Maximizing Healthcare Consolidation Value Through Collaboration

Avoid healthcare M&A transaction pitfalls with expert guidance

Private equity continues to drive healthcare M&A, with investments in physician-owned hospitals and ambulatory surgery centers rising.

Some physicians attempt to handle the process alone or with a single attorney. However, healthcare transactions are tricky, and there’s only one chance to get it right. Teaming up with investment bankers and healthcare real estate specialists who work collaboratively can lead to better deal alignment and structure considerations, ensuring the highest valuation for the business and real estate.

Monetizing passive healthcare real estate assets
helps physician-owners and creates opportunities
to maximize their Practice’s value

1. POPULATION DEMOGRAPHICS: AN
AGING U. S. POPULATION

The population in the United States is aging
rapidly, forcing changes in housing, the
workplace, healthcare, and virtually every other
aspect of the economy.1 In fact, within the next
two decades, Americans 65 years and older
will outnumber children in this country for the
first time since the U. S. Census Bureau began
counting.

²

A key driver in the growth of independent specialty practices is the change to regulatory and reimbursement policies that allow practitioners to perform Centers for Medicare & Medicaid Services approved procedures in ambulatory surgery centers rather than on an inpatient hospital basis. This creates a significant pathway for practitioners to take advantage of a new revenue stream for cases that they’re already doing and grow their practices. Before these changes, certain specialists
were almost entirely hospital-driven because there was no practical or viable mechanism for physician-driven, physician-centric businesses to thrive. It isn’t just new revenue streams driving specialists
in this direction, however. In private practice,
specialists can be more autonomous than they
would be in a large hospital system. They can make their voices heard, govern themselves internally, have more control over patient care and monetize services to improve their compensation.
But in the absence of size, controlling sites of service, and having robust data collection and data management, it can be difficult for small practices to grow and be consistently profitable. This is especially the case with alternative payment models and in light of increasing consolidation of health systems, payers, and primary care, and other referral sources.

AN AGING AMERICA³

Seniors expected to outnumber minors by mid-2030s

As the nation grows older in the coming decades,
the demand for healthcare services is expected
to increase dramatically, according to the
U. S. Centers for Medicare & Medicaid Services
(CMS). In particular, spending on Medicare is
expected to peak – both as a share of the overall
economy and the nation’s total healthcare bill –
within the next two decades, CMS data shows.
The federal program currently insures about
54 million Americans and covers the costs of
inpatient stays, outpatient care, prescriptions
drugs and other common healthcare services,
according to the Congressional Research Service.

⁵

1https://www.census.gov/

2 Ibid.

3 Ibid.

4http://www.medpac.gov/

5https://crsreports.congress.gov/

MEDICARE SPENDING⁶

Federal program covers a wide range of healthcare
services for seniors

TOTAL BENEFIT SPENDING =$814 BILLION

As the nation grows older in the coming decades,
the demand for healthcare services is expected
to increase dramatically, according to the
U. S. Centers for Medicare & Medicaid Services
(CMS). In particular, spending on Medicare is
expected to peak – both as a share of the overall
economy and the nation’s total healthcare bill –
within the next two decades, CMS data shows.
The federal program cur srently insures about
54 million Americans and covers the costs of
inpatient stays, outpatient care, prescriptions
drugs and other common healthcare services,
according to the Congressional Research Service.

6 https://crsreports.congress.gov/product/pdf/IF/IF10885

Part A: Inpatient hospital services, skilled nursing care, hospice care and some home health services

Part A and/or B

Part B: Physician, laboratory, outpatient hospital and some home health services, physician-administered drugs, and durable medical equipment

Part C: Medicare Advantage

Part D: Optional outpatient prescription drug benefit

PRACTICE CONSOLIDATION: THE SHIFT
TO PHYSICIAN EMPLOYMENT

Another macro trend impacting the healthcare
industry, which is being driven by America’s
demographic shift towards an aged population
amongst other factors, is the drive towards consolidation in healthcare services.
Mergers and acquisitions are one of the
primary ways this consolidation is achieved,
though there are others. For example, in
2018, the percentage of physicians who
were employed (47.4%) surpassed those
who owned their Practices (45.9%). This
is a startling statistic considering that as
recently as 2012, 53.2% of physicians owned
their Practices compared with 41.8% who
were employed. In under a decade, the shift
towards physicians being employed en
masse – and further consolidation – has
continued and accelerated. This trend is
more pronounced in some specialties (e.g.
psychiatry) when compared to others (e.g.
surgical subspecialties like cardiovascular
or orthopedic surgery). Furthermore,
according to the AMA, this trend is even
more pronounced amongst the youngest
generation of physicians – aged 40 and
younger – where the percentage of employed
physicians was estimated at 69.8%. This shift
in physician Practice ownership is another
way consolidation is occurring without direct
mergers or acquisitions activity taking place.
This trend is not surprising, as the benefits
of consolidation can be significant, including
superior economies of scale, improved patient
care and experience, and enhanced negotiating
power with insurers and regulators.

A SHIFT IN PHYSICIAN PRACTICE OWNERSHIP

⁷

For the first time, fewer physicians are owners than
employees

3. INEXPENSIVE CAPITAL AND THE
   SEARCH FOR HIGH-YIELD INVESTMENTS

   Along with an aging population and a rapidly
   consolidating physician workforce, inexpensive
   capital – a direct byproduct of short-term
   borrowing rates set by the U. S. Federal Reserve
   Board – has pushed yield-hungry institutional
   investors into once obscure healthcare real estate
   and business investments over the past decade,
   generating unprecedented valuations for these
   properties and Practices.

   

   

   With many other types
   of investment opportunities drying up or leaving
   investors searching for higher yield, investors
   are willing to pay a premium for assets widely
   considered to be recession proof given the
   shifting demographics: For example, in many
   markets, MOBs and other healthcare real estate
   assets are now selling for as high as 17 times
   earnings.

   ⁸

   This has been especially true during the COVID-19 pandemic where healthcare (along with tech) has emerged as a beacon of returns
   and a relatively safe space for investors to
   place their capital.

   CHEAP MONEY9 Historically low federal funds rate is driving shift to
   healthcare-focused real estate

   

   FEEDING FRENZY10 Private equity, REITs now involved in more than 3/4s
   of all MOB sales

   

   

   7 https://www.ama-assn.org/system/files/2019-07/prp-fewer-own
   ers-benchmark-survey-2018.pdf

   8 https://www.healthcarerea.com

   9 https://fred.stlouisfed.org/series/DFF

   10 Revista

   Investors and practitioners share a desire for
   growth and increased revenue. But doctors
   approach prospective deals with a distinct set of
   concerns about consolidation and acquisition, as
   essential as such transactions may be for viability
   and growth. Evaluating opportunities involves
   much more than considering financial terms.
   Specifically, the challenge for doctors in private
   practice is how to balance their desire for
   autonomy with the ability to access capital or take
   advantage of scale so they have a level playing
   field. A practitioner who’s obtained independence
   and control over his or her practice will be
   understandably reluctant to work for a hospital
   system or a big medical group. After being an
   owner, the physician won’t want to become an
   employee.
   Practitioners may be able to address these concerns
   by choosing partners they’re comfortable with and
   those that align with their goals. In turn, investors
   must be cognizant of the tension practitioners feel
   between necessary growth and desired autonomy
   and its role in their decision-making process.
   Failing to acknowledge and address these concerns
   during negotiations could quickly sour a practice
   owner on the potential benefits of a proposed
   transaction.
   Similarly, the medical practice advisers who find
   opportunities, connect potential partners and
   facilitate deals for practice owners also need to
   recognize and consider how emotional these
   transactions can be for practitioners who live and
   breathe the business they’ve built for themselves.
   Advisers want all parties to see the opportunity as
   a win-win. The adviser’s role is to provide sound,
   objective data to help guide doctors through the
   process and make them feel good about what
   they’re doing.

   It’s about more than dollars and cents

   Merritt Healthcare Advisors focuses exclusively on representing owners of surgical facilities and health care practices that are considering strategic options, whether selling an interest in
   their organizations, creating new partnerships or growing through acquisitions.
   As the industry’s leading mergers and acquisitions firm, our proven process and extensive buyer network enable us to help our clients realize the absolute best financial and nonfinancial outcomes.
   We’re unique in that we’re the only firm that combines an investment banking background
   with actual “owners” experience that comes from developing and managing our own health care facilities. We’ve used this experience to
   successfully complete more than $4 billion in transactions on behalf of our clients.

   SLB: HAVING CAKE, EATING
   IT TOO

   In many cases, a Sale-Leaseback (“SLB”) offers
   the best of both worlds for physician MOB
   owners. The arrangement, in which physicianowners sell the majority of the property and
   retain continued physician-ownership in a
   tax-deferred manner, allows physician partners
   to monetize all or a portion of their real estate
   while leasing it back. In doing so, ownership
   can unlock up to 100% of their passive equity to
   invest in their core business, modernize facilities
   and equipment, expand an existing facility,
   build a new facility, reduce debt, make partner
   distributions, and maintain stability for their
   Practice in the future.

   In a seller’s market, owners can take chips off
   the table, retain control through a long-term
   lease with multiple renewal options, retain the
   ability to reinvest proceeds tax-deferred into a
   larger diversified medical office portfolio, and
   maintain physician alignment between the
   real estate and the Practice. This last point is
   paramount to the success of any transaction
   being considered by physicians for their
   Practice’s operations. Real estate is a key factor
   healthcare operations investors consider when
   evaluating a potential investment opportunity.
   The real estate-practice relationship is most
   attractive when (1) there is a long-term lease in
   place (e.g. 12 year lease term with four 5-year
   options to extend), (2) the ownership is stable,
   and (3) there is common ownership between the
   healthcare operating business and the real estate
   entity. By pursuing a SLB strategy and ensuring
   an investment banker and healthcare real estate
   specialist coordinate their marketing strategies,
   physicians can have the best of both worlds
   when monetizing their assets.

   Practice focus:

   Free up time to focus
   more on the practice of medicine and
   less on real estate ownership and
   management issues.

   Improved economics:

   Unlike traditional debt financing with a loan-to-value ratio of 65 to 75%, a sale-leaseback unlocks 100% of the value.

   Practice alignment:

   A SLB offers creative transaction structures that allow for continued physician-ownership in the real estate, providing lower buy-in for physician recruitment.

   Portfolio reinvestment:

   SLBs also offer the ability to structure a tax-deferred transaction and diversified income through an UPREIT transaction.

   Improved financial statements:

   The lease can be structured as an operating lease to reduce any impact on the balance sheet and loan covenants.

   Operational control:

   Maintain longterm full operating control over the facility with the ability to modify the space as the business evolves.

   Tax benefits:

   Rental payments are fully deductible, whereas a fully depreciated asset does not offer any tax benefits

   Reduce conflict:

   Eliminate challenges of having future physicians as owners in the practice but not in the real estate.

Interested in learning more
about the healthcare real
estate landscape? Let’s talk.

Merritt Healthcare Advisors
is the industry’s leading healthcare advisory
firm focused exclusively on representing owners
of healthcare businesses, surgical facilities
and practices that are considering a strategic transaction, whether it is partnering with another
group, selling an interest in their business or
growing their business through acquisitions. We
offer:

Extensive M&A Experience, Proven Track Record

As licensed investment bankers*, we offer extensive M&A expertise that is the result of completing over $4 billion in healthcare transactions.

Industry Specialization

We are focused solely on representing business owners of healthcare practices, surgical facilities and their associated businesses who are considering a transaction.

Extensive Relationship Network

Our leadership team has extensive experience working with healthcare organizations, hospitals, national strategic firms, private equity and industry leaders on a national level.

Operational Expertise

In addition to transactional expertise, Merritt Healthcare principals have developed and operated over 20 ASCs, partnering with over 300 physicians in the process.

Process and Approach

We are committed to developing a deep understanding of a potential transaction. There are many elements involved in a successful process, and it is our job to ensure that your long-term objectives are met. Our Clients can also expect senior level commitment on all transactions.

Exceptional Results

Merritt has consistently been able to achieve the optimal financial and non-financial results for our Clients. We have the expertise, knowledge and experience required to manage this extremely time-consuming and complex process.

HREA | Healthcare Real Estate Advisors (HREA) is a national leader in advising healthcare providers and real estate investors with various monetization strategies, including disposition, debt & equity recapitalization, and tax-deferred structures, such as the §1031 Exchange or UPREIT. In addition, HREA’s capabilities also include providing health systems and physician groups with 100% non-recourse financing for new development and expansion, as well as monetizing surplus and non-essential real estate assets. We offer:

SPECIALIZATION:

Our relationships in the healthcare industry consistently garner 20%+ additional sale proceeds over fair market value and prevent costly mistakes through a wellnegotiated lease.

EXPERIENCE:

Our expertise ensures that our client maintains long-term control of the building with numerous control provisions that allow for growth, including no personal guaranties, multiple lease extension options, and the ability to modify or expand the building.

FIDUCIARY RESPONSIBILITY:

We are fierce advocates for our client, the owner of the property. Many investment groups will attempt to approach owners directly in order to take advantage of a lack of market knowledge.

MARKET INSIGHTS:

HREA is a member of Revista, the leading healthcare real estate data platform that provides information on local area dynamics, including supply/demand for various healthcare provider specialties, as well as admissions and revenue for all ASCs and hospitals.

Improved financial statements:

The lease can be structured as an operating lease to reduce any impact on the balance sheet and loan covenants.

Operational control:

Maintain longterm full operating control over the facility with the ability to modify the space as the business evolves.

Tax benefits:

Rental payments are fully deductible, whereas a fully depreciated asset does not offer any tax benefits

Reduce conflict:

Eliminate challenges of having future physicians as owners in the practice but not in the real estate.