Definition
Multiple arbitrage is a financial strategy central to many private equity (PE) investments in healthcare. It works by acquiring smaller, independent practices at a certain valuation multiple (e.g., 5 times their annual profit) and combining them into a larger, consolidated company. Because larger companies are generally seen as more stable and command higher prices, this new, larger entity can be sold later at a much higher valuation multiple (e.g., 9 times its combined annual profit). The profit for the investor comes from this difference between the lower entry multiple and the higher exit multiple.
Why This Matters to Healthcare Providers
Understanding this strategy helps you understand the “why” behind a PE firm’s interest in your practice. Their goal is often to use your practice as part of a larger platform, creating value through increased scale, which can significantly influence deal structure, your future role, and the long-term plan for your business.
Example in Healthcare M&A
Scenario: A private equity firm identifies the dermatology market in a large state as highly fragmented, with many successful independent practices. They plan to execute a “roll-up” strategy driven by multiple arbitrage.
Application: The firm acquires five different dermatology practices. Each practice generates $1 million in EBITDA (a measure of profit) and is purchased for a 5x EBITDA multiple, meaning a $5 million price per practice. The total investment is $25 million.
Outcome: The five practices are integrated into a single platform company with $5 million in total EBITDA. Three years later, the PE firm sells this larger, more attractive platform to a national healthcare system for a 9x EBITDA multiple, or $45 million. The $20 million gain was created primarily through multiple arbitrage; by creating scale, they were able to sell the combined assets for a higher multiple than they paid for the individual parts.
Related Terms
- Roll-Up Strategy – The process of acquiring and merging multiple small companies in the same industry to create a larger entity. This is the primary method for achieving multiple arbitrage.
- EBITDA – A key metric for measuring a practice’s profitability. Valuation multiples are almost always applied to EBITDA to determine a practice’s value.
- Platform vs. Bolt-On – In a roll-up, the “platform” is the first practice acquired that forms the foundation. “Bolt-ons” are the subsequent smaller practices acquired and integrated into the platform.
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Frequently Asked Questions
What is multiple arbitrage in healthcare private equity?
Multiple arbitrage is a financial strategy where smaller healthcare practices are acquired at a lower valuation multiple and combined into a larger company, which is then sold later at a higher multiple, generating profit from the difference.
Why is multiple arbitrage important for healthcare providers?
It explains why private equity firms are interested in acquiring healthcare practices, as they use these practices to create larger platforms that can be sold at higher valuations, impacting deal structures and future plans for the business.
Can you give an example of multiple arbitrage in healthcare M&A?
A private equity firm buys five dermatology practices each earning $1 million in EBITDA for 5 times their EBITDA (total $25 million). After combining them, the larger entity with $5 million EBITDA is sold for 9 times EBITDA ($45 million), making a $20 million gain from multiple arbitrage.
What is the relationship between multiple arbitrage and roll-up strategy?
The roll-up strategy involves acquiring multiple small companies and merging them into one larger entity, which is the primary method to achieve multiple arbitrage by increasing scale and thus the valuation multiple.
What are EBITDA and its role in multiple arbitrage?
EBITDA stands for earnings before interest, taxes, depreciation, and amortization, and it’s used to measure a practice’s profitability. Valuation multiples are typically applied to EBITDA to determine practice value in multiple arbitrage.