Public Healthcare Operators: Valuation Trends Summary
June 21, 2022
Written by: Savanna Dinkel, Zach Sadau, Vincent M. Kickirillo, CFA, CVA
Over the past several years, private equity firms have increasingly turned to specialty physician practices in order to generate significant returns for their investors. Since 2011, dermatology has been an active market for these types of transactions and the market is not anywhere close to cooling down. According to Irving Levin Associates, there have been 37 dermatology transactions in 2017 through November, up 46% from 2016 (Philips). Dermatology practices are attractive to private equity investors for several reasons including their steady growth, strong demand, and attractive market dynamics.
According to IBISWorld, the dermatology industry is a $14.3 billion industry expected to grow approximately 2.4% compounded annually over the next four years (Oliver 4). Main drivers of growth include an aging population and an increased awareness of skin cancer. By 2020, there will be approximately 56 million Americans over the age of 65, up from approximately 43 million in 2012, representing a compounded annual growth rate of 3.4% (Ortman et al. 26). With approximately 44.5% of the dermatology industry’s revenue currently generated by patients over the age of 60, the aging population will prove to be a strong tailwind to industry growth (Oliver 16). Further, over 5.4 million cases of nonmelanoma skin cancer are treated each year in the U.S. alone (“Cancer Facts & Figures” 24). According to the Skin Cancer Foundation, there are more new cases of skin cancer than breast, prostate, lung, and colon cancers combined (“Skin Cancer Facts & Statistics”). As a result, the demand for dermatology is not expected to slow anytime soon. More recently, dermatology revenue growth has also been supported by an increase in disposable income, resulting in strong growth in cosmetic dermatology, a higher margin segment. With these trends supporting dermatology industry revenues and steady cash flows, it is no surprise why private equity firms are looking to get some skin in the game.
Although there is an increasingly high demand for dermatologists, there is a shortage of them in the United States. Currently, there are only approximately 14,000 dermatologists in the US and according to Merritt Hawkins’ 2017 Survey of Physician Appointment Wait Times, the average wait period for a dermatologist was 32.3 days, the highest of the five specialties surveyed (“Practice Management 2.0” & “Survey of Physician Appointment Wait Times” 12). As a result of this mismatch between supply and demand for their services, dermatology practices are expected to continue to remain busy and be able to defend their high margins.
Furthermore, private equity firms have increasingly been attracted to dermatology practices because of their interesting value propositions. The main segments of dermatology include general (56%), cosmetic (21%), Mohs surgery (15%), other (5%), and dermatopathology (3%) (Oliver 4). General dermatology and Mohs surgery provide the practice with steady and recurring cash flows, while cosmetic dermatology is characterized by high-margins, since procedures tend to be paid out-of-pocket, with opportunities to upsell. The cosmetic segment is much more consumer-centric, offering a direct-to-consumer aspect that skillful private equity firms can capitalize and grow. While receiving steady cash flows from the general and Mohs surgery side, a private equity firm with additional marketing experience might be able to further extrapolate revenues and value from the practice through the cosmetic side.
The dermatology market is a highly fragmented market, with the three largest industry practices accounting for less than 2.0% of revenue as of 2016 (Oliver 20). In such a fragmented industry, private equity investors see an opportunity to create economies of scale through industry consolidation. For the independent dermatologist, which makes up one-third of the market, it can be difficult to keep up with administrative tasks and regulatory requirements (Oliver 20). Recently, there has been a shift in physician preferences to become part of a larger organization in order to alleviate these administrative burdens. Through consolidation, private equity firms are able to leverage back office functions such as marketing, billing, supply inventory, compliance, and other administrative activities across multiple locations. Further, with an increase in market share, the practice can gain stronger negotiating power with payors and improve commercial payor reimbursement contracts.
Coupled with the strong tailwinds mentioned above, a private equity firm’s skill and business experience can help magnify the value in a dermatology practice. Private equity investors understand the significant administrative needs of managing a business. By investing in multiple practices, private equity investors can consolidate the practices, creating platform companies in order to scale administrative functions. These administrative functions have become and will continue to become even more tedious as the Medicare reimbursement changes from a fee-for-service model to a value-based model. As discussed previously, a majority of dermatology practices are independent and thus lack the infrastructure to efficiently comply with the increased reporting needs. By scaling these functions, the dermatologist is allotted more time to spend on generating revenue through patient care, which, as mentioned previously, is in high demand.
Additionally, investment may be extremely attractive for physicians approaching retirement by helping evaluate a buyout and providing smooth succession. For younger physicians, a private equity investment can provide a more flexible work schedule and allow the dermatologist to practice without the stress of managing a practice. The greatest value-add of a private equity investor will be its ability to consolidate and streamline administrative burdens across multiple locations. By shifting administrative responsibility, the highly demanded dermatologists will have more time to see patients and increase practice volumes. In addition, private equity investors might be more equipped to take advantage of marketing and upsell opportunities in the cosmetic dermatology portion of the practice.
As with all investments and partnerships, there are risks to be considered. The goals of physicians may be challenging to align with their private equity partners since private equity firms tend to have investment horizons between 3-7 years. As a result, the private equity firm may be more focused on short-term growth versus long-term practice stability. Further, while private equity partnerships may make sense for soon retiring physicians looking for a buyout, younger physicians just beginning their career may be reluctant to sacrifice future earning opportunities. Issues may also occur as the physicians deal with the loss of autonomy that tends to accompany private equity partnerships. These conflicts are not insurmountable, but the physicians and private equity partners should take time to ensure that their goals are aligned in order for the investment to succeed.
The first step in evaluating a potential partnership between a private equity firm and a dermatology practice will be to acquire an in-depth understanding of the dermatology market and its main drivers. Further, it is critical that the purchase price of the dermatology practice, the post-transaction physician compensation, and the management agreement be consistent with fair market value given the increasing healthcare regulatory scrutiny. Before entering into a partnership, a comprehensive due diligence process should be undertaken in order to help achieve compliance and assist with making a sound investment decision.
Despite these potential challenges, private equity firms offer opportunities and means for dermatology practices to take advantage of recent trends and grow their practice. By consolidating and creating economies of scale, dermatologists can focus on meeting the high patient demand and continue to grow the cash flows of the business. Partnerships with private equity firms provide ample opportunities for value growth, not only benefiting the practice, but also, providing returns to the private equity firm’s investors.
“Cancer Facts & Figures 2017.” American Cancer Society. Published 2017. https://www.cancer.org/content/dam/cancer-org/research/cancer-facts-and-statistics/annual-cancer-facts-and-figures/2017/cancer-facts-and-figures-2017.pdf.
“Practice Management 2.0.” Triple Tree. Published April 2017. https://www.triple-tree.com/strategic-insights/2017/april/dermatology-an-industry-poised-for-continued-evol/.
“Skin Cancer Facts & Statistics.” The Skin Cancer Foundation. Published February 2017. http://www.skincancer.org/skin-cancer-information/skin-cancer-facts.
“Survey of Physician Appointment Wait Times and Medicare and Medicaid Acceptance Rates.” Merritt Hawkins. Published 2017. https://www.merritthawkins.com/uploadedFiles/MerrittHawkins/Pdf/mha2017waittimesurveyPDF.pdf.
Oliver, Kelsey. “Dermatologists in the US.” IBISWorld. Published December 2016. IBISWorld Industry Report OD4168.
Ortman, Jennfer, Victoria Velkoff, and Howard Hogan. “An Aging Nation: The Older Population in the United States.” Published May 2014. www.census.gov/prod/2014pubs/ p25-1140.pdf.
Philips, Lisa. “Dermatology Deals Up 46% in 2017.” Irving Levin Associates. Published November 2017. https://healthcare.levinassociates.com/2017/11/21/dermatology-deals-keep-coming/.