(Bloomberg Businessweek) -- Not long after Gavin Newsom, the governor of California, ordered the state’s 40 million residents to stay home to stop the spread of the new coronavirus, Dr. Greg Morganroth called his team of doctors and said their dermatology group was staying open.
Morganroth is chief executive officer of the California Skin Institute, which he founded in 2007 as a single office in Mountain View. He’s since expanded to more than 40 locations using a financing strategy that’s become exceedingly common in American health care: private equity. In this case, he took out a loan from Goldman Sachs Group Inc. that could eventually convert to an equity stake. CSI is now the largest dermatology chain in California.
But the Covid-19 pandemic put Morganroth in a precarious position. Most medical procedures were characterized as nonessential by government officials and practitioners. Doctors were closing offices, and patients were staying away to limit their potential exposure to the virus.
CSI took a different approach. Morganroth explained his thinking on April 2 in a Zoom call with more than 170 dermatologists from around the country organized by the Cosmetic Surgery Forum, an industry conference. Contrary to what they might have heard, Morganroth told them, they should consider staying open during the pandemic. “Many of us are over-interpreting guidelines,” he said.
For a moment there was an awkward silence. Doctors had thought they were signing up for advice on how to apply for government money that would help them meet payroll while they were shut down; they hadn’t expected to be told not to shut down at all. Morganroth continued: “We are going to be in a two-year war, and we need to make strategic plans for our businesses that enable us to survive and to rebound.”
Back at CSI, the company’s front-office staff was working the phones, calling patients in some of the worst-hit areas and reminding them to show up for their appointments, even for cosmetic procedures such as Botox injections to treat wrinkles. During the videoconference, Morganroth argued that offering Botox in a pandemic wasn’t so different from a grocery store allowing customers to buy candy alongside staples.
“If I had a food supply company and had to stay open, and I had meat, bread, and milk, would I stop making lime and strawberry licorice?” Morganroth asked. “I would make everything and go forward.”
From a public-health point of view, some of the doctors believed, this was questionable. Common reasons for visiting a dermatologist’s office—skin screenings, mole removals, acne consultations—aren’t particularly time sensitive. Serious matters, such as suspected cancers and dangerous rashes, can be handled, at least initially, with telemedicine consultations. Then doctors can weigh the risks for their patients and determine who needs to come in. In a statement, CSI says that it followed local and state laws for staying open, while providing “necessary care” for patients, and that it had not required doctors to come to work.
Morganroth’s defense of pandemic Botox might seem odd, but it made perfect sense within the logic of the U.S. health-care system, which has seen Wall Street investors invade its every corner, engineering medical practices and hospitals to maximize profits as if they were little different from grocery stores. At the center of this story are private equity firms, which saw the explosive growth of health-care spending and have been buying up physician staffing companies, surgery centers, and everything else in sight.
Over the past five years, the firms have invested more than $10 billion in medical practices, with a special focus on dermatology, which is seen as a hot industry because of the aging population. Baby boomers suffer from high rates of two potentially lucrative conditions: skin cancer and vanity. Some estimates suggest that private equity already owns more than 10% of the U.S dermatology market. And firms have started to expand into other specialties, including women’s health, urology, and gastroenterology.
There’s nothing inherently wrong with any of this. But some doctors say that the private equity playbook, which involves buying companies, drastically cutting costs, and then selling for a profit—the goal is generally to make an annualized return of 20% to 30% within three to five years—creates problems that are unique to health care. “I know private equity does this in other industries, but in medicine you’re dealing with people’s health and their lives,” says Michael Rains, a doctor who worked at U.S. Dermatology Partners, a big private equity-backed chain. “You can’t serve two masters. You can’t serve patients and investors.”
Investment firms, and the practices they fund, say these concerns are overblown. They point out that they’re giving doctors a financial shelter from the rapidly changing medical environment, a particularly attractive prospect now, and that money from private equity firms has expanded care to more patients. But they’ve also made it next to impossible to track the industry’s impact or reach. Firms rarely announce their investments and routinely subject doctors to nondisclosure agreements that make it difficult for them to speak publicly. Bloomberg Businessweek spoke to dozens of doctors at 10 large private equity-backed dermatology groups. Those interviews, along with information obtained from other employees, investors, lawyers, court filings, and company records, reveal how the firms operate, and why they sometimes fail patients.
The process is never exactly the same, but there are familiar patterns, which tend to play out in five steps.
Step 1: Marriage
The strange thing about private equity money in medicine is that for-profit investors have long been prevented from buying doctor’s offices. Corporate ownership goes against a doctrine set by the American Medical Association, the main trade group for doctors in the U.S., and is prohibited by law in many states, including Texas and New Jersey. For most of the past 100 years, if you wanted to make money on a medical practice, you needed to have a medical license.
Yet over the past decade, lawyers devised a structure that allows investors to buy a medical practice without technically owning it: the MSO, or management service organization. Today, when an investment firm buys a doctor’s office, what it’s actually buying are the office’s “nonclinical” assets. In theory, physicians control all medical decisions and agree to pay a management fee to a newly created company, which handles administrative tasks such as billing and marketing.
In practice, though, investors expect some influence over medical decision-making, which, after all, is connected to profits. “When we partner with you, it’s a marriage,” said Matt Jameson, a managing director at BlueMountain Capital, a $17 billion firm that recently invested in a women’s health company, while speaking at a conference in New York in September. “We have to believe it. You have to believe it. It’s not going to be something where clinical is completely not touched.” (When contacted by Businessweek, Jameson asked to clarify his comments. “Doctors and other qualified healthcare professionals at the providers we’ve invested in make medical decisions,” he said in a statement.)
The typical buyout starts with the acquisition of a big, popular practice, often with multiple doctors and several locations, for as much as $100 million. (Investors typically pay between 9 and 12 times annual profit.) This practice functions as an anchor, like a name-brand department store at a shopping mall, attracting patients and doctors to the new group as it expands. Then comes the roll-up: The private equity firm purchases smaller offices and solo practices, giving the group a regional presence.
As part of the new structure, investors deal with paperwork and save money by buying medical supplies in bulk. Crucially they also negotiate higher insurance reimbursement rates. One dermatologist who sold her practice to the California Skin Institute says she was surprised to find out the bigger group’s payouts from insurers were $25 to $125 more per visit.
When individual doctors sell, they generally receive $2 million to $7 million each, with 30% to 40% of that paid in equity in the group. After the acquisition, doctors get a lower salary and are asked to help recruit other doctors to sell their practices or to join as employees.
At first, doctors are generally thrilled by all of this. They have financial security and can focus on treating patients without the stress of running a business. Patients, for the most part, are in the dark. Unlike when your mortgage changes hands, you usually aren’t notified when a big investment firm buys your doctor. Sometimes the sign on the door bearing the physician’s name stays put, and subtle changes in operations or unfamiliar fees may be the only clues that anything has happened.
Step 2: Growth
The promise of more patients is a big draw for doctors. By sharing marketing costs and adding locations, the new companies can advertise more and attract customers. Private equity-owned practices have been diligent users of social media, announcing newly added doctors and posting coupons on Twitter and Instagram. But these practices can be aggressive in ways that make some doctors uncomfortable.
At Advanced Dermatology & Cosmetic Surgery, the largest private equity-backed group in the field, with more than 150 locations across the U.S., that sense of discomfort came shortly after Audax Group bought a controlling stake in what was then a much smaller chain in 2011. The new management team introduced a scorecard that rewarded offices with cash if they met daily and monthly financial goals, according to a lawsuit filed in 2013 against the company by one of its dermatologists. The doctor alleged that the bonus program encouraged staff to do as many procedures as possible, rather than strictly addressing patients’ medical needs.
In some of the company’s Florida offices, the doctor alleged, medical assistants responded to the bonus structure by ticking extra boxes on exam reports, stating that doctors checked many more areas of the body than they actually had. That led to higher patient bills, defrauding the government under its Medicare program, according to the lawsuit. The federal government declined to join the case, and it was dismissed about a year after it was filed. Advanced and Audax declined to comment.
Private equity-backed practices also try to increase revenue by adding more-lucrative procedures, according to doctors interviewed by Businessweek. In dermatology, this means more cosmetics, laser treatments, radiation, and especially Mohs surgeries—a specialized skin cancer procedure that removes growths from delicate areas like the face and neck one layer at a time, to limit scarring. The surgery involves expensive equipment and specialized doctors, so some large medical groups keep costs down by assembling traveling Mohs teams, who fly in from other states. Others create mobile labs in vans that set up in clinics’ parking lots.
Most dermatologists use outside labs and pathologists, but private equity-owned groups buy up existing labs and hire their own pathologists. Then doctors are encouraged to refer patients within the group and send biopsy slides to the company-owned labs, keeping the entire chain of revenue in-house. This takes advantage of a regulatory quirk that has made dermatology, and a handful of other specialties, attractive to private equity. Under the 1989 Stark Law, doctors aren’t allowed to make patient referrals for their own financial gain. An exception was made for some fields because it’s more convenient for patients, explains Dr. Sailesh Konda, a Mohs surgeon and professor at the University of Florida. “But that can be abused.”
Step 3: Synergy
Now comes the cost-cutting. This is supposed to be the hallmark of private equity, and, done right, it can work to the benefit of doctors and patients. But there are pitfalls unique to medicine, where aggressive cuts can lead to problems, some of them merely inconvenient and some potentially dangerous.
A doctor at Advanced Dermatology says that waiting for corporate approvals means his office is routinely left without enough gauze, antiseptic solution, and toilet paper. Even before the great toilet paper shortage of 2020, he would travel with a few rolls in the trunk of his car, to spare patients when an office inevitably ran out. The company declined to comment.
At the country’s second-biggest skin-care group, U.S. Dermatology Partners, a former doctor says a regional manager switched to a cheaper brand of needles and sutures without consulting the medical staff. The quality was so poor, she says, they would often break off in her patients’ bodies. Mortified, she’d have to dig them out and start over. She complained to managers but couldn’t get better supplies, she says. Paul Singh, U.S. Dermatology’s CEO, says the company uses a “reputable, global vendor for medical supplies.” “While our group may have standardized purchasing processes, individual providers have the autonomy to procure specific supplies that they need for a particular patient situation or patient population,” he says in a statement.
Doctors who join a private equity-backed group generally sign contracts that state they’ll never have to compromise their medical judgment, but some say that management began to intervene there, too. Dermatologists at most of the companies say they were pushed to see as many as twice the number of patients a day, which made them feel rushed and unable to provide the same quality of care. Others were forced to discuss their cases with managers or medical directors, who asked the doctors to explain why they weren’t sending more patients for surgery. Multiple practices also encouraged doctors to send home Mohs surgery patients with open wounds and have them come back the next day for stitches—or to have a different doctor do the closure the same day—because that would allow the practice to collect more from insurers.
That’s if doctors are performing the procedures at all. At Advanced Dermatology, several doctors say they were asked to claim that physician assistants, or PAs, were under their supervision when they weren’t seeing patients in the same building, or even the same town. Because PAs are paid less than dermatologists, this allowed the company to keep costs low while growing the business. In a statement, Eric Hunt, Advanced’s general counsel and chief compliance officer says that having PAs on staff enables the company to “provide access to quality dermatological care to more patients.”
Step 4. Rolling Up the Roll-Up
Advanced Dermatology was sold in 2016 by Audax to Harvest Partners LP, following a pattern that’s typical in the industry. At some point, after costs have been cut and profits maximized, most private equity-owned medical groups will be sold, often to another private equity firm, which will then try to somehow make the company even more profitable.
Having reduced most of the obvious costs, Advanced Dermatology began skimping on more important supplies, including Hylenex, according to doctors and other employees. The drug is an expensive reversal agent used when cosmetic fillers, which are supposed to make skin look plumper, go wrong. Not having enough is dangerous: Patients who get an injection that inadvertently blocks a blood vessel can be left with dead sections of skin or even go blind if they don’t get enough Hylenex in a matter of hours. The company says that it stocks Hylenex in every office that performs cosmetic procedures, and that it “has no records of any provider being denied an order for this medication.”
Advanced Dermatology also started giving even more authority to PAs, according to doctors and staff. Without enough oversight some were missing deadly skin cancers, they say. Others were doing too many biopsies and cutting out much larger areas of skin than necessary, leaving patients with big scars. Doctors who complained about the bad behavior say they saw PAs moved to other locations rather than fired or given more supervision. Hunt, the company's lawyer, says that all PAs get six months of training and are supervised by experienced doctors.
Advanced Dermatology also put more pressure on doctors to send biopsies to in-house labs. The move made sense financially, but some of the doctors didn’t trust the lab. One of its two pathologists in Delray Beach, Fla., Steven Glanz, had a history of misdiagnosing benign tumors, which led patients to undergo surgeries that were later found to be unnecessary, according to doctors who worked with him. Dermatologists who warned that Glanz was a danger to patients say that their complaints to Dr. Matt Leavitt, the group’s founder and CEO, were ignored. More procedures, doctors knew, brought in more money.
Glanz, who had been with the practice since its early days, was known to read slides under a microscope with a pistol on his desk. After he was arrested with a handgun, a folding knife, and a vial of methamphetamine crystals, he was fired and Florida’s state medical board fined him $10,000, requiring him to complete a five-hour course on ethics before he could resume practicing. But his former colleagues were unsettled; they knew Glanz’s signature was on years of reports that determined treatment for patients. Some slides were reevaluated, and pathologists noticed mistakes. Managers told some doctors and their staff that patients, even those who’d been misdiagnosed and had unnecessary procedures, were not to be told. Glanz pleaded guilty to stalking and a firearms violation and was sentenced to probation. When a reporter called his office and identified herself, the receptionist hung up. Further attempts to reach Glanz were unsuccessful. Advanced’s Hunt says that he was “formally released from employment three years ago,” but did not comment further.
Of course, some doctors pushed ethical boundaries long before private equity came into the picture. But critics of the industry, including doctors and investors, say management teams put in place by private equity firms tend to look the other way as long as a medical practice is profitable. Of the dermatologists with the highest biopsy rates in the country (between 4 and 11 per patient, per year), almost 25% were affiliated with private equity-backed groups, according to Dr. Joseph Francis, a Mohs surgeon and data researcher at the University of Florida.
Medical providers may have also been blurring ethical lines at U.S. Dermatology Partners, which was until recently on its second private equity owner, Abry Partners LLC. At four of the company’s offices in Texas, a doctor and his PAs were doing more biopsies than necessary, according to employees. These employees say the staff routinely called patients with benign lichenoid keratosis, small brownish blotches that usually go away on their own, and told them the growths should be removed. Under instruction from the doctor, the staff coined a new medical diagnosis, “pre- pre- pre-cancer,” and then talked patients into coming in for removal, employees say. Singh, the U.S. Dermatology CEO, says that the company trusts doctors to make the right decisions and that it monitors them through routine audits.
Step 5: Sell-Off
In some cases the cost-cutting either becomes impossible or leads to compromises in care too obvious to ignore. In 2016 a DermOne LLC office in Irving, Texas, had been using a faulty autoclave machine to sterilize surgical equipment—the state and county health departments identified 137 patients that needed to get tested for blood-borne diseases such as HIV and hepatitis. By 2018, DermOne’s backer, Westwind Investors, wanted out.
Westwind had been one of the earliest firms to build a big dermatology business—with practices in five states—but others had grown larger. After the debacle in Irving, the Nevada-based firm sold DermOne’s medical records and patient lists, as well as some of its offices, to other groups. It dissolved the remaining offices, leaving some patients abruptly without care. Westwind did not respond to repeated requests for comment. Two other private equity-backed groups, TruDerm and Select Dermatology LLC, have also gone out of business in the past two years.
The surviving chains have been saddled with large piles of debt they’re now struggling to repay. In January, U.S. Dermatology Partners defaulted on a $377 million loan, meaning the private equity backer, Abry Partners, had to hand over the keys to its lenders, Golub Capital, Carlyle Group, and Ares Management, which will now oversee a chain with almost 100 locations, receiving 1 million visits from patients a year. Abry did not respond to requests for comment.
For the medical groups that make it, the game plan is to eventually sell to the largest players, such as KKR, Blackstone Group, and Apollo Global Management. Pioneering investors, including Audax, are now buying practices in other fields—a concerning development to critics who note that the areas that are currently attracting investment, such as urology, generally involve more invasive procedures. Should doctors performing vasectomies be thinking about the dollar-rate returns for KKR—or any private investor?
“It’s ultimately going to backfire,” says Dr. Jane Grant-Kels, a veteran dermatologist and professor at the University of Connecticut School of Medicine. “There’s a limit to how much money you can make when you’re sticking knives into human skin for profit.”
One paradox of the Covid-19 pandemic has been that even as the virus has focused the entire country on health care, it’s been a financial disaster for the industry. And so, while emergency room doctors and nurses care for the sick—comforting those who would otherwise die alone, and in some cases dying themselves—private equity-backed staffing companies and hospitals have been cutting pay for ER doctors. These hospitals, like the big medical practices, make a large portion of their money from elective procedures and have been forced into wrenching compromises.
For investors with capital, on the other hand, the economic fallout from the virus is a huge opportunity. Stay-at-home orders have left small practices more financially strained than they’ve ever been. That will likely accelerate sales to private equity firms, according to Marc Cabrera, an investment banker focused on health-care deals at Oppenheimer & Co. Independent doctors or groups that previously rebuffed offers from deep-pocketed backers “will reconsider their options,” he says.
Many doctors may ultimately come to regret cashing out, but it’s hard to get out once you’re in. As part of an acquisition, the private equity groups typically require doctors to sign yearslong contracts, with noncompete clauses that prevent them from working in the surrounding area.
As governors throughout the nation ease restrictions on businesses, Advanced Dermatology is opening its most profitable offices first. The company received an undisclosed sum under the Cares Act, as part of the government relief package intended for health-care workers. Hunt, Advanced’s chief compliance officer, told employees in an email earlier this month that the money would be used for protective gear, such as masks, and to replace “millions of dollars” in lost revenue.
The group had closed most of its offices since the stay-at-home orders were issued in March, cutting pay for doctors and furloughing staff. With cities and states beginning to consider reopening, doctors and PAs say they’ve been told they should be prepared for a full schedule. Hunt says the company is following the appropriate safety measures, but employees fear it will be nearly impossible to keep patients apart in waiting rooms. Opening in a reduced capacity, they understand, is not an option.
Read more: Private Equity Ate Finance, and Now It’s Taking Over the World
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