On March 25th McGuireWoods hosted a webinar for private equity investors that provided an overview of key business issues and due diligence process for investments in the dialysis and physician practice spaces.  If you missed the webinar, an archived copy of the webinar is available on our webite.  This entry provides a brief summary of one of the most important aspects of making an investment in any space: due diligence. 

The dialysis market has been a lucrative area for investment by a number of private equity funds.  Here are a few key areas for conducting diligence on these investments:

• Referral streams - understanding where referrals for the facilities come from is essential.  Further, investors must ensure that relationships with referral sources are in compliance with the Anti-Kickback Statute and Stark Act.
• Medical Director Agreements - ensuring that facilities are properly staffed with CMS-mandated medical directors and that medical director relationships meet appropriate regulatory requirements and include enforceable non-competes.
• Payor Contracting - conducting an analysis of reimbursement rates and ability to retain payor contractrs from commercial payors. 

After being decimated in the late 90s, the physician practice management space is again seeing interest from investors.  When investing in this market, a few key diligence areas include:

• Structural Issues - state corporate practice of medicine laws typically prohibit employment of physicians by corporations that are owned by non-physicians.  As such, physician practice management companies are typically structured as a management relationship with a "professional corporation."
• Management Agreement Structure - state laws prohibiting fee splitting impact the structure of management agreements.  It is important to confirm compliance with fee splitting laws to ensure enforceability of management agreements. 

For a copy of the full presentation, email us at kwerling@mcguirewoods.com or awalsh@mcguirewoods.com. 

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As physicians face the reality of consolidation in certain segments of the healthcare industry, rising costs such as the costs of malpractice coverage, the tangible and intangible costs of administering a private practice and the critical importance of power in the managed care contracting process, many are moving away from traditional private practices with a few colleagues and making momentous changes in the way they practice.  

One way for physician practices to prosper is by strategically restructuring such that they themselves can acquire the scale and resources to accomplish their goals with more autonomy. 

Another option that has gained increasing popularity is for practices to join forces with physician organizations with vast resources, economies of scale, significant management expertise and sophisticated information networks such as large practices, hospitals and physician practice management companies (PPMCs). Of course, as with any transition in practice methodology, there are price tags that come with such a movement.   There are a few different PPMC models, some including ownership of the managed practices under an umbrella organization and others involving purely fee-based management services such as management services organizations (MSOs). The long-term viability of the PPMC model has been seriously questioned in the past decade as former publicly traded PPMC giants like PhyCor* and MedPartners** quickly rose to prominence and nearly as quickly fell from grace.   However some industry experts believe that some of these consolidation approaches, including MSOs and umbrella organization PPMCs, can still be a good solution for physicians in the right format and right circumstances. 

As the larger consolidating organizations flourish, so do investment opportunities. McGuireWoods will be hosting a complementary webinar on Thursday, March 25th focusing on issues relating to investment in the physician practice management space as well as the dialysis industry. This webinar is the first in a series organized by Krist Werling, myself and other colleagues at McGuireWoods that will focus on assessing targets, conducting due diligence and related issues in various healthcare niches.  Registration is available here, and in future posts we will further discuss the opportunities and challenges in these niches.

* In late 2002, PhyCor emerged from Chapter 11 bankruptcy. One of its divisions, privately-held Pivot Health, continues to provide healthcare management services. 

* Following the decline of its PPMC business in the late 90’s, MedPartners began to focus exclusively on prescription benefits management as Caremark Rx and Caremark International, which merged with CVS in 2007 into what is now CVS Caremark (ticker symbol CVS).

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McGuireWoods hosted its 7^th Annual Healthcare and Life Sciences Private Equity & Finance Conference last month in Chicago, IL. With over 250 attendees, the conference was an opportunity to gauge the temperature of the current deal-making environment in healthcare and Life Sciences. A few observations from the event, the panelists and the attendees:

• Increased in Activity in 2010. The first clear observation is that most deal makers, including the private equity fund professionals and investment bankers expect 2010 to see a relatively brisk increase in deal activity. According to a William Blair report, healthcare saw only 157 private equity deals in 2009, compared to 180 in 2008 and 241 in 2007. Brian Scullion of William Blair, sighted strategic buyers as a likely continued source of deals in 2010 due to the increased needs of strategics to find revenue growth. 

• Focused Diligence Is Key to Success. Many panelists described the dangers of investing in healthcare and life sciences if not done properly. Focused due diligence and use of industry experts can help avoid disasters and ensure that deals are structured properly. 

• Healthcare Reform Will Not Discourage Investment. Following the heels of the Scott Brown win in Massachusetts, some speculation that Healthcare Reform will not be finalized in the form previously anticipated appeared to give many attendees and panelists encouragement in that it would not have an adverse impact on potential investments in the healthcare and life Sciences sectors. Although some sectors (i.e., specialty hospitals) viewed negative impact from healthcare reform as inevitable, certain others, such as medical devices and outpatient services, do not appear to be headed towards in any significant changes in their business.

• Growth Companies. We were pleased to have 16 different growth stage companies present at the conference. These included PerkSpot, Pathfinder Health, Nephroceuticals, Advanced Life Sciences and a variety of other companies that are seeking capital and opportunities for growth. It is always encouraging to see the excitement of entrepreneurs and managers of growth-stage businesses. If you did not have an opportunity to attend the conference and would like to be introduced to any of the presenting companies listed here, please contact Krist Werling at kwerling@mcguirewoods.com or Amber Walsh at awalsh@mcguirewoods.com.

• Strong Companies Can Survive and Thrive. The final theme from the conference was that strong companies with “quality” earnings are surviving and thriving during this economic downturn. These companies have focused their efforts on strictly managing costs and improving revenues during this downturn. For example, Brad Wilsted, of Blue Ridge Capital, described how many companies can focus on same store growth during this time to improve revenues while not spending excessive amounts of money on marketing or other costly initiatives. According to the keynote panel, which included speakers such as Ned Villers from Water Street Healthcare Partners, these strong companies are still seeing good valuations when approached by potential private equity investors.

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The healthcare sector saw a significant decrease in the number of private equity transactions completed last year. Pitchbook reported that approximately 125 deals were completed where private equity funds invested in healthcare companies in 2009. This is down from 233 in 2008. This reduction takes into account both general economic conditions which saw declines in almost every sector, the overhang of healthcare reform where many investors saw tremendous uncertainty in the healthcare sector due to the potential for healthcare reform and the concern that some funds were over-invested in healthcare. Interestingly enough, much of the over-investing in healthcare resulted less because sponsors increased their percentage of investment in healthcare but more due to significant reductions in the values of the other investments which left their overall percentage of investment in healthcare higher both on the equity or debt side and thus over invested in healthcare. 2010, however, has already seen significant pickup in healthcare investing and new interest in the healthcare sector.

Fellow McGuireWoods attorneys Krist Werling, Scott Becker and I recently published a short article discussing the following four key concepts relating to healthcare investing:

1) Types of buyers from the perspectives of goals and strategies;

2) Types of target companies from a compliance orientation perspective;

3) Healthcare diligence issues; and

4) False claims recoveries issues.

It is critical for any investor in healthcare to have a firm understanding of each of concepts.  The more knowledgeable the investor in these areas, the more capable they will be to evaluate risks of investment. 

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The U.S. dialysis industry includes more than 4,000 outpatient dialysis facilities (in addition to a large number of home dialysis programs) that service more than 350,000 patients suffering from end stage renal disease (ESRD). The industry self-classifies dialysis companies as either large dialysis organizations (LDOs) or small dialysis organizations (SDOs). The LDOs are few in number and include DaVita and Fresenius Medical Care, both publicly traded companies, as well as DSI Renal and Renal Advantage, both of which are backed by private equity funding.  In mid-2008, Congress passed the first major Medicare payment overhaul for dialysis providers in 25 years. Two years later, in anticipation of the January 1, 2011 implementation date, LDOs and SDOs alike are taking a close look at the potential impact on their businesses.   

As part of a more comprehensive ESRD program reform bill, the payment formula for dialysis treatments was reconfigured into a bundled payment for all dialysis services (including pharmaceuticals such as the common anemia management erythropoietin-based drugs). Pricing for those services will be influenced by a market update mechanism starting in 2012. Providers can elect to fully participate in the bundles approach in 2011 or may instead elect to have the approach phased in over four years beginning in 2011. Physicians will also get a 2% increase in the Medicare payment if they submit prescriptions electronically. Those who don’t use the so-called e-prescriptions by 2011 would have their fees cut by 1% the following year, rising to 2% in 2014. 

It is likely that the new bundling system will impact SDOs and LDOs differentially for a variety of reasons. For instance, LDOs enjoy impressive purchasing and contracting power and other economies. Further, some LDOs are vertically integrated such that their key equipment and fungible products suppliers are affiliates, which can result in a significant cost savings to the LDO.  

On the other hand, some industry analysts believe the impact of bundling will be felt differently by providers not necessarily along SDO versus LDO lines but rather based on other factors, such as a provider’s historical drug dosage orders or based on geographic factors. For example, Shari Levanthal of the American Society of Nephrology published an interesting article last year describing the findings of Columbia University/Harlem Hospital researchers who believe that dialysis providers in the east and southeast are particularly likely to feel an adverse financial impact due to historical variances in Medicare reimbursement.

In any event, the January 1^st implementation date for the new methodology is quickly approaching and dialysis providers of all size, modality focus and patient population would be wise to assess now the potential impact on their businesses and strategies for keeping costs low and quality high. 

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