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Money Changes Everything? Private Equity in American Healthcare

Illustration c 2023 Bryce C. Hendry

Daniel McKegney had some tough news for his dad in North Carolina.

Daniel had been in rehab outside Austin, Texas for three months. He needed more time and money to work on his fentanyl addiction. The bills from BRC Recovery, a treatment provider owned by a private equity (PE) company, already were about US$150,000.

As reported in Kaiser Family Foundation Health News, “McKegney wasn’t happy with his care. … he had been advised against the long-term use of Suboxone, a medication often recommended to treat opioid addiction, because BRC does not consider it a form of abstinence.”

After five days of detox, McKegney’s plan included a weekly therapy session and 12-step group meetings, which are available at no charge to many Americans. McKegney told KFF Health News that a BRC staffer had recommended a fourth treatment month and had been in the room when Daniel called his dad.

The involvement of PE firms in addiction treatment is one front in a broad advance by mammoth investors across American healthcare. Susan Birk has described how private investment is now significant everywhere in medicine -- hospitals, biotech, billing, staffing, hospice, pharma, veterinary, surgery, elder care, dermatology, medical devices, and more.

I had begun noticing articles on private equity in healthcare in 2021. A colleague and I are studying the history of how Medicare has been financed and why Medicare and all other US healthcare costs have risen without pause despite equally persistent efforts to rein them in.

The articles raised questions about how PE firms’ goals and practices affect patient access, treatment, and costs. So I set out to understand how this works; I’d ask you to consider this a very early report.

PE firms’ clients are large institutional investors -- pension and retirement funds; university endowments; foundations; sovereign wealth funds; and insurance companies. Ultra-wealthy people can also participate. Many of America’s roughly 4,000 PE firms manage billions of dollars.

They invest in privately owned companies and focus on strategy and finances in two main ways. First is by making add-on acquisitions that increase revenues and the scale of operations. The second is by an array of financial engineering methods by which debts, often taken on to buy a company, move to the acquired company. At the same time, non-clinical assets – often land or buildings – come under the PE firm’s control and generate sales and lease-back revenue for the PE firm. The goal is almost always to sell the company in three to 10 years, sometimes to other PE firms.

According to PitchBook, a firm whose tracking provides the best available data, private equity has poured close to $1 trillion into some 8,000 healthcare transactions in the last 10 years, with more than 10 percent of those deals in 2022.

The historical issues raised by all that money are long-standing. On what economic principles and goals should we operate health care? Is medicine a business like any other, driven by investor/owners, or do its life-and-death stakes make it different? Should they?

Advocates argue that PE companies bring money, management skills, and new technologies to our fragmented medical system. PE firms know how to make organizations more efficient and can achieve economies of scale. They can negotiate better reimbursement rates from payers. They know how to drive quality improvements and strong investor returns.

Critics contend that PE’s priority on short-term profits puts patients at risk through staffing and other cost reductions as well as by loading acquired companies with debt; and by creating incentives for clinicians to see more patients and order up more tests and procedures. In addition, PE’s drive to consolidate companies into larger entities can reduce local and regional competition.

Let’s keep going on the basics.

In 2021, management scholars David Dranove and Lawton Burns wrote that our healthcare system comprises about two dozen industries, including not just doctors and hospitals but pharmaceutical companies, long-term care providers, clinics, medical device makers, and more.

These companies serve a mammoth market. According to the Center for Medicare Services, health spending in the U.S. in 2021 was US$4.3 trillion, or just under $13,000 per person. About 18% of our entire Gross Domestic Product went to healthcare. CMS expects both GDP and healthcare spending to grow about 5% per year until 2030.

Laura Katz Olson, distinguished professor of political science at Lehigh University and author of a recent book on private equity and healthcare, says a PE firm typically puts up about 2% of a company’s purchase price. Investors kick in 35-40%, and 55-60% is borrowed. As noted, this debt moves to the acquired company, a tactic that adds immediate pressure to grow revenue. So PE firms look for strong revenue streams and acquisitions that widen those streams.

Although Olson says some recent studies indicate profits may not be as high as advertised, a 2023 Bain & Company report said that, between 2010 and 2021, PE firms averaged returns in healthcare of 27.5%, compared with 21.1% in other industries.

Is any of this regulated? Lightly at best. The current transaction threshold that triggers Federal Trade Commission scrutiny is $101 million, so deals for less – the vast majority -- move ahead unperturbed.

As a large healthcare payer, the federal government is entwined with PE. Many firms invest in companies with ties to those taxpayer-funded revenue streams called Medicare and Medicaid. Federal legislation in the last 15 years has helped the investment climate by expanding coverage and by funding increases for behavioral health treatment. Medicaid currently pays for about 40% of all US treatment for substance use disorder.

So what does a PE deal look like?

Here’s one that features key attributes: targeting a fragmented market; using debt; growing revenue; exiting (selling) quickly.

In 2015, Flexpoint Ford, a Chicago-based PE firm, bought a controlling stake in Summit Behavioral Healthcare, which offered addiction treatment programs. Flexpoint launched a buying spree that expanded Summit from three clinics in three states (102 beds) to 14 clinics in nine states (662 beds). Two-and-a-half years after they bought it, Flexpoint sold Summit to two PE firms.

Now, a fair and full analysis of this event would require a systematic look at Summit’s clinical results during Flexpoint’s whirlwind ownership. That data is hard to get; several observers have noted that the PE business is nothing if not private.

Private equity began to take its current form in the 1980s. That’s when an inventive group of corporate “raiders” – Carl Icahn, Michael Milken, and others – pioneered ways to make stock purchases, shareholder activism, and high-risk debt – junk bonds -- into weapons of hostile company takeovers. The new owners made big changes at the acquired firms, became wealthy, and enjoyed a brief ride as culture heroes. A Reagan-era fervor for deregulation and privatization had set the tone.

Greg Koonesman, a specialist in healthcare financial advisory services, told researchers that 30 years ago, PE didn’t have much presence in healthcare. By 2019, several thousand firms were in the sector. Olson said activity accelerated after 2015. In 2018 PE healthcare deals topped $100 billion for the first time – a 20-fold increase since 2000.

With recession jitters rising in 2023, Bain & Co. says that there are pockets of strength in economic slumps -- veterinary, dental, radiology, oral surgery, and vision. In addition, the life sciences look promising, with demand for tools, diagnostics, lab services, outsourced services, and information technology less likely to falter.

Private Equity in Behavioral Health

Daniel McKegney and his family are hardly alone in their entanglement with private equity and rehab. America’s fragmented drug treatment industry is ripe for the consolidations that PE firms favor. A 2022 report counted more than 16,000 treatment facilities for substance use disorders in the US. Private for-profit organizations operate about two out of every five and are gaining market share. That market comprises more than 20 million Americans over age 12 who have a substance abuse issue.

According to a report from the Private Equity Stakeholder Project, an industry monitoring and research group, behavioral health – autism, addiction, eating disorders -- is a prime PE target. There were 97 known deals in 2018, a new record, and in 2021 there were 127 mergers and acquisitions. Industry observers envision a business landscape of modestly better access to treatment, good funding, and more open attitudes on mental health issues.

BRC Recovery, the McKegneys’ provider, also bought the Nashville Recovery Center in 2021. Two reporters from Nashville Public Radio spoke with Marina, a southern California physician. Marina enrolled her niece in a three-month program for alcohol addiction. She paid BRC’s $30,000 per month fee upfront because her niece didn’t have insurance.

Where Do We Go From Here?

Private equity firms are a good bet to expand their reach across medicine. There’s a lot of “dry powder” – money looking for outlets – here and in Asia.

What role should PE companies play in an industry that affects us all? Are we okay with a fraying healthcare system increasingly tied to investor returns and debt financing? Will we exit the pandemic without any considered, collective assessment of how we might improve access, delivery, and funding?

We may get a partial answer in 2024, when an intriguing lawsuit is scheduled for trial in federal court. The American Academy of Emergency Medicine Physician Group, based in Milwaukee, sued Envision Healthcare, which is based in Nashville and is owned by Kohlberg Kravis Roberts, a large and legendary PE firm.

The ER physicians contend that Envision violates California law when it uses “shell business structures to retain de facto ownership of ER staffing groups.” California, and more than two dozen other states, have laws prohibiting the corporate practice of medicine. The content of these laws, and their histories, are highly variable and complex. The lawsuit challenges the legality of an ownership and operating model that PE firms deploy widely.

The trial and the debate over PE in medicine raise a question of how closely we want to harness our healthcare system to high-octane profit maximization. A 2021 report from the Petris Center at UC-Berkeley and the American Antitrust Institute concluded that “the private equity business model is fundamentally incompatible with sound healthcare that serves patients.” That’s an ominous assessment that deserves attention from clinicians, their professional groups, and patients. It also offers a growth opportunity for elected officials seeking a chance at real leadership and genuine public service.

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