How a thesis on the obesity crisis led to Varsity’s orthopedics deal

Varsity Healthcare Partners’ longstanding thesis around the threat of obesity led it to a largely uncharted area for private equity: orthopedic services.

If history repeats itself, more consolidation is poised to follow as the PE community looks to deploy capital in new specialty physician markets.

Varsity invested in Orthopaedic Institute, the largest provider of orthopedic services and ancillary offerings in north-central Florida. The recent announcement confirmed a Buyouts report that unveiled the deal about a month earlier.

“Something that has worked well for [Varsity] is finding things early, before the masses of capital are in it,” David Alpern, the firm’s founding partner, said.

The lower-middle-market firm’s push into musculoskeletal care is similar to earlier plays in vision and dermatology. In all three instances, Varsity was one of the first sponsors to enter each niche market. Both vision and derm have since seen significant PE investment.

So far this strategy has done well for Varsity, which earlier this year sold EyeCare Services Partners to Harvest Partners. Terms weren’t disclosed, but sources previously said the ophthalmic-services company scored a mid-teen multiple of its at least $22 million in projected run-rate EBITDA for 2017.

Alpern hinted that gastroenterology and women’s health are next on its radar, but he added that Varsity remains interested in finding ways to invest around the obesity crisis. Interestingly, it’s the work Varsity did in obesity that laid the foundation for its investment in Gainesville, Florida-based Orthopaedic Institute, he said.

“If you want to be long in obesity, you want to be long in fitness,” Alpern explained. “Consequently, if people are more active, two things will cut your way. There will, unfortunately, be a host of chronic injuries just based on the way we exercise. Two, we have an aging society and that population tends to get hurt more. The incident of acute injury is higher.”

In other words, orthopedics is a unique vertical in that its demand is twofold: An aging population means more knee and hip replacements and the like. At the same time, an active young demographic sets the stage for more treatment needs for conditions that are likely to result from exercise and sports injuries.

Varsity will continue to look for other ways to tackle obesity from an investment perspective, Alpern said, with a particular emphasis on services that will garner reimbursements from insurers. The firm is unlikely to invest in a fitness solution, given the volatility in this area from a consumer perspective, Alpern said.

“Obesity and treatment of obesity creates such a cost problem for the health system,” Alpern said. “It’s very difficult to crack. … We’re looking for something that’s service-based, holistic and sticky. We haven’t found that yet.”

First-mover benefits and challenges

Being one of the first movers in a given segment has its advantages, but getting such a deal done isn’t an easy task.

“It’s not an issue of supply,” Alpern said. “It’s an issue of willingness to transact. When there’s no PE role model, the sellers aren’t entirely sure why you do this.”

PE’s presence in orthopedic services in minimal, though earlier this year Frazier Healthcare Partners and Princeton Ventures did invest in CORE Institute, a provider with locations in Arizona and Michigan.

Orthopaedic Institute, for its part, had 25 doctor-owners who have remained shareholders post-transaction, Alpern said. Its total doctor network has grown to 33 doctors almost entirely organically, he said.

Though terms of last week’s transaction weren’t disclosed, Buyouts reported in October that the company generates EBITDA in the low teens.

“To get to a reasonable scale, you probably have to have a lot of partners,” Alpern said. “What does that mean? You’re transacting with a higher shareholder base, which is more difficult.”

“You have to have a good entrepreneurial spirit because you don’t have to do this,” Alpern went on. “You do this because you see a really offensive move to make” in Florida.

Broadly speaking, larger practice groups are considered better equipped to deal with changes in healthcare reimbursement and policy.

“As the market continues to move toward value-based care or result-based care, if you own all these touch points and have that ball control, you are in the best particular position to lead that change,” Alpern said.

Varsity intends to invest in the medical group’s orthopedic clinics and outpatient surgery centers, as well as ancillary services like imaging, physical therapy, hand therapy and pain injection. The idea is to expand Orthopaedic’s market share both by adding new doctors and through roll-ups across the north central Florida region, the partner said.

Varsity, with offices in Los Angeles and Stamford, Connecticut, invests out of its Fund II, a $300 million pool that closed in January.

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David Alpern, founding partner of Varsity Healthcare Partners. Photo courtesy of the firm.