The healthcare industry continues to experience broad merger and acquisition (M&A) activity across a number of sectors. Amid a rising number of transactions, financial buyers appear to be looking to expand further into the space, particularly ophthalmology.
There is presently a significant interest from private equity, private equity-backed management service organizations (MSOs), large independent medical groups, and well-resourced multi-specialty physician groups in acquiring physician practices. This is likely due to public pension funds, endowments, and family offices seeking diversification via the private equity asset class in light of its perceived superior return potential as well as the opinion of many that valuations in the public equity markets are stretched. A low-interest-rate environment, which allows buyers to employ debt to boost returns on invested capital, has also contributed to healthy M&A activity and industry consolidation.
The organic growth opportunities that exist in ophthalmology, private pay components of certain procedures, and the sector’s fragmented ownership structure make it an especially attractive segment for private equity. Conversely, physicians are having to contend with changing technology, regulations, reimbursement systems, and rates instead of spending more time with patients, expanding their practice with new physician hires, building new locations. and negotiating new and incremental contracts with payers. These factors, as well as historically high earnings before interest, taxes, depreciation, and amortization (EBITDA) multiples being paid for practices at present, have inspired physician practice owners to pursue or at least inquire about a sale. The multiples available to practice owners today, in our view, allow them to de-risk their financial future considerably. We believe that any independent practice with more than $5 million in EBITDA should seriously consider an exit.
Another consideration is that insurance groups (e.g., UnitedHealth/Optum) are looking to manage population health. Thus, they will want to acquire practices to be able to service members across a wide geography to ensure their plans are competitive and attractive to employer groups. We have not seen as much activity from insurance buyers in ophthalmology, but we are seeing it in multi-specialty groups.
Factors driving ophthalmology practice growth include:
Consolidation is by no means limited to ophthalmology as a number of large multi-specialty practices were acquired last year. The big news in this space late in 2018 was UnitedHealth (Optum) announcing plans to buy DaVita Medical Group for $4.9 billion.
Review of DaVita’s financial statements indicates that 2017 adjusted operating income was about $52 million and the business has approximately $239 million in annual depreciation and amortization expenses, yielding estimated EBITDA of $291 million. This puts the enterprise value (EV)/EBITDA multiple on the deal at about 16.8x. Revenues for DaVita were $4.7 billion for full-year 2017, putting EV/revenue at just over 1x.
Multiples vary by discipline, but in general smaller practices are being acquired from 7x to 9x, and platforms are trading anywhere from 11x to 15x, tending toward the mid to high end of this range recently. This multiple arbitrage, in addition to acquisition and organic growth that can be achieved, creates a tremendous opportunity for private equity to continue to roll up this fragmented industry, particularly those areas with above-average growth, favorable demographics, and a high cash-pay component to their business, and where reimbursement and regulatory pressures are less of a factor.
At a recent industry conference, a CEO of a large practice commented that he thought that the ophthalmology sector was only 2% consolidated, indicating a tremendous opportunity for consolidation. That number is a bit dated, but we would still say that it likely remains far less than 10% consolidated.
According to PitchBook, there were 16 ophthalmology practices acquired in control transactions in 2018 versus twelve in 2017. We expect the level of activity to remain at this healthy level going forward as more private equity money finds opportunities in the sector. [See figure 1]
Ophthalmology practices that are well-managed can achieve 20% EBITDA margins due to high profitability on cataract procedures that use advanced lenses, for example. This favorable financial profile is attractive to private equity sponsors looking to enter the sector.
We have highlighted a number of the large platform acquisitions that have taken place in the industry since 2015. We would note that our experience indicates a large number of willing buyers in this market, which bodes well for practices evaluating whether to run a sale process.
In preparation for a sale process, there are some unique aspects of ophthalmology practices that owners should consider.