By Jason Ruchaber, CFA, ASA and Kyle Tormoehlen, AM, MBA
Now that we are well into 2011, it is safe to say that this will be one of the busiest years (in terms of total transaction volume) that the healthcare industry has experienced in many years. Though a significant portion of the transactional activity is centered on physician practice acquisition and employment, these transactions have a substantial ripple effect across all healthcare entities. In our work as providers of fair market value (FMV) consulting and valuation services to the healthcare industry, we have also seen a significant uptick in transactional activity in other areas, including radiation therapy, diagnostic imaging and ambulatory surgery.
It goes without saying that much of the transactional activity is being driven by healthcare reform – notably, the push to create accountable care organizations (ACOs). How ACOs will ultimately affect the delivery of healthcare remains to be seen, but the mass migration to physician employment by health systems is a fundamental shift in the industry that is likely to have a significant impact for years to come. In the last decade, the majority of transaction activity has centered on hospital/physician alignment strategies in the absence of direct employment. Alignment structures such as co-management arrangements, medical directorships, joint ventures, etc., dominated the landscape and allowed hospitals to integrate with otherwise independent physicians. In today’s market, as a condition of the hospital’s practice acquisition and subsequent physician employment, physicians are oftentimes precluded from holding ownership interests in competing entities and are required to divest ASC or other ancillary service line ownership. While the members of a single physician practice seldom comprise the total ownership group of a multispecialty ASC, the rise of the direct employment model will have significant impacts on the financial performance and the fair market value (FMV) of ASCs across the county.
As such, physician recruitment will become more difficult. Hospital employment is likely the single biggest competitive threat currently faced by ASCs. In the coming years, the vast majority of primary care physicians will be employed by health systems, thus limiting the referrals to surgical specialists outside of the system. Given the preliminary information regarding ACO programs, many primary care physicians will have substantial financial incentives to join a health system, thus exacerbating this trend. To better integrate the different dimensions of care, hospitals are actively recruiting and acquiring surgical specialists, which will greatly limit the supply of eligible physician investors in freestanding ASCs. Overall, the data indicates slower annual growth as the ASC industry enters a mature phase of the business cycle, which is being driven in part by a lower number of available physician investors.
Physician recruitment and succession are critical elements to the viability of the ASC business model. As existing physician owners approach and enter retirement, the recruitment of new physician investors will continue to be highly competitive. Those ASCs unable to attract new physicians may experience minimal or zero growth in cases and revenue and, as medical supplies and labor costs continue to rise, a reduction in profit.
The industry will also see more hospitals seeking to expand ownership in existing ASCs. With a direct employment model, the need for hospitals to align with physicians through an ASC joint venture may no longer be as necessary – and may even be prohibited as a provision of the physician’s employment contract. We have already seen a significant shift in behavior by hospitals as they now increasingly look to expand their existing ownership percentage or acquire ASCs outright (i.e., through 100 percent ownership). In many cases, the goal is to convert the freestanding ASC into a hospital outpatient department (HOPD) to take advantage of significantly higher reimbursement. While noting that reimbursement will vary across markets, we have observed HOPDs to receive upwards of a 100 percent premium relative to their freestanding ASC counterparts for a similar mix of procedures.
