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Is there space in healthcare for private equity participation? If you listened to the Federal Trade Commission’s recent workshop, their answer may appear to be “none”. But we think enforcers have a narrower focus than their rhetoric suggests, both in nature and in scope.
Under the current Administration, both antitrust agencies have taken an aggressive enforcement posture against private equity in general. FTC chair Lina Khan has told agency staff that private equity models “may distort ordinary incentives in ways that strip productive capacity and may facilitate unfair methods of competition and consumer protection violations.” At the Antitrust Division of the Department of Justice, Deputy Attorney General Jonathan Kanter has described private equity firms as “top of mind for me, and… for the team,” noting that their business models are “often very much at odds with the law, and very much at odds with the competition we’re trying to protect.” Similarly, Deputy Assistant Attorney General Andrew Forman remarked that “private equity firms can be fundamentally different than other market participants,” noting that the Antitrust Division “often looks more favorably on a market participant as a buyer of assets than a private equity firm.”
The antitrust agencies’ critique of private equity is even sharper in the context of the healthcare sector. FTC Chair Lina Khan has described private equity healthcare buyers as “short-term, high-risk, and low-consequence owners[]” rewarded by a “flip and strip” approach. According to the agencies, these characteristics create financial incentives that are misaligned with those of both their investors and their portfolio companies, resulting in decisions to cut costs and increase prices at the expense of patient care and working conditions. Specific practices that spark regulatory ire include roll-up acquisition strategies, leveraged buyouts, sale-leasebacks of real estate, and the collection of monitoring or transaction fees.
The DOJ and FTC further describe private equity ownership to be difficult to detect and insulated from legal recourse, bemoaning the fact that many acquisitions are too small to trigger the HSR reporting thresholds or are controlled contractually and so not subject to the HSR Act. The FTC’s lawsuit against Welsh Carson filed in Texas last year for “rolling up” anesthesiology practices illustrates the agencies’ response to both issues, via its application of the new merger guidelines addressing “serial acquisitions” and its inclusion of a veil-piercing argument to assert liability for the private equity fund.
The antitrust authorities have also announced a collaboration with the Department of Health and Human Services to share information on healthcare deals. In addition, the federal agencies may learn of deal activity through partnerships with state attorneys general, who possess state-level enforcement powers distinct from those available to the federal agencies.
We think this diagnosis of the healthcare sector’s ills comes with two key limitations. First, the blanket characterization of private equity firms does not capture the wide range of private equity investment strategies across financing methods, sector specializations, time horizons, and exit plans. In particular, the “flip and strip” criticism leveled by Chair Khan fails to consider investment strategies characterized by longer time horizons or that emphasize organic growth. For example, long-dated funds and permanent capital funds can hold investments for decades or even indefinitely, reducing the short-term financial pressures the FTC ascribes to private equity. Healthcare investors should be prepared to explain how their strategy is distinguishable from the agencies’ dated and monolithic perception.
Second, we also anticipate that regulatory scrutiny is directed primarily at retail and consumer-facing operations. Such operations include hospitals and clinic chains, that are more sensitive because they are in direct contact with patients. Hospitals and clinics are also easier enforcement targets because their geographic markets are often local, making them more susceptible to consolidation. In comparison, healthcare and life sciences entities with business-to-business operations instead are less likely to trigger the same concerns with regulators.
Despite the adverse regulatory environment, healthcare deals - even those with retail components - are not off-limits. Private equity buyers and their deal counterparts should, however, anticipate longer investigations when preparing for such deals. Investors should be able to articulate a clear plan for their investment post-closing to avoid misinterpretations of their intended strategy. These efforts should also be well-documented so as to better substantiate any representation made to the antitrust agencies.