- Market awaits first potential exit: Frazier’s CORE
- Muskuloskeletal offers more platform-appropriate opportunities, but consolidation likely to occur more slowly
- Investor playbook for derm translates easily to ortho
Sponsors are getting serious about investing behind money-making orthopods as other pockets of healthcare like dermatology grow increasingly crowded.
“There is a ton of sponsor interest,” Jeff Swearingen, co-founder and managing director at Edgemont Partners, said. “These are big businesses with a lot of cash flow.”
While orthopedics ought to remain a lower-middle-market transaction environment for the foreseeable future, it’s safe to say that some larger buyout funds will look down market, Swearingen said.
More PE groups are getting educated on orthopedics and large blue-chip groups are starting to poke around in the space, agreed Robert Aprill, an associate at Provident Healthcare Partners. While a number of groups will come to market in 2019, Aprill expects the “spigot will open” in 2020.
That may be partly because investors are watching to see how the largely uncharted segment’s first exit plays out.
That first exit may involve CORE Institute, one of the specialty’s first to attract outside investment. The company is in the early stages of a sales process, Buyouts reported earlier this month. The process comes about two years after Frazier Healthcare Partners led a growth-equity investment in the group alongside Princeton Ventures.
“Everyone is looking at Frazier’s potential exit as validation” of the segment, Swearingen said.
Having witnessed early movers in parallel specialties like dermatology and vision care, sponsors are now thinking through how to replicate that success in orthopedics, Swearingen said. “Several of the early movers had outsized returns, and everyone has taken note of that.”
One example is Varsity Healthcare Partners, which, akin to earlier plays in dermatology and vision care, was among the first to deploy capital into musculoskeletal care via its deal for Orthopaedic Institute.
Both the firm’s 2017 sale of EyeCare Services Partners to Harvest Partners and 2016 sale of Forefront Dermatology to OMERS Private Equity produced mid-teen multiples of Ebitda, Buyouts reported.
Slower, yet more investable
While investors have taken longer to flock to orthopedics in the first place, deal flow is also likely to be slower in the initial rounds of investment partly because doctor-owners have less incentive to transact, Aprill said.
“In ortho, [doctors] are so highly reimbursed,” Aprill said. “They’re less sensitive to market shifts and reimbursement changes. So if things are good, they’re less likely to shake the branches.”
But as physician specialties across the board continue to see record-high valuations — with prices commanded by “derm groups siding on the field of bananas,” for instance — healthcare investors are increasingly shifting their attention to orthopedics, he said.
“More groups are starting to look at [orthopedics] because they’ve been priced out of parallel sectors,” Aprill said.
And while investors have taken longer to get behind orthopedics, Aprill suspects the opportunity is greater. If you compare orthopedics with urology, dermatology or ophthalmology, for example, there are more investable platform companies just because an individual doctor can generate so much money, Aprill said.
“An individual orthopedic surgeon can easily bring in seven figures. If you start to think about that, it only takes about 10 surgeons to be a platform in the eyes of PE.”
While 2019 may see some large groups — those with 100 or so doctors — either transact or explore transactions, Edgemont’s Swearingen expects more activity among midsized groups with about 15 to 40 doctors.
“In my mind, a well-run 25-doctor group could be a platform for private equity,” Swearingen said.
Same playbook, new specialty
Besides increasing demand for musculoskeletal care — fueled by an aging population and an active, young demographic prone to injuries resulting from exercise — investing in orthopedics isn’t a far cry from investing in dermatology.
Many of the macro reasons that PE likes dermatology apply in orthopedics, Swearingen said. Like other specialties, orthopedics is attractive in that it lends itself to ancillary income, through ownership of ambulatory surgery, imaging, physical therapy and durable medical equipment.
“It’s easy for [firms] to shift that thesis to ortho,” Swearingen said.
Orthopedics, like dermatology, depends on procedure-based patient care for much of its volume, while both align with a continued trend around the shift in patient volume to lower-acuity settings, he said.
Favorable demographic trends combined with the push-to-pull volume out of the hospital ultimately fuels demand for these groups, Swearingen said. “There’s a fundamental supply-demand imbalance.”
Swearingen cautioned that some longtime healthcare investors may be wary of transacting in the segment due to the challenges of structuring go-forward ownership and compensation arrangements with owner-doctor groups.
It’s also tough to predict where the first wave of orthopedic groups will trade given the lack of deal flow to date. But Swearingen said quality groups of scale are likely to command low-double-digit multiples of Ebitda.
Orthopedics and other specialties may share a similar investor playbook, but clinical differences are likely to be reflected in expansion and consolidation strategies, Aprill said.
As more national platforms take hold in specialties like ophthalmology and dermatology, orthopedic platforms are likely to concentrate on building regional hubs. That goes back to doctor compensation, Aprill explained.
“What looks small on the outside financially can make a big impact. … That’s going to be the play. Building through smaller, local acquisitions.”
Varsity’s Orthopaedic is a good example. Founding Partner David Alpern previously told Buyouts that it would look to bulk up the platform’s market share by adding new doctors and rollups across the north-central Florida region.
Other PE-backed groups in the space include Atlantic Street Capital’s OrthoBethesda and Candescent Partners’ Southeastern Spine.
Action Item: Read more about Frazier’s Core Institute: https://bit.ly/2sWKJVH
Update: This story has been revised with Edgemont Partners’ recently re-branded firm name. A previous version included its former name, Edgemont Capital Partners.