Physician practice-management companies (PPMs) first stormed the initial-public-offering market in the mid-1990s, promising to consolidate highly- fragmented medical specialties and to reduce operational costs.
A juicy story, to be sure, given that public companies still only control about ten percent of physicians' practices. High expectations, however, were soon followed by monumental disappointments, leaving a foul taste that still sours the industry. As a result, few sectors have faced more resistance from the capital markets, or been as volatile in the aftermarket than PPMs.
"A lot of factors have contributed to this," said Minneapolis-based Piper Jaffray analyst Brooks O'Neil. "These include very early-stage consolidation among young, fast-growing companies, limited information technology and high investor expectations."
Coastal Physicians (NYSE:DR) and Physician Resources Group (NYSE:PRG) are perhaps classic examples of companies that failed to fulfill investor expectations.
Coastal Physicians priced 3 million shares at $11 1/2 in June 1991 through a syndicate led by Smith Barney Harris Upham (now part of Wall Street giant Solomon Smith Barney), climbing to $40 1/4 in 1994. Heavy debt whittled away most of the gains in the second half of 1995. The stock recently closed trading at three-quarters of a dollar.
Physician Resources Group, a Smith Barney-led June 1995 IPO priced at $13 a share, suffered the wrath of investors for a different reason no intrinsic value gained as the company expanded. In 1996, the Dallas-based operator of ophthalmic and optometric practices acquired 140 practices for about $500 million, financed in large part through the company's strong stock price.
"They grew too fast and were never able to really add value to the practices," said one industry analyst, who requested anonymity.
During the acquisition spree in June 1996, the company's stock peaked at $33 3/8 before investors had second thoughts after the company's poor 1996 second-quarter operating results were posted. The stock recently closed at $4.
Despite the appetite for additional capital among PPMs, such horror stories have made it difficult, if not impossible, for underwriters to drum up support for proposed offerings. In 1997, three companies were unable to attract sufficient investor interest, despite the fact that 13 PPMs were previously able to price IPOs, raising $369.4 million in capital.
In the fourth quarter of 1997, Dentalco postponed its Morgan Stanley Dean Witter, Discover & Co.-led offering, citing market conditions. In December, First New England Dental withdrew its proposed $27.6 million offering, through New York-based Furman Selz.
Pentegra Dental (AMEX:PEN), which originally filed its intent to go public in October with Lehman Brothers in New York serving as lead for the deal, is making another run at the public markets with Minneapolis-based Dain Rauscher, the deal's former co-manager, serving as lead.
"Unfortunately, it's set at a pretty low valuation," said Wade Massad, director of equity syndication at Dain Rauscher, referring to the deal's proposed $5 to $7 asking price.
Still, all is not pessimistic. Massad for one, sees a silver lining. "This [latest deal] is slowly but surely coming along," he said. "If you look at how these [PPMs] have performed over time, they have done pretty well."(Pentegra Dental was slated to price the week of March 23, according to Massad.)
Through the close of trading on March 27, the average return for last year's 13 IPOs within the sector stood at 33.23 percent above offering.
Despite some continued market skepticism, other companies are helping to fill in the supply side of the equation. But the question remains: Will investors return to this once problematic industry?
Despite the earlier setbacks, O'Neil and others believe the sector is poised to deliver explosive growth.
"You need mass to achieve economies of scale," said San Francisco-based Volpe Brown Whelan & Co. analyst John Ederer, alluding to one of his favorite picks, American Oncology (Nasdaq:AORI), which had 35 practices in 15 states under management at year's end.
Aiming to avoid the pitfalls taken by less successful offerings, the Houston-based company is taking care to improve operating margins within each acquired business. That has led to the recruitment of more physicians, the addition of subspecialties within a practice's core specialty, (such as cancer treatment), payer agreements, alliances with pharmaceutical entities as well as clinical research.
"When you have 300 physicians who see 80,000 new cancer patients each year, that's valuable stuff to pharmaceutical companies," Ederer noted.
Ederer rates American Oncology a "strong buy," forecasting that 1998 earnings will jump to 65 cents a share, up from a 1997 earnings per share of 48 cents, on revenues of $431 million (before climbing to 85 cents on revenues of $557 million in 1999.) American Oncology closed late March at $15 9/16, 25.9 percent below its June 1995 opening through Baltimore's BT Alex. Brown.
In a related sector, Monarch Dental (Nasdaq:MDDS), currently the largest publicly-traded DPM (dental practice-management company) with 99 dental practices under management, is viewed by some analysts as a key consolidator within the industry.
"This is a highly-fragmented industry," noted St. Petersburg-based Raymond James & Associates analyst Michael Baker, who initiated coverage of the company with a "buy (1)" rating. "In spite of the growing number of participants, DPMs' penetration of the market has not even begun to scratch the surface," Baker said in a report.
"Revenues of the DPMs total approximately $335 million, which represents only one percent of the $35.4 billion market," he added.
On top of that potential growth, Baker notes that the Dallas-based Monarch Dental has been able to boost revenues from acquired practices by about ten percent. Another advantage is insulation from potential healthcare reform. Whereas general PPMs rely upon Medicare and Medicaid to compensate for about 32 percent of revenues, DPMs only rely upon such sources for about four percent of revenue, Baker noted.
One thing for certain is that PPMs will continue to tap the IPO market. Whether they will be able to price potential IPOs or become fodder for existing public entities, companies within this largely privately-held industry will nonetheless continue to affect the IPO market.
"I tend to think we're in the first inning of a nine-inning game," Piper Jaffray's O'Neil said. "In general, we remain very positive about the outlook for the industry."
There's at least 100 private, venture-backed PPMs, O'Neil noted, adding that issuance from these companies will keep the IPO market flush with supply.
Even so, Ederer questions the marketability of all the supply.
"There are a lot of PPMs that are venture-backed that aren't going to make it to the public markets," he said. "That's fertile ground for potential acquisitions."
Nevertheless, the forward calendar is sprinkled with some offerings from the sector.
Late last month, American Medical Providers (Nasdaq:AMPZ) was slated to price 3.7 million shares, between a proposed price range of $10 to $12, through a syndicate headed by A.G. Edwards in St. Louis. American Dental Partners (Nasdaq: ADPI), slated to price two million shares through a BT Alex. Brown-led syndicate on the week of April 6, could stand to become the largest publicly traded DPM.
Physicians Trust, the operator of 14 neuro-musculoskeletal practices, filed its intent to test the public waters on March 3, through a syndicate headed by Radnor, Pa.-based Pennsylvania Merchant Group.
Stephen Lacey is associate editor of The IPO Reporter, a sister publication of Traders Magazine.
