ASC Transactions & Valuation in the Current Healthcare Climate: Q&A With Jon O'Sullivan of Health Economix
Jon O'Sullivan recently sold his interest in valuation firm VMG Health and started a new company, Health Economix, which will focus on assisting clients with transactions, valuation and investment. Here he discusses his transition to the new role, as well as trends in transactions and valuation in the ASC industry.
Q: You've sold your interest in VMG Health and are starting a new venture, Health Economix. Could you tell me a little about the transition?
Jon O'Sullivan: I'm focusing more on representing clients in their transactions, whether they are buying and selling transactions or looking at investments in different opportunities — helping do the feasibility of those investments. And I'm also focusing on potentially co-investing with clients in surgery centers or healthcare real estate. My focus is on the surgery center industry, as well as working with surgical practices, surgical hospitals, hospitals that have surgical service lines, and surgeons. And then I also have an investment in a sister company called Ortho Economix, which provides surgical practices with a full set of back-office services — billing, accounting, information technology and HR.
Q: How will this change your day-to-day life, compared to your work with VMG?
JO: After 17 years with VMG and working with over 65 people, a lot of my activities were focused on managing the growth of the company, with less focus on client issues. I had a real desire in getting back into dealing with client issues, especially different transactions and different investments. I wanted to participate in helping surgeons and facilities through those strategic changes. This also allows me the opportunity to seek out investments that I wouldn't participate in as part of VMG.
We're very focused at this point in time on keeping Health Economix small and staying very focused. We want to use the Becker's conferences to help create awareness, and we want to be very specific and target about who we work with.
Q: What do you think are the biggest opportunities for physicians in healthcare right now?
JO: When we started VMG in 1995, there were one or two firms that did healthcare valuation. Now there are easily between six and 10 firms that do it, and it's become very much a commodity-driven business. Most valuations, if they're done right, are pretty much the same. So the question is, as healthcare providers, how do you manage that valuation process? For those people who do a lot of transactions, how do you manage that process so you rationalize the cost you spend when you're getting that valuation done?
As everyone in the surgery center market knows, it's a pretty mature market. There are not a lot of surgery centers or surgical hospitals being built versus 10 years ago. When you're acquiring existing facilities, or selling existing facilities, or merging facilities together so they're run together, how do you facilitate those transactions? I see a lot of the activity in the market centered on consolidation and growth, and for physician practices — especially surgical practices — you have the same issues: How do they position themselves in a marketplace that's changing?
I've had a lot of practices ask if they should sell to a hospital and become employed. It sounds like an easy answer, but it's very rarely a satisfying solution for physicians. They've got to look at what their market is, and what they have to do in the market to be relevant. That typically means having greater alignment with a hospital or surgery center management company that has a strategy beyond a single surgery center.
Q: Do you believe hospital partnership is realistically the future for surgery centers? Or do you think we'll see some reversal in the next 10 years?
JO: I do think it's a trend — it has been a trend and will continue to be a trend. Five or 10 years ago, physicians were looking to break away and become independent of hospitals, and we've come full circle, to where hospital alignment is perceived as an imperative. How does that alignment work? Employment doesn't work, so some other form of alignment — whether it's a joint venture with a hospital or a joint venture plus other physician arrangements — makes a lot more sense. A lot of it has to do with contracting, and a big part of it has to do with the election.
Q: Why do you see hospital employment failing for physicians?
JO: Physicians, by nature, are very independent. They're very independent, and they tend to look at how hospitals' internal processes run and see them as very dysfunctional. When they see those processes overlaid on their practice and their daily lives, they generally can't change them, and because they can't change them, they become very frustrated.
I don't think hospital employment will reverse completely, in part depending on the physicians in the market they're in. In some marketplaces, there will be practices that, once they're embedded with the hospitals and benefitting from better managed care contracts and reimbursement, their ability to exit out of that successfully may be limited. There may be other practices in other markets that have more ability to re-establish themselves.
Q: What issues and grievances do you see come up with physician practices that pursue hospital partnership?
JO: It goes back to the particular strategy and market. For example, if a physician group is going to align with a hospital in an employment or PSA agreement, the key issues are: how much autonomy the practice has within the structure; the parameters of the relationship as it relates to managing a practice; and the parameters of a relationship as it relates to finance. If the physicians are compensated, how are they compensated? If they're compensated on a collections basis, how involved are the physicians in determining what the collections process is?
If it's some other form of relationship, the same issues apply. In a merger of two practices, you need to assess how well the two cultures fit together. What are the differences between the practices, in anything from how their employees are compensated and the benefits they derive, to how the physician's compensation structures work.
Q: In light of hospital partnership and employment, is there a place for independent ASC investment in the future?
JO: You know, I don't think it's going to go away. I think physicians will always seek to provide a better environment to provide services to their patients. In doing that, they'll want to have a stake in it, and as long as the regulatory environment allows them to have a stake in the surgery center, the next generation of physicians will want to participate.
Having said that, we are in a much more mature marketplace, so the real question becomes: What are the opportunities for physicians to participate? Do they invest in existing centers, where they may not achieve as great of a financial return, or will they have the opportunity to participate in de novo centers, where they have greater economic opportunity?
Q: Do you predict a resurgence of de novo centers in the next five or 10 years?
JO: I think there will always be an opportunity for de novo centers because, as time progresses and physicians come out of residency and establish practices, there will be pockets of physicians who haven't invested. They'll learn that developing a de novo center is economically effective for them. There will also be situations where mature centers are actually slowing down, which will yield a different valuation and create opportunity for physicians to come in and recapitalize.
Q: What trends are you seeing in valuation? Are surgery centers receiving different prices than in the past?
JO: With the growth and maturity of the surgery center marketplace, one of the obvious results is that people are very aware and have a much greater understanding of how to value a surgery center. They understand the factors that impact valuation — the type of physicians that work there, the reimbursement levels, factors that might create risk for the surgery center. These are issues that, four or five years ago, physicians and surgery center operators didn't have a great grasp on.
Today, most of these constituencies have a pretty solid understanding of the values of a center; getting the valuation is just a formality. So the values of centers haven't changed. What's changed has been the variables that may yield a different value for the same center. A lot of mature centers are slowing down, and a lot of out-of-network centers are moving in-network.
Q: Are there opportunities for partnership for "turnaround" centers that are struggling to survive?
JO: Hospitals are looking for a relationship with the physicians, so whether it's a well-run or a poorly-run surgery center, the hospital is really interested in the physicians who are advantageous to the hospital. I don't see any distinction between hospitals looking at well-run versus poorly-run centers. A well-run center may have a higher valuation, and the hospital will pay more; if it's a poorly run center, it will have a lower valuation and a greater opportunity to create value. The question becomes: Why does a surgery center sell to a hospital? It's usually one of two things: To gain access to better managed care contracts, or to add additional physicians' volumes to the center.
For a standalone surgery center in a marketplace penetrated by managed care, my experience has been that hospitals can get anywhere between 25 to 40 percent additional reimbursement for the same volume. There are marketplaces where that's not true, but in general, that's what I've seen. When the surgery center is talking to a hospital, there's usually an analysis done that will determine the yield on reimbursement.
Q: You mentioned the election earlier. How do you think the outcome of the election could impact physicians and the ASC industry?
JO: The Affordable Care Act has created a much greater push towards accountable care organizations and a much greater push for hospitals to create integration in their systems. That includes the acquisition of physician practices, including surgical practices that might only be affiliated with a surgery center. There's been a lot of consternation on the part of ASCs that if that trend continues, your case volume will diminish if you're not aligned with the hospital. So from that perspective, a Democratic administration would continue that trend and pose a potentially greater threat to growth in the surgical marketplace.
Under a Republican administration, there would be some thought about repealing the Affordable Care Act. If the act is repealed, you have a much more deregulated marketplace and more demand for investment in surgical or short-stay hospitals. You also have less emphasis on ACOs and more emphasis on freestanding surgery practice and surgery centers.
Q: Anything else to add?
JO: As we look at hospitals themselves — and particularly smaller and short-stay hospitals — we will see a continued consolidation in the hospital marketplace. It follows the very same trend as surgery centers, and it relates to reimbursement cuts for health systems. Whether it's a surgery center, surgical hospital or hospital, we have to ask how those entities will fare and survive in the face of reimbursement cuts.
My role is to work with facilities through those transitions — to work with practices and determine the best strategy for them in this environment.
Learn more about Health Economix.
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