Subsector Snapshots — Investors Are “Head Over Heels” for Orthopaedics

August 26, 2021

The orthopaedic services sector is one of the fastest-growing segments in the healthcare industry, with orthopaedic conditions generating more than 137 million annual provider visits. This surge in growth also holds true for investment interest and transactions in the space. Over the past several years, even throughout the slower months of early 2020 during the COVID-19 pandemic, orthopaedic deals have been highly sought after and highly competitive. Investor interest in this “hip” subsector is on the rise for many reasons, and with a high demand for services, increased movement to outpatient venues, and high-value ancillaries, investor interest in the orthopaedic sector is only expected to grow.

Read on for a “subsector snapshot,” detailing five key takeaways and considerations related to orthopaedics, an overview of recent transactions and a prediction as to future investment interest.

1. Orthopaedic Market-Dynamic Considerations: Five Key Takeaways. There are many characteristics that help explain why the orthopaedic sector has become so attractive to investors; however, the orthopaedic space also poses unique challenges. As such, investors should consider the following dynamics:

  1. The orthopaedic space is increasingly turning to alternative payment arrangements. Orthopaedic practices are increasingly utilizing bundled payments and risk-sharing programs for common procedures, such as total knee and hip surgery. These payment models include traditional payors and direct-to-employer reimbursement. With bundled payments, payors generally negotiate a single, global fee for the full “bundle” of care, inclusive of post-operative care, surgery, anesthesia, the facility fee, etc. These types of payment models have, overall, been met with success; however, investors should carefully diligence bundled payment/risk-sharing payment arrangements to ensure that proper data collection and analysis has been conducted to best ensure financial viability. In addition to bundled payments, value-based care models are becoming more popular in the orthopaedic sector. Under this payment model, payors can reward or penalize providers based on reductions in cost and increases in quality. Lastly, as the already high demand for services continues to grow and the nation’s population continues to age, concierge medicine — which is becoming more popular in the space — will likely take off in coming years.
  1. The widespread use of ancillary services is an enticing growth opportunity for investors and physicians but adds additional regulatory complexity. Orthopaedics lends itself to an array of ancillary service lines, such as imaging, physical therapy, some limited types of durable medical equipment and ambulatory surgery centers (ASCs). These ancillary services produce additional revenue and allow providers to serve as a “one-stop shop” for patients, facilitating access to care and consumer convenience. Further, as payors continue to emphasize moving appropriate cases (such as some partial and total joints) to outpatient sites of service, which are historically lower cost for the payor and patient, the ability to invest in ASCs is attractive to potential investors. Although ancillary businesses can be lucrative, they can also pose risk under federal and state fraud and abuse laws. Thus, it is important to understand and analyze how these ancillaries fit within the overall corporate structure, related financial arrangements and other operational considerations to ensure compliance. For example, factors such as referral patterns (within and outside the practice), payment of revenues from the ancillary service lines (whether in the form of distributions or physician compensation), corporate structure and governance become critically important in analyzing these arrangements. Providers and investors are constantly looking for ways to experiment with new and innovative ancillary arrangements. A word of caution, however, is warranted. With expansion into new and different models often comes regulatory uncertainty as the law attempts to keep pace with the speed of business innovation and evolving models of care.
  1. The orthopaedic space is ripe for continued innovation and development in emerging areas. Given the number of ancillary service lines that complement orthopaedic practices, emerging technologies (such as implants and robotics) as well as provider services (like regenerative medicine) allow for constant clinical innovation within the space. Regenerative medicine, for example, allows providers to replace or “regenerate’ human cells, tissue or organs to restore or establish normal function. This is relevant to the orthopaedic space due to the possibilities created, including the widening scope of minimally invasive treatments, and assisting ability to heal from invasive surgeries. However, in some cases, such new technologies are not proven effective for different uses. Accordingly, the U.S. Food and Drug Administration (FDA), which has authority to regulate regenerative medicine products, has been looking at claims regarding these products. The FDA is concerned that many patients seeking cures and remedies may be misled by information about products that are illegally marketed, not shown to be safe or effective, or may lead to safety issues that put patients at risk. Therefore, providers should understand the legal parameters with respect to communications and advertisements regarding regenerative medicine procedures products.
  1. Physician alignment is key to success. While some orthopaedic surgeons may view the sale of a practice as a loss of independence, there is increased recognition that the healthcare industry has changed and that size and scale matter. Orthopaedic surgeons tend to have a strong entrepreneurial disposition, allowing investors to tap into that spirit and work to advance physician alignment strategies through compensation and growth throughout a larger platform. Orthopaedic compensation models generally follow the “eat what you kill/heal” model, and the introduction of relative value unit compensation models have historically been met with resistance. Thus, physician alignment models are critically important. Here, we see more models that allow physicians to participate in overall platform expansion and incentivize physicians to align with investor goals. Important in the structure is the mechanism for expense allocation, which should ensure that individual decisions impact compensation while group overhead is fairly allocated.
  1. Orthopaedic practices often have strong hospital relationships and complex written arrangements. Due to the overlap of services and volume of cases, many orthopaedic practices have established long-lasting relationships with local healthcare systems and hospitals, which is attractive to investors. These relationships often take shape through various arrangements, such as transfer agreements, call-coverage, personal services agreements, medical directorships, sports medicine sponsorships and co-management agreements. Many of these arrangements, such as clinical co-management arrangements whereby physicians oversee and manage a particular hospital service line, are growing in popularity. These type of partnerships with local health systems can strengthen ties with the health system but can also implicate federal and state fraud and abuse laws if not properly structured.

2. Recent Transactions Within the Orthopaedic Space. The past several years have seen a flurry of transactions within the space. In 2019, Revelstoke Capital Partners and Beacon Orthopaedics and Sports Medicine Ltd. announced the launch of a national management services organization, OrthoAlliance, and Kohlberg & Company invested in Connecticut-based Orthopaedic Neurosurgery Specialists. Despite the COVID-19 pandemic, 2020 also saw numerous notable deals, including Cobepa’s closure of a growth equity investment in Laurel, Maryland-based Precision Orthopedics; FFL Partners’ formation of U.S. Orthopedic Partners (USOP), a new orthopaedic health services organization; and Beacon Orthopaedics’ addition of seven physicians formerly with OrthoCincy and Reconstructive Orthopaedics & Sports Medicine.

3. Future Market Predictions. Despite the ballooning of investor interest in this space over recent years, the orthopaedic subsector remains highly fragmented, with partnership opportunities and transactions in the space expected to boom in coming years. Given the orthopaedic sector’s position for inclusion of ancillary services, innovation and alternative payment models, strong interest in this sector is expected throughout 2021 and beyond.

For more information regarding the orthopaedic subsector or any other healthcare sectors, please contact one of the authors.