This interview was originally published in PE Hub.

Ophthalmology has seen over 330 PE-backed physician practice management (PPM) transactions over the last five years, according to global advisory firm Stout’s newly released report, Eye Care Industry Outlook 2024. Despite higher interest rates, strong ancillary service add-on potential continues to attract PE to the space. To learn more, PE Hub spoke with Stout’s Nick Janiga, Managing Director, and Daniel Levin, Director, about the opportunities and how PE is helping these businesses scale.

What tailwinds are driving the surge in PE-backed eye care transactions?

Nick Janiga: Outside of maybe a few health systems, most health systems we’ve worked with haven’t focused too much on ophthalmology practices, unlike with PE. There’s maybe a couple in the Northeast and other locations that have big ophthalmology departments, but for the most part, ophthalmologists haven’t been the focus of health system acquisitions over the last dozen years or so.

Daniel Levin: Some of the primary reasons that PE buyers have been interested in this space is that the industry remains kind of fragmented with a lot of smaller practices operating independently. Historically, there’s not been a great deal of interest in these types of practices from health systems. The nature of the specialty lends itself to a number of ancillary services that can be developed or grown with PE money and sponsor money, particularly ambulatory surgery centers (ASCs). You see a lot of larger platforms operating surgery centers as well as performing optometry and selling various products. The ability to drive additional revenue streams helps with income repair for the selling parties and grows EBITDA for the platform. Also, one tailwind in general that is really helping most healthcare is the aging population.

What about the PE model makes it the right fit for eye care practices?

Nick: I think small to midsize physician practices and ophthalmology practices particularly can be light on having management and administrative teams support the physicians. Thus, the physicians are stuck doing more administrative work and not operating at the top of their medical license.

Getting access to a more structured and experienced management team allows them to focus on the things they may want in terms of providing care and treatment to patients. The access to capital can help expand practices and add additional subspecialties in large or small to midsize ophthalmology groups, such as adding a retina specialist or ASCs, bringing optical in-house, or allowing physicians more time to participate in clinical research. These are value-added activities the physician practice may not have time to do as an independent practice.

Daniel: Lots of smaller physician practices, owned and operated by physicians, don’t necessarily have the experience to scale a business the way a PE sponsor would. The ability to gain scale, professionalize operations, and then add on these ancillaries can really lend itself to someone with more experience operating and growing businesses, allowing physicians to focus more on the clinical side of the practice.

How are valuations for these types of businesses faring?

Nick: We’re seeing probably a one-to-two times EBITDA downturn in valuation multiples over the last 18 months or so within the space. We’re seeing larger bid-ask spreads in terms of what buyers are willing to pay and what sellers are willing to sell at. We’re seeing some deals reach completion but just from an earnings adjustment. There are certain EBITDA adjustments that buyers are willing to accept, but the more creative or lower probability adjustments that were being accepted in late 2020 and 2021 and even parts of 2022 aren’t really being accepted right now.

We’re expecting an uptick in volume in 2025. You have some sellers kind of waiting on the sidelines and some buyers anticipating more practices to come to market in 2025. Lower interest rates should help with those acquisitions.

A lot of the activity we still see happening is around grade A assets and practices. There are also a few sub-grade A acquisitions happening at fairly depressed multiples because there may be fewer options available for those practices. In terms of what makes a grade A practice or asset, we would expect it to be a fairly stable to growing practice without a great degree of normalizing adjustments. It has a mix of well-tenured senior, mid-level, and early career physicians and good support staff. It has systems where the data for the practice is readily available to buyers and doesn’t have a pieced-together administrative group.

Daniel: We’ve certainly seen valuations in the PE space come down in the past 12 to 18 months. Obviously, with higher interest rates, some of the math around these transactions has changed, and in general, PE activity has been slower. We continue to see deals completed in this space but at a lower volume than in 2021 and the early parts of 2022. We are expecting things will probably get a little better as interest rates hopefully begin to go down in the next couple months and would expect that to have probably an upward impact on valuation multiples.

What makes these investments ripe for add-on consolidation?

Nick: When you have midsize to larger practices, they often have enough operating room utilization time to really support their own ambulatory surgery center. To the extent that the practice and the doctors have the capital to start that ASC and hire the right support staff to help manage it, that can be a really important aspect. It can be more complicated in states that require certificates of need for ASCs. In some states it’s easy to obtain those certificates of need. In others, it can be quite difficult due to the political environment as well as the demonstration of need required. With larger groups, you can start to have subspecializations, such as retina physicians. That can be helpful in terms of referral patterns within the practice.

With larger groups, you can also start to enter clinical research and be part of different trials. With a smaller practice, the doctors probably don’t have the ability to really focus on those areas and hire the support staff necessary to be involved in those trials. Many times, in joining a PPM company, you can start to get that scale through that PPM, the management team, the network of physicians, and physician practices part of that platform.

Daniel: With PPMs, you might also get benefits around things like purchasing power. Similarly, PPMs may be able to improve payer contracts either at the practice or at some of the other ancillaries like the ASC, for example, in a way that a standalone practice may not be able to achieve on its own.

Are there any recent transactions that reflect PE’s interest in eye care?

Daniel: EyeCare Partners, which Partners Group acquired in 2019, recently completed a $275 million recap, and we expect more of these types of recaps if and when interest rates decline in the coming months. EyeSouth Partners, backed by Olympus Partners; Retina Consultants of America, backed by Webster Equity Partners; and Spectrum Vision Partners, backed by Blue Sea Capital, have also done several deals in the last couple of years. We’ve personally worked with a number of PPMs that are doing acquisitions in both the Midwest and on the West Coast in recent years. So we do continue to see active platforms in the ophthalmology space but also focus specifically on either retina or optometry as kind of a standalone model.

Are there any headwinds affecting PE dealmaking in this subsector?

Daniel: The big one, I think, is interest rates for the time being. The higher rates kind of change the math and amount of debt you can utilize in these deals. Hopefully as that environment begins to ease a little, that will make that headwind less of a factor. There are always certain risks around reimbursement when dealing with governmental payers, and those sorts of factors come into play. But I think primarily from a PPM standpoint, interest rates have really been what’s driven the slowdown.

Still, I think we can expect an increase as interest rates decline. I don’t think that 25 or 50 basis points is necessarily going to make a big difference, but if we do have several rate cuts over the next couple of months, we should start to see buyers and sellers become more active in the market.

Nick: Certainly provider and other acquisition opportunity shortages can be an aspect if you’re trying to buy into certain geographic areas or if there are maybe just very few independent groups or independent physicians available. I wouldn’t say this is necessarily the case for ophthalmology, but certainly I think there’s been a couple of PPM companies that haven’t maybe gone quite to plan. If physicians are talking to their colleagues across the country or people that they know in the industry, there may be some reticence to PPMs from that standpoint.

But I agree with Dan. I think we’re still going to continue to see deal activity each year. I expect deal activity to increase in 2025. I think we’ll start to see some platform consolidation in the not-so-distant future.