LBMC Experts Share Insights on Valuation, Vetting
Amid continuing uncertainty for the healthcare industry as professionals and politicians debate the best way to transform the delivery system, deals are still getting done ... but buyers have to be even more savvy when it comes to due diligence to get the most accurate picture possible before committing funds.
Despite ongoing health reform debates in D.C., Lisa Nix, shareholder and practice leader for Transaction Advisory Services with LBMC, said there is a continuing trend towards consolidation in the healthcare middle market. "It's still a sellers' market, and buyers still have money to put to work," she said.
However, she noted, buyers are drilling deeper on the numbers. "Healthcare valuations remain extremely high with double digit EBITDA multiples in certain healthcare sectors, but buyers are definitely becoming more discriminating, performing - from what we can see with our clients - more due diligence pre and post letter of intent," she said. "Deals that are ultimately getting done are high quality assets and those where the valuations are holding through the diligence process."
Nix said specialty physician practice consolidation continues. "We are still seeing a tremendous amount of activity with single specialty roll ups by private equity groups - particularly with dermatology, ophthalmology, radiology, dentistry and anesthesiology - as the trends continue with physicians desiring to focus more on the practice of medicine and less on the administrative and back-office challenges of operating a stand-alone practice," she said.
Other trends include state-specific regulations driving organizational and legal structures and governance, along with the continued rise of retail health.
As a result of the high healthcare valuations, Nix said, "We are seeing more and more interesting structures in this competitive deal environment." She continued, "An example of this is the increased use of various insurance products to cover some ... not all ... of either the buyers' or the sellers' transactional risks related to representations and warranties, tax indemnifications and other specific contingent liability exposures." Nix added using this tactic is subject to an underwriting process that includes insurance due diligence.
The continued meshing of retail offerings and medical services has led to more mid-level practitioners performing revenue-generating services within their scope of practice to provide more access to patients, while leveraging physicians' time more effectively and bolstering the bottom line.
Technology as Tool
Compliance and regulatory due diligence for healthcare service providers, particularly in the realm of billing and coding, is no longer an option and now usually occurs on the front end of the diligence process, noted Nix. Aiding in that step are sophisticated healthcare data analytics and benchmarking tools.
Rachel Harris, senior manager for LBMC Healthcare Consulting Practice, said using technology to create dashboards has helped make sense of an enormous amount of data in a very visual manner for clients. The analytical team also helps buyers and sellers do a much deeper dive and review a broader set of variables than the client might have initially considered.
"We really saw a lot of hospitals and health system acquisitions that were about market share. They weren't as concerned about how it looked post-close," she said, adding the attention was most keenly focused on acquiring the patient base.
It wasn't that due diligence wasn't completed, but the deals focused on a reporting package at the macro level. "But nobody really wanted the story it told," she said of the 10,000-foot view. "What they missed is the noise underneath the reporting tools."
Harris said as private equity groups and venture capitalists have become more involved in purchases ... and as some M&A deals by hospitals and health systems have proven more complicated in hindsight ... the level of detail in due diligence has become significantly more granular. "They want to know what the end of the story looks like as they are still writing it. They want to have some post-close assurances," she said.
She likened the level of detail that is now available through transactional analytics to the use of smart keys. Certainly, it's possible to pop the hood, look around and provide some solid information on a car you are about to buy. However, she continued, mechanics now have the ability to do a deep dive on a car's complex mechanical and electrical systems by simply inserting a smart key into a dock. "If you have the tools to analyze a buy at this intricate level in the same time or less, why wouldn't you?" she questioned.
Four Components of Vetting
Harris said there are four key components to be considered during the due diligence process: integrity, stability, sustainability and opportunity.
Integrity, she noted, looks at accuracy, which requires more intricate information in the reporting packages. "It's understanding the parts ... not just the sum," she said. Harris added totals might look fine, but when you begin to dig deeper, you get a clearer picture if some important "over and under" values have washed out to get to that final number.
"Stability," she continued, "is what you can rely upon." The macro view of a cardiology service line might show what appears to be stable volumes and revenue stream across a three-year period. "But what analytics digs up is your biggest payer has drastically cut reimbursement starting in month 34 of 36 so your volume is stable, but you now have a big hit from the biggest payer. That might change the valuation," she noted.
"Sustainability is not only what's sitting still but what can be relied on," Harris continued. In the cardiac service line example, revenues won't be sustainable despite stable volumes once the largest payer institutes a 25 percent reimbursement cut.
"Payment reform really plays into sustainability," she added, noting one of the questions now asked during the due diligence process is where a practice or facility stands in terms of MACRA compliance. "We calculate what happens with penalties or full participation."
Last, but certainly not least, is opportunity. "Once we've finally defined what we have as a core practice and found that it's an accurate, stable, sustainable book of business, then we look for where there is an opportunity for growth," Harris said.
"When you are able to get into that level of details with analytics, it tells a much different story," she added of the deep dive. "My hope is it gives the buying entity real confidence."
Due Diligence: Not Just for Buyers
Due diligence cuts both ways. Nix advised, "If you are contemplating selling your business, consider having sell-side due diligence performed. The benefits of embarking in a sell-side process several months in advance of transaction launch - particularly for companies that are cash basis, unaudited, and/or have challenging historical financials - far outweigh the costs."
Billing and coding issues could cause significant delays in closing a transaction. While the mistakes were most likely unintentional, it raises a flag for buyers who tend to then expand the scope of review to ensure there are no other regulatory surprises waiting. "It should go without saying that it is certainly worth spending a little money up front and investing in a sell-side billing and coding diligence process in order to identify and remediate any billing and coding issues before such issues are identified by a potential buyer," Nix said.
She added some of the other benefits of a sell-side diligence report include:
- Increasing credibility of seller's financial information in the market,
- Allowing buyers to make a more well-informed ... and possibly higher ... bid,
- Preparing the seller's management team and minimizing business disruptions during the buyer's due diligence process,
- Potentially lessening the buyer's diligence cycle if there are reports with supporting data that could be shared with the buyer's team, and
- Decreasing the surprises, which increases the probability of a successful transaction.
Although buyers don't want to get a reputation of stalled or re-traded deals, Nix said significant issues that come up during due diligence process certainly can't be ignored. When valuations don't hold up, buyers have to change the deal structure, reduce the purchase price, wait on stronger results, or walk away.