Four ways that private equity and venture capital are disrupting hospitals and health systems

Banker Commentary by Aaron Newman, February 2022

<p>Four ways that private equity and venture capital are disrupting hospitals and health systems</p>

Traditionally hospitals and health systems have been the nexus of care delivery for their communities. Over the past several years, private equity and venture capital investment has significantly disrupted the legacy business model of hospitals and health systems.

When patients have an episode of care, their likely first call was to their provider affiliated with a local hospital. And despite consolidation of hospitals and health systems over the past decade, this dynamic has remained intact until recently. Over the past several years, private equity and venture capital investment has significantly disrupted the legacy business model of hospitals and health systems. In 2020 alone, global private equity dry powder was estimated at $3 billion, with healthcare accounting for approximately 18% of reported deals. Moreover, healthcare private equity deal volume increased by ~21% in 2020 and is on pace to surpass this level of activity in 2021. As a result, hospitals and health systems must understand and evaluate the following four ways that private equity and venture capital are fundamentally disrupting their business models and proactively assess strategic alternatives to fortify their market position.

Growth in Medicare Advantage

Traditionally, Medicare fee for service patients have been a significant, yet low margin, source of revenue for hospitals. This dynamic is due to Medicare’s low reimbursement rates, coupled by an aging U.S. population driving an increasing percentage of Medicare volume relative to total payor mix. In addition, Medicare eligible populations often have a higher prevalence of chronic conditions with associated high costs of care. According to recent CMS data, while representing only 15% of the U.S. population, the Medicare eligible cohort group accounts for 34% of all healthcare spending.


In an effort to solve this conundrum, there has recently been an emergence of provider organizations, such as Chicago-based Oak Street Health (NYSE: OSH), focused on transforming care delivery for the Medicare population, specifically Medicare Advantage enrollees. Oak Street Health, which was initially backed by private equity firms General Atlantic and Harbour Point Capital, went public in August 2020 via a $328 million IPO offering. The company aims to solve the high-cost, high-acuity, poor outcomes dynamic through a team-based primary care delivery model aimed at enhanced patient-provider engagement through tech-enabled solutions resulting in reduced hospitalizations and emergency room volume. As of Q3 2021, Oak Street Health operates 110 locations in 31 markets covering 132,000 patients.

Physician Aggregation

Historically, physicians have had a limited number of options with regards to their employment model – become a hospital employee, have a contractual arrangement with a hospital, such as a professional services agreement, or be on a partnership track with an independent physician practice. However, over the past several years there has been rapid consolidation of physicians fueled by private equity and other for-profit healthcare companies. In 2020 alone, there were 188 reported M&A deals in physician services, an increase of 40% relative to the 10-year average.


Provider organizations such as Summit Health, backed by global private equity firm Warburg Pincus, are rapidly consolidating markets and offering physicians a different employment and ownership option. Specifically, Summit Health has experienced rapid growth fueled by a billion-dollar-plus buyout from Warburg Pincus in 2019. As of today, Summit Health has more than 2,000 providers, 8,000 employees and over 200 locations in the ultra-competitive New Jersey and New York market.

Delivery of Care at Lowest Cost Setting

Hospital and health systems have struggled over the past decade to maintain strong operating margins due to a myriad of external pressures. The legacy brick and mortar business model has innately high fixed costs resulting from depreciation and debt service. Moreover, labor costs have recently precipitously increased due to shortages caused by the COVID-19 pandemic. This dynamic has resulted in insurance companies using reimbursement rates to incentivize care delivery at lower cost settings, which frequently results in more convenient care and improved patient outcomes.


One area that has experienced a transformation in care delivery is home health and hospice, as demonstrated by Amedisys (NASDAQ: AMED) $250 million acquisition of Contessa Health in June 2021. Contessa Health, backed by BlueCross BlueShield Venture Partners and other notable venture capital firms, is an innovative provider organization that has developed tech-enabled solutions and advanced data analytics that result in superior care management for a challenging patient population. Contessa will expand Amedisys hospice business line and be among the first home-based care companies to offer hospital or skilled nursing at home on a national scale.

Disruption from Nontraditional Care Providers

The traditional hospital business model has utilized primary care physicians as the gatekeeper for patient access to other episodes across the system of care delivery, such as specialty, tertiary, or quaternary cases. Hospitals, however, lack the focus on convenience that consumers desire, resulting in longer than wanted wait times for patients. In addition, hospitals traditionally have needed to subsidize their primary care provider networks as loss leaders in their broader systems of care delivery.


In response to consumer preferences, there has been a shift in the primary care delivery model led by nontraditional care providers such as CVS Health and Walgreens. Both companies, historically pharmacy-based chains, have utilized their nationally scaled retail footprint as access points to capitalize on the changing needs of consumers/patients for convenient care delivery in a low-cost setting. For example, Walgreens has recently expanded its partnership with Chicago-based VillageMD by investing an additional $5.2 billion in the private equity and venture capital-backed company, bringing Walgreens' ownership stake from 30% to 63%. VillageMD provides primary care services across 15 markets to more than 1.6 million patients.


The investment by Walgreens will fund the opening of roughly 600 VillageMD locations across Walgreens' retail platform by 2025 in more than 30 markets across the U.S.


These four trends, amongst numerous others often driven by private equity and venture capital investment, will continue to provide significant challenges to the legacy hospital and health system landscape.

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