It may be hard to believe, but many experts believe the days of the independent family doctor, running a small, highly personal private practice, may be coming to an end. An estimated 2,910 physicians were involved in mergers or acquisitions last year - nearly double the number in the previous year - according to a new report from PricewaterhouseCoopers. Mergers and acquisitions of physician practices has hit a record number this year, and this trend is expected to continued as the new health reform law is implemented.

Although some patients may miss the old days, this consolidation may actually be good for doctors, hospitals and patients in the long run. This consolidation will free up capital, which healthcare providers desperately need to install new technology to maintain electronic medical records, track healthcare quality, and implement other changes required by health reform. From the physician's perspective, the consolidation will give much-needed relief to doctors who have been increasingly squeezed by shrinking reimbursement rates.

"Physicians want stability so they can focus on practicing medicine," said a local physician who is talking with MidCap Advisors to understand the options for his group. "We are seeing cuts in everything from office fees to procedure reimbursements, and we're being asked to make substantial investments in our practice to comply with healthcare reform.  It's taken the fun out of running a practice.  My partners and I just want to get back to seeing patients."

Some specialties are really under pressure, and not just because of health reform. This year, Medicare came down hard on cardiologists, cutting fees by 10% to 40% for nearly all the services they provide. As a result, the American College of Cardiology predicts that 60% of cardiology practices are planning layoffs and 39% are considering selling themselves to hospitals or merging with another group.

Because sales of physician's practices are private transactions, little data is available about the terms of each deal, but in general, they all shared some of the following characteristics:

• The size of the physician group, the specialization of its doctors, the profits from the ancillary business, and the value of the tangible and intangible assets were viewed as value drivers by the hospitals, groups, or other healthcare service provides that acquired them and presented them with significant strategic opportunities.
• The physicians were offered attractive employment contracts that included production-based compensation formulas and incentives to align both the physicians' and hospital's interests.
• The practices were valued by an independent, third-party valuation firm to support or determine a purchase price based on fair market value.
• A great deal of the value of the practices came from ancillary services, such as lab work, ambulatory surgery, sleep studies, weight loss programs and clinical studies.
• The physicians and the hospitals agreed to management structures that provide the physicians with an ongoing role in group governance and the management of their "internal practices" within the hospital or other buyer.

Why The Increase in Transaction Activity Now?

There are a number of reasons for the increase in transaction volume. As alluded to above, a combination of economic and regulatory pressures has significantly changed the business environment for both physicians and hospitals.

Reimbursement pressures. Changes in Medicare are driving down the profitability of physician practices. In addition, in many large metropolitan markets, payers have used the leverage gained from market consolidation to win significant concessions from physicians.  These changes plus the uncertainty of the impact of new healthcare reform have reduced the profitability of most practices and made practicing medicine more and more difficult.

Physician shortages. Many hospitals view the acquisition of physician practices as one way to address chronic medical staff shortages.  A recent study by the Bureau of Labor Statistics suggests that by 2014 there will only be enough physicians to fill 75% of open medical staff positions. In some states such as Arizona and Florida, where the population of retirees is growing rapidly, acute physician shortages are the norm.  With healthcare reform expected to add an additional 32 million patients to the healthcare system, the shortage of doctors nationwide is expected to get worse.

Changes in law.  In the 1990s, doctors and hospitals developed various structures so that the physicians and hospitals could share in, rather than compete for, ancillary income streams.  However, in late 2007, sweeping changes to the Stark law and other rules not only stemmed new deals, but also required the restructuring or termination of joint ventures already in place. This caused physicians and hospitals to once again compete for revenue from ancillary income streams.

Capital constraints. Over the last 10 years or so, many physicians invested heavily in equipment and facilities to capture ancillary income. This led to excess capacity in many markets. Over the years, this equipment and these facilities have become outdated resulting in a drop in revenues.

If you are a physician thinking about selling or merging your practice, please contact the MidCap Advisors office nearest you.  Our Healthcare Specialty Practice Group would be happy to help you understand the value of your practice and explore your options.