Eileen Appelbaum, PhD - Private Equity in Healthcare

Dr. Eileen Appelbaum discusses her research into private equity investment in healthcare. She discusses how PE investment evolved from hospitals to hospital based physician practices and now focusing on outpatient physician practices. She also talks about her recent paper, "Private Equity Buyouts in Healthcare: Who Wins, Who Loses?"

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Announcer : 0:00

Ask Me MD, medical school for the real world with the MD Dr. D.J. Verret.

D.J. Verret, MD, FACS : 0:06

Greetings and welcome to Ask Me MD, medical school for the real world. I'm Dr. D.J. Verret, and this week we have a special series of interviews with researchers who've looked at the effects of private equity investments in healthcare. Our first researcher is Dr. Eileen Appelbaum, co director of the Center for Economic and Policy Research, and a fellow at Rutgers University. Dr. Appelbaum recently published some of her research that looked at the evolution of investment of private equity and health care, as well as some of its economic effects. We'll talk to Dr. Appelbaum about her research right after this

Announcer : 0:44

Welcome back to Ask Me MD, medical school for the real world. I'm Dr. D.J. Verret and today we have the great pleasure of talking with Dr. Eileen Appelbaum, co director of the Center for Economic and Policy Research, and a fellow at Rutgers University, about private equity and health care, Dr. Applebaum. Thanks for joining us.

Eileen Appelbaum, PhD : 2:27

Thanks for having me. I'm looking forward to this.

D.J. Verret, MD, FACS : 2:29

Yeah, I think this is going to be a lot of fun, obviously a lot of acquisitions in healthcare from private equity and a pivot. I've seen at least from from hospital base to more outpatient. Can you tell our listeners kind of give us a background of your experience in and what brought you to researching private equity in healthcare?

Eileen Appelbaum, PhD : 2:49

Or Sure. So I have a long background in looking at Employment Relations, those kinds of issues from both the employer and the employee side. So I published a book co authored, pulled manufacturing advantage in 2000. And look at the new kinds of practices that were being introduced in manufacturing at that time, and what the effects of them were both on workers and on employers. Why did some employers introduce those practices, for example? And what was the payoff? And I've looked at pay family leave? Again, looking at it in California with a survey of employers and employees to see the effects on both it's easy to predict the effect on employees. But how did employers deal with it? And what were their experiences? So I have a long interest in these kinds of questions. And as I was continuing to research them, what I discovered is that when you look at these relationships, you think that they are between the employees and in a business, and the employers are the managers in that business. And it became increasingly clear that in many of these cases at that time, especially in retail, and manufacturing, if you go back to that earlier period, that there was a there was somebody behind the screen, pulling the strings in those math negotiations over those kinds of relationships. And I came to understand the private equity played a large role in many of these companies. And I wanted to understand what private equity was all about. And I have to say, it's a very complicated question. And so I have a co author, and the two of us worked from 2010 until the book was published in 2014. Studying the industry and trying to understand it. book is called. It's a private equity at work when Wall Street manages Main Street, and we were not mainly looking at health. At that time, and subsequently, we've taken a look at an app and a report that was just published by the Institute for new economic thinking, looking specifically at health care. So these are complicated stories to tell, and it takes quite a bit of digging to find them. I want to say one thing about the work on private equity. It turns out that most of the private equity deals are made by smallish private equity funds and firms. And they buy they purchase or acquire small, smallest companies at the lower end of the middle market. And in those situations, private equity has a lot to offer. And our book is as balanced as we could make it, we sought out the good cases, the bad cases are easy to find you read about them in the newspaper or the bankruptcy proceedings. But the good cases are more difficult to to get your hands on. But we did find that many of the smallest private equity firms actually did what is advertised, they improved operations, they introduced new technology, they put people on the board of the acquired company that know how to market nationally know how to market globally. And it was a win win win all the way around. So I want to be clear that that certainly happens. And your listeners should know that they may be dealing with a small private equity firm, and the story will be very different than what you see when you're looking at a Blackstone or KKR. And the other side of that is that it's what most of the deals are it are these smallest firms making by smallish companies. Most of the money goes into big companies, big private equity firms, buying big companies, like Toys R Us or like a hospital chain, buying up a lot of health care providers. And then those cases, in order to make money and get out in a few years, you basically see a lot of financial engineering, and a lot of practices that may seem maybe legal. I'm not saying anything illegal is being done, but maybe doubtful, you may want to wonder whether you would like to hook up with. So just to just to be fair to the industry. There are lots of good examples. But the big private equity firms provide us with a lot of examples that are not so good.

D.J. Verret, MD, FACS : 7:37

You mentioned the report that just came out and and I read it, it was it was a fascinating read, it was just over 100 pages, but to see the the research that you guys put into it, and the evolution that you outlined of private equity, particularly in healthcare, which is obviously what most of our listeners are interested in, was just fascinating to me. When you when you looked at that, when you looked at the healthcare space, what's the goal of private equity in these healthcare acquisitions? And kind of how have you seen them start achieving those goals?

Eileen Appelbaum, PhD : 8:13

Right, so we looked at the large private equity firms, which were buying up lots of providers, with hospitals, and then later on doctors practices and other parts of the of the industry, like revenue cycle management. That's that's the old fashioned term for revenue cycle management is Bill collecting. And that's a lot of what the, of what those organizations do. But we began with the hospitals because actually, we began studying health care, private equity and health care, even though we didn't get around to writing this. And so recently, we began studying you in 2010. Because it seemed to us that nobody makes money in hospitals. So that was our impression. I have other ideas about that now, but anyway, our initial impression was that nobody makes money in hospitals out of private equity expect to make money. And it was a time to look at it because there was a lot of activity in the years just before that. HCA went public in 2006. It made a ton of money and HCA had for bain capital and the other private equity investors. And they Bain Capital, which had wanted wanted to sell it earlier. Actually, they sold it in 2011. They put it in 2006. But they took money out of the hospitals. I don't know whether your listeners know what a dividend recapitalization is all about. I think they may be familiar with the fact that when private equity buys any company, it buys it with lots and lots and lots of debt. And it is the company and not the private equity firm that's responsible for repaying the debt. And so HCA was already highly indebted. They couldn't sell it in their preferred timeframe. And they but they like to have what they call liquidity events. They like to be able to give money back to the private equity investors in their funds. And so they do something called a dividend recapitalization. They go into the junk bond market. And they have the company in this cage. HCA sell junk bonds at high interest rates. And then they take that money and they use it to pay themselves a dividend. That's a dividend recapitalization. So Bain and the other private equity investors in HCA had already made lots of money before they actually sold the company back to the public markets. And then they made money on that. So other private equity firms looking at that said, Hey, if they could do it, we could do it. And then the second thing was, this was, we already knew that we were going to get the Affordable Care Act by 2010. It was pretty clear even a little bit earlier than that, even though it didn't fully go into effect until 2012. But many, many private equity firms believed that that the Affordable Care Act was supposed to reduce costs and maintain quality. And there were many, many things going on in teaching hospitals and other big hospitals. That got very high reimbursements for Medicare and Medicaid payments, especially the teaching hospitals. And they thought that they would be able to attract those patients. If Obamacare was going to work the way it was advertised, then people who have broken a leg or had some more routine services that they need it from a doctor would come to their local hospital and not run downtown to the teaching hospital. But that did not materialize. So whatever their calculations where they bought up these hospital chains, and we went there are three big private equity firms in the space. Subarus with the Stewart hospital chain. Lennar green with prospect medical holdings, and Apollo with I think it's called rcpch. At this point, oh, it's called lifepoint at this point, went through a number of names. But in any case, these are the big players. And none of them is making a whole lot of money out of this, except to the extent that still Stuart was not making much money for service at all. Leonard green took a lot of money out of prospect by by these dividend recapitalizations. And Apollo has continued to be invested in the smaller hospitals, and I wish them a lot of luck because we need those smaller safety net and rural hospitals. But service It was a money losing deal for that. I should say there were other private equity firms of what other chains they could never make money taking them public, they could never get a share price they wanted. They could never sell them to a strategic acquirer because they had too much debt on them. They ended up selling them to other private equity firms. So steward what asis Apollo one was like Capella, and so on. And so we ended up with these three really big, private equity firms, and they were not really able to make money. And so in the end, they partnered with a medical record medical properties trust, and they made their money by selling they made their money back by selling the real estate on the hospitals that they bought to medical properties trust. And in the case of Stewart, which I know the best medical properties trust and partnered with, they put the steward they put equity into storage, they gave him money to do more acquisitions. And Seward has been on a buying spree since then. So it's really gotten to be quite large, with many, many employees, hospitals across many states. And never really, the money is being made on the real estate somehow. It never really made money as a hospital chain. So these are some, you know, some of the complications that a lot of private equity firms seeing this decided they didn't want to be anywhere where CMS could make decisions about how much they would be paid for anything that they did. And they got into other things a big area that they got into as I'm sure you know, is buying doctors practices, in specialties, that take place within hospitals, mainly like emergency room, anesthesiology, radiology, mostly those kinds of practices and envision and teamhealth envisioned on by KKR. And females owned by Blackstone, they put up tons and tons of practices. And they now supply at least a third, the last time I looked, it was a third of the doctors practices that practice in hospitals. So they were, they've been very aggressive and buying up doctors practices, and they make their money, it's not a mystery how they make their money. Once they own these practices, and they have supplied them to hospitals that are must haves in health care plans, then they are able to it's they drive a hard bargain. In the case of envision, they typically do not go into network, they are not part of any network. And they make their money doing surprise medical billing. And in the case of team health, they use the threat of being able to go outside any network and to negotiate much higher prices for the services they provide, compared to what had been negotiated, or what had been paid by insurance companies previously, there's a really good study by Zack Cooper and his colleagues at Yale University, documenting in great detail, what happens to prices of emergency room care, once the docs that are running the emergency department are on the payroll of, of Envision, or teamhealth. So we know for sure that they make their money by driving up these kinds of prices. So either consumers through surprise billing, or through threatening insurance companies that they will use surprise building, they will go out of network, surprise belly. So that of course, that's excited a lot of interest in Congress about ending surprise billing, and we can see what happens. So as I mentioned, when private equity buys a company, it puts the debt or forms a company in these cases, it puts the debt on that company. And so envision and teamhealth, which are advertised as management services organizations, we can talk about that more later on in this conversation. But anyway, as management services organizations, the debt is on them. And InVision is carrying more than $5 billion in debt. And teamhealth is carrying more than two and a half billion in debt. And although things owned by KKR and Blackstone rarely are distressed that everybody thinks this is pretty safe. What happened is when Congress began debating this, is that the debt of both those companies fell below 80 cents on the dollar, which means they fell into distress territory. Now, they recovered somewhat when Congress went home without including this last December. And it's unlikely to come up at this time in the middle of a period of other kinds of stresses and problems to deal with. But so the debt recovered somewhat, but it made it really clear that the the creditors who hold the debt of InVision and teamhealth understand that their ability to repay that debt depends on their being able to charge more for their the services of their doctors than anybody else is able to charge. And that differential is what allows them to pay down the debt so or to be able to pay the debt is some of this, our balloon payments are going to pay it all at once at a certain point in time. And the creditors are really afraid that if a built a really limit, a surprise medical bill goes through that that debt is never going to be worth 100 cents on the dollar. So that's how they made the money in hospitals. And the reason they can do that is you show up in the emergency room. I think the last question you you say doctor saved my life. The last question you ask is are you in my network? If the hospital is in your network, I think the assumption on the part of most patients is that every doctor they will see is in their network. And so they are really surprised when they get those surprise bills. anesthesiologists, you meet your anesthesia. geologists at 530 in the morning on the day of your surgery, and he hands you a sheaf of papers to sign and you sign them. You're not thinking anything about it. But in that bunch of papers is something that says, I'm going to bill you separately, I'm not liable for anything bad that happens to you. Good luck in your and of course, radiologists, it's a similar situation. So initially, that's what they bought. And that's how they made their money. We can go on and talk about things that all I know you have more questions?

D.J. Verret, MD, FACS : 20:33

Yeah, I like to focus a little bit more on the on kind of the recent acquisitions and some of the outpatient markets. But one thing you said I want to touch on real quick, you mentioned, that HCA did not make the timeframe that the private equity wanted. What is the timeframe for these investments by the private equity groups?

Eileen Appelbaum, PhD : 20:54

They like to sell them in three to five years

D.J. Verret, MD, FACS : 20:58

And one of the things in the, in your paper that I that kind of was a concrete subject that I generally knew is that private equity is focused on that three to five year timeframe and not necessarily the ongoing operations of the company, correct?

Eileen Appelbaum, PhD : 21:15

That's right. That's right. And you can see that that the operations of the company, they certainly don't want companies they own to fail. Absolutely, they don't want them to fail. But what they are most focused on is having those companies provide money that they can distribute back to their investors they are they have promised investors, outsized returns. Remember, if you invest in a private equity fund, you have tied your money up for at least 10 years, you have all kinds of risks there, you don't know, the fact that you committed the money, they don't take the money on the day you committed it, they call the money whenever they see an advantage, and they distribute the returns whenever it suits them. So you have no idea when they're going to call that money. And you have no idea when you're going to see a return. So, so these are risks to you as an investor. And if an investment is really risky, then the investor expects a premium. And so private equity wants to provide returns to its investors that exceed what they could have gotten by investing in the stock market. We can talk about that too, but that whether they perform as advertised, even in financial terms, is a quite as questionable. But in any case, that's their goal is to make outsized returns. So they need to make more than just the normal profit on these hospitals. And these are generally speaking, community type hospitals, often even rural, or hospitals that are in suburbs or rural areas. So if they're if they don't have other means of making this extra money, that's not like a, it's not like the Cleveland Clinic, which would never sell itself to private equity. But the Cleveland Clinic as the probably your listeners know, has had a commercial arm for since 2000, that has made tons of money for the hospital. It doesn't need private equity at all. But the hospitals, the private equity typically buys don't have those abilities. Often, however, because of their location in a suburb, sometimes in a desirable, smaller community. In cases, it's a rare case like Ottoman Hospital in Philadelphia, where the real estate was so much more valuable than anything anybody could do with a hospital. And it was pretty clear why they had bought it. But yeah, that's that's their goal is to make a lot a lot of money and to be able to sell and it's three to five year timeframe. This has not been possible for private equity and hospitals after HCA.

D.J. Verret, MD, FACS : 24:19

One other one other vocabulary term that you used in your paper was dry powder. And and the concept that private equity has a certain amount of money that they need to invest before they can actually go and raise more money and they're only making money on invested money. So they're always looking for a new deal. Can you can you kind of explain that a little bit more for us?

Eileen Appelbaum, PhD : 24:47

So let me just correct one thing. A large private equity firms raise a new fund every two or three years. They don't wait for the 10 years. You never know how they're performing. When you invest in this Next fund. So just to clarify that, but dry powder refers to those commitments Remember I said that if a an investor or pension fund or a wealthy individual, or a sovereign wealth fund or an insurance company, or an endowment, like at your university wants to invest in private equity, they make a commitment. And they immediately begin paying management fees on that commitment. They don't wait till the money's invested. The manage the private equity fund takes 2% each year of whatever was committed. So 20% of the money that is committed by a pension funds, or an endowment or whatever, over the 10 year period goes to as management fees directly to the private equity firm. But in any case, the other 80% is waiting around to be called, well, money that has been committed, but has not yet been called, is what we call what is termed dry powder. And if we look globally, right at this exact moment, because they're having a lot of trouble figuring out where to put their money in private equity firms have $2 trillion in dry powder, and in the US is probably about 1.3 or 1.5 trillion in dry equity in dry powder. So it's a lot a lot of money. And the investors asked to keep that money liquid. So when they calculate your return from investing in private equity, they don't calculate the fact that you have had to spend five years as much as five years with that money in some liquid form that you can then quickly provide to the private equity firm when they call it. And so this greatly distorts what the returns are to begin with. But in any case, that's what dry powder is we have a lot of available right now, private equity is looking to buy up all kinds of things going forward, we can talk about what that is, and a lot of that if they like to do what they've already done and what they know will work. And buying up doctors practices is something they know a lot about as

D.J. Verret, MD, FACS : 27:29

Well. And that's what I'd like to turn to in our last few minutes here is with that idea of so much dry powder. You know, I've seen as a Facial Plastic Surgeon dermatologists referred to me a lot. I've seen a lot of private equity acquisitions in that space. But as we were talking offline, you had mentioned there's there's a real potential post COVID to see even more private equity in outpatient practices for several reasons. So

Eileen Appelbaum, PhD : 27:59

First of all, if that's what they want to do, they've any any in hospital practices that could be bought have already been bought. So that's no no opening for them. And so they've moved into dentistry and dermatology, they moved into that pretty early. And now they're moving into ob gyn orthopedics, it's they've got tons of dry powder, they expect to be able to buy up companies. And there are two places that they're looking they're looking for a a doctor's practice where the founders are aging out and are looking for a liquidity event and a way to get out and make money. And they are looking at the startup practices young doctors who have invested a lot in technology and systems and so on in order to be able to serve their patients better and have gone into debt in order to do that. And now the pandemic has thrown all of those calculations off. The PPP loans that many doctors practices did get can only be used for paying your staff, paying your utilities paying your rent or your mortgage. They cannot be used to pay debt on equipment or anything like that. And so you're going to have a lot of these younger practices that are in a really bad situation, they're going to face a choice in many cases between losing their practice, or selling out to private equity and private equity thinks that lots of them are going to want to sell and it's more complicated. You can if you are a private equity own doctor's practice, you cannot charge more than the going rates in your community for your services. It's not like you were trying to peg into an emergency room bleeding. You have to deal with whatever's there. You can choose your dermatologist, you can choose your dentist, your ob gyn, your orthopedist. And so the way that they are Make Money is in the incentives they provide doctors, this is this is really disturbing. And I'm not saying that, as I said at the beginning, a small private equity firm is not the ones that are doing this. It's a really big private equity firms buy up a lot of these doctors practices, put the doctors internally in competition with each other. They emphasize productivity, they tell you what the wage they're paying to you is relative to the money that you're bringing into the practice. And there's a lot of pressure in that situation to bring more money in. And of course, you know that the only ways of doing that are to order more tests than you might really need. Hopefully not, but sometimes perform more more procedures that are needed. Replace doctors with physician's assistants or nurse practitioners will often we'll call for more tests and so on, because they don't have the knowledge and the experience to be able to make a definitive diagnosis on their own. So they call for them because they need them, but they need them because they're not answers. So they're, they're the all of those kinds of things, hopefully not too many unnecessary procedures. And this can, this can be very difficult. I know for sure that this has happened in dentistry, because we have really a quick case study, they're written up by USA Today. And in that case, everybody was disappointed the dentists who signed up, we're not signing up to be under such pressure to produce the partners who sold to private equity. But there was going to be a liquidity event at the end, they did sell a North America Dental Group to a British organization, which looks a lot better place to be. But even even the doctors who sold the practice of were told that they will have a liquidity event, we're disappointed in what they got. Because these things are not spelled out. You know that you have a stake in the private equity fund. But you don't know what share the fun your stake is. And you don't know how many other dentists are in that same little pool. And so the amount of money that particular dentist got when it was sold, who had sold the practice and were promised a liquidity event was much less than they ever expected. So there was disappointment all around, not to mention patients who had unnecessary procedures, who were definitely disappointed.

D.J. Verret, MD, FACS : 32:40

Dr. Appelbaum. Thanks so much for joining us today, some excellent education and a little bit more into the opaque window of private equity, equity, ownership and healthcare. Certainly a lot more to study there as well.

Eileen Appelbaum, PhD : 32:55

Thank you very much.

D.J. Verret, MD, FACS : 32:57

You're listening to Ask Me MD, medical school for the real world. I'm Dr. DJ Verret, we've been talking with Dr. Eileen Appelbaum, co director of the Center for Economic Policy and Research and a fellow at Rutgers University about private equity and health care. Until next time, make it an awesome week.

Announcer : 33:15

Thank you for joining us for another episode of Ask Me MD, medical school for the real world with Dr. D.J. Verret. If you have a question or an idea for a show, send us an email at questions at Ask Me MD podcast.com