Survival skills: Some PPMs have found their niche

Stephen J. Dresnick, MD, has seen it all in the physician practice management industry.

The emergency physician founded Sterling Healthcare Group Inc., a pioneering PPM, in 1987. It grew quickly, went public in 1994, and was sold to San Diego-based FPA Medical Management Inc. in 1996. That was about when the roller coaster reached the top of the hill.

FPA went bankrupt in 1998, and Sterling was sold to Coastal Physician Group of Durham, N.C., which later became PhyAmerica Physician Group. A name change couldn't alter its fate, however, as PhyAmerica filed for bankruptcy in 2002.

Not one to frighten easily, Dr. Dresnick, backed by partners, bought his company back out of bankruptcy last year, and the reincarnated Sterling Healthcare got back in the market in February. Its focus is hospital-based physician services, and it has resumed its original strategy of growing organically, which was a key to success in the company's former life.

"As I look back, at the time, given the information, selling the company was the right decision," said Dr. Dresnick, who serves as president and CEO of the Durham company. "Today there's a lot less competition. Now's a good time to be in this industry."

It's a good time because natural selection weeded out all the bad business models, leaving few companies with which to compete. As evidenced by Sterling Healthcare's odyssey, much of the competition in the PPM industry wound up in bankruptcy court a few years ago without much warning to burned investors.

But while the Wall Street health care darlings of the mid-1990s, such as PhyCor Inc. and MedPartners Inc., imploded at the turn of the millennium, little-noticed specialty PPMs managed to survive. Today, many are thriving, gaining value by concentrating on their niche services and developing stronger relationships with their affiliated physicians.

For instance, Pediatrix Medical Group Inc., a Sunrise, Fla.-based company that specializes in mostly newborn and maternal-fetal care, recorded about $84.3 million in net income, or $3.43 per share, last year. Houston-based US Oncology Inc., which boasts a network of more than 900 physicians in 32 states, has had an up-and-down existence in recent years, but it posted net income of about $70.6 million on $2 billion of revenue for all of 2003, and $44.7 million on $1.1 billion of revenue for the first six months of 2004.

Some new companies also have emerged in the wake of the PPM decline, including PainCare Holdings Inc. The Orlando, Fla.-based company, which specializes in pain management, minimally invasive spine surgery and orthopedic rehabilitation, has expanded aggressively since its start in 2000. It reported net income of $2.7 million for the first six months of 2004, compared with income of $886,000 during the same period last year.

Not every remaining PPM is impressing investors, but there are plenty of success stories out there, enough to provide an interesting contrast to the myriad failures in the last decade.

"Primary care PPMs were in business for the wrong reasons," said Ted Schwab, a partner with Sokolov, Sokolov & Burgess, a Scottsdale, Ariz., consulting firm. "Specialty PPMs are in it for the right reasons. Primary PPMs were trying to make money through controlling referrals, while specialty PPMs were getting better margins on new and existing business."

The PPM craze

PPMs made a dramatic splash early on with investors, gobbling up physician practices at a rapid rate. Companies were built on the idea of buying the assets of primary care and multispecialty practices, signing long-term agreements and then managing them for a fee. But the growth Wall Street was counting on came from acquisition and not from profit gains at individual practices.

Companies, caught up in the buying frenzy and the competition between other PPMs and hospitals, which also started acquiring practices, were waving enormous sums of money at physicians to purchase the assets of their practices. The offers, many of which were made in shares of stock, were accompanied by service and attention promises regarding clinical resources, which often went unfulfilled as bloated companies focused on acquisitions.

As the value of the PPMs started to plummet, many physicians were left with very little support or financial motivation.

"Going into a lot of those deals, I wasn't the only one questioning what these people were doing," said Mark Coel, a partner and health care attorney with Michaud, Buschmann, Mittelmark, Millian, Blitz, Warren & Coel P.A. in Boca Raton, Fla. "It wasn't uncommon for a practice to get a multiple of 10 or 12 on earnings for a purchase price."

Specialty PPMs, meanwhile, were taking a different approach as they flew under the Wall Street radar. With fewer competitors, they were able to target the most valued practices in each market, making cash offers and developing partnerships with the physicians. Their commitment to technology and opportunities to explore ancillary revenue streams made them flexible as well, Schwab said.

The single-minded focus of both the PPM and physician group, regardless of the specialty, helped drive amicable relationships.

Pediatrix, for example, originally started as a group practice in 1979, and grew with the demand for neonatology services in hospitals around the country. The company focuses on adding value to the practices through billing, collecting and other business services as well as clinical value through research and education investments, said Karl Wagner, chief financial officer for Pediatrix.

The company continues to acquire practices at an aggressive pace, but deals with practices are always made with cash, Wagner said. In fact, Pediatrix has made only one deal with stock, when it acquired Dallas-based Magella Healthcare Corp., a national group of neonatal and maternal-fetal medicine subspecialists, in 2001.

"The reason we [make acquisitions with cash] is so the physician knows what they're getting the day they close the acquisition," Wagner said. "With stock, the value can move downward. It's better for physicians to have expectations."

It has been easy for physicians to buy into the Pediatrix philosophy as well. Keith Meredith, MD, a neonatologist with a Phoenix subsidiary practice, was a partner with a group in Colorado Springs, Colo., when Pediatrix came calling in 1997. Initially, the group declined an acquisition offer, but after watching the company operate from afar, the doctors agreed on a deal.

The transition from practice owner to employee "wasn't difficult, because all of the things promised actually happened," said Dr. Meredith, who is now medical director of neonatology for Phoenix Perinatal Associates, owned by Pediatrix affiliate Obstetrix Medical Group. He sought a transfer to another practice within the company, an opportunity he said would not have been available had the practice not agreed to join the Pediatrix network.

"One of the reasons this organization does well, purely from an organizational approach, is it began as a single specialty," Dr. Meredith said. "They have a better understanding of how to attract and keep physicians."

Adding value

Involving physicians and providing them with resources that will help them in their clinical efforts is a trademark of successful specialty PPMs. For example, the idea of adding value to the business, and being able to prove it consistently, is what helped US Oncology grow, said David Chernow, a co-founder and former president of the company's physician services group.

Chernow left US Oncology about three years ago to become president and CEO of Junior Achievement Worldwide, a nonprofit organization that teaches young people about business and economics. The memories of business success with US Oncology are still fresh in his mind, however.

"The key issue was there needed to be a value exchange," Chernow said. "US Oncology does something for doctors they could not do for themselves."

Companies are constantly adapting to the changing health care environment as well. US Oncology, for example, has been vigilant lately in converting all of the practices in its network from a net revenue model, where practices aren't as accountable for costs, to an earnings model, where performance fees are aligned with earnings before income tax. The conversion helps to align economic incentives for both the PPM and physician practices, the company said in its 2003 annual statement.

Officials from US Oncology declined to comment on the specialty PPM industry, citing the company's transition to private ownership. In a transaction valued at about $1.7 billion, US Oncology was recently purchased by the private equity firm Welsh, Carson, Anderson & Stowe, which previously held about 14.5% of the company's stock. Chernow speculated that the move was not a sign of trouble at the company but a lack of public recognition for the company's value, since the firm that purchased it was already a major public investor.

US Oncology's transition to private status is an indication of the climate surrounding PPMs. They no longer garner the attention they had in the last decade, and it's not likely they'll be the darlings on Wall Street anytime soon. And that's not a bad thing, Schwab said.

"Wall Street runs in big trends, and investors were burned badly," Schwab said. "Even with the new flavor, it's still probably going to be five or 10 years before they come back around. That's fantastic for companies. It'll keep them more disciplined, and it keeps them close to their core business."

Dr. Dresnick is an example of that approach, as Sterling Healthcare works at securing partnerships with hospital-based physicians. The goal, which harkens back to Sterling's origins, is simple: Align company and physician incentives, so the better everyone does at their jobs, the better everyone does financially.

"At the end of the year, they should be able to look back and say they had a better deal with Sterling," Dr. Dresnick said. "To me, that's a model that can do well and be successful."