fundamentals of healthcare valuation

March 10, 2015

Fundamentals of Healthcare Valuation

Fundamentals of Healthcare

Valuation

March 10, 2015

Kathryn A. Culver, CPA

March 10, 2015


Agenda

Valuation Overview

Healthcare Valuation Approaches

Healthcare Valuation Considerations and Trends

March 10, 2015


Valuation Overview

March 10, 2015


Overview

• What is value and what is a valuation?

• Why is a valuation performed?

• How does one perform a valuation?

Approaches

Standards of value

Premise of value

Assessment of risk

March 10, 2015


What is Value and

What is a Valuation?

• What is value?

The amount of money that something is worth. The price or

cost of something.1

• What is valuation?

An independent, unbiased opinion of value for businesses

and business interests of all sizes.

1 Merriam-Webster Dictionary

March 10, 2015


Why is a Valuation Performed?

Mergers and acquisitions

Divestitures

Joint ventures

Estate and/or gift planning

Regulatory compliance purposes

Dispute-related valuation services

Tax-related valuation services

Divorce

Lost profits analyses

Buy-sell agreements

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How does one value a business?

• Typical Business Valuation Approaches

– Cost / Asset Approach1

o Net asset value method

– Income Approach2

o Discounted cash flow method

o Single period capitalization

– Market Approach

o Guideline public company method

o Guideline transactional / mergers-and-acquisition method

1 The entity is not necessarily assumed to be a going-concern.2 Assumes the entity is a going-concern.

March 10, 2015


Cost / Asset Approach

• Based on the principle of substitution

– Cost to replace

• Usually involves separate valuation of each item on the

balance sheet

– Adjust tangible assets, intangible assets, and liabilities to their

market values

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Income Approach

• Present value of all future benefits

– Direct correlation between the amount of income a property will

earn and its value

• Requires:

– Projection of future income stream

– Determination of an appropriate discount rate (or cost of capital)

• Market risk

• Size risk

• Company-specific risk

• Industry risk

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Market Approach

• Also based on the principle of substitution

– Prudent buyer will pay no more for a property than it would cost to

acquire a substitute property with the same utility

• Compare subject property to similar properties that have

recently sold

• Use of guideline company transaction data to develop market-

based multiples

– Publicly traded companies

– Acquired / merged companies

– Prior transactions in company’s stock

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Standards of Value

• Intrinsic Value

• Investment value (synergy)

• Fair value

• Fair market value

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Fair Market Value

• Hypothetical willing buyer

• Hypothetical willing seller

• Reasonable knowledge of the relevant facts by both

parties

• Neither party is under compulsion to buy or sell

• Arm’s-length transaction in an open and unrestricted

market

• Presumed ownership transfer as of a specific date

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Healthcare Valuation

• Why is Valuation Important for the

Healthcare Industry?

• Reasons for Healthcare Valuation

• Key Regulations

• Fair Market Value in Healthcare

Valuation

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Understanding the Context

What makes a healthcare valuation

different than 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

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Approaches

March 10, 2015


Mechanics of the Asset Approach

• Derives an indication of value based on the anticipated cost to replace, replicate, or recreate the asset

• Often considered a “floor” value

• 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

• Net Asset Value Method

Asset Approach

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Mechanics of the Asset Approach

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

March 10, 2015


Mechanics of the Income Approach

• Based on the entity’s earning power (i.e., ability to generate positive cash flow in excess of the physician’s fair market value compensation).

• Used most frequently for healthcare companies

• Critical to appropriately project cash flows and assess risk

• This approach is not without regulatory risk

• Primary methods include:

Discounted Cash Flow Method

Capitalized Income Method

Income Approach

March 10, 2015


Discounted Cash Flow

(DCF) Method

• Value is based on the entity’s projected net cash

flows discounted to present value

• Requires projections of revenues, expenses, capital

expenditures, etc.

• Risk of the cash flows is factored into the discount

rate

• Typically are used for large practices with substantial

ancillary revenue and/or mid-level providers

March 10, 2015


Capitalized Income Method

• Relies upon a single period earnings stream as a

proxy for future years (as opposed to projections)

• Value is determined by capitalizing the earnings

stream

• Generally difficult to use for physician practices –

past is not always a reliable indication of the future

for most practices

March 10, 2015


…does not have

remaining profits

after physician

compensation

the NAV method

will likely be

appropriate and

should be used.

…has profits

remaining after

FMV physician

compensation

an income

approach will

probably be

required.

Which Method is Appropriate?

IT DEPENDS…

If the Practice…

March 10, 2015


Mechanics of the Market Approach

Market Approach

• Determines an indication of value-based multiples derived from similar businesses/interests that have been bought/sold

• Not used very commonly in healthcare

Not many publicly traded healthcare companies

Lack of reliable transaction data involving companies that are sufficiently similar

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

March 10, 2015



Considerations and Trends

March 10, 2015


Hospital/Physician

Alignment Transactions

#

• Hospitals and physicians are actively

seeking ways to strategically and

financially align themselves.

• Successful alignment transactions can

result in substantial benefits to all parties

including patients.

– Improved efficiencies and quality of care

– Reduce costs and waste

– Better bargaining power with third-party

payers

March 10, 2015


“Buy and Employ” Transactions

• Typical Transaction:

– Hospital buys the practice at FMV

o Usually structured as an asset purchase

o Cash and AR normally excluded

o Net after-tax proceeds can be substantially

different depending upon the deal structure

“Buy and Employ”

Transactions

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“Buy and Employ” Transactions

– Physicians employed by the hospital

o Generally under some type of productivity-

based compensation arrangement

(wRVUs)

o Generally involves a period of guaranteed

compensation (assuming productivity does

not decline substantially)

o Often includes other types of arrangements

as well (e.g., co-management, call pay,

quality incentives, etc.)

“Buy and Employ”

Transactions

March 10, 2015


FMV Compensation

• Required for any transactions in which a financial

relationship exists between parties with the ability to refer

patients

• Not very prescriptive

– Use of multiple, objective compensation surveys

– Attributed clinical compensation rates for clinical services and

administrative compensation rates for administrative duties

• Relationship with commercial reasonableness (to be

discussed later)

March 10, 2015


Compensation and Regulatory Issues

• Post-transaction compensation structure factors into the

practice valuation

– Health systems cannot pay for a revenue stream twice – once

with the “purchase” and then on-going in the physician

compensation plan

• Fair market value and commercial reasonableness

(addressed hereafter) must also be considered with

regard to physician compensation

March 10, 2015


Fair Market Value Appraisals

• Physician Compensation

– Employment

– Call Coverage

– Medical Directorship

– Hospital-Based Services

Financial Assistance

– Professional Services

Arrangements

– Clinical Research

– Consulting Services

• Management Agreements

• Clinical Co-Management

Agreements

• Shared Savings

Arrangements

• Employee Leasing

Arrangements

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FAIR MARKET VALUE

Compliance Issues Regarding

Hospital-Physician Financial Relationships

COMMERCIAL REASONABLENESS

Overall Arrangement

“WHY?”

SENSE CENTS

Range of Dollars Only

“HOW MUCH?”

Scope

Key Question

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Commercial Reasonableness• Department of Health and Human Services Definition1

– An arrangement which appears to be “a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.”

• Stark Definition2

– “An arrangement will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician of similar scope and specialty, even if there were no potential designated health services (DHS) referrals.”

• OIG Threshold 3

– Compensation arrangements with physicians should be “reasonable and necessary.”

1 63 Fed. Reg. 1700 (Jan. 9, 1998).2 69 Fed. Reg. 16093 (March 26, 2004).3“OIG Compliance Program For Individual and Small Group Physician Practices,” Notice, 65 Fed. Reg. 59434 (Oct. 5, 2000); OIG Advisory Opinion

No. 07-10, September 20, 2007, pg. 6, 10; “OIG Supplemental Compliance Program Guidance for Hospitals,” Notice, 70 Fed. Reg. 4858 (Jan. 31,

2005).

March 10, 2015


Factors in Determining CR

Business Purpose

Provider Analysis

Facility Analysis

Resource Analysis

Independence & Oversight

Commercial

Reasonableness

Determination

March 10, 2015


Contact Information

Kathryn A. Culver, [email protected]

http://twitter.com/kculvercpa

http://www.linkedin.com/in/kculvercpa

Pershing Yoakley & Associates, P.C.865-673-0844

www.pyapc.com

http://twitter.com/pya_pyahc

http://www.linkedin.com/company/84085

ATLANTA | NASHVILLE | KANSAS CITY | KNOXVILLE | TAMPA

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