Our McGuireWoods colleagues, Scott Becker and Bart Walker, recently published an article entitled "Strategies for Hospital Leadership and Identifying Strengths, Allocating Hospital Resources and Focusing on Profitable Niche Leadership" which contains key concepts on strategic planning for hospitals.  In light of healthcare reform legislation, trends in reimbursement, growing interest in accountable care organizations and other issues facing the U.S. healthcare industry, now is an ideal time for hospital leaders to reevaluate their strengths and use those strengths to meet their challenges  

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The following is a list of eleven of the more experienced and active private equity investors in the health care and life science space. These investors are from large private equity funds that specialize primarily in growth-stage, buyout and platform funding transactions. 

1.                  Robert Womsley, Jim Connelley and Ned Villers – Water Street Healthcare Partners. Mr. Womsley, Mr. Connelley and Mr. Villers each work with the Chicago-based firm of Water Street Healthcare Partners. Water Street has over $1 billion in capital under management. Water Street exclusively invests in the health care and life sciences space with portfolio investments across both medical device, medical device distribution and health care providers. Several of their portfolio companies include Medical Specialties Distributors, Sarnova and Access MediQuip. More information is available about Water Street at www.wshp.com. 

2.                  Craig Frances, M.D. Craig Frances leads the health care team at Summit Partners. Summit Partners is one of the nation’s largest private equity funds with headquarters in both Palo Alto and Boston. Dr. Frances serves as a director of HealthCare Partners, National Veterinary Associates and Physicians Formula Holdings. Dr. Frances can be reached at cfrances@summitpartners.com and more information about Summit Partners is available at www.summitpartners.com. 

3.                  Scott Perricelli and David Stienes – LLR Partners. LLR Partners is a large Philadelphia-based private equity fund that invests in a variety of different sectors including healthcare services. Mr. Perricelli and Mr. Stienes led a recent transaction by LLR Partners to fund a platform company called Vivera Health which will seek to build out fertility surgical and laboratory facilities throughout the country. Scott is available at sperricelli@llrpartners.com and David is at dstienes@llrpartners.com and more information about LLR Partners is available at www.llrpartners.com. 

4.                  David Koo and R. Craig Collister – RoundTable Healthcare Partners. RoundTable Healthcare Partners is based in Lake Forest, Illinois and was founded by senior executives from Baxter International and American Hospital Supply. Mr. Collister and Mr. Koo represent the next generation of leadership at RoundTable and focus on investing in various sectors of the healthcare space including medical devices. RoundTable has deep experience in investing in disposable and generic sectors of both medical device and pharmaceutical industries. More information about Mr. Koo and Mr. Collister and RoundTable Healthcare Partners can be found at www.roundtablehp.com. 

5.                  Jeremy Silverman – Frontenac Company. Jeremy Silverman is a managing director at Frontenac Company. Frontenac is a Chicago-based private equity fund that invests in a variety of sectors and focuses portions of its funds on the healthcare space. During the 1990s, Frontenac was a leader in the practice management consolidation. Current Frontenac portfolio investments include Crescent Healthcare and E+ Cancer Care. More information about Jeremy Silverman and Frontenac can be found at www.frontenac.com. 

6.                  Reeve Waud and David Neighbours – Waud Capital. Reeve Waud is the founder of Waud Capital and David Neighbours is a Partner at Waud Capital which is a manager of over $1 billion of funds also based in Lake Forest, Illinois. Waud Capital has invested in Acadia Healthcare and Hospitalists Management Group, LLC and has had significant success in the healthcare space. To further their management expertise, Waud Capital Partners has brought on board Gary Mecklenburg, the former CEO of Northwestern Memorial Hospital in Chicago, Illinois as an Executive Partner. More information about Waud Capital can be found at www.waudcapital.com. 

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In two prior posts regarding, we addressed various questions for a seller to consider when selecting an investment bank to help the seller achieve its transaction goals.   Those questions, as well as those below,  are just a handful of questions that we suggest companies consider . Ultimately, if you determine that working with an investment bank makes sense for your transaction, a bank can help you move a transaction along in an efficient, low stress and financially rewarding way if you are able to find the right bank for you.

 Is the magnitude and type of transaction exciting to the investment bank such that it will keep the bankers’ attention and keep energy focused on pushing the deal through to completion?    In other words, does the deal fall within the bank’s sweet spot? Deals that are at the larger end of a bank’s typical transaction size may mean that the bank has fewer contacts with the types of investors/buyers that should be targeted. Deals that are in the smaller end of a bank’s typical transaction size may not keep the bankers’ attention to drive the deal efficiently toward closing. 

Will the investment bank be willing to follow your management’s lead on the key deal terms (including which targets are contacted, how the various stages of the process will run, etc.)? With the seller management team, does the bank have strong relationships with one or a few leaders that you perceive would be favored over other seller leadership? Alternatively, do you as the seller prefer an investment bank that will lead you through the process and is the investment banker able to do this for you?

Are the bankers willing and able to provide significant research and insight into potential buyers?  For many sellers, choosing a buyer turns on not only the purchase price but on the buyer’s reputation and own strategic goals as well. This is particularly true when all or some of the seller management team will be staying with the buyer going forward.   Most investment banks have research teams who can provide the desired information, but if in-depth information relating to the buyers is important to you, this is one aspect of the bankers’ services that should be discussed.

 Does the proposed timing and track of the deal process proposed the investment bank make sense to you and work with your needs and goals?

Finally, what do the bankers’ clients have to say about them?  The bankers should offer the ability to contact references from current and former clients. Discussing your questions with these references, particularly former sellers, may prove to be very enlightening as to the road ahead. 

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As a follow-up to our prior post on the topic, below are a few key additional questions that sellers can consider when evaluating investment banks in order to find the bank that will ultimately meet the sellers' needs.  These questions are excerpted from a recent article authored by Krist Werling, Scott Becker and me.

One additional question sellers should ask ia How many investor/buyer targets does the investment bank intend to contact with the request for proposal? More specifically, how many potential investors/buyers does the investment bank intend to contact at each stage of the process? Investment banks can very greatly in their philosophy of which and how many targets to contact. Some believe in disseminating the RFP to as many possible targets as are available in the industry whereas others chose to limit distribution to a few select potential investors/buyers that they believe would have the most interest and that would be the best match for you. You should ask how many targets does the bank intend to initially contact and sign confidentiality agreements, how many will receive RFPs, how many will be invited to management meeting and with how many will the bank negotiate offers/letters of intent? Investment banks can very greatly in their philosophy of which and how many targets to contact. Depending on your own sales philosophy, this is another way that you can distinguish among investment banks.

Within the spectrum of investors/buyers that the investment bank intends to contact, how many strategic buyers vs. financial buyers such as private equity funds will be targeted? Strategic buyers are existing players in the industry that may seek to purchase or invest in your business in order to expand an existing business in a strategic fashion, and this may be a more or less attractive option for you as a seller depending on your relationships with your competitors in the industry, your willingness to divulge confidential information to competitors, etc. Financial buyers often will be willing to ultimately pay a higher price for the business where strategic buyers are often more stream-lined in their acquisition methodology and thus more likely to close the deal quickly and efficiently.  To this end, challenges can arise with investment banks when they have too high a comfort level in one part of the market vs another. For example, in one healthcare transaction for a small specialty hospital chain with outstanding earnings, a client hired an investment bank for the principal purpose of seeking financial buyers.   There, the bankers spent the great majority of their efforts with strategic buyers seeking, in the client’s view, the easier close but not necessarily the maximum price.  Ultimately, the client perceived that it already knew each of the strategic buyers and that pricing from the strategic buyers would not permit a deal.

Do the investment bankers understand why your company is ready to sell at this time? Have they worked out the background story of the sale – essentially explaining why, if the business is such a great thing, you now want to part with it?   Buyers will want to know why you are selling and your story about why you want to sell thus becomes an important part of the process.

Do the bankers believe you need to take significant measures to get the business more fully in shape to sell at a maximum price and are you willing to takes these steps?

What is the investment bank’s philosophy with respect to the completion of due diligence and negotiation of the form of purchase agreement/investment documents before signing a letter of intent? In other words, is the investment bank comfortable with signing a letter of intent before diligence is substantially complete and before at least a rough form of purchase agreement is agreed upon? Investment banks have different philosophies on the wisdom of signing of letters of intent early vs. further long in the process and it is important you be comfortable with the bank’s intended approach although the determination of which negotiation approach will likely be as dependent on the negotiation power of the seller (i.e. on the strength of the seller’s business and interest it generates) as it does on the investment bank’s own philosophy.

What are the fees to be charged by the bank? Most banks will charge a retainer fee (which will be treated as a deposit on payment of the full fee) as well as a sliding scale fee based on achieving targeted outcomes. 

Who at the investment bank will be contacting the potential investors/buyers? In other words, will be bankers that you meet with during the initial selection process and works with most closely at the senior leadership level actually be contacting the targets and doing much of the ground work? Likewise, will those particular bankers be present at management presentations and at other key discussions with potential buyers after initial contact is made?

What does the investment bank believe is the range of value for your business? Specially, what assumptions of earnings are used to generate the value range, what multiple of earnings do they anticipate an investor/buyer paying? Within the total purchase price, what does the bank anticipate will be the buyer’s split of cash and debt financing? Although it is important for you to know that the investment bank values your business and will strive hard to achieve the most lucrative deal possible, it is also important to insure that you are working with an investment bank that sets aggressive but reasonably achievable targets.

In addition to the questions raised in Part I of this discussion, these are just a handful of questions that we suggest companies consider when assessing the value of various investment banks.  In Part III we will discuss a few remaining issues for sellers' consideration when making this important decision.

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On July 23^rd, at the same time that it released the final rule relating to the new bundled payment methodology for renal dialysis providers, CMS issued a proposed rule that would create a new Quality Incentive Program (QIP) for dialysis services, tying a facility’s payment to how well it meets the QIP performance standards.   The QIP, which is the first pay-for-performance program in a Medicare fee-for-service payment system, is scheduled to begin on January 1, 2012. 
 
The Medicare Improvements for Patients and Providers Act of 2008 (MIPPA) required CMS to develop the QIP to improve the quality of care facilities provide to dialysis patients.  The proposed rule utilizes just three dialysis quality measures, all of which are measured on a facility-wide basis by looking at the total patient population of the facility as compared to national averages: Hemoglobin above 12 grams per deciliter (g/dL), Hemoglobin below 10 g/dL and URR (urea reduction ratio) above 65%.  These common measures of dialysis quality are what most industry experts expected to be included in the rule and are consistent with CMS’s own QIP outline released in September 2009.  However, in light of comments received during the bundled payment rule-making process, CMS proposes to weight Hgb <10 as the most important of the three measures, accounting for 50% of a facility’s score, while the other two measures would each count for 25%. Each of the three measures would factor into the Total Performance Score, a 30 point scale which measures performance against 2008 national averages (or 2007 performance, if it is lower). The proposed rule includes a sliding scale of payment reductions for 2012, where the minimum Total Performance Score (TPS) that facilities would need to achieve in order to avoid a payment reduction would be 26. If a particular facility does not achieve a TPS of at least 26, the reimbursement withhold would be in .5% increments. 

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For many healthcare companies, when it is time to sell or refinance their business, finding an investment bank that fits the needs, philosophies and goals of the seller can be an important component for success during the sale/refinance process.   Earlier this year, Barclays PLC represented biopharmaceuticals company Ception Therapeutics, Inc. as it closed the $250 million sale of 100% of its capital stock to Cephalon, Inc., arguably helping Ception to achieve optimal pricing. Likewise, in 2006, when hospital system HCA went private via a $33 billion management leveraged buyout, the largest in history at the time, Merrill Lynch Healthcare Investment Banking Group acted as financial advisor to HCA through the process, likely increasing HCA shareholders’ return.  

Utilizing an investment bank is not necessary for all companies in all transactions, but an investment bank can help the seller successfully market the business and attract the right potential investors/buyers and ultimately can result in not only a more lucrative deal but a transaction that otherwise meets the seller’s goals. Assessing which investment bank is right for a seller can be a daunting process, but there a few key questions that you as the seller can pose to your leadership when evaluating the various banks in order to find the bank that will ultimately meet your needs.  In a recent article authored by Krist Werling, Scott Becker and me, we addressed a number of questions that a seller should consider during the selection process.

One of the first key questions a seller should ask is this:  How well versed is the investment banker in your particular industry?  Not only are there investment banks that specialize in healthcare (either boutique investment banks that focus on healthcare or healthcare divisions of larger more diverse investment banks) but some investment banks have specialized experience and knowledge about a particular industry within healthcare such as surgery centers, imaging facilities, etc.   For example, Bank of America-Merrill Lynch, William Blair, Goldman Sachs, Morgan Stanley, JP Morgan and others have significant health care banking groups within their larger investment banking segments and have made headlines with some of the most substantial healthcare M&A deals in the past calendar year, including Pfizer’s purchase of Wyeth for $66.2 million, Roche Holding’s acquisition of the remaining 44% of Genentech and Merck’s purchase of Schering Plough. Middle market more general investment banks like Dresner Partners also often have healthcare experience.  Other banks like Cain Brothers, Leerink Swann and Edgemont Capital Partners have the advantage of focusing nearly exclusively on health care services. Working with an investment bank that understands the complexities of your industry enables the bankers to jump right into a transaction without the need for you to educate them about your industry or to explain basic fundamentals about your business.

The seller should also ask Does the bank understand your individual company as an entity with a unique model, management team and philosophy?   Have they taken the time to get to know your corporate culture and special aspects of your product and service delivery and do they appreciate the ways in which your company differs from your industry competitors?

The seller should further consider Is investment banking a main focus of the company?  We generally caution people against hiring parties to do investment banking services where this is not a core part of their efforts.   For example, one client hired a big four accounting/consulting firm a few years ago to help sell its specialty pharmaceutical business. Investment banking was a newer business line for the big four firm. After months without good results, the client hired William Blair, a company that does focus in investment banking and in part in healthcare and had much better results: i.e. the client ultimately completed a transaction which exceeded essentially all of its targets. 

There are a number of additional considerations when selecting the right investment bank discussed in the article.  In future posts, we will address these questions.

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Yesterday, CMS issued a release regarding the much anticipated final rule laying out the new bundled prospective payment system (PPS) for renal dialysis facilities.  The rule itself was published on July 23, 2010.  Under the new  PPS, CMS will make a single bundled payment to the dialysis facility for each dialysis treatment that will cover all renal dialysis services and home dialysis commencing on January 1, 2011.  It replaces the current system which pays facilities a composite rate for a defined set of items and services, while paying separately for drugs, laboratory tests, or other services that are not included in the composite rate.   At the same time, CMS issued a proposed rule that would create a new Quality Incentive Program (QIP) for dialysis services that will link a facility’s payment to how well it meets the QIP performance standards, which will be discussed in a separate blog post.  
 
Currently and through the remainder of this year, Medicare makes a composite rate payment to ESRD facilities for furnishing outpatient maintenance dialysis in the facility or in the beneficiary’s home.  The composite rate payment covers dialysis treatment costs and certain routinely furnished ESRD-related drugs, laboratory tests, and supplies.  The Medicare Improvements for Patients and Providers Act of 2008 (MIPPA)   required  CMS to develop a new, fully bundled prospective payment system for renal dialysis services to replace the existing composite rate payment methodology.

According to the CMS issuance, CMS received nearly 1500 public comments in response to the ESRD PPS proposed rule that appeared in the September 29, 2009 Federal Register.  Among the major concerns raised by the comments were the proposals surrounding payment for home dialysis training; inclusion of additional payment adjustments for patient characteristics in the payment methodology; and inclusion of former Part D prescription drugs related to ESRD treatment in the payment bundle.   In the final rule CMS: 
 
 1) Creates a home or self-care dialysis training payment adjustment specifically directed to patients trained by facilities certified to provide home dialysis training. 


 2)  Finalizes payment adjustments for dialysis treatments furnished to adults for patient age, body surface area, and body mass index, onset of dialysis, and certain co-morbidities, but does not finalize adjustments for the patient’s sex or the patient’s race or ethnicity. 


 3)   Finalizes a payment adjustment for dialysis treatments furnished to pediatric patients, based on patient age and dialysis modality, but not co-morbidities.  


 4)   Finalizes a definition for renal dialysis services that includes ESRD-related oral-only drugs, but postpones payment for such drugs under the ESRD PPS until Jan. 1, 2014.

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On May 26th, CMS released a proposed rule setting out new credentialing and privileging processes for physicians and other healthcare professionals who provide telemedicine services, a move which may lesson burdens on healthcare providers considering telemedicine options. Further, next week CMS is expected to release an additional proposed rule re additional services which may be reimbursed by Medicare if provided via telemedicine. Both rules, if they become law, could increase opportunities for growth in telemedicine companies.

Proposed Rule re Cross-Credentialing

Prior to January 1, 1999, Medicare coverage for services delivered via a telecommunications system was limited to services that did not require a face-to-face encounter under the traditional model of medical care, such as interpretation of an x-ray or electrocardiogram or electroencephalogram tracing, and cardiac pacemaker analysis. Then on October 1, 2001, section 223 of the Medicare, Medicaid and SCHIP Benefits Improvement Protection Act of 2000 significantly expanded Medicare telemedicine services services to include consultations, office visits, office psychiatry services, and certain other services that have been added over the years. However, in addition to state licensure and other issues faced by hospitals and physicians providing these services, one challenge for hospitals has been the process of granting credentials to these physicians. Under existing Medicare Conditions of Participation (CoP), the governing body of a hospital must make all privileging decisions based upon the recommendations of its staff, after the staff has examined and verified the credentials of practitioners applying for privileges. Thus a hospital must conduct individual appraisals of its prospective members and examine the credentials of each candidate to make a privileging recommendation to the governing body. Hospitals may use third-party credentialing verification organizations, but the governing body remains responsible for the privileging decisions.

By contrast, the proposed rule released on May 26th would allow the governing body of a hospital whose patients receive telemedicine services to grant privileges based on recommendations from its medical staff, which, in turn, would rely on information provided by the distant-site hospital. In the proposed rule, CMS would require the local hospital to verify that:

1. The distant-site hospital is a Medicare-participating hospital.

2. The physician is privileged at his own hospital and that the distant-site hospital provides the local hospital a current list of the physician’s privileges.

3. The physician holds a license issued or recognized by the state in which the local hospital is located.

4. The local hospital has evidence that the distant-site hospital conducts an internal review of the physician’s performance of his privileges.

The local hospital must provide relevant information to the distant-site hospital for its use in periodically evaluating the physician, including all adverse events that might have resulted from telemedicine services provided by the physician to the local hospital’s patients, as well as all complaints the local hospital has received about the physician. CMS believes its proposal would "allow for the advancement of telemedicine nationwide while still protecting the health and safety of patients." CMS is currently taking comments on the proposed rule through July 26th.

Anticipated Proposed Rule re Additional Telemedicine Services

According to the American Telemedicine Association, on or about July 13th CMS is expected to release an additional proposed rule re additional services which may be reimbursed by Medicare if provided via telemedicine. At a minimum, these two proposed rules suggest a greater degree of acceptance of telemedicine services than ever before. If the proposed rules becomes law, many hospitals will likely take advantage of such cross-credentialing options and opportunities to bill Medicare for additional telemedicine services, and telemedicine providers may flourish in the process.

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One aspect of investing in a healthcare facilities business of which investors should be aware is the impact of state certificate of need (CON) laws. A  CON is a state regulatory review process that requires an application to the appropriate state board for the grant of a CON prior to developing, or in some states expanding or modifying, a covered healthcare facility. CON laws arose in the 1960’s as many states attempted to curb rising healthcare expenditures through planning and regulation.  In 1974, Congress passed the National Health Planning and Resources Development Act, mandating that all states adopt CON laws.  A decade later, Congress allowed the federal law to expire, and several states quickly repealed or let sunset their CON laws. Now, according to the National Conference of State Legislatures, 36 states plus the District of Columbia have CON laws that govern some healthcare facilities. Some state laws govern primarily hospitals while other state laws govern a broader array of facilities. Supporters of CON programs believe they help ensure access to healthcare, keep quality high and lower costs by evaluating whether a particular service or facility is actually needed in the proposed area.  Opponents believe it stymies healthy competition that is needed to keep quality high.

Investors should become familiar with the CON requirements, if any, in the states in which their target businesses operate, including the facilities governed by the CON laws and the rules on expansion and modification. Investors should consider whether such restrictions work to the businesses’ benefit currently and whether the restrictions will continue to be beneficial in the future. The presence or lack of state CON requirements also will likely factor into valuation of the business. In certain circumstances, a CON can be considered a valuable asset of the business that was hard-fought and costly to obtain, and state CON requirements can in some cases function as a protection for the business against emerging competitors in at least the short term. However, in most states, CONs are tied very specifically to a designated location and designated size (e.g. based on number of beds, procedure rooms etc) and facilities in a CON state can have less flexibility in terms of modifying business lines as facilities in non-CON states. In those CON states closely regulating expansion and modification, obtaining the necessary approvals can be an expensive and lengthy process.

Additionally, investors should understand the workings of the state CON board and the current political and legal issues facing those boards. For example, the gle provides that no person shall construct, modify or establish certain types of healthcare facilities or acquire major medical equipment without first obtaining a CON or exemption from the Health Facilities and Services Review Board (the Board).  In a recent article, McGuireWoods healthcare attorneys Jeff Clark, Jason Greis and Joe Hylak-Reinholtz discussed some key recent changes to the Illinois CON law impacting Illinois healthcare providers and their investors.  The authors discussed that on March 1, 2010, an important provision in the Illinois law relating to the legislature's decision to alter, yet again, the number of members on the Board (increasing its size from five to nine members) became effective. The change represents the third time since 2003 that the state legislature has altered the number of members on the Board. The change is important because the addition of four Board members could create new opportunities or lead to unforeseen challenges for future CON applicants. The viability of potential projects may be shaped by the individuals Governor Quinn appoints to fill the new Board vacancies. Changes such as these in state CON laws and boards can have significant impacts on a business and should be carefully considered by investors as well.

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In prior posts I’ve discussed the significant impact of the Patient Protection and Affordable Care Act (the PPACA, more commonly referred to as the healthcare reform legislation) on the physician-owned hospital industry.  Section 6001 of the PPACA stymies growth of the industry by prohibiting expansion of existing physician-owned hospitals and bans any new physician-owned hospitals that are not Medicare-certified by December 31, 2010 (i.e. hospitals violating those limitations will not be permitted to bill Medicare/Medicaid for referrals made by their physician owners). Although a number of exceptions apply to the expansion prohibition, most industry analysts believe meeting the exceptions will be challenging to virtually impossible for existing physician-owned hospitals.

According to a press release issued today by Physician Hospitals of America (PHA), the trade association for the industry, there are approximately 265 existing physician-owned hospitals, 29 of which are scheduled to open and receive their Medicare certification by December 31, 2010. An additional 45 hospitals are currently under development and are not expected to be open or Medicare-certified by December 31, 2010. According to PHA, there were also 39 hospitals that were previously under development but were abandoned as projects due to passage of Section 6001.

In response to Section 6001, PHA and Texas Spine & Joint Hospital (TSJH) jointly filed suit today in U.S. Federal Court, Eastern District of Texas, challenging the constitutionality of Section 6001 on grounds that the law is a violation of due process and equal protection rights, and that the Section is void due to a contradictory, vague and arbitrary nature. TSJH is a privately owned hospital specializing in orthopedic and spine surgery, procedures, and tests which had sought and won local zoning approval to expand its facility with an additional 20 Medicare beds, which expansion project would now be prohibited by Section 6001.

Industry supporters and opponents will be carefully following progression of the lawsuit as the resolution is anticipated to have a profound impact on the ability of the physician-owned industry to thrive.

Scott Oostdyk and Victor Moldovan of McGuireWoods are representing PHA and TSJH in the lawsuit. 

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Now more than ever, it is critical that anyone contemplating investment in a healthcare sector carefully review the target company’s compliance protocols. We have always strongly recommended that investors analyze the company’s compliance program, as well as efforts at adhering to the program requirements, in order to better gauge the company’s overall goals and philosophy regarding compliance. Understanding a company’s compliance culture can help the buyer assess the risks it may be taking with investment in the company and what challenges, if any, may be on the horizon for the company.

Now, under the Patient Protection and Affordable Care Act (the PPACA, more commonly referred to as the healthcare reform legislation), certain healthcare providers, as a condition to participation in Medicare, must have in place a compliance plan that meets the requirements to be laid out by the Secretary of HHS. The PPACA lists several detailed requirements for the compliance plans of skilled nursing facilities (SNFs), likely due to the industry’s historical scrutiny and highly publicized investigations from the SNF industry in the past few years. SNFs must implement these compliance plans pursuant to the requirements of Section 6102 of the PPACA within 36 months following passage of the PPACA, and regulations must be issued by the Secretary of HHS for SNFs with additional guidelines no later than two years following passage of the PPACA. 

By contrast, the Secretary of HHS is mandated with determining which provider types must have compliance plans in place and what those plans must entail. HHS has informally indicated that it would likely roll out the compliance plan requirements on an industry-by-industry basis. It is likely that the requirements for most industries will closely follow the key components of the DHHS Office of Inspector General model compliance plan published for healthcare providers in 1997, which has subsequently been updated.

For healthcare providers without compliance plans that wish to make early moves toward a full compliance program, or for buyers who seek additional comfort through early implementation, an article entitled “A Practical Compliance Plan Approach for ASCs” authored by Scott Becker, Melissa Szabad and myself is available here. Although this article speaks specifically to the ambulatory surgical center industry, it has practical implications for most healthcare providers. 

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On Wednesday, March 12^th, McGuireWoods hosted our 8^th Annual Business & Legal Issues in Dialysis & Nephrology Symposium. Leaders from various perspectives in the industry provided presentations and lead discussions on a wide array of topics, including the effects of the Patient Protection and Affordable Care Act (the PPACA, commonly referred to as the Health Care Reform Law), key compliance issues and investment scenarios.

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In recent years there has been growing public awareness of end of life decisions and the importance of documenting advance healthcare decisions. In fact, April 16^th is National Healthcare Decisions Day, a nationwide educational event founded by McGuireWoods partner Nathan Kottkamp.   Advance directives are legal documents, prepared by patients in advance of the need for healthcare services, that directs the healthcare the patient does or does not want if he or she becomes unable to make decisions. Advance directives may include durable powers of attorney, living wills and organ donation directions.  Nathan recently discussed advance directives, including issues arising out of healthcare reform debates, on Countdown with Keith Olbermann. 

From the perspective of many healthcare providers, providing information about advance directives is required by law. The Conditions of Participation in the Medicare and Medicaid programs require hospitals, critical access hospitals, skilled nursing facilities, nursing facilities, home health agencies, providers of home healthcare (and for Medicaid purposes, providers of personal care services), hospices, ambulatory surgery centers, and dialysis facilities to inquire about and provide information to patients regarding advance directives. Further, the Conditions of Participation require all of these healthcare providers, except ASCs and dialysis providers, to provide public education about advance directives. Additionally, healthcare accreditation bodies Joint Commission and AAAHC have accreditation standards requiring facilities to honor advance directives.

In connection with the national focus on advanced healthcare decisions, new companies have emerged to assist patients and healthcare providers with the advance directives process. Embark Health, for example, has developed and is actively distributing Advance Directive Solution (ADS), a comprehensive online and telephonic resource with all the information and legally current forms to create an enforceable advance directive. Embark Health is also in the process of rolling out The Personal Legacy Solution (PLS), an electronic repository for tracking the location of assets, the location of other important items or documents, and for storing important messages to loved ones (all of which will be retrievable in accordance with the individual member’s specifications).  Embark Health markets these products directly to patients as well as to and through large systems such as health plans, hospitals and other providers. Burgeoning companies like Embark Health and others may provide an opportunity for investors interested in healthcare and healthcare IT services.  

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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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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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In a prior post, I discussed the legislative challenges faced by physician-owned specialty hospitals during the past decade.  One powerful weapon specialty hospitals have in the fight against industry adversaries are research findings showing that specialized surgical care results in better outcomes and fewer serious post-surgical complications such as blood clots, infections and heart problems.

One such study was released online in the British Medical Journal on February 11th.  As reported by Becky Soglin of The University of Iowa Health Care Media Relations, the findings were based on data for nearly 1.3 million Medicare patients who received hip or knee replacement surgeries between 2001 and 2005 at 3,818 hospitals in the United States. The results grouped hospitals into five levels of specialization.  The most specialized hospitals had fewer complications or deaths within the first 90 days after a surgery than less specialized hospitals did.  For one example as cited by Ms. Soglin, the rate of death for patients who had hip and knee replacements was twice as high at the least specialized hospitals compared to patients treated at the most specialized hospital -- 1.4% compared to 0.7% within the first 90 days after surgery. 

Of course both sides of the specialty hospital debate cite statistics relating to the impact of specialty hospitals on the U.S. healthcare system at large.  For specialty hospitals, continued focus on impressive clinical outcomes is critical.  Additionally, specialty hospitals have become popular among patients for their high quality facilities and highly focused care.

Industry adversaries include political powerhouses like the American Hospital Association, which claim that specialty hospitals waste government funded healthcare dollars by permitting physicians to refer to entities in which they own interests and cherry-pick patients with the most lucrative insurance coverage thereby overburdening general acute hospitals with excessive indigent populations.

The future of national healthcare reform efforts is unclear.  Even if specialty hospitals again escape restriction in a consolidated healthcare reform bill,  it is certain that specialty hospitals will not be forgotten by their opponents. 

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The National Health Expenditure Accounts (NHEA) are published by the Centers for Medicare and Medicaid Services (CMS) and are the official estimates of total national healthcare spending.  CMS began releasing the NHEA in 1960. The NHEA measures annual U.S. expenditures for healthcare goods and services, public health activities, program administration, the net cost of private insurance, and research and other investment related to healthcare. The data are presented by type of service, sources of funding and sponsors.

According to CMS, U.S. healthcare spending continued to grow in 2008, increasing 4.4 percent compared to 6.0 percent in 2007. This increase was the lowest in healthcare spending since 1980. Total health expenditures reached $2.3 trillion, which translates to $7,681 per person or 16.2 percent of the nation's Gross Domestic Product (GDP). Data for 2009 has not yet been released.

Through its Office of the Actuary, CMS releases each year projections of healthcare spending for those same categories as are measured in the NHEA.

An overview of NHEA and projection methodologies can be found on the CMS website as well as NHEA historical data. Also available from CMS are the actuarial projections .

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One of the less publicized aspects of recent Congressional healthcare reform efforts is the continued efforts of some legislators to severely limit physician ownership in specialty hospitals, this time through the current U.S. House of Representatives and Senate bills.

There are nearly 200 specialty hospitals in the United States, as well as many in various stages of development. These specialty hospitals most commonly concentrate on surgical procedures, although there is a subset of the specialty hospital market that focuses on cardiovascular services, and there is a growing trend toward specialization in other nonsurgical areas such as special cancer treatment hospitals, children’s specialty hospitals and renal hospitals.

These hospitals are often physician-owned and operate pursuant to a specific exception to the federal Stark Law known as the “whole hospital exception” which permits physician to refer to the hospitals in which they own equity. The U.S. House of Representatives and Senate have both passed bills containing language that seriously alter the so-called "whole hospital exception" to the Stark Law on which these specialty hospitals rely, including by limiting the ability of existing hospitals to expand, limiting the level of physician ownership in such hospitals and prohibiting the development of new physician-owned hospitals which have not yet achieved certain developmental milestones (such as Medicare certification) by a set date.  

The House and Senate are working to consolidate their reform bills but it is yet unknown whether Congress will be able to pass any health care reform bill, particularly given the recent shifts in the power with the election of new Massachusetts Senator-elect Brown. Even if a consolidated bill is adopted, the details of such limitations on physician-owned hospitals are unclear; however, most industry leaders believe any consolidated bill would include some additional restrictions on physician-owned hospitals.

One thing is certain. The political future of physician-owned specialty hospitals is hazy, and if the current healthcare reform efforts do not produce a bill with restrictions on physician-owned hospitals, industry opponents are unlikely to lay down their swords. 

Physician Hospitals of America (PHA) is the industry trade association for physician owned hospitals.

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