Gastroenterology: An escalating trend in private equity healthcare transactions

In September 2019, Becker’s ASC Review published an article written by VMG Health titled “Gastroenterology: An Emerging Trend in Private Equity Healthcare Transactions.”

This article discussed private equity (“PE”) firms’ increased interest in the gastroenterology (“GI”) provider industry, the current market dynamics and value creation opportunities within the GI industry, players in the space, and the future of PE transactions in GI. Since our previous article was published, the market continues to see consolidation of GI physician practices by PE or PE-backed firms. Most notably, we have begun to notice a shift from the formation of platform GI businesses to tuck-in, also referred to as add-on, acquisition activity by these platform companies.

Market Update and Recent Transactions
The largest and most active player in the space is GI Alliance, which was formed through a strategic partnership between Waud Capital and Texas Digestive Disease Consultants in 2018. Since inception, GI Alliance has actively pursued tuck-in acquisitions to grow its platform, solidifying its place as a key player in the market. In our initial article, we identified a few different groups that we believed would be attractive targets. Since then, GI Alliance has partnered with many of these organizations, including Illinois Gastroenterology Group, Arizona Digestive Health, and Digestive Health Associates of Texas. As a result, GI Alliance now represents over 800 total providers, including 430 gastroenterologists and complementary physicians and 380 advanced care providers.¹

Another main player in the space is Gastro Health. Gastro Health partnered with Audax Private Equity in 2016, marking the first major PE deal in the GI physician space. Since then, Gastro Health has also actively pursued add-on acquisitions, growing from 47 physicians in 2016 to 238 as of December 2019.^2,3 In February 2021, it was announced that Audax Private Equity had hired an investment bank to provide sell-side advice for the sale of Gastro Health. The potential sale of Gastro Health marks the first full investment life cycle of PE involvement in GI. Market participants will be interested to learn the results from this transaction as it will establish a metric to evaluate subsequent transactions. Historically, valuation multiples on adjusted EBITDA metrics for these platform companies have been in the low to mid-double-digit range.

While GI Alliance and Gastro Health have continued to pursue tuck-in acquisitions nationally, more regional PE-backed GI practices have also been active. These groups include United Digestive (formed by Frazier Healthcare Partners in 2018), US Digestive Health (formed by Amulet Capital in 2019), Gastro Care Partners (formed by Varsity Healthcare Partners in 2019), One GI (formed by Webster Equity Partners in 2020), Pinnacle GI Partners (formed by H.I.G. Capital in 2020), and Allied Digestive Health (formed by Assured Healthcare Partners in 2021).

Tuck-In Acquisitions
With the emergence of these GI platforms over the past couple of years, we have noticed a subsequent increase in tuck-in acquisitions. As a result, the environment has become more competitive, with some independent GI practices transacting up to high single digit multiples. Demand for tuck-in activity is not uncommon for PE-backed practice management platforms, who frequently deploy this strategy in fragmented industries as an avenue to grow their businesses.

Through acquisitions, platforms have the opportunity to leverage their scale and create value. Through consolidating practices, the platform is able to easily scale back-office functions, such as billing, accounting, scheduling, and HR, as well as implement best-practices in treatment protocols. This decreased administrative burden is also advantageous to the physician partners who are allotted more time to focus on patient care, thereby growing the procedure volume and cash flows of the business. Additionally, economies of scale and consolidation of practices can allow a platform to build-out or leverage an already existing suite of ancillary services, such as ASCs, in-office endoscopy suites, anesthesia, and pathology. Especially in the GI space, these ancillaries are often steady and profitable. Other benefits of scale include more favorable vendor pricing, easier recruitment and training of physicians, brand recognition, and infrastructure for additional tuck-in acquisitions.

In addition to the attractive business model, there has been a shift in market dynamics that might further entice a group to sell its practice to a PE-backed platform. Most notably, the coronavirus (“COVID-19”) pandemic has had an impact on the healthcare industry, especially surgical specialties that were forced to suspend elective procedures. Independent practices were especially affected by the pandemic as compared to management-led institutions who tend to have access to more resources and diversification. Based on a recent study by Bain & Company, the percentage of physicians citing financial stability of employer as a key professional criterion has almost doubled since the COVID-19 pandemic.⁴ Now more than ever, physicians are attuned to the benefits that a strong financial partner can provide.

As with all investments and partnerships, there are risks to consider. It may be challenging to align the goals of physicians with their PE partners, who typically have an investment horizon between three and seven years. Additionally, when partnering with a PE firm, physicians may see a reduction in base salary in exchange for future equity returns or “earnings repair” based on the performance of the business. The success of this model is often dependent on the physicians continuing to work at historical production levels for the promise of equity returns at a later date. Physicians and PE investors should take time to ensure that their incentives and expectations are aligned in order for the investment to succeed.

Future of the Field
Over the past few years, we have watched the GI space evolve from an emphasis on investment in and development of platform companies to a focus on the growth of these platforms through tuck-in acquisitions. Further, now with the ripening of one of the original platform companies, we will be able to observe recapitalization metrics, which will likely be used as a reference for future platform transactions.

Even with the development of several PE-backed platform companies as discussed earlier, the GI market remains highly fragmented and is ready for continued consolidation in 2021. Players like GI Alliance and Gastro Health have been actively recruiting and partnering with physician practices. As the other platform companies follow suit, the demand could continue to foster a competitive bidding environment for the sale of independent GI physician practices.

For physicians who are part of strong and growing practices, these tuck-in acquisitions present potential opportunities for financial stability and growth, as well as the ability to monetize the equity in their practice. However, as with all investments and partnerships, extra care should be taken to ensure both parties are entering into a favorable arrangement. Post-transaction physician compensation, earnings repair, and equity investment opportunities should make sense for both parties. Additionally, it is important that financial advisors with industry knowledge provide due diligence to ensure a healthy transaction. VMG is a trusted financial advisor with experience in the physician services space and offers an unmatched industry experience that is beneficial to acquirers and targets alike.