current issues in healthcare valuation

Date: October 14, 2014

Prepared for Texas Society of Certified Public Accountants

Current Issues in Healthcare Valuation

Texas Society of Certified Public Accountants

Business Valuation, Forensic & Litigation Services Conference

October 14, 2014

Carol Carden, CPA/ABV, ASA, CFE



Agenda

Understanding the context

Avoiding pitfalls in projecting cash flows

Sources of industry data

Common approaches and application

Latest trends in industry and M&A activity



Understanding the Context

What makes a healthcare valuation different than that of any other company?

What makes a healthcare valuation different than that of any other company?

• Highly regulated environment• Less access to market data• Significant fluctuation in trends between years –

constantly changing and evolving• Complex interplay between patients, providers,

insurers and the government – can be tricky to get your arms around




Stark Regulations

Impacts entities in which a physician has an ownership

interest

Stark Regulations

Impacts entities in which a physician has an ownership

interest

Anti-kickback

Prohibits the consideration of

the value or volume of referrals

Anti-kickback

Prohibits the consideration of

the value or volume of referrals

IRS

Comes into play with not-for-profit

entities

IRS

Comes into play with not-for-profit

entities

Regulatory EnvironmentsRegulatory Environments




Fair Market ValueThe value in arm’s-length transactions, consistent with the general market value.

Fair Market ValueThe value in arm’s-length transactions, consistent with the general market value.

General Market ValueThe price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement.

General Market ValueThe price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement.




Buyers do not want to chance

inheriting liability related to

malpractice and billing errors

Buyers do not want to chance

inheriting liability related to

malpractice and billing errors

Important to understand when

projecting and adjusting balance

sheet

Important to understand when

projecting and adjusting balance

sheet

Impacts analysis if market

transactions are incorporated into

analysis

Impacts analysis if market

transactions are incorporated into

analysis

Impacts working capital projectionImpacts working capital projection

Healthcare

transactions are

generally

structured as asset

sales:

Healthcare

transactions are

generally

structured as asset

sales:

Deal Structure

Deal Structure



Projecting Cash Flows

Common Mistakes in HealthcareCommon Mistakes in Healthcare

Unrealistic growth rates

Not factoring in

reimbursement trends

Consideration of post-

transaction factors

Inadequate assessment

of risk factors

xxxx



Projecting Cash FlowsContributing Factors to Unrealistic Growth RatesContributing Factors to Unrealistic Growth Rates

Analysis of the payer mix

is a must!

Identification of industry

reimbursement trends

Failure to analyze capacity

constraints

What does perpetuity

really mean?

Failure to assess referral

sources

Concentrated in a few

individuals?

Where are they in their career

life cycles?




Analysis of Reimbursement TrendsAnalysis of Reimbursement Trends

Healthcare Reform…

Now What???

All healthcare industry

segments are not created equal…

imaging for example

What has happened to

this particular sub-sector in the past few

years?

What is out there regarding healthcare as a whole and the

particular segment you

are appraising in particular



Healthcare Reform

Healthcare Reform

ACOs

Bundled Payments

Incentives for

Primary Care

Increase in Insured Population

Medical Home

Models




Consideration of Post-Transaction FactorsConsideration of Post-Transaction Factors

Bear in mind the definition of FMV, particularly as the regulators define it

There is more at stake in healthcare, up to and including

criminal charges!

Be careful about volume assumptions as well as expense efficiencies and contract improvements

For physician practice valuations, post transaction compensation must factor into your analysis




• Increased regulation

• Possible criminal penalties

• Concentration of referral sources or payers

• Technology can become outdated very quickly

Inadequate Assessment of Risk FactorsInadequate Assessment of Risk Factors

The more successful a company becomes, the more it shows up on the radar screen for changes – just ask the imaging industry

=



Sources for Industry Data

• MedPac Report

• Medicare Proposed and Final Physician Fee Schedule

• Stock analysts’ reports for certain segments

• MGMA

• Intellimarker Survey (for ASCs)

• Ingenix (for hospitals)

Reimbursement TrendsReimbursement Trends

Expense BenchmarkingExpense Benchmarking



Sources for Industry Data

• First Research

• Industry associations such as the American College of Cardiology, National Cancer Institute, American College of Radiology

• Irving Levin Healthcare M&A Report

Industry AnalysisIndustry Analysis

Market TransactionsMarket Transactions



Common Approaches

• Used when company is not profitable enough to result in a value greater than tangible assets

• Used currently for many physician practice valuations because hospitals are not paying for goodwill or other intangible assets because profits of the practice are generally consumed in the form of compensation to the physician

Asset ApproachAsset Approach



Common Approaches

Can be complicated as many smaller healthcare companies

are on a cash basis

Very common for many working capital assets to be excluded, so important to understand the

terms of the acquisition

Asset Approach (Continued)Asset Approach (Continued)



Economics of a Physician Practice

Practice staff expenses

Practice supply expenses

Practice overhead expenses

CollectionsCollections

Therefore: Use of the asset approach is common

even when normalized

for productivity



Common Approaches

Market ApproachMarket Approach

• Not used very commonly for healthcare transactions

• Do not have publicly-traded companies in many segments

– Even when they exist, it is difficult to translate a business with multiple segments across multiple geographies to a single location, single specialty company

• Private transaction data is scarce

• Healthcare delivery is so market-specific, it is difficult to translate transaction data from one market to another



Illustration of Market Approach

AMSURG ASC

LOCATIONS Many Usually one

GEOGRAPHIC SPAN National Usually one

ACCESS TO CAPITALExtensive Limited

ECONOMIES OF SCALE Extensive Very limited



Common Approaches

Income ApproachIncome Approach

• Used most frequently for healthcare companies other than practices

• Critical to appropriately project cash flows and assess risk

• Educational hurdles:

– Tax effecting

– Control over the referrals

• This approach is not without regulatory risk – OIG advisory opinion not really in favor of income approach



Common Approaches

Income Entity/Common Approach(based on my experience and in order of preference)

Income Entity/Common Approach(based on my experience and in order of preference)

Asset Income MarketPhysician Practice + +

(if there are ancillary services or significant physician extenders)

-

Hospital + + +Imaging Center + + +Dialysis Clinic + + +Cancer Center + + maybe

Hospital/Physician Joint Venture - + -



Trends in Industry and M&A Activity

– Single largest acquisition trend right now

– Involves primary care & specialty practices

– Generally only paying for tangible assets

– Post-transaction compensation is a key assumption

Hospital/

Physician

Joint

Ventures

Hospital

Acquisition of

Physician

Practices

• Generally involves ASCs• Likelihood of cash distribution is a key driver• Many are structured as pass-through

entities so this becomes an important component of the valuation



Trends in Industry and M& A Activity

• Many are structured as clinical co-management agreements

• An alternative to an equity joint venture

• Involve specialty service lines of the hospital such as cardiology and orthopedics where the hospital needs a deeper level of clinical involvement

• Easier to unwind than equity joint ventures

Management AgreementsManagement Agreements




• •

• •

• •

What about

healthcare reform?

Current thinking…

is that it will further spur consolidation in the industry between hospitals, physician,

and ancillary providers, such as

imaging centers

At a minimum…

it will make projection of revenues

significantly more difficult due to the

bundling of payments



Enactment of provisions of PPACA is expected to increase

the number of covered individuals by 32 million.

By 2019, primary care visits are predicted to increase between 15.07 million to 24.26 million.

Assuming stable levels of physicians’ productivity, the

increased demand would require between 4,307 to 6,940 primary

care physicians.

Trends in Industry and M&A ActivityEffect of PPACA on Primary Care




Care delivery will likely shift to

mid-level practitioners changing the cost

structure of practices

Work relative value unit assignments likely to increase over the next

few years

Critical to the success of an ACO or bundled payment initiative

Will likely be a shortage by 2014 – even more so

than currently



22 of the original organizations from the Pioneer ACO program remain; represents approximately 699,000 covered lives

As of January 2014, 351 ACOs provided care to 5.3 million beneficiaries (up from 250 a year ago).

Approximately 250 commercial ACOs representing approximately 12.4 million covered lives

Trends in Industry and M&A ActivityACOs – Where are They Now?



Five-year initiative launched January 31, 2013

Private payers already using

bundled payments

Based on Medicare ACE Demonstration Project – free range

ACO

Single payment for defined group of services within

specified episode of care

Pricing based on discount of payer’s historic total cost

Gain-sharing incentives

Trends in Industry and M&A ActivityBundled Payments for Care



Trends in Industry and M&A ActivityImpact on valuations

We will be living in the “straddle” for several years

Benchmark compensation data will take 2 – 3 years to catch-up to changes in the industry and will, therefore, not be as meaningful

As appraisers, the “art” part of our analysis will become more prominent and we will have to develop new approaches and be prepared to defend them



Questions



Contact Information

Carol Carden, CPA/ABV, ASA, CFE

Shareholder

Pershing Yoakley & Associates, P.C.

(865) 673-0844

[email protected]

www.pyapc.com

Twitter: @carolcardenpya

current issues in healthcare valuation

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