The Truth about Private Equity and Radiology with Dr. Kurt Schoppe

Have you ever talked to someone above you on the food chain—usually with the word manager, director, or Vice President somewhere in their job title—and after they depart, you just stared blankly into the distance while slowly shaking your head thinking, Wow, they really don’t get it. What a useless bag of skin?

Well, that’s the opposite of my friend Dr. Kurt Schoppe, a radiologist on the board of directors at (my friendly local competitor) Radiology Associates of North Texas and payment policy guru for the American College of Radiology where he works on that fun zero-sum game of CMS reimbursement as part of the RUC. He’s whip-smart and has a unique perspective: Before pursuing medicine, Dr. Schoppe was a private equity analyst.

Consider this transcribed interview a follow-up to my essay about private equity in medicine published a few months ago.

Here’s our (lightly edited conversation):


Ben White:  One thing I think people don’t realize when it comes to PE is that, while I’ve argued that it’s a problematic trend, at the end of the day, each group–whether PE or not–is unique. I think it’s reasonable to use the trends (unhappy partners, employee exodus, high RVU demands, generalized misery) as datapoints in your personal decision-making, but ultimately if you’ve seen one PE group, you’ve seen one PE group.

Kurt Schoppe: I try to emphasize to people it is a funding model. Just like academics is a funding model, private practice is a funding model. And there are many iterations of each and everybody can be a bad actor. So some of these private practices also have a bad reputation for a reason, and that’s because they treat people poorly.

And it does seem like, anecdotally, that some of those practices have been the ones that most eagerly end up selling to PE. I’ve heard multiple stories of associates being milked, being told to put up big numbers so they can “make partner” only to have the current shareholders sell the group before they can finish the work-up and benefit. So you have some folks fresh out of fellowship working extra hours trying to knock out 90 to 100 RVUs a day just so a group could look ripe for a sale and get a 10x multiple on their hard work.

And that’s classic. Because they get a multiple out of that extra productivity.

They talk about capitalizing a portion of your revenue because if you think about most of these sales, they don’t have a typical way to calculate the value of the group, because we don’t retain any earnings like most businesses. You know, at the end of the year, if we started with a million dollars in the bank, we want to finish with a million dollars in the bank or less, because anything over that we have to pay tax on. And so all the profits are distributed to the partners with the idea that there isn’t anything left at the end. That’s not a traditional way to value a company.

Instead, say everybody makes $500,000 a year. They may choose to capitalize $100,000. So they are basically buying 20% of your revenues forever (where they get the first 20%). So if you get a 10x multiple, you’re paid upfront a million dollars for that share of your group, and then from then on out, you only get $400,000 while the PE firm gets that first $100,000.

And so the problem is, what if you were averaging 90 or 100 RVUs a day for that $500,000? Well, you’ve still got to do that, but now you only get $400k.

And only the partners who sell the group get the big payout, which might be based on unsustainable productivity. It’s like the buffet problem where you serve yourself with your eyes. That multiple makes squeezing for productivity upfront or running lean super tantalizing. But that work volume may not make economic sense if you didn’t benefit from the sale.

Some of which may have been cash but a good chunk is probably equity. In my mind, in a private organization that equity is not really quantifiably valuable. There’s no way to assess its value, and it can go to zero. Equity by definition can be worthless. The shares that you or I can buy from Facebook are not the same shares that Mark Zuckerberg has. And that’s true of the healthcare private companies as well, not all shares are created equal. When I worked in private equity, share construction was part of my job. And so these shares, ownership shares or senior shares or others, they start looking like debt pyramids [which determines the order in which debts are repaid]. Now, these pieces determine your rights as a shareholder. And your contract may say “equity,” but it does not necessarily have the same rules and responsibilities or entitlements that some of the other equity does. And that’s what a certain PE-backed radiology group’s radiologists found out internally when certain shareholders got equity ostensibly valued at X dollars per share, but they only got a fraction of that during an internal sale [when a new PE company bought in], because their shares weren’t worth the same. And what they didn’t have was the share conversion table. And one of the reasons they do that is so the doctors can walk around, say, hey, we own a majority of the company and the reality is…no, you don’t.

Right, you basically own like the common stock version.

Correct. You own the little piece of the stock that we say is okay for the doctors to own. And you do own a majority of that. 

So back to capitalization and the buy-out, if you sell a big enough share of your future revenues, you can make what one of our board members called “generational money.” And if all you have to do is just chain yourself to a machine for five years to meet your contractual obligation post-sale, it’s easy to see why you might bank on that. Some of those established docs had to have been thinking: You know, I might be willing to sell out to you for the right price. And damn, it feels like that might have been it.

Do you have a feeling for the typical stipulations/limits on when they can sell their equity shares?

That’s it. That’s the part of the contract deals that we just don’t know. It depends on what their holding period is. But when it comes to the valuation, the things that are going to bump your multiple have nothing to do with the money you’re bringing in at that point. It’s marketing, how much they want that particular market, and it’s the psychology of it.

You talk about this in your article–which is a great point–when you talk about how they’re recruiting mammographers, and they’re doing the same thing for teleradiology. They’re not funding a lot of those positions out of operations. They’re funding those positions with debt. And that’s why it’s an unsustainable offer, as soon as, say, mammo valuations are cut (which they will be, by the way, there’s your government payment policy inside perspective).

Do you have any guess as to how much longer these companies can keep this debt funding going? How big a change in the market would it require to throw a wrench in the easy money machine?

I don’t know. It’s so hard to predict for everybody. And anyone watching needs to separate their feelings from what they can support with the data. I agree with you that in my gestalt opinion–both professionally from a finance background and professionally from a radiology operations background–I don’t believe their model is sustainable as it is currently designed.

Now, they can always change, they can pay people less, they can get rid of some of their administrative overhang, but on their current trajectory, I agree that is unsustainable. In essence, it’s unstable because they’re more sensitive to certain changes. And this is where you get to things like the No Surprises Act, E&M code revaluations, and the threats to the conversion factor and private payer contracts.

(By the way, academics are actually exposed a little worse than private practice, because on average, academic health centers demand a premium on their private payer contracts compared to the median in-network rates, because employers want their employees to have access to these academic referral centers, which gives those referral centers negotiating leverage over those private payers.)

You have to understand who is the client of a health insurance company. It is not the patient. The client of a health insurance company is the business that uses that health insurance company to manage their health care plan. We call these insurance companies payers, but they’re not payers; they’re claims administrators.

So the insurance companies, their bid, their pitch is not to patients. Patients are not their clients. The patients are immaterial to this. Everything is about managing costs for the employer. The employer is their client. That’s why they negotiate. That’s why they want lower rates, because then they can say: we can administer your health care plan, and it will cost you less money. That’s the game. That’s why the No Surprises Act is important because it puts all the negotiating leverage into the insurers’ hands, in which they can then dump anybody who’s above the median in-network rate, and then those people will be compelled to accept that rate, which will then be artificially suppressed because you got rid of the people that are high within the network, which by and large is very frequently academic medical centers.

The anti-No Surprises lawsuits just started recently, so we’re still quite a long way away from that being resolved.

Correct. And not all of them have turned the screws yet because they’re smart enough to kind of wait it out a little bit. But United, for example, had been playing footsie with radiology groups and other large staffing groups for several months even before the No Surprises Act passed.

To me, that’s one of the problems of chasing some of the really good-sounding employee positions. They may be good right now, but you’re talking about your career. Is it gonna be 1, 2, 3 years of that? Is this going to be sustainable? Like if you want to take the sure bet of some good money right upfront then that’s fine, but you need to know what you’re signing on for and have the right expectations for the future.

Overall I think most people going into private practice are still interested in partnership tracks. Otherwise, it’s a stroke of the pen and the jobs change. And because I think, fundamentally, they know that employees are on the chopping block first.

But it’s fine to take those positions. But take them knowing that the time horizon is not infinite. That shouldn’t be in your plan, and you should be comfortable with it, be comfortable moving when or where things shift.

Exactly, it’s totally fine. Go for it. But then know that you may have to kind of start from scratch at some point potentially and be okay doing that. If you’re okay doing that, by all means.

Yeah, absolutely. I agree with that. You should just go into it eyes open, understanding what the compromise is.

I just want you to know, I don’t think these groups are fundamentally abusing people. I just prefer my philosophy for working.

I do feel like they’re using size and arbitrage to dominate and have a negative impact. When you talk about their pitch, they make a lot of these promises about support, software, AI, etc. Basically nothing has happened for years. So their deliverables should cause you to question the promises.

I’ve really only ever heard the negative side. I’ve never actually seen the on-the-ground positive side from any individual rad. I’m sure there are plenty of individual positive experiences and at least some neutral ones. But in terms of a tangible benefit of a group being part of the larger organization, basically crickets.

I hear from management staff talking about how poorly managed some of these groups are and the fact that they are fearing an exodus of docs once their terms expire. And you’re already looking at–like you mentioned–more posts on the ACR than there are graduating residents.

And let’s say, imaging volumes are increasing about 3% per year. Rad residency positions are mostly flat. So there’s a literal shortage, and it’s going to get worse unless huge AI productivity gains magically appear. And a lot of groups are already behind on hiring, a lot of groups are looking to hire 10% just to get their current productivity needs down to their desired level.

So if you’re a 10-person group, you need one rad. Well, that may or may not be achievable. You’re a 200-person group? You need 20 rads. That’s a lot of bodies.

So where do you see all this going? Do you think it will be the prophesized big death spiral in the next couple of years, where a lot of groups implode?

This is where you get into scenario planning. There are lots of different ways that this can play out. And so, let’s look at it probabilistically. 

So let’s say current status, no change: I think their recruitment problems will continue. And it’s reasonable to expect that it’s hard to continue debt funding them when they start having those senior notes come due, because it’s hard to fund those from operations when you owe eight times as much as you make [ed: S&P recently estimated Radiology Partner’s debt as 10-11x adjusted earnings per Radiology Business]. So I think that puts them in a tenuous position. There are lots of operational decisions they can make to streamline, but it starts threatening the idea that they’re the future. Does that make sense?

So if they start having to cut non-profitable groups or hospitals, if they start to have to redistribute rads around because their non-competes won’t let them stay local, they’ll want to redistribute them to other owned practices to consolidate around their good payers. So they start to shed their peripheral contracts and other stuff, but then locally, there’s not enough work for the rads. Well, their contracts are structured in such a way they can move them or have them read for somewhere else. They start doing that though and that hurts them in the market for jobs, at least to a degree.

But you have to understand that most people coming out of training, they’re going to take a job, and if they need to be somewhere geographically, that usually means way more than the job itself. And so while I respect and want people to be informed and make informed decisions, there’s some stuff that just matters more. And they’ll take a sub-optimal job to be in a certain geographic location. So life is about balances, it is what it is. So yeah, that’s where we’re at.

What I would want to happen is you starve these non-optimal business models from what they need, which is physicians. They need warm bodies, and you starve them through the market of choice.

Let’s consider an alternative future. Let’s say some similar form of No Surprises goes through and private payers pinch the network rates, Medicare continues to trim the conversion factor because of E&M redistribution, etc. And so you’re just fundamentally going to be making 5, 10, to 20% less on your contracts. That will severely compromise their operational plans, and everyone will make less money. 

Independent groups that run like ours have a lot of tolerance for making less money. People will be unhappy about it, but it is what it is, they’ll be there. You can tweak vacation, overnight pay etc, and we’ll be fine. 

I look at a leveraged group, and they don’t have that much wiggle room. They’re going to be much more sensitive to reimbursement changes than we are because we don’t have any debt to service. Your need for operational cash flow to service your debt is a fixed amount or minimally fluctuates per year. So if your operational cash flow is significantly decreased, you’re either not paying your debts or you’re not paying your rads. And it’s very hard to pay your debts if you don’t bring in any revenue. And that’s where you get pinched. And think about it from the purchased group’s perspective: They still have to make those pre-sale RVUs but now they get paid less. They’re having to recruit at that initial RVU volume, but those people they’re recruiting never got that huge payday.

And who wants to produce 30%+ more RVUs per day for the same amount of money? You’d basically feel taken advantage of immediately not to mention waiting for the other shoe to drop when the vesting period ends (and the possible exodus begins). With all the teleradiology spots around, it’s not as though most people couldn’t bail and find some way to pay the bills, at least on a temporary basis.

So radiology is not magic and you talk about it in your post. Physicians don’t produce exponential revenue per work. It’s a linear relationship. You’re going to get paid based on the amount of work you do and that’s linear. When you’re looking at these Silicon Valley unicorns and the rest, like when you’re selling software, you can sell software at $100 a unit to 100 people. And it requires, you know, 10 units of service. You sell it to 100 more people, you only need to do three more units of service. You sell it to another 100 people, that’s only another one unit of service. That’s where they bring in exponential revenues compared to their underlying costs. We don’t have that model. That’s not the health care model. There’s no exponential relationship between work and revenues in healthcare, it’s linear. Facebook can sell more ads on an exponential basis to their users than it costs them to support, that’s exponential revenue. We just don’t have that.

So they can model it out differently. They plan to consolidate so they can get better payer contracts. But if No Surprises goes through, then all of that leverage over payers disappears. They could have the entire market, and all the payers do is bump them down to the median in-network rate. And to give you an example of how that gets determined, say your wife in psychiatry has private payer contracts. They may include the entire codebook in her contract, even though the only CPT codes she cares about are the ones related to psychiatry. So they may have every CPT code in there and a rate listed for what they would pay her if she did a cystourethroscopy or a partial nephrectomy. It may be under contract, but she’s clearly not going to do them. So she doesn’t care about it. They just say this is our book of business, we give it to everybody. These are the rates, and they know they’re negotiating with a psychiatrist so she’s only going to negotiate the ones that matter for her. But all of those other codes are still contracted rates they have with an in-network physician and–guess what–they contribute to what the median in-network rate is. You want to talk about some sneaky stuff? So they contracted with a psychiatrist for what rate she would do a CT abdomen/pelvis knowing she would never do one. But that contracted rate now drags down the median in-network rate. Tada! Shenanigans.

That…that’s ridiculous.

You got to play the whole game, you can’t just play the part that you like.

That’s an incredible degree of sneaky informational asymmetry and arbitrage.

And that’s what I feel about these practice model things. You know, their arbitrage only works if you let them take advantage of you. The hill to climb for being informed and working with these entities is not high. I just want people to make informed decisions. Like if the business model works then so be it. I have some philosophical disagreements with them, but we just have different approaches to doing business. I think having an outside investor in the doctor-patient relationship is an inherent conflict of interest that cannot be resolved.

It’s messy. If you’re gonna add complexity to the system, you have to get something in return for that additional complexity, some meaningful benefit. If there’s no benefit, then why are you adding the additional layer of complexity?

Absolutely. Keep it simple. Keep it simple. Same thing with the finances. You don’t need to do options trading or credit default swaps. The marginal return on that is almost nothing. That’s where you get into the messaging, separating the marketing and the myth from the actual operations. Their operations work just like yours and just like mine, there’s not some scale to achieve here.

Obviously, no one has a crystal ball, but do you think in the next few years with high inflation, rising interest rates, and a likely credit crunch that it may become impossible to raise more money to fund operations or buy more growth?

So rising interest rates could be a problem, but they’re not looking for government-backed debt. When you have a line of credit from an investment firm, they’re free to negotiate that interest rate, completely separate from LIBOR, completely separate from the Fed rate, or anything else, because it really just comes down to the cost of money. And so the big PE firms may be willing to give these companies more debt at a discounted rate or even delayed interest payments because they may have other things written into the contract where they get to take over an equity position in some situations. So these private debt offerings are just different than a lot of the debt that you can track publically.

If they go to Bank of America or Goldman or some of these other investment banks, those banks are held to federal funding rules with regards to their interest rates and cash reserves etc. They have different rules than a private equity firm sitting on $8 billion of investable funds that’s writing a $500 million debt instrument for a private company. Those are just not comparable. Because that private equity firm is free to lose all that money, and the government wouldn’t have to do anything about it. But if Goldman Sachs underwrites $500 million, the government is on the hook to a certain extent. 

It’s clear that there’s been an abundance of cash looking for places to be invested in recent years. I wonder if in the future these firms will be as eager to throw good money after the bad.

In 1998, people were basically writing blank checks for and other BS, but in 2001, you couldn’t raise $10.

One of the better business books I read was the story of Amazon and how their chief financial officer in 1999 basically saved the company. It wouldn’t exist right now if he hadn’t predicted the dot com crash and secured funding that got Amazon all the way through the tight credit market. Because that’s what you’re really looking at in those crashes; it’s not that everything goes to zero, it’s that those companies can’t necessarily rely on revenues as they’re being developed. So it’s credit markets getting tight, that was the threat to debt-funded groups.

So say a PE-backed radiology company needs to pay off a $1 billion note, and they know they can’t do it. You pay a coupon rate every year and then you have a balloon payment at the end. It just comes down to what’s the market like when they owe that money. If the market is loose money with reasonable interest rates, they just raise debt, pay that off, and then that goes into the future and it’s a non-event. But if the credit markets get tight in that time horizon, then they could be in a really bad way.

In essence, that’s why your business model is either stable or unstable, high risk or low risk. It depends on the timing and your external factors. A stable low-risk business doesn’t require credit, is not operating on a lot of debt, and then can float with the fluctuations in reimbursement and the global economic environment without it impacting its operations. That is traditionally what healthcare has been. Healthcare wasn’t making extravagant purchases and operating on huge debt to EBITDA ratios and tended to be stable across business cycles. That’s not so much the case now when a lot of these healthcare companies are debt-driven, have high debt-to-EBITDA ratios, and are much more exposed to some of these macroeconomic trends. A couple years of reduced revenues prior to needing to raise money to pay off huge debts is not a good place to be. 

This is the problem I have with CEOs and us making celebrities out of business people. People discount the role of luck.

I think for a long time people in healthcare succeeded in spite of themselves, not because of themselves. And then they internalize that success as being because of their own skills, decisions, amazing abilities, or whatever pleasant adjectives they choose to describe themselves with, and I just don’t buy it. The vast majority of them got lucky, were in the right place at the right time, and had a few things pan out. They’re discounting the fact that a lot of these things are global trends, not their personal influence within the small ripples around them. It’s like blaming the President for everything and giving the President credit for everything. One person isn’t driving this bus. And some of these trends are much bigger than one person, the same thing in business. 

That’s a key point. It’s fascinating to me that people can so easily think their skill set in a certain domain can be copy/pasted and applied elsewhere, even in violation of basic arithmetic or common sense.

It’s the same problem when doctors have money and they think they can do real estate. This is why I tell people: delegate tasks, not understanding.

Delegate tasks, not understanding. Dr. Schoppe, thanks for joining me and sharing your wisdom.


[You may also enjoy his interview with Strategic Radiology from 2018]


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