Are traditional health systems and private equity-backed groups natural competitors? Maybe not.
Levin Associates’ proprietary deal database, which tracks mergers and acquisitions in real time, shows the fast pace at which both sides have been consolidating the medical marketplace over the past decade.
The data also shows a new trend taking hold: Rather than competing against each other, health systems and PE firms are forming partnerships. Many experts in the healthcare industry anticipate this trend is here to stay.
Levin Associates attended AHLA’s Health Care Transactions Conference on April 17-19, 2023, and the insights shared below are from panel discussions our writer observed in person.
Why would hospitals want to partner with private equity firms and other non-traditional groups?
The reasoning for hospitals is fairly obvious: Not-for-profit health systems could use the extra funding. More than half of hospitals (53%) had negative projected operating margins in 2022, with the median operating margin coming in at just 0.9% for the year.
“It’s pretty grim. 2022 was probably the worst financial performance year since the financial crisis,” said Nick Bidwell, a Senior Vice President at Kaufman Hall. He noted that “the baseline revenue profile for most systems just hasn’t kept pace” with “ballooning expenses.”
Bidwell continued, “Losses are starting to abate a little bit [in 2023]. But most CEOs and CFOs that we talk to think this is really more of a systemic issue.”
Jim Cotelingam, the chief strategy officer for the Cleveland Clinic, agreed. “I think it’s important for health systems to really think about diversifying how they think about partnerships. While there might be reluctance, I think health systems are going to have to get over that,” Cotelingam said. “The market is moving too fast for us to stay back in the past with the older models and ways of thinking.”
Partnerships are a solution to expand patient care services.
Cotelingam added that partnerships can help health systems “add new capabilities, diversify their revenue, and adapt to the new environment.” He highlighted two examples from his home state of Ohio:
- The not-for-profit health system OhioHealth has partnered with ChenMed to open geriatric-based primary care clinics in underserved neighborhoods. ChenMed is backed by investment firm Turner Impact Capital.
- The Cleveland Clinic has a partnership with PathAI, an organization focused on artificial intelligence-powered technology for pathology. PathAI is a privately-held venture capital-backed company.
Matthew Weiss, a Managing Director at EY Parthenon, pointed out that partnerships with PE-backed firms could also help health systems manage physician shortages. The Association of American Medical Colleges projects that by the year 2033, the U.S. will have between 21,000 and 55,000 fewer primary care physicians than is needed.
Health systems are “having trouble attracting, recruiting, and retaining primary care physicians in a number of different markets,” Weiss said. “I think that’s led health systems to partner with non-traditional primary care entities like One Medical and VillageMD and others if they can.”
(Amazon formally acquired One Medical in February 2023. VillageMD is majority owned by Walgreens).
“Revenue” isn’t a bad word.
One of the sentiments shared at AHLA’s conference was that private equity has a public relations problem. Robert Homchick, a Partner at Davis Wright Tremaine, acknowledged that in the court of public opinion, health care is viewed differently than other types of goods and services.
“When you bring a profit motive and investment in healthcare, there’s this natural grinding of gears because some people say, ‘Wait a second, you’re trying to make a profit and that’s my mother in that rest home,’” Homchick said. “Well, the truth of the matter is without private equity. we would lose a very important piece of access to capital.”
“I’m always a little surprised when hospitals get attacked for looking for other avenues of revenues to support their mission” to provide quality patient care, remarked Larry Kraemer, EVP and General Counsel for Northwell Health.
Kraemer made the argument that traditional health systems need funding to adequately serve communities and it’s not a bad thing to seek it out. “Where is the money going to come from to reinvest in hospitals? Where’s the money going to come to do all these things and to serve the community’s needs? You need a margin to do that. That gets lost a lot of times in the politics of the day.”
What’s in it for private equity?
Private equity is also incentivized to work with traditional health systems. Antonia Peck, a Partner at Womble Bond Dickinson, said partnering with an established health system can give a private equity-backed group more credibility with patients.
“One of the main things that will attract PE to form a venture with a not-for-profit healthcare organization is that in the market you’re in, usually health systems have great brand name recognition,” Peck explained. “They have the trust of their community.”
Another incentive is the opportunity to benefit from the health system’s long-standing relationships with payers, said Andy Murray, a Partner at Bradley Arant Boult Cummings.
“There is a lot of migration of procedures out of hospitals and into outpatient settings. When a health system comes along and says, ‘we’re going to invest in this joint venture facility,’ payers are receptive to that,” Murray shared as an example. He said in this situation, the PE-backed group “might actually be able to get better rates than the freestanding facility would, because the payers are seeing this as an opportunity to have some alignment between those facilities” and the hospitals.
Peck added a layer of caution, noting that the two sides may have “diverging interests” at times and that it’s important for leaders to ensure everyone is on the same page before entering a partnership.
“PE firms are entities meant to turn a profit. Yes, they do bring healthcare and they do increase the efficiency of healthcare, but they are business entities meant to reward their investors,” Peck said. “Non-profit entities are tax-exempt and have to be really strategic and strict about guarding their non-profit status. It is really important that at the beginning, you level-set on mission and vision, and the strategy of whatever venture it is that there’s a partnership on.”
Erin Laviola is a writer for Levin Associates.
