valuation issues in healthcare

Date: December 1, 2014

Prepared for Tennessee Society of Certified Public Accountants

Valuation Issues in Healthcare

Tennessee Society of Certified Public Accountants

Healthcare Conference

December 1, 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 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

Anti-kickback

Prohibits the

consideration of

the value or

volume of

referrals

IRS

Comes into play

with not-for-profit

entities

Regulatory Environments




Fair Market Value

the value in arm’s-length transactions, consistent with the general market

value.

General Market Value

the 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

Important to

understand when

projecting and

adjusting balance

sheet

Impacts analysis if

market

transactions are

incorporated into

analysis

Impacts working

capital projection

Healthcare

transactions are

generally

structured as asset

sales:

Deal

Structure



Projecting Cash Flows

Common Mistakes in Healthcare

xxxx




Contributing 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 cycle?




Analysis of Reimbursement Trends



Healthcare Reform

Healthcare Reform

ACOs

Bundled Payments

Incentives for

Primary Care

Increase in Insured Population

Medical Home

Models




Consideration 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 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 Trends

Expense 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 Analysis

Market 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 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)



Economics of a Physician Practice

Practice staff expenses

Practice supply expenses

Practice overhead expenses

Collections

Therefore:

Use of the asset approach is common



Common Approaches

Market 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 CAPITAL Extensive Limited

ECONOMIES OF SCALE Extensive Very limited



Common Approaches

Income 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)

Asset Income Market

Physician 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 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 the PPACA are 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

valuation issues in healthcare

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market transactions

general market valuethe

service agreement

armslength transactions

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asset sales

result of