. (2022). Association of private equity acquisition of physician practices with changes in health care spending and utilization. JAMA Health Forum, 3(9), e222886. https://doi.org/10.1001/jamahealthforum.2022.2886

Zhu, J. M., Hua, L. M., & Polsky, D. (2020). Private equity acquisitions of physician medical groups across specialties, 2013-2016. JAMA, 323(7), 663-665. https://doi.org/10.1001/jama.2019.21844