IVCA Q&A: Cressey & Company LP Principal David M. Schuppan

IVCA Q&A: Cressey & Company LP Principal David M. Schuppan

June 2, 2009

CHICAGO - “ With the new administration in Washington, D.C., the health care industry will be going through a significant shift in the coming years.

David M. Schuppan is a principal at Cressey & Company LP, which is a private investment firm focused on the health care industry. He recently talked with the IVCA on the overriding issues in health care investment and the current state of the transition specifics.

IVCA: What is the status of the health care industry during both the current economic situation and the change of the guard in Washington?
David Schuppan: The aggregate health care industry is constantly evolving to better meet the needs and address the limitations of its key constituents. This includes patients, providers and payors (e.g. private employers and insurers as well as government entities). At any point in time (the present included), certain segments of health care go through material change.

This includes changes in reimbursement, quality, access, technology or competitive activity. One of the key competencies of health care-focused private equity investors is to understand where, why and how these changes are occurring and to make intelligent investment decisions that optimally position the portfolio to capitalize on the resultant opportunities.

In today's market - “ while changes in both the executive branch and overall economy may have accelerated some evolution of the health care system - “ we haven't seen diminished investment opportunities in health care-focused private equity.

In fact, for certain sectors that generate significant value to the health care system (e.g. low-cost settings, superior and proven clinical outcomes, etc.), we feel private equity investment opportunities could be expanding.  We believe that disproportionate market share and returns tend to accrue to well-managed and capitalized business in times of dislocation.

IVCA: As an acquisitions expert, what are the key factors in assessing a health care-related company or hospital before acquisition consideration?
DS: Aside from more common acquisition criteria surrounding financial performance, operations excellence, management strength, growth opportunities and quality of earnings, there are unique factors in assessing potential health care investments.

This includes the reimbursement landscape. Most health care companies are price takers (i.e. can't negotiate prices with payor sources like Medicare, Medicaid or large managed-care companies). As such, understanding the past and prospective reimbursement nuances and trends is essential to assessing risk and returns.

This also includes the labor markets. Health care is fundamentally a local, service-focused industry delivered by skilled clinicians. Understanding the dynamics and trends of clinician turnover, credentialing, availability and compensation are keys to assessing risk and returns.

We also have compliance. Health care is a regulated industry with both civil and criminal penalties for non-compliance. Understanding an investment's specific regulatory landscape as well as compliance culture, programs and track record are essential and non-negotiable to assessing risk and return.

We also have clinical outcomes. Unlike most other industries, health care has been dilatory to emphasize pay for performance for clinical outcomes relative to medical dollars spent. The trend is quickly changing toward a focus on value-based purchasing. As such, it's important to quantitatively and qualitatively evaluate a potential investment on its clinical outcomes (relative to industry and internal benchmarks) and industry reputation.

Finally, we have systems and controls. Underinvestment or weaknesses in systems and controls can be both costly and potentially criminal and need to be assessed carefully.

Growth businesses in general need efficient and scalable processes and systems. When other complexities of running health care businesses are added (including geographically dispersed labor, regulatory compliance and outcome tracking), having strong systems and controls becomes a competitive imperative.

IVCA: Your investment strategy is direct and simple: target, buy and build. On the - œbuild-  end of the paradigm, how do you create new ideas for sales and marketing enhancements?
DS: Good question. We (and management) generate a significant majority of our investment returns from post-close investments in incremental growth activities (- œbuild- ) such as organic growth (via a sales force), de novos and tuck-in acquisitions.

As business-building partners to management in these growth-oriented categories, we spend considerable time and resources working to expand and improve our support capabilities.

One way we accomplish this objective is by limiting the number of health care sectors we target each year to build deeper and more robust proprietary sector insights and relationships that can be both valuable and differentiated to our management partners.

Additionally, we always seek to foster the sharing of best-in-class management practices among our existing portfolio and executive board members. We also utilize the assistance of third-party experts and consultants when the opportunity warrants doing so.

IVCA: Aside from the potential monetary reward, do you find any common threads in the type of person or companies that seek to invest in health care?
DS: My personal opinion is that many of the most successful health care investors have a genuine sense of altruism underlying many of their health care investment decisions. Simply put, health care is the business of cost-effectively improving the quality of an individual's life.

While the definitions of - œcost effectively-  and - œquality of life-  may vary according to individual points of view, successful investors - “in an industry where providers compete on service - “ have long understood that being a market leader in both categories is essential to generating superior returns across multiple reimbursement, economic, investment and various other cycles.

Altruism - “ or sincere passion for pursuing best-in-class clinical outcomes and customer service - “ is one trait that originally permitted successful health care investors to demonstrate that investments in quality and compliance (which can inherently be in conflict with - œcost effective-  particularly in the short term) lead to exponential returns in the long term.

IVCA: In your oversight role at portfolio companies, who is your main contact at each of them? How much and what type of monitoring do you do?
DS: As a strategic business-building partner to management, Cressey & Company doesn't become involved in either the delivery of clinical care or day-to-day operations of our portfolio companies.  Instead, we work closely with management at the board level to accomplish a variety of objectives.

These include refining strategic and tactical plans (corporate governance), supplementing growth activities and providing related transactional assistance (business development), assisting with the building out of management teams and boards as well as structuring and financing the aforementioned strategic activities.

As such, the typical contact people at each of our portfolio companies range across senior management. Aside from typical financial reporting and board meetings, we informally communicate with management on a daily to weekly basis depending on the strategic activities being pursued, management's desire for assistance with acquisitions, executive recruitment and operational improvements.

IVCA: What makes you optimistic about growth potential in the health care industry?
DS: Health care is one of the largest, most diverse and fastest-growing segments of the domestic economy the provision of which is both an essential and a value-added service to society. It has traditionally been recession resilient.

Health care is also a fundamentally local, labor-intensive and service-oriented business which is both highly fragmented and only moderately scalable. - œExecution-  tends to be the primary source of competitive advantage (not first to market, size, intellectual property, etc).

Though these dynamics will continue to be influenced by changes in government, the economy and the capital markets, they are inherently fundamental to health care and not expected to diminish soon. Health care-focused private equity should continue to have excellent opportunities to generate outsized returns especially given the industry's track record in supporting above-market execution.

More specifically, we have and should continue to be able to attract and motivate leading management as well as drive and expand best practices through sound corporate governance as well as growth capital and assistance. The fundamental key to continued investment success is focusing on high-growth health care sectors and management partners.

IVCA: With offices in Chicago and Nashville, Cressey & Company is firmly entrenched in the Midwest. What advantages do these locations have for your business?
DS: For more than 30 years, Chicago and Nashville each have had a strong claim to being domestic hubs for health care private equity investing and provider-based businesses. As such, we have found it helpful on many levels to be an active and meaningful local participant in both communities.