Q4 concludes a transitional year for the healthcare services industry. In spite of the best efforts of Congressional Republicans to dismantle the Patient Protection and Affordable Care Act (PPAC), it remains the law of the land. Twenty six state attorneys general have filed suit, claiming that Congress exceeded its authority by requiring individuals to purchase health insurance and by trying to shift more of the costs of care to state Medicaid programs and the Supreme Court will hear arguments in March. Meanwhile, Accountable Care Organizations (ACOs) are being formed in every region of the country as bundled services and patient coordination are beginning to take root.

The healthcare services M&A market was very active as providers of all types and sizes looked for opportunities to mitigate the effects of the changing regulatory environment and benefit from the slowly improving economy. Buyers are in the market for strategic reasons, but in an election year with the Bush tax cuts scheduled to expire and discussion of the possibility of increased capital gains taxes, many sellers will be looking to close a transaction before the tax man can take a bigger bite out of the proceeds.

Medicare

The Medicare program is at the center of the national debate about taxes and expenditures. It’s one of the most effective and successful federal programs, but spiraling costs are simply unsustainable. The Super Committee failed to make the tough decisions needed to balance the budget, but fiscal concerns such as program growth and integrity have not gone away. During the negotiations, many threats to Medicare Home Health providers were proposed. However, since they failed to make a deal, the fallback of “sequestration” will be implemented instead. This is actually very good news for home health providers because co-pays, accelerated rebasing, and any cuts to Medicaid are now off the table and cuts to Medicare will be limited to 2% per year starting in 2013. Also, the 2012 Final Rule had no ugly surprises, but rather a delayed implementation of the case mix creep cuts that should make it a bit easier to adjust to the new environment.

Most of the publicly traded home health providers reported significant losses in Q3, thus short-term investors drove stock prices way down in Q4. Some analysts pointed to the woes of the largest home health providers as evidence that the PPAC is putting undue pressure on providers. While it’s true that the PPAC requires all providers to do more with less, a closer reading would reveal that large home health providers are well positioned to benefit from the PPAC because they are at the fulcrum of efficiency generated from outcome-based patient coordination. This interpretation seems to be supported by long term investors, as many of the largest transactions in 2011 were recapitalizations sponsored by private equity groups taking advantage of the wave of consolidation flooding across the home health industry.
There were many significant home health transactions in 2011 and many had the common denominator of the buyer not being another home health agency. This reverses the trend initiated during IPS of facility-based providers being disincentivized from offering home health services. Now that providers can bundle home health with other services, ALFs, SNFs, and LTACs are motivated to provide home health for reasons that are reminiscent of the “old days” under reimbursement. We’re seeing a lot activity at the top and bottom of the market as hospitals and group practices surgically seek strategically located provider numbers and private equity groups look to establish platform investments and roll-up complementary add-ons.

Hospice

The hospice segment continues to be a victim of its own success. After years of underutilization, hospice services are becoming more integral to the continuum of care as payers insist on economic efficiency and beneficiaries accept the importance of palliative care to their quality of life. Hospice providers are multiplying rapidly and, with a performance differential of almost 10x, the proportion of for-profit to non-profit providers has skyrocketed. Public awareness and scrutiny of the hospice benefit has increased as one of the largest providers is being prosecuted for false billing and there have been several prominent media stories warning of clinical and financial abuses. Just like some home health providers have been caught “gaming the system” regarding therapy visits, some hospice providers are getting noticed for “cherry picking” the least intensive Alzheimer’s patients and leaving the more expensive cancer patients for non-profit providers to serve. The U-shaped billing model being discussed by CMS is designed to eliminate this practice by trying to match funding to need within the treatment cycle rather than using a one-size-fits-all approach that is easily manipulated.

Given the marked increase in services and the relatively small number of providers, the hospice segment is experiencing dramatic growth right now. There are roughly ten times more home health agencies than hospices, and it seems like just about every one wants to expand into the hospice market to hedge against some of the regulatory challenges facing the home health industry. Most of the largest transactions announced by publicly traded home health providers in 2011 have been acquisitions of hospices and long term care and other post acute providers have also been in the hunt. Thus, prices for hospice providers are at an all time high with EBITDA multiples climbing to heights not often seen outside the tech industry!

Medicaid

Medicaid providers continue to tighten their belts as the weak economic recovery has forced states to cut rates, reduce hours, and limit eligibility of beneficiaries. Long term prospects still look promising as CMS tries to reduce costs of acute care through prevention afforded by chronic assistance with the activities of daily living and budget “sequestration” should protect providers from any deeper cuts. Hope for one new payer is evaporating as the Obama administration finally concluded that the CLASS Act is financially unsustainable. However, the demand for Medicaid services continues to be as high as the margins are low.
Some larger providers of nonmedical care are dealing with shrinking margins by rolling up competing agencies to spread their administrative costs over greater revenue. In what we considered to be another example of the myopic vision of stock market investors, one of the largest publicly traded Medicaid homecare providers was taken private in the beginning of 2011; it was another smart-money bet on the importance of homecare to the future efficiency of the overall healthcare industry.

Private Pay

The economy has been the dominant factor restricting growth in the private pay segment. Many successful providers have lost significant volume since 2008, so many prospective sellers remain on the sidelines because they can’t get the premium prices they once would have commanded. As the economy sputters, the usual regulatory issues such as worker classification and licensure continue to smolder. We thought the employer mandate of the PPAC was bad enough, but we were unpleasantly surprised by the Department of Labor ruling effectively eliminating the overtime exemption for companionship workers – including live-ins. Although the segment should rebound nicely once the economy recovers and the labor market tightens, we aren’t seeing a lot of deal flow as providers are focused on operations right now rather than growth.

DME

2011 was a decisive year for DME/O2 providers. The implementation of Competitive Bidding in pilot markets was met by howls of dissatisfaction from providers, beneficiaries, and patient advocates. The jury is still out as to whether internet providers can offer the same level of products and services as their traditional counterparts, but policymakers remain committed to extending Competitive Bidding to 90 new markets. This portends very difficult operating conditions for providers who don’t diversify their payer and product mixes. Meanwhile, patients are increasingly paying cash for needed products online and the number and variety of private pay DME/O2 equipment providers is exploding. This new segment is highly fragmented and we’re starting to see leading providers building market share through acquisitions.

Conclusions

We are seeing more buyers, more types of buyers, and more aggressive buyers than we have seen since the implementation of PPS. Efficiency and program integrity are driving the market as regulatory conditions continue to increase incremental costs and administrative burdens for providers, stimulating smaller operators to sell and larger operators to buy before margins are compressed any further. We predict 2012 will be a blockbuster year for M&A in the healthcare services industry as the recovering economy should allow more providers to capitalize on the ever increasing number of beneficiaries and ever increasing need for care.

If you’d like to discuss how all of this affects you, feel free to contact us any time. We are always happy to discuss market conditions, valuations, and the process we undertake to effect a successful transaction.