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Do you know what to do if a PPMC shows interest in partnering with you and your practice?

Fam Pract Manag. 1998;5(6):49-59

To gain the advantages that come with being part of a larger business entity, some family physicians are selling their practices to physician practice management companies (PPMCs). Their practices thus become affiliates of the larger organization the PPMC is building.

Access to capital, skilled leadership, managed care expertise, information systems and economies of scale are touted as major benefits of PPMC affiliation. Unfortunately, not all PPMCs are created equal. The right PPMC can offer you and your practice tremendous resources, but selling to the wrong one could cost you your current income and potentially your entire practice. (See “Physician Practice Management Companies: Too Good to Be True?” April 1998.)

While PPMCs have become a multibillion-dollar industry, some experts question the long-term viability of that industry. With the oldest PPMC in business only since 1988, and most industry start-ups barely five years old, they question whether PPMCs can generate enough revenue to remain profitable once the current rate of practice acquisition and industry consolidation slows down. Some experts also voice concerns about the ability of PPMCs to stimulate practice development and foster quality care.

Before you consider PPMCs

Some practices turn to PPMCs in the hope of resolving their own organizational problems. Bad idea, says Stephen George, MD, MBA, a family physician who is founder, chairman and chief executive officer of First Physician Care, a primary care PPMC based in Atlanta. He maintains that a mutually beneficial affiliation is most likely to happen when a practice and PPMC both have their acts together.

“Physicians need to first focus on their internal vision, mission and values,” says George. “They must know where they are headed and what is required to get there before starting a discussion with a PPMC.”

According to George, a PPMC can be a very effective enabler of well-organized practices by providing access to capital, specialized management services, information systems, managed care contracts and liquidity by converting their private practice equity value into cash, notes or stock.

But can PPMCs in fact deliver what they promise? “Even the state-of-the-art PPMC in this country is a work in progress,” says Nathan Kaufman, senior vice president of Superior Consultant Co. Inc., The Kaufman Group Division in San Diego. “It's still a research and development effort. You really can't point to one place and say, ‘These guys have it right and we can basically model this throughout the country.’”

Kaufman says his experience is that PPMCs are reasonably successful at improving practice revenue and reducing expenses from a third to half the time. When they're not, physicians are stuck with less compensation for the same amount of work.

“This is a 40-year decision you're making,” cautions Kaufman. “It needs to be an extremely informed decision, and the information you need is not the sales brochures and the visits to the handpicked clinics, but an understanding of the upside and the downside.”

When PPMCs target your practice

Depending on who's doing the counting, only 5 percent to 8 percent of American physicians are currently affiliated with PPMCs. That means there are still lots of physicians, physician groups and clinics for PPMCs to sign up. Existing PPMCs are being joined by start-ups. Mergers and acquisitions within the industry are another way PPMCs are growing.

Why the emphasis on growth and mergers? “The objective is to gather up enough covered lives so that you are a significant player with the managed care companies,” explains Geoffrey Anders, JD, president and chief executive officer of The Health Care Group, a health care consulting firm with offices in Plymouth Meeting, Pa., and Greenville, S.C. “If you have those covered lives in significant amounts in one market, that is economic power.”

If you are among the vast majority of unaffiliated physicians, you may find yourself being wooed by multiple PPMC suitors. “When a PPMC sales representative knocks on your door, you should realize that this is an experienced salesperson whose sole reason for living is to talk you into a deal,” says Michael Parshall, who is a vice president of The Health Care Group and specializes in the PPMC industry.

Even if affiliation is not in your plans, talking with PPMC representatives can be a great opportunity to find out what's happening in your marketplace and what the going sale price is for your practice, provided you avoid some potential pitfalls:

  • Do not sign a “letter of intent” that restricts you from talking to other PPMCs and may legally obligate you in other ways.

  • Do not provide detailed financial data about your practice. For example, data that reveal the relative profitability of physicians in your practice may tempt a PPMC to “cherry pick” the most profitable physicians for affiliation and exclude the rest.

  • Do not take at face value claims that one or more practices in your market have committed to affiliation with a PPMC.

Should you decide that PPMC affiliation may be the right move for your practice, you can maximize your chances for a successful partnership by taking several basic steps.

Retain experienced advisors

“Most of the time, a small cadre of physician leaders in a group does the negotiating and the majority simply go along with the deal,” says Kaufman. “For the physicians doing the actual negotiating, this is probably the first and only time they've ever negotiated a deal like this, and it's an extremely complex deal, whereas the people they're negotiating with have negotiated hundreds of these deals and know what all the issues are.” Kaufman emphasizes that professional advice is absolutely critical when dealing with PPMCs.

What kind of professional advisors should you retain? “At a minimum, a lawyer and an accountant who are very experienced in this area,” says Anders. “The main thing is to get somebody who knows how medical practices work and who knows how these PPMC transactions work.”

In addition to advising you, negotiating with PPMCs and reviewing contract provisions, experienced professionals can direct the due-diligence process, a broad assessment of a PPMC's suitability that includes an in-depth evaluation of references, senior management, corporate philosophy, financial stability and past performance.

Do due diligence right

“When a typical primary care physician does due diligence on a PPMC, he or she flies to the corporate headquarters for a barbecue, visits four hand-picked centers where everybody says everything's great and then signs a 40-year deal,” says Kaufman. “But what if the PPMC can't do for that physician's group what it claims to have done for others?” The point, Kaufman says, is not to decline the barbecue invitation or the site visits, but to get beyond the PPMC's canned pitch.

Anders recommends taking the following steps to collect as much information as possible to evaluate a PPMC:

  • Look at the PPMC's broad business strategy. “If there is no strategy other than buying up practices here and there, I would be concerned that they are simply trying to play the arbitrage between the private and public markets, rather than trying to develop a profitable professional practice management company,” says Anders.

  • Ask the PPMC to identify resources and services that distinguish it from other companies. Does it, for example, offer some innovation in the delivery of care, or is it just buying up practices because it has some venture-capital money?

  • Ask the PPMC about its business plan for your practice in particular and its overall plan for your market. Is it going to invest capital? What is that capital going to be used for? What guarantees do you have that the PPMC will fulfill its promises? Does the PPMC have a record of executing business plans after acquisitions?

  • Satisfy yourself that you want to be partners with the company you're considering. You can do that, in part, by reviewing management résumés or executive histories and by studying financial reports.

  • Check references to find out if the PPMC is able to grow the practices it has acquired. Find out who the affiliates are and where they're located. Talk with as many physicians in the company's network as possible.

  • Check Nexus and other news sources for articles about the PPMC to see how the outside world views this company. You would be shortchanging yourself not to look at what others have to say.

  • Find out if the PPMC has a high enough penetration of practices in your market to achieve significant efficiencies from economies of scale. “If there are only three freestanding practices and the hospital has bought up everything else, the chances of high penetration in your market may not be very good,” says Anders.

“Due diligence also involves understanding how the philosophy, goals and purpose of the organization influence the provision of patient care,” says family physician Jeoffry Gordon, MD, who sold his San Diego solo practice to FPA Medical Management in 1994. “You find that out by assessing the PPMC's reputation in the community and by looking at how it balances the clinical needs of doctors and patients with the need to live within a budget and organized medical services.”

You can accomplish this, in part, by gathering information on the PPMC's approach to risk management, utilization management and quality assurance and the role of primary care physicians in the system. Does the PPMC value primary care physicians? How is this reflected in its governance structure and policies and procedures? What type of clinical support is provided? How does the PPMC handle utilization management? Does it sanction carveouts? Does the PPMC reward quality care? Does it have a quality-improvement committee? Does it provide feedback on quality initiatives?

Obviously due diligence takes a while. Family physicians who have been involved in this process report that it can consume several months. According to Ken Davis, MD, it took the six physicians of Conroe Family Practice four months to ink their deal with Sadler Clinic, a PhyCor affiliate in Conroe, Texas. “There were a lot of things to iron out,” says Davis. “We wanted every possibility covered.”

Mergers and acquisitions

Given the frequency of mergers and acquisitions in the industry, it's highly likely that the ownership of a PPMC will change several times over the life of a physician's affiliation contract. Such consolidations can have a significant impact on the PPMC's philosophy, business strategies, management personnel, stock value and even its specialty focus.

A number of concerns were raised last year when PhyCor, the second-largest PPMC in the country, announced plans to acquire MedPartners, the largest. PhyCor, based in Nashville, Tenn., has tended to affiliate with large multispecialty groups in markets with limited managed care. MedPartners, located in Birmingham, Ala., is more diversified and has a strong presence in capitated markets. While strategic and cultural differences prevented completion of the transaction, experts believe that large-scale mergers and acquisitions will happen more and more frequently over time.

Public vs. private PPMCs

PPMCs typically go public or are acquired by larger PPMCs that are already publicly traded. PPMCs that are still privately owned invariably hold out the prospect of a significant increase in the value of their stocks when either of these events takes place. But there are no guarantees. “All things being equal, I would be much more inclined to do a deal with a pre-public practice management company simply because I'm going to get a bigger bang financially on the eventual public offering of its stock than I would on a company that's already publicly traded,” says Anders. “If I'm going to take a chance on this industry to begin with, I might as well roll the dice on the whole deal. The problem is that there's greater risk because you don't know if that PPMC will actually go public.” For all you know, of course, its stock may in fact decrease in value.

Whether the PPMC you are considering is a publicly traded or privately owned entity, you need to determine at least the current value of its stock and how the value has varied over time. Also find out what assumptions it's using to project its future worth and find out what unbiased experts think the prospects for the stock are.

Good chemistry, shared values

As Anders points out, you have to satisfy yourself that you want to be a partner with the company you're considering. The PPMC has to look good on paper and survive all the due diligence you and your advisors can throw at it. But physicians who say they are satisfied with their PPMC affiliations also give considerable weight to personal chemistry.

“You can have all the lawyers and all the accountants in the world, but you have to have a good feeling deep down about the folks you're going to be working with, that they have the same vision and goals that your group has,” says Michael Jutras, MD, medical director of medical management for First Physician Care of North Texas Inc.

This may be where the barbecue at corporate headquarters and the site visits come into their own. “We think it's important for the physician group and the company to spend a significant amount of time together,” says Tom S. Dent, executive vice president, chief operating officer and a founder of PhyCor. “They need to make sure, first of all, that their philosophies are aligned in terms of how they see the world, how they see medicine and where they see medicine going, and, secondly, whether these are people that both the company and the physicians can live and work with.”

Get it in writing

Consultants warn that the typical 40-year PPMC affiliation contract is designed to make it very difficult for physicians to extricate themselves. Dent concedes the point, saying that affiliation is meant to be a permanent relationship. Usually, restrictive covenants require a physician to buy out of the contract for an amount equal to two years' gross income or to agree not to practice within a defined geographic area for two years.

Anders and Kaufman encourage physicians and their advisors to consider all aspects of the deal, the financial as well as the nonfinancial. The key, says Kaufman, is to anticipate the downside. For example:

  • What happens if practice expenses go up or if revenues go down?

  • How is the PPMC's performance measured? Are there provisions for getting out of the deal if the PPMC doesn't perform satisfactorily?

  • Under what other conditions can you get out of the contract?

  • How will the revenue from new ancillary services be divided?

  • What guarantee is there of physician autonomy in clinical decision making?

“Use the negotiating leverage you have at the beginning to get what you want,” adds Parshall. “Do not assume that things will somehow work out after the fact.”

Don't do it for the money

Selling your practice to a PPMC can generate a substantial economic windfall. You may even reduce your long-term tax liability if the proceeds are taxed at the capital gains rate instead of the higher ordinary income rate. But if you do it only for the money, you'll probably regret it.

“Physicians who make their decision based upon what someone will pay are in for a very unpleasant, unsuccessful experience,” says Dent. “No one will pay a physician enough to make it worth his or her while to form a bad partnership. The money is not that significant over the long term.” What physicians should be looking for in an affiliation, according to Dent, is a partner they can live with, one who will aid their decision making and actually make their lives easier and their practices more competitive.

Recognize the risk

Industry blandishments and affiliated physicians' testimonials notwithstanding, Anders, Kaufman and Parshall agree that it's still too early to tell whether physicians are actually better off, financially and otherwise, by affiliating with a PPMC. They contend that the evidence in support of affiliation falls short on several counts:

  • Few, if any, PPMCs have demonstrated that they can generate substantial long-term “same-store growth” in their affiliated practices and pass that new revenue on to their affiliated physicians.

  • Many PPMCs seek global capitation contracts to maximize their revenues, usually at the expense of hospitals. Many PPMCs also develop ancillary services as a major source of new revenues for their affiliated groups, also at the expense of hospitals. But hospitals are merging to retain these revenue streams, so PPMCs may not realize the new revenues they're counting on in these areas.

  • Some PPMCs have sophisticated systems to benefit their affiliated groups, but most PPMCs have not invested significantly in information-system infrastructure.

  • Most PPMCs know more about how to raise and invest capital than about how to run a medical practice.

“Whether PPMCs can achieve the results they promise is still very much open to question,” cautions Anders.

“The problem is that after you pay expenses and legitimate compensation to the physicians, there's no money left over,” says Kaufman. So how do PPMCs create profits? One way, according to Kaufman, is to structure the deal so that the PPMC gets paid out of the same pool of money as the physicians. That creates profits for the PPMC, but at the same time it lowers the compensation for the physicians. “That's why PPMCs turn to what were traditionally hospital revenues, such as ancillary services, to get the physicians back to their original compensation structure, but the results on that have been very mixed,” says Kaufman.

PPMCs have reduced expenses and increased revenues with ancillary services, better management and global capitation contracts in some instances. But according to Kaufman, there are at least as many affiliated groups where revenues have not increased, expenses have not declined and physicians have become unhappy. Eventually, Kaufman believes, PPMCs may face the dilemma of either generating earnings for their investors or maintaining physician compensation levels (see “Wall Street, PPMCs and your practice”).

Another factor to consider is that affiliated physician compensation is reduced by the percentage of the PPMC's management fee, typically 15 percent to 20 percent of practice revenue after expenses are paid. If revenues don't increase, physician compensation remains below pre-affiliation levels, but the PPMC still gets its percentage. If expenses increase, the PPMC bears only 15 percent to 20 percent of the burden.

Even when physicians receive less compensation for the same work, the PPMC still gets the same percentage of practice profits; if there is no performance clause in their contract with the PPMC, they may be stuck indefinitely. To the extent that they elected to have their practice sale proceeds paid to them in stock, physicians can also lose if PPMC stock underperforms. PPMCs argue that they share in both feast and famine with their affiliates, but the way Kaufman sees it, the typical PPMC affiliation arrangement puts physicians at disproportionately greater risk.

Wall Street, PPMCs and your practice

Some experts believe that the successes PPMCs claim at the group practice level cannot be sustained or replicated when the current feeding frenzy of mergers and acquisitions comes to an end. In other words, these critics claim that the industry is being capitalized by inflated stock prices and not by actual revenue growth generated at the level of affiliated group practices.*

“The question is, is this an industry that lends itself to going public long term?” asks Nathan Kaufman, senior vice president of Superior Consultant Co. Inc., The Kaufman Group Division in San Diego. “Can a PPMC grow that physician group on a same-store basis at a rate of 20 percent a year like Wall Street expects? If not, Wall Street is going to punish it.”

That's exactly what happened in the first quarter of 1998, Kaufman maintains. The pace of acquisition slowed and growth from existing practices did not materialize, so PPMC stocks declined.

“PPMCs are Wall Street-driven, and if your group fails to hit the quarterly earnings forecasts, then you don't know what will result,” adds Geoffrey Anders, JD, president and chief executive officer of The Health Care Group, a health care consulting firm with offices in Plymouth Meeting, Pa., and Greenville, S.C. “The PPMC may balance the books by reducing physician compensation. And if your group or an individual physician doesn't hit the numbers, you can also expect that the PPMC will exercise increasing control over your operation.”

*According to Sherlock Company, in Gwynedd, Pa., publishers of PPMC, a monthly newsletter that provides financial analysis of publicly traded physician practice management companies, PPMCs are trading at price/earnings (P/E) ratios of 25 to 50 times their trailing cash flow, compared to a long-term average of 14 to 17 times for Standard & Poor's 500 stocks. Normally, says senior health care analyst Douglas B. Sherlock, CFA, higher P/E ratios mean that Wall Street believes these firms will grow faster than the Standard & Poor's 500.

The key question

Most family physicians would probably agree with PPMC executives like George when he says that physicians have an awesome opportunity to work effectively together to rechannel their individual control, power, autonomy, independence and authority to the stronger collective good of their physician organization, and that the power of physicians today is in their ability to work together. The question each practice needs to answer for itself is whether it can afford the price PPMCs are charging — and whether a given PPMC can deliver what that price is supposed to purchase.

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Copyright © 1998 by the American Academy of Family Physicians.

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