valuing hospitals

Valuing Hospitals

© 2014 Business Valuation Resources, LLC

[email protected]© 2014 Business Valuation Resources, LLC

Hospital ValuationsIn the Health Reform Era

July 31, 2014

Don Barbo, DirectorDeloitte Financial Advisory Services LLP

Robbie Mundy, Senior ManagerPershing Yoakley & Associates, P.C.



Hospital Transaction Activity

Rebound in transaction activity as the credit crisislessened

Passage of healthcare reform increased the pace oftransaction activity

Transaction volume expected to continue increasing ascapital begins flowing to the market

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Announced Hospital Transactions

5272

90100

8380

125

156

247

283

0

50

100

150

200

250

300

2009 2010 2011 2012 2013

Number of Deals

Number of Hospitals


2013 Transactions Fewer, but Larger.

2013 transaction volume decreased to 83, down from 100 during 20122013 dollar volume increased to $19 billion, up from $2.2 billion in 2012Four deals $1 billion or greater during 2013, whereas none exceeded $550million during 2012

10 Largest Announced Transactions, 2013

Acquirer Target Price Hospitals Beds

Community Health Systems, Inc. Health Management Associates, Inc. $7,600,000,000 71 11,000

Tenet Healthcare Corporation Vanguard Health Systems, Inc. $4,300,000,000 28 7,081

Fresenius Helios 43 German hospitals $4,175,200,000 43 11,800

Catholic Health Initiatives St. Luke's Episcopal Health System $1,000,000,000 5 1,098

Medical Properties Trust, Inc. 3 IASIS Healthcare hospitals $283,300,000 3 670

Vibra Healthcare 16 health care facilities $186,500,000 14 1,181

HCA West Florida 3 IASIS Healthcare Hospitals $146,000,000 3 691

Sabra Health Care REIT, Inc. Forest Park Medical Center $119,800,000 1 54

Prime Healthcare Foundation Knapp Medical Center $110,000,000 1 209

Carolinas HealthCare System Cleveland County HealthCare System $101,000,000 3 504Source: Irving Levin Associates, March 2014.

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Hospital Transaction Multiples

0.73

0.60

0.68

0.60

0.56

0.40

0.50

0.60

0.70

0.80

Median Price to Revenue

9.9

8.3

10.1

7.9

9.2

5.0

6.0

7.0

8.0

9.0

10.0

11.0

Median Price to EBITDA


Publicly-Traded Hospitals

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Total Enterprise Value to Revenue

Community Health Systems,Inc.

Health ManagementAssociates, Inc.

Tenet Healthcare Corporation

LifePoint Hospitals, Inc.

HCA Holdings, Inc.

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Publicly-Traded Hospitals

5.5

6.5

7.5

8.5

9.5

10.5

11.5

Total Enterprise Value to EBITDA

Community Health Systems,Inc.

Health ManagementAssociates, Inc.

Tenet Healthcare Corporation

LifePoint Hospitals, Inc.

HCA Holdings, Inc.


Health Care Industry PerformanceS&P 500 Market Indices

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Health Care Industry PerformanceS&P 500 Market Indices


Healthcare Industry Survey Feedback

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Future Outlook on Consolidation

Acute sector consolidation is likely to accelerate as hospitals seeksustainability due to:

Increased margin pressures from payer mix erosion, higher supplychain and labor costs, and increased competitionIncreased regulatory compliance costs: due to the Affordable CareAct, ICD-10 conversion, HITECH, anti-fraud and other federal and statelawsIncreased operational integration of physicians, allied healthprofessionals, post-acute providers, and retail health in value-baseddelivery systemsPayment reforms, including bundled payments, and declining Medicarereimbursement ratesIncreased implementation of clinical improvements based on newdiagnostic and therapeutic models and the ongoing convergence ofphysical and behavioral health


Potential Impact of Health Reform onVarious Provider Business Models

Copyright © 2011 Deloitte Development LLC. All rights reserved.

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Potential Impact of Health Reform onVarious Provider Business Models

Copyright © 2011 Deloitte Development LLC. All rights reserved.


Analysts Give Not-For-Profit Hospitalsa Negative Outlook for 2014

Downgrades will continue to exceed upgrades because cutting costs to meet revenuepressures is getting more difficultCited the following pressures: Transition to value-based reimbursement, more risk-based contracting, health insurance exchanges, the two midnight rule, cuts toMedicare, and volatility associated with Medicaid

In 2012, hospital revenue grew 5.2 percent, but revenue growth expectations forfiscal year 2014 are only projected to be between 3 percent and 3.5 percent.

Median financial ratios were generally stable in 2012, as well as most of this year.However, Medicare cuts and sequestration, Medicaid funding issues, declininginpatient volumes and the rise of high deductible health plans are heightening threatsto hospital profitability.

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Challenges Facing the Hospital Industry

Slow Economic RecoveryAlthough unemployment rates are declining, high unemployment inrecent years has resulted in increased bad debt and charity careHealthcare spending grew 3.7% in 2012, compared to 4.6% for theoverall economyPatients have delayed care, which has led to a decrease in electiveprocedures for hospitalsAccess to capital has been constricted

Competitive LandscapeAdvances in medical technology have led to a migration of cases toASCs and specialty hospitals

-cases and commercial insurance patients, leaving the hospital with lessprofitable casesHospital proponents argue that specialty hospitals draw specialtyphysicians and staff away from the community hospitalsASCs and specialty hospital proponents argue that they provide moreefficient and convenient care for patientsPhysician ownership a complicating factor for hospitals

Source: United States Department of Labor

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

U.S. Unemployment Rate

0

1,000

2,000

3,000

4,000

5,000

6,000

1991 2012

Medicare-Certified ASCs

Source: MedPac Report to the Congress, March 2003 & March 2014


Challenges Facing the Hospital Industry(continued)

Physician and Nurse ShortagesProjected shortage of 130,600 physicians, including 68,500 primary carephysicians by 2025, according to Association of American Medical CollegesProjected nursing shortage of 1.05 million full-time nursing positions by 2022according to the American Association of Colleges of Nursing

Increased Governmental ScrutinyMedicare Recovery Audit Contractor (RAC) audits

Purpose is to identify Medicare overpayments and underpaymentsRACs are paid on a contingency fee basis

Increased enforcement of fraud and abuse laws

U.S. ex rel Elin Baklid-Kunz v. Halifax Hospital Medical Center - $85 million settlementU.S. ex rel Michael L. Drakeford, M.D. v. Tuomey Healthcare - $238 million judgment

Increased scrutiny of merger activity by the Federal Trade Commission (FTC)

P.A.

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Challenges Facing the Hospital Industry(continued)

Reimbursement PressuresMedicare FY 2014 final rule increased inpatient payments to generalacute-care hospitals by 0.7% and outpatient payments by 1.7%Hospitals that do not successfully participate in the quality reportingprogram will have a 2.0% reduction in paymentsAutomatic market basket reductions required in the healthcare reformlaw

Increased Reporting RequirementsValue-Based Purchasing

FY15 scoring: clinical process of care (20%), patient experienceof care (30%), patient outcomes (30%), and efficiency (20%)

Conversion from ICD-9 to ICD-10 delayed until October 1, 2015Electronic Health Records and Meaningful Use Requirements

-


Overview of Healthcare Reform

Affordable Care Act (ACA)Signed into law on March 23, 2010Primary goals:

Provide healthcare coverage for many uninsuredReform healthcare system to improve qualityReduce overall healthcare costs

Health Care and Education Reconciliation Act of 2010Signed into law on March 30, 2010Includes several amendments to the ACA, including providingmore generous health insurance subsidies to lower income groups

Supreme Court upheld the constitutionality of ACADecision made on June 28, 2012Although the majority of the legislation was upheld, certainprovisions, such as Medicaid expansion, were made optional

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Specific Healthcare Reform Provisions AffectingHospitals

Individual insurance mandate and voluntary Medicaidexpansion

Tax penalty for non-compliance beginning in 2014, althoughpenalty is nominalEach state must establish healthcare insurance exchange by2014, thereby expanding access to insurance

States were given the option to either form their own state-runexchange or partner with federally-run exchangesTo date, only 17 states have set up their own exchanges

States provided financial incentives by the federal government toexpand Medicaid coverage eligibility to 133% of FPL, althoughexpansion is voluntary


State Adoption of Medicaid Expansion

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Specific Healthcare Reform Provisions AffectingHospitals (continued)

Bundled Payments for Care Improvement Initiative(BPCI)

Innovative new CMS payment model that began in 2013 withinwhich participating organizations enter into payment arrangementsthat include financial and performance accountabilityUnder this payment model, multiple providers receive one bundled

certain medical conditions

Value-based purchasingBeginning in 2013, a percentage of payments to hospitals became tied toperformance on certain quality measuresBase payments to hospitals are either increased or decreased dependingupon whether or not certain quality benchmarks are achievedHospitals face up to a 2% reduction in Medicare payments if benchmarksare not achieved



Hospital market basket updateMarket basket is a fixed-weight index used to determine price changes for amix of hospital goods & servicesUtilized by CMS to determine changes to the fee schedules for hospitalinpatient and outpatient servicesMarket basket reduced by 0.3% in 2014; 0.2% in 2015 & 2016; and 0.75% in2017-2019

Disproportionate Share Hospital (DSH) PaymentsPayments under the Medicare/Medicaid programs intended to compensatehospitals that serve a high percentage of low-income or indigent patientsIn 2014 and 2015, hospitals receive only 25% of current Medicare DSHpayments, with remaining 75% allocated to hospitals based onuncompensated care costsMedicaid DSH reductions delayed until October 2015 hospitals face a $1.2billion cut in Medicaid DSH payments in 2016

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Hospital-Acquired ConditionsRefers to conditions acquired by patients during a hospital stayReduces Medicare payments by 1% in 2015 for hospital-acquiredconditionsIntended to incentivize hospitals to improve infection controlprograms

Hospital Preventable ReadmissionsReduces Medicare payments made to hospitals for preventablehospital readmissionsBeginning in FY2013, if hospital has higher than expectedreadmissions rate for certain specified conditions, Medicarepayments could decrease for Medicare dischargesLargest potential reductions 2% in FY2014, and 3% in FY2015 andbeyond



Restrictions on physician-owned hospitalsNo new physician-owned hospitals allowed under Medicare afterDecember 31, 2010Existing physician-owned hospitals limited

Aggregate physician ownership percentage cannot increaseCannot add beds, surgical suites or procedure rooms unless anexception applies

Medical device excise taxStarting in 2013, medical device manufacturers pay a 2.3% excisetax on medical device salesExempts certain devices commonly purchased by the public, suchas eyeglasses, contact lenses, and hearing aidsApplicable to many common hospital supplies, such as bedpansCost is anticipated to be passed through to hospitals (and ultimately,to patients)

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Accountable Care Organizations

What is an Accountable Care Organization (ACO)?Organization of physicians, hospitals, and other healthcareproviders who agree to be provide coordinated, high-qualitycare to their Medicare beneficiaries

What is the purpose of an ACO?The goal of coordinated care is to provide patients,specifically those chronically ill, with care while avoidingunnecessary duplication of services and preventing medicalerrorsIntended to reduce healthcare costs and improve patientquality


Accountable Care Organizations(continued)

Medicare Shared Savings Program (MSSP)Voluntary program which allows an ACO to share in the savings it generatesDesigned to improve beneficiary outcomes and increase value of carethrough:

Promoting accountability for the care of Medicare FFS beneficiariesRequiring coordinated care for services provided under Medicare FFSEncouraging investment in infrastructure and redesigned care processes

Requires at least 5,000 Medicare beneficiariesCMS identifies target spending levels and if the cost is below thetarget, then it may share in the savingsRequires meeting certain quality standardsTwo models:

One-sided model: The ACO shares in only the savingsTwo-sided model: The ACO shares in the savings and the losses

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Accountable Care Organizations(continued)

Medicare Pioneer ACO ProgramIntended to test the MSSP with experienced healthcare organizations32 healthcare systems began in 2012Pioneer ACOs participated in the two-sided model, with higher levels ofrisk/reward than the MSSPIn July 2013, nine of the organizations announced they were leaving theprogram

Prevalence of ACOsAs of May 2014, 338 ACOs participating in MSSPCovers 4.9 million Medicare beneficiariesOf the 338 total ACOs, 333 participate in the one-sided model and only 5participate in the two-sided model


Specific Hospital Value Drivers

Location of the facilityAge and appearance of the facilityPrimary services and specialty services providedMedical staff composition (both employed andprivileged)Ability to recruit physicians to the areaCompetition in the market areaDemographics of the communityLevel of community supportInfluence of commercial payors in the local marketRelative contracting strength of the hospital

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Specific Hospital Financial Statistics

Inpatient AdmissionsInpatient DaysAverage Length of Stay

Calculated as Inpatient Days divided by Inpatient AdmissionsIncentive for hospitals to keep this ratio low

Calculated as Inpatient Days divided by 365Measure of the average number of inpatients in a facility onany given day

Occupancy RateCalculated as ADC divided by number of beds in serviceMeasure of how close the hospital is to capacity


Specific Hospital Financial Statistics(continued)

Outpatient VisitsPay attention to the ratio and trends of inpatient to outpatient activityMany hospitals have flat or declining inpatient admissions but areshowing growth in outpatient visits

Calculated as Inpatient Days multiplied by the ratio of gross patientrevenue to inpatient revenueMeasure of the total volume activity (both inpatient and outpatient) ofa hospital

Case Mix IndexMeasure of the costliness of patients treated at the hospital ascompared to other hospitalsHigh case mix index typically means that the hospital is treating morecomplex inpatient cases

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Specific Hospital Financial Statistics(continued)

Specific Operating ExpensesSalaries and benefits expense

Salaries/benefit expense as a percent of net revenuesSalaries/benefit expense per FTE employeesNumber of FTE employees per in-service beds

Medical supplies expenseMedical supplies expense as a percent of net revenuesMedical supplies expense per APD

Bad debt expenseBad debt expense as a percent of net revenuesHas been an increasing expense for many hospitals


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