One of the signature debates of this year’s US presidential election has serious ramifications for the private equity industry. And this time, it has nothing to do with the way carried interest is taxed.
In March, the Supreme Court is scheduled to hear arguments on The Patient Protection and Affordable Care Act of 2010 – otherwise known as President Barack Obama’s massive overhaul of the US healthcare system – which is intended to drive down costs and add an estimated 30 million Americans to the nation’s insurance roster. Among the reforms are slowdowns on Medicare and Medicaid reimbursements, which many healthcare providers rely on for earnings.
“You’re at an inflection point. There will be net winners, because there will be growth in certain areas, and there will be net losers, because there will be things going the other way,” says Craig Frances, managing director at Summit Partners (he’s also a physician). “It makes you that much more careful as an investor.”
The impact has already been seen in the earnings of private equity backed healthcare providers. Morningstar analyst Michael Waterhouse’s prediction that the PPACA would subdue Hospital Corporation of America’s top line was borne out in HCA’s third quarter report, which saw an increase in admissions but a decline in revenue.
“A few years ago, people could buy and sell hospitals and not think anything of it,” says healthcare private equity specialist Ira Coleman of McDermott Will & Emery. “Government reimbursement always plays a part in healthcare investing, because they are almost always the largest payer. So if the largest payer says ‘we’re paying less for a certain type of service’ the private equity industry talks about that.”
Of course, these reforms and their impact on medical reimbursements will only remain in place if the ever-unpredictable Supreme Court upholds the rulings of three Federal Circuit Courts, which struck down separate challenges to the law for a variety of reasons. A final ruling is expected in June.
Until then, sources say they expect fund managers to stay away from investments affected by what one GP referred to as “the taint of smaller reimbursements”. However, in an industry as broad as healthcare, uncertainty about whether reform will be upheld doesn’t translate into a dearth of opportunity.
“On the margins, I think very often people say ‘healthcare reform’ and think it’s somehow ‘healthcare remade overnight’. The reality from our perspective is that [although] healthcare reform [is] attention grabbing, implementation of it tends to be incremental in nature,” says Oliver Moses of MTS Healthcare.
What’s more, because the industry is so fragmented across dozens of local or niche sub-sectors, certain areas will probably be unaffected by reform. In fact, in some sectors it will be actively encouraged. Investors in managed care providers and benefit management companies touch all the necessary bases for investment in the modern healthcare industry, says Frances: quality-of-care improvement, implementation of cost-saving efficiencies and strong returns.
In particular, healthcare IT has received a lot of attention since the reforms were signed into law. While many industries invested heavily in technological development over the years, healthcare has lagged behind. For instance, as of 2009, only 17 percent of physicians used an electronic records system, according to The New England Journal of Medicine. Building databases of patient records was a priority for reformers, and this has encouraged many fund managers to invest in the space in the last three years, sources say.
It’s all part of a larger trend that Coleman says involves “moving from buying hospitals and adding economies of scale to [the] changing of business models for better care, lower cost and [driving] a return.”