By Lloyd M. Krieger
he recent announcement that MedPartners , the nation's largest physician-practice-management company, is abandoning its core business sounds the death knell for Wall Street's latest health-care investment fad. As investors lick their wounds, they are left wondering what went wrong. The answer reveals much about where the health-care industry is headed, and what to look for when the next health-care craze hits the Street.
As health-maintenance organizations did before them, physician-practice-management companies quickly acquired familiar initials when they became the darlings of health-care investors. And like HMOs, the PPMs capitalized on fundamental trends in the industry and promised to use new dynamics in health care to reap profits for their stockholders.
PPM companies recognized that in the new market-driven health-care industry, managed-care insurance companies control the patients and the money. Physicians felt powerless as HMOs and similar outfits bullied them with practice restrictions and muscled them into accepting lower fees.
When PPMs burst on the scene three years ago, things looked particularly bleak for America's doctors. With the rest of the industry going corporate, physicians remained fragmented practitioners in a cottage industry. Small group practices were the height of modernity. Doctors lacked negotiating clout, sophisticated computer systems and the size or depth needed to manage the financial and operational challenges that HMOs were passing over to them.
Physicians needed help. They needed to industrialize to gain increased operating efficiency and management discipline. They needed to combine forces with colleagues to achieve economies of scale and a critical mass that would allow them to negotiate more effectively with managed-care plans.
Physician-practice-management companies promised to meet these needs. The companies bought physician practices, brought in sophisticated managements and lowered overhead, all while negotiating better deals with HMOs. It sounded great: Doctors practiced medicine while the professional managers developed business strategy and improved operations.
For a short time, it was great. Increased efficiency brought practice overhead down by an average of about 15%. Increased negotiating clout often raised reimbursements and lowered the cost of supplies by similar margins. Some 40,000 doctors sold their practices to PPM companies and industry experts predicted that fully half of the nation's physicians would join PPMs by the end of the decade. PPM stock prices soared.
Then the bottom fell out. A year ago the two largest PPM companies, MedPartners and Phycor , entered merger negotiations. Apparently what they learned about each other wasn't good. After the deal fell through a few months later, MedPartners admitted that 1998 earnings probably would be 30% below expectations. The stock eventually went to $4 a share from $26.
The entire industry has been in free fall ever since. Phycor's stock fell by half. Coastal Physician Group , an early highflyer at $37 a share, recently changed hands for 40 cents a share. Physician Resource Group , an ophthalmology PPM, had traded at $32 but fell to $4. FPA Medical is reorganizing under the protection of the bankruptcy laws.
Brooks O'Neil, an analyst at Piper Jaffray, specializes in physician organizations and had been a big booster of PPMs. "The stocks have been crushed," he says. For the first 10 months of the year, the group of publicly traded PPM stocks was down 32%. PPM venture capitalists who once assembled roll-ups have shifted to the creation of vulture funds that buy depressed PPMs in hopes of capitalizing on the industry depression.
Several things went wrong, but they boil down to one failure. Though they gave the appearance of addressing the needs of physicians and the whole health-care industry, PPMs looked only at the short term and failed to deliver on the promise of uniting disparate groups of doctors. The idea was good, but the development was shallow and the execution awful.
PPMs traded at two or three times the earnings of the practices at their heart. They fueled their growth with rapid-fire acquisitions. They did not cultivate their market through increased efficiency or revenues, but rather through a buying binge.
That binge, in turn, drove up the price of practices to a point where even the best managers could not have made money improving them. But all too often, business management of existing practices still took a back seat to additional practice purchases.
It's an old story for Wall Street, although more often seen in hamburger franchises or big-box retailers than in health care.