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Q1 of 2012 was unusual in that everybody was talking about the future of healthcare. The Supreme Court heard arguments for and against the Patient Protection and Affordable Care Act (ACA) and pundits of all types weighed in on the implications of those arguments. The conventional wisdom before the hearings was that, although it would be a rigorous academic exercise, the law would probably be upheld. Many observers were surprised by the court’s aggressive questioning and now many are saying they won’t be surprised if at least some elements are overturned. The central issue for the court is whether it is unconstitutional for the government to require individuals to buy health insurance in order to ensure that the interstate market for health insurance is functional. This always seemed like a red herring to us because Congress could simply restructure the law to avoid any issues of constitutionality if the political will existed to do so. Since the Democrats have adopted many of the Republicans’ core ideas regarding healthcare reform (not least of which is the individual mandate) but the Republicans still refuse to cooperate to implement any policy, it’s clear that the stalemate is not constitutional nor is it policy related: it’s just politics exaggerated for the election year. The individual mandate doesn’t impact homecare providers directly, but without it many of the core elements of the law no longer make sense. A bigger issue for homecare providers that is under consideration by the Supreme Court is whether it’s coercive for the federal government to require the states to spend more money to increase enrollment in their Medicaid programs. Precedent would suggest that, although the states may not agree with federal policy, they are not required to participate in the Medicaid program and thus must submit to federal requirements if they want federal money. Although most of the attention went to the Supreme Court, annual budget proposals highlighted the two main partisan approaches to the evolution of healthcare reform. The Obama administration more or less proposes staying the course, preserving Medicare and Medicaid as entitlement programs and hoping that increased efficiency and decreased fraud will free up enough money to pay for it all. The other side of the argument was represented by House Budget Chairman Paul Ryan’s proposal to replace the current entitlement programs with block grants and vouchers to assist the elderly and infirmed to access care through private markets. Whichever philosophy one subscribes to, the fact is that we all must do more with less so providers who can deliver the best care with the greatest degree of efficiency will be best positioned to capitalize on changes in the marketplace. We are seeing two forces impacting the M&A market for healthcare service providers right now: first is the drive towards efficiency that attracts investors to the most efficient providers in the continuum of care, second is the political and regulatory uncertainty that scares investors and encourages them to wait on the sidelines until they can better predict the future. The result is that the primary actors in the market today are those who are already committed to the industry and have already mapped out a strategy to succeed no matter what happens in the policy arena. Medicare Medicare Certified home health providers continue to exist at the fulcrum of efficiency and patient coordination. Thus, they continue to gain importance within the continuum of care. None of the primary issues debated by the Supreme Court directly impact Medicare Certified home health providers, but if the law is determined to be non-severable then a finding of unconstitutionality for the individual mandate could jeopardize the constitutional parts of the law that do impact Medicare Certified home health agencies. If the ACA is invalidated, providers may be relieved of the employer mandate to provide health insurance for all employees, but it’s likely that other provisions such as bundling services and creating ACOs will survive in another form, so the Supreme Court decision will probably not drastically change the course of evolution for this segment of the industry. Conversely, the budget debate has much more radical implications for the future. The Obama approach and the Ryan approach present two starkly different philosophies that voters have been considering for the last few elections. Most providers have become very comfortable with the philosophy of entitlements, but if Obama’s efficiency measures can’t cover the spiraling costs of growing programs then radical measures such as those proposed by Ryan will become very real options no matter who wins the next election. With the economic recovery teetering and austerity in the air, at least voters will have the privilege of supporting one direction or another. Either way, the home health industry’s critical role in reducing costs while improving outcomes makes providers attractive acquisition candidates no matter what happens with the Supreme Court or the budget. Although regulatory uncertainty has probably cooled the market temporarily as buyers and sellers wait to find out what happens with the Supreme Court and the election, we are seeing activity among those who are already committed to the industry and who want to be positioned for either a worst case or best case scenario. We’re seeing upward pressure at the top of the market and downward pressure at the bottom of the market as conditions continue to favor larger providers. At the top of the market, we’re definitely hearing from more buyers than sellers but inventory is scarce as any desirable acquisition candidates have a lot to gain from staying off the market and growing themselves as competition from smaller providers continues to weaken. Opportunities abound at the bottom of the market, especially in saturated markets where provider capacity has outstripped beneficiary growth and referral sources dry up as a consequence of consolidation and bundling. Prices at the top have been untested due to a lack of inventory, but at the other end of the spectrum prices seem to have bottomed at the replacement cost of starting from scratch, which hasn’t changed for years. More good news for smaller providers is that we’ve seen some small transactions that were financed by third parties, suggesting that lenders are starting to become more aggressive as the healthcare industry leads what little traction the economic recovery has displayed. As always, what few larger providers do choose to exit can command very respectable premiums and buyers are having no problem securing financing if necessary. Hospice All things considered, it’s been a pretty good quarter for hospice providers. The U-shaped billing model is still being discussed, but hospice providers are facing no new rate cuts and relatively little exposure to the Supreme Court decision. The disproportionate imbalance between supply and demand in the hospice segment combined with unparalleled growth prospects in a relatively favorable regulatory environment has lead many different types of providers to consider hospice as a desirable vehicle for diversification. Home Health Agencies and Skilled Nursing Facilities are probably the most complementary buyers, but we’ve noted interest in hospice from all points on the continuum of care and from financial as well as strategic investors. The rare hospice that does sell seems to fetch such a premium that Irving Levin and Associates warns of a possible bubble. Given the significant growth prospects and limited competition, we expect hospice transactions to continue to set the bar at a fairly high level. Medicaid Medicaid providers have found themselves in the center of the spotlight during the Supreme Court arguments and they have used the opportunity to draw attention to the central role they play in preventing acute episodes that cost so much and compromise the quality of life for so many people. The logic is undeniable: the more we spend on chronic care, the less we’ll need to spend on acute care. The only question is Who pays? The Obama administration has been so aggressive about shifting costs from the Medicare program to the Medicaid program that many states claim it’s coercive. Federal dollars are being used to pay for most of the transition, but eventually the states will be required to contribute a much greater share to care for a much larger eligible population, so the states are fighting to preserve as much flexibility as possible into the future. …and although the CLASS Act has been left for dead by many, it’s still on the books as a potentially new payer for assistance with the activities of daily living. Even without the ACA, Medicaid programs will grow significantly because of their importance to containing costs while preserving the quality of life for beneficiaries. Growth has been constrained because the sick economy hasn’t been able to generate the tax revenue necessary to pay for services. As the economy recovers, states will be in a better position to pay for services and providers should be able to take advantage of their position as the lowest cost alternative to support individuals with assistance with the activities of daily living. If the ACA is upheld, the organic growth of Medicaid will be further augmented. While the market waits for the economy to restore growth, providers are hunkering down and cutting costs to survive the lean times. Economies of scale are necessary, so successful operators are seeking acquisition candidates to help them spread their costs and increase their revenues. Smaller providers are faring the worst because they are least able to absorb rate cuts and compete effectively. We are seeing activity in states with stable legislative environments that have settled on rate cuts and eligibility requirements that efficient providers can live with. Private Duty The part of the ACA that private duty homecare providers object to most is the employer mandate. While not unconstitutional, the employer mandate would disproportionately hurt private duty providers because of the high use of low wage and part time employees. Where Medicaid providers may hope that severability protects them if the individual mandate is declared unconstitutional, private duty providers may hope that a lack of severability protects them if the individual mandate is declared unconstitutional. A bigger regulatory issue for private duty providers is the Department of Labor’s attempt to revoke the companionship exemption from the payment of overtime. This would result in some combination of increased cost and decreased services, potentially placing the most vulnerable at risk. Durable Medical Equipment What could the Supreme Court do to the DME industry that hasn’t been done already? DME providers are settling in for the long haul as hopes for the repeal of competitive bidding have faded. Providers have accepted that they need to adjust to lower margins and new models are being developed to deliver quality products and service at historically low prices. The second round of competitive bidding includes most major metropolitan areas, so a great deal of dust will be settling in the next few quarters. Providers are diversifying their payer mixes to survive if they don’t win the bid and negotiating new supply contracts to survive if they do. What few buyers are braving this segment are either looking for winners to invest in or losers to mop up. Conclusions In the first quarter of 2012, the forces of certainty and uncertainty were playing against each other to keep the market relatively calm. The market is certain that the necessity of efficiency places homecare of all types at the center of healthcare reform, but is uncertain about the political and regulatory environment. In one scenario, the Supreme Court upholds the ACA and President Obama and the Democrats carry the election, in another, the Supreme Court overturns the law and Mitt Romney and the Republicans carry the election: reality will probably be somewhere in between these extremes. While these two scenarios may have radically different implications for the future of healthcare delivery, either way, payers and policymakers will be relying on homecare providers to deliver the highest quality of care for the lowest cost. Many buyers are looking for opportunities to leverage the efficiencies of homecare, but aren’t necessarily finding candidates that warrant a transaction. Some sellers are skeptical of the market, focusing instead on preparing their businesses for whatever changes may occur to best position themselves for an exit in the future. The transactions that are closing are between knowledgeable parties who are executing strategies that make sense no matter what happens with the Supreme Court or the election. 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. |
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Market Conditions
Market Conditions Q2 2012
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Most of the media attention in Q2 was focused on the Supreme Court decision regarding the Patient Protection and Affordable Care Act (ACA). Hundreds of separate provisions of the law hung in the balance while the Court considered whether the Individual Mandate and the Expansion of Medicaid are constitutional. Meanwhile, the Republican presidential candidates debated the similarity between the healthcare policies implemented by Governor Romney in Massachusetts and the ACA introduced by President Obama. As the quarter came to a close, the Supreme Court announced their decision: The Individual Mandate is constitutional because it’s a tax and the states can decline to expand their Medicaid programs without jeopardizing their current funding. The decision was surprising because pundits in the media thought they had considered every possible scenario and the conventional wisdom seemed confident the law would be upheld until it became confident the law would be overturned. Nobody could have predicted that the Individual Mandate would be constitutional (but not because of the Commerce Clause) by virtue of it being a tax (but not for the purposes of the Anti-Injunction Act). The Medicaid ruling made sense to a lot of people, but the logic behind the Individual Mandate ruling was more confusing. Was Justice Roberts apolitical and scholarly or cleverly partisan? The clearest result of the ruling is to hand the decision about the future of our healthcare system back to the electorate. If Obama is reelected, the current entitlement system will remain in place and the reforms of the ACA will be put to the test. Otherwise, any number of alternatives could be considered. Out of the media spotlight, the realities of underfunded entitlement programs continue to mount and pressures to deliver quality outcomes via efficient models continue to build. In June the CBO reminded us of the unsustainability of the current model by noting that, if we don’t change, Medicare will become insolvent by 2024. Former US Comptroller General David Walker remarked that the ACA “focused more on expanding coverage and not enough on controlling costs” and several voices have called for new models to improve patient coordination and reduce waste and inefficiency. MedPAC criticized the fee-for-service model as an obstruction to patient coordination and CMS has proposed bundling services into Accountable Care Organizations and incentivizing providers with pay-for-performance to reduce hospitalizations, re-hospitalizations, and duplication of services. A Rand study highlighted Consumer Directed Health Plans and a Forbes study recommended Value Based Pricing as alternatives to traditional fee-for-service models. No matter which alternatives might be considered, former Director of OMB Peter Orszag predicts that “providers will be bearing much more risk for care than today.” Medicare Medicare Home Health providers weren’t waiting for the Supreme Court decision to start preparing for the implementation of the ACA. Even if the law were overturned, experimentation with new models of delivery is well under way. Over 50 Accountable Care Organizations in 18 states have already been formed to serve over 1 million beneficiaries and there are more than another 150 applications being processed. With efficiency through patient coordination as the foundation of reform, home health providers are well positioned to capitalize on the changing environment. A PriceWaterhouseCoopers study warned that the ACA will spawn a “new era of megapayers” such as CMS, states, and large employers. Healthcare Advisory Partners has warned that the conditions exist to allow “mega-providers” to form, but opportunities still exist for smaller providers who can add value by increasing efficiency and reducing costs for their partners. As long as patient choice is preserved, smaller providers will have the opportunity to distinguish themselves as worthy alternatives who can deliver superior care with superior efficiency. Program integrity continues to be the factor which most undermines the potential importance of home health to the evolution of the healthcare delivery system. Deputy Attorney General James Cole announced that a $375 Million fraud indictment of a doctor working with home health agencies in Texas was the “single largest fraud amount orchestrated by one doctor in the history of Medicare Fraud Strike Force operations.” The Strike Force indicted another 107 individuals for $450 Million in Medicare fraud in Miami, Baton Rouge, Houston, Detroit, and Los Angeles and the OIG has instructed CMS to widen sanctions against potentially fraudulent providers before terminating them from the program. Such sanctions could include civil monetary penalties, suspension of payments, and/or the appointment of temporary management! As always, this is good news for the majority of providers who deliver legitimate care, but innocent agencies can be swept up and destroyed by RAC audits that could be unnecessarily attracted by sloppy practices. Although the Supreme Court has ruled that the ACA is constitutional, that doesn’t guarantee that it will remain the law of the land. The House of Representatives voted to approve Paul Ryan’s budget proposal to replace Medicare with vouchers and Medicaid with block grants (of course the Senate and President didn’t agree) and MedPAC recommended exploring alternatives to fee-for service payment models as well as potentially introducing deductibles and co-pays for beneficiaries. The election should give greater clarity to the direction voters want policymakers to pursue, but market forces will still dictate that all providers will be need to increase communication and coordination throughout the continuum of care while reducing costs and delivering positive outcomes. Now that the Supreme Court has ruled, providers are thinking about next year’s budget. Rate cuts are an inevitable part of CMS’s proposed rule for 2013, but CMS may be miscalculating new rates by underestimating provider expenses because they only consider “reimbursable costs,” not actual costs such as marketing, telehealth, and the extra costs of compliance with new regulations like face-to-face encounters, therapy assessments, and now the employer responsibility requirements of the ACA. A program integrity measure to require all vendors to have individual NPI numbers is projected to save CMS $1.6 Billion, but, just like with PECOS, providers will have to bear the incremental cost of compliance. Provider cash flow would be further eroded if “sequestration” is triggered by Congress failing to reconcile their budget. The bad news for providers is reduced rates and increased regulatory complexity, but the good news is a vastly expanding market and an elevated status due to the importance of home health in the coordination of care for improved efficiency. We see current conditions as very advantageous for larger providers (especially those who are related to significant referral sources) and potentially disadvantageous for smaller providers (especially those who don’t become indispensable to their referral sources). At the top of the market, we’re seeing strategic buyers and private equity groups aggressively seeking opportunities to consolidate operations and eliminate administrative costs: At the bottom of the market, we’re seeing facility based buyers and new entrants who are attracted to growth and margins that beat just about any other industry in the economy right now. Hospice Although hospice hasn’t experienced the same level of regulatory scrutiny to date, just about every measure implemented to improve the efficiency and program integrity of the home health program will probably eventually also be applied to hospice. The newly introduced Hospice Evaluation and Legitimate Payment (HELP) Act would require that hospices be surveyed every three years and would refine hospice face-to-face encounter rules. The HELP Act would also implement testing of new payment methodologies to more accurately reflect the nature and timing of actual hospice expenses. Operationally, hospice providers have been spared the worst of possible rate cuts while they adjust to proportional CAP calculations and other changes necessitated by the ACA. Hospice providers continue to enjoy exalted status in the M&A market as palliative care gains importance as a tool to improve efficiency. Many different types of providers have concluded that hospice services are complementary with their own. The fact that hospice margins remain relatively generous as service utilization expands dramatically has attracted buyers of all types and sizes to the hospice M&A market. The great demand of buyers simply can’t be satisfied by the modest numbers of providers currently in existence. Thus, prices will remain high until enough new providers are created to satisfy demand. Medicaid The Supreme Court decision prevents the federal government from withholding financial support for existing Medicaid programs if states refuse to adopt new programs. It’s logical that increasing chronic care and assistance with the activities of daily living will prevent more expensive acute care, but the issue has become highly politicized because states contribute significant funding to chronic care covered by Medicaid but the feds pay for acute care covered by Medicare. CMS estimates that the 15% of Medicaid beneficiaries who are dual eligible account for 40% of the program’s expenses. A recent Kaiser study found that most dual eligible patients interact separately with each program with none of the patient coordination that could reduce costs and improve outcomes. CMS has started to work with 25 states to explore options for integrating Medicare and Medicaid to improve patient coordination and reduce waste. System-wide pressures to deliver quality outcomes as efficiently as possible dictate that Medicaid will continue to expand. The Supreme Court decision gives states much more flexibility to influence the nature and extent of that expansion. The National Governor’s Association has started to emphasize delivery system reforms in addition to reducing provider payment rates to gird for the expected increase in beneficiary population size. California has initiated a patient coordination demonstration project for dual eligibles that could save over $1 Billion and Oregon has accepted $1.9 Billion in federal funding to experiment with Coordinated Care Organizations (not to be confused with Accountable Care Organizations). Thirty states have reduced provider rates or implemented program integrity measures: Twenty states have introduced managed care models or limited program enrollment. As Medicaid programs continue to grow, providers must adapt to changes intended to foster efficiency. Shifting beneficiaries from Long Term Care settings to Community settings is not only a great opportunity for payers to reduce costs, but also for homecare providers to grow. Federal support continues as the Community First Choice Option and now Money Follows the Person programs start to get traction and the HHS has given grants to Aging and Disability Resource Centers. …and the ACA calls for federal financial responsibility for the first few years of implementation. Some providers are still stuck between the promise of growth in the future and the reality of reduced rates and increased costs in the present. Consolidation is inevitable as smaller providers find it difficult to absorb costs while larger providers thirst for revenue. We’re seeing selective interest in Medicaid homecare providers from strategic and financial buyers, but geography and size are important considerations. Durable Medical Equipment HHS claims that Competitive Bidding saved 42% in its first year with no negative impact on the health or access of beneficiaries. Really??? Is HHS saying that 42% of its prior expenditures on DME/O2 products were wasteful or fraudulent? Has HHS not noticed the chorus of complaints about beneficiary access? Although the American Association for Homecare, 30 patient advocacy groups, and 145 members of Congress disagree, CMS is rolling Competitive Bidding out to 91 new MSAs and the entire country should be covered by 2016. As providers will need to deliver product for less, we’ve seen more interest from buyers who want to drive costs down through efficiencies of scale. As the current bid unfolds, we’ll have a better idea of what threshold providers will have to meet to remain competitive. Private Duty Although more impacted by economic conditions than regulatory conditions, private duty homecare providers were still monitoring the Supreme Court decision. Even though the Employer Mandate was not at issue, private duty providers may have been hoping for the Court to overturn the entire law, sparing them the expense of providing healthcare insurance for employees or pay a penalty. It wasn’t to be, but perhaps a positive unintended consequence of the Individual Mandate might be that awareness is raised for non-mandated Long Term Care policies as everyone is encouraged to take responsibility for their own potential care needs. Private Duty providers are equally concerned about the possible phase-out of the Companionship Exemption from minimum wage/overtime requirements as legislation was introduced to prevent a change. Much like the Employer Mandate, eliminating the Companionship Exemption would increase incremental costs, forcing providers to become more efficient. Although the economy still hasn’t completely recovered, many private duty providers have seen steady increases in volume as more affluent families see non-medical care as a very worthy expenditure. A HHS study found that consumers are willing to pay a premium if they believe they are getting value for their money, supporting our contention that private duty providers should try to compete on quality rather than price. This translates to company valuations as buyers are always more impressed by sellers who deliver quality without compromising margins. We’re seeing more buyers seeking acquisition opportunities, but relatively few sellers who have recovered sufficiently to be ready to divest. As the economy continues to improve, we expect an increase in demand for services combined with the need to be more cost efficient to increase activity in the market. Conclusions Every type of healthcare reform being implemented or considered is intended to increase economic efficiency. This is true at the macro-system level and the micro-provider level. The market-driven path to efficiency is consolidation: Operators making acquisitions to increase their revenue while decreasing their relative administrative costs. Irving Levin & Associates reported that M&A transactions in the healthcare services industry increased in Q1 of 2012 with managing editor Stephen Monroe saying that the “market is currently being driven by middle market deals.” The Nashville Care Council noted that market forces are keeping M&A activity “active but not frenetic.” The PWC study found that, in light of the patient coordination directives of the ACA, “incentives for collaboration are quickening the convergence of” different types of providers and “organizations that were previously sitting along the sidelines are going to have to get the ball rolling.” Georgetown University predicts that “the healthcare economy is expected to grow at twice the rate of the national economy” and Bill Bernstein, chairman of the healthcare practice at Manatt Phelps predicts that “It’s unlikely that the election would lead to a change in a lot of the fundamental provisions of the ACA” because “the genie’s out of the bottle.” Homecare providers of all types are at the center of the action because they are experts in the patient coordination that leads to greater efficiency. Some are waiting to see what happens with the election, but many others are moving to get ahead of the curve. We’re seeing many different types of buyers – private equity sponsored, facility based, and others who are interested in acquisitions to leverage homecare to make their own operations more efficient and profitable. As the economy continues to strengthen and the regulatory environment continues to become more certain, we expect demand for all types of homecare providers to continue to increase. 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. |
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Market Conditions Q4 2011
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Q4 2011 Year in Review
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. 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. 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. |
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Market Conditions Q3 2011
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Q3 was dominated by the debt ceiling debate and the failure of Congress to address the financial problems of the nation. The debt ceiling was increased, but only on the condition that a Super Committee of select Democrats and Republicans be formed to identify $1.3 trillion in budget cuts to bring spending under control. In what Jeffries and Co. described as “emotional selling,” the stock market punished all healthcare companies for fear that the Super Committee would attack Medicare and Medicaid, destroying margins for providers. Homecare providers were included in the carnage because investors lumped them together with all companies that rely on government payments for their revenue.
We feel the markets overreacted to short term bad news without considering the long term prospects of the homecare industry. The markets don’t seem to understand that the efficiencies homecare providers bring to the system are pivotal to reigning in costs. With their expertise in patient coordination, homecare providers are perfectly positioned to profit from the reforms of the Patient Protection and Affordable Care Act (PPAC). Congress expressly identified “team based models” to improve chronic care and reduce costs for the most expensive dual eligible beneficiaries and homecare agencies already “team” with other types of providers to deliver positive outcomes. Given the importance of homecare in improving the cost effectiveness of care and the relatively small number of publicly traded homecare companies, we would think investors would be falling over each other for the opportunity to own a piece of the fastest growing segment of the fastest growing industry in the economy. The healthcare industry in general and the homecare industry in particular are among the leading lights of what is still a very sluggish economy. Healthcare spending is projected to increase almost 6% through 2020 (1% faster than GDP) and healthcare jobs have increased by almost 5% while the overall labor market has shrunk by over 3%. Irving Levin and Associates has reported that 2011 has been a record year for healthcare M&A. At Healthcare Advisory Partners, we have certainly noticed a significant increase in transactions in 2011 over 2010. The PPAC struck fear in the hearts of providers in 2010, but in 2011 leading providers responded by aggressively making strategic acquisitions to scale up in preparation for the future. Reforms such as ACOs and rate cuts favor larger providers, so this highly fragmented industry is very ripe for consolidation. Medicare Medicare certified home health agencies are central the CMS’s efforts to reduce the costs of care, but policymakers continue to squeeze providers. In addition to proposing a 3.5% rate reduction, CMS recommends the elimination of two hypertension codes and a re-weighting of therapy codes to counter widespread gaming of the system. Also, all providers must endure the inconvenient revalidation of their provider numbers and continued headaches associated with the face-to-face encounter requirement and the implementation of the PECOS system. Meanwhile, the Independent Payment Advisory Board is a new layer of bureaucracy for providers to fight as Congress explores replacing SGR with PACE and the threat of co-pays never seems to go away. What is bad news for many providers is good news for others. As operating conditions continue to become more difficult, many agencies are simply going out of business. Also, program integrity measures are starting to bear fruit (so far in 2011, RAC audits have recovered almost 10 times the amount recovered in 2010) and more fraudulent operators are being put out of business. With record M&A activity, consolidation is also reducing the number of providers in the program. Since the number of beneficiaries continues to grow at almost 5% per annum, any reduction in the number of agencies means those that remain have that much more market to capture. The simultaneous increase in market and decrease in competition presents significant growth opportunities for leading providers. At the top of the market, valuations for larger, more successful agencies are as high as they ever have been. At the bottom of the market, an increase in the number of sellers hasn’t reduced prices because the opportunity costs of starting from scratch have never been higher. Hospice Hospice providers are becoming victims of their own success. Since payers have encouraged beneficiaries to access end-of-life care, hospice utilization is at an all time high. While this has reduced costs associated with treatment of terminally ill patients, it has boosted spending on hospice 70% from 2005 to 2009. Naturally, such an increase warrants greater scrutiny by the OIG and hospice providers are now subject to RAC audits just like their home health cousins. Media attention from the New York Times and USA Today has suggested that for profit providers are abusing the system by admitting patients that aren’t terminally ill and collaborating with SNFs to double dip. In spite of the attention, policymakers still support the hospice benefit as a way to cut costs while allowing beneficiaries to die with dignity and comfort. CMS proposes a 2.5% increase for hospice providers, but not without caveats: face-to-face encounters will now be required for hospice providers and CMS is introducing a Proportional CAP calculation methodology and exploring a U Shaped billing schedule. Given the dramatic growth of the segment and the relatively small number of providers, it should come as no surprise that hospice providers are in very high demand. Just about every homecare and long term care provider seems to want to add hospice to their service lines, but there just aren’t very many opportunities to buy. Thus, hospice transactions continue to be relatively infrequent and expensive. Medicaid The story of short term pain prior to long term gain continues for Medicaid providers. The biggest disappointment of Q3 is probably the handwriting on the wall suggesting that the CLASS Act may never be implemented. The HHS staff was reduced as the sustainability of the program is being reconsidered. That doesn’t change the strategy of reducing acute costs in the Medicare program by increasing chronic care in the Medicaid program. Medicaid spending is projected to grow by 20% because of the PPAC, increasing from 15% of healthcare spending to 20% by 2020. Along with growth comes increased regulation and scrutiny as CMS published rules for face-to-face encounters and RAC audits for Medicaid providers. In a blow for program integrity, Maxim Healthcare agreed to pay $150 Million after being investigated for submitting false claims. Considering the relative size of Maxim and their fine as compared to Gentiva, LHC Group and other Medicare providers who have paid fines or settlements, this was a significant offense! Private Pay Issues such as worker classification, the companion overtime exemption, and the employer mandate continue to simmer, but the economy is still the primary factor impacting the market for private pay providers of nonmedical care. Some providers are starting to diversify, but they’re finding that many insurance payers and the VA require Medicare Certification, even for the provision of nonmedical care. Buyers have emerged from hibernation, but they’re not finding many willing sellers. Many would-be sellers have lost market share since the peak in 2008 and don’t want to sell when business is off. Now that the economy seems to have bottomed, the labor market should tighten up and business should improve. DME Traditional DME providers just can’t catch a break. The OIG reported that 9% of power wheelchairs purchased were not medically necessary and an additional 52% had insufficient documentation. Vociferous complaints from providers and beneficiaries about competitive bidding have fallen on deaf ears. Policymakers will expand the program to 91 new markets. Meanwhile a robust private pay DME segment seems to be flourishing on the internet. Conclusions Q3 was dominated by the bluff and bluster of politics as the Super Committee weighed various tradeoffs among the competing priorities of the nation. Healthcare providers of all types seized on opportunities for growth as the economic and regulatory environment continue to encourage consolidation through mergers and acquisitions. 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. |
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Market Conditions Q2 2011
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M&A Market Conditions: Q2 2011 in Review
In Q2 of 2011, the implications of the Patient Protection and Affordable Care Act (ACA) continued to sink in as the economy continued its slow and relatively jobless recovery. Believe it or not, the healthcare services industry was one of the best performing segments of the economy as Reuters reported that healthcare jobs lead the way with roughly 20,000 jobs/month created in Q2 and Fitch Ratings reported that healthcare providers look relatively stable as low interest rates have stimulated many to refinance debt in preparation for operations in the new era of enhanced efficiency and consolidation. Balancing federal and state budgets and implementing operational reforms such as the Employer Mandate and Accountable Care Organizations are the primary issues facing providers and influencing the mergers & acquisitions marketplace currently. In Q1, the Obama administration published a budget proposal that was generally supportive of homecare providers who participate in the Medicare and Medicaid programs. In Q2, House Republicans led by Budget Committee Chairman Paul Ryan responded with a budget proposal of their own which would radically restructure both Medicare and Medicaid. The Ryan plan would eliminate Medicare as the guarantor of healthcare services for the elderly by replacing it with a voucher program to subsidize the purchase of private insurance by seniors over state regulated exchanges and it would replace Medicaid (and the federal requirements for participation) with block grants to give the states more flexibility in determining eligibility and services offered. Of course the Ryan budget was immediately criticized by advocates for the elderly such as the AARP and Leadership Council of Aging Organizations for denying the most vulnerable beneficiaries access to care. The CBO found that most elderly people would pay more for care and the Kaiser Family Foundation estimated that 44 million Medicaid beneficiaries would lose access to care under the Ryan budget. In a New York Times editorial, Peter Orszag pointed out that the policy shifts healthcare costs to consumers without reducing costs overall. Since the Ryan budget was proposed in the beginning of the quarter, the budget brinksmanship has only increased from the threat of a government shutdown to the current debate about the debt ceiling and the preservation of the full faith and credit of the United States. Medicare It seems rather quaint that last quarter we were so worried about rate cuts and other tweaks to the Medicare program when in Q2 Congressional Republicans would have us wonder if the Medicare program would even survive at all. Entitlement spending threatens to bankrupt the federal government and estimates regarding the date of Medicare insolvency have been recalculated to be five years sooner than previously predicted, so something must be done! Since homecare is the most efficient link in the continuum of care, it’s only logical that expanding homecare should be a significant part of the plan to reduce health care costs across the board. However, with proposals ranging from the introduction of co-pays and means-testing all the way to replacing Medicare with vouchers to subsidize private insurance, the question remains: What type of healthcare system will homecare be expanding within? Many different proposals to control health care costs are being debated, but the one that providers must react to right now is the Patient Protection and Affordable Care Act because it is the only proposal that currently has the force of law. As ever, the primary elements of the ACA that affect homecare providers in the M&A market are the 36 Month Rule, Rate Cuts, and Bundling of Services into Accountable Care Organizations. The proposed rule published in the Federal Register describes ACOs as “a legal entity comprised of eligible participants to manage and coordinate care for Medicare fee for service beneficiaries.” The rule doesn’t specifically mention the role of home health in ACOs, but the expertise of home health providers in managing care suggests that home health agencies stand to become part of the foundation of the ACO model. The only problem is that the rule also states that ACO participants shall exert “proportionate control over the ACO’s decision making process” and home health providers are proportionately the smallest providers participating in ACOs. Thus, in order to take their rightful place at the core of the ACO model, home health providers will have to convince their larger primary and acute care counterparts that they offer a significant value proposition of reduced costs through increased efficiencies. According to a study published by KPMG and EptseinBeckerGreen, roughly 30% of large providers surveyed are still unsure about assuming the risks in exchange for the rewards associated with participation in an ACO. Our experience is that the other 70% are quite sure of the financial benefits of being first and are aggressively preparing for the new world order that is approaching much faster than many people might have anticipated. We are aware of many ACOs in every region of the country that are being formed to take effect in 2012. Since most home health providers are far too small to establish their own ACO (AHA estimates start-up costs to be $10-$20 Million), home health providers must position themselves to be included as partners to avoid being left behind. In theory, this shouldn’t be too difficult because home health agencies are already informal partners with their referral sources and are already accustomed to delivering cost effective care management to achieve positive outcomes for patients. Under ACOs, this partnership is formalized and the home health agency is included in the risk/reward equation and is financially incentivized for concrete contributions such as reducing lengths-of-stay and re-hospitalizations. The impact on the M&A market is that leading home health agencies are very much in demand as large providers prepare to either establish or participate in emerging ACOs and successful agencies continue to command top premiums. On the other end of the spectrum, the 36 Month Rule (which prohibits a newly formed or recently acquired agency from being sold for at least 36 months) continues to protect the smallest providers from having much competition when they sell. The 36 Month Rule has prevented sellers from “flipping” newly created provider numbers as well as keeping many legitimate but young agencies from coming on to the market. The flood of weak agencies heading for the exits before Bundling is implemented that was predicted by some has not materialized. Also, a recent HHS Departmental Appeals Board decision prohibits the relocation of acquired agencies and prohibits the temporary cessation of operations between owners, further limiting the options for buyers who “just want a provider number.” In all but the most overcrowded markets, it’s still pretty tough to find a clean little agency that is willing to sell for a steep discount. Since the value of the opportunity costs associated with starting from scratch has remained unchanged, the value of small agencies that are clinically sound but not financially successful has also remained unchanged. Of greatest importance to home health providers who are considering an acquisition or divestiture is that all of the current winds of change are blowing in favor of larger providers. If the ACO experiment is successful, the net result will be far fewer providers providing care to the same large and growing base of patients. As fragmentation in the industry is supplanted by consolidation, the surviving providers will gain market share much more easily than in the past (which is why we warned against “too big to fail” last quarter) and become much larger than what is normal today. While this might be wonderful for the shareholders of the surviving providers, the value being created is at the expense of the multitudes of providers who become excluded from the system. Rate Cuts and non-ACA issues like Face-to-Face Encounters and PECOS only serve to enhance the advantages of large providers over small. Meanwhile, program integrity continues to be an issue threatening to undermine the homecare industry’s claims that home health is a solution rather than a problem for government payers. CMS has stepped up its predictive modeling enforcement efforts by hiring Northrop Grumman to identify and analyze suspicious claims for the National Fraud Prevention Program. Many of the largest home health providers are still under investigation related to the Wall Street Journal article about therapy threshold manipulation, which is of great concern because it might suggest that “gaming the system” could be routine throughout the industry. Gentiva made news by settling a case accusing them of using improper marketing techniques under IPS for $12.5 Million, which, given that most providers gross far less than $12 Million, highlights the growing gap between large providers and small. As always, the market rewards providers who stay on the right side of the law and punishes those who push the limits on questionable practices. Although the threat of Bundling services into ACOs might have scared many smaller providers into selling, we have not observed this to be true in the market. Many providers are still in the process of understanding ACOs and the impact they might have on the industry in general and their specific agencies in particular. Any successful agency that would warrant a premium valuation on the market today would also probably make a good ACO partner in the future. Since the upside to participating in an ACO is so great, many successful providers who might otherwise want to sell are strongly considering staying in the business to capitalize on the consolidation to be expected. This means that, even though the market is crowded by buyers preparing for Bundling, there are relatively few good agencies for them to buy! We are consistently hearing from two types of buyers who have different approaches to the market. Large homecare providers (many who are private equity sponsored) are looking for relatively large acquisition candidates so they can compete effectively against facility-based providers. Facility-based providers are in the market to buy small provider-number deals so they can provide the full continuum of care without being beholden to the large homecare providers who are gaining market power through consolidation. The only problem is that sellers aren’t as motivated to sell as some buyers might like and there is a shortage of good listings on the market. Since larger sellers need to be incentivized to forgo the opportunities inherent in Bundling and smaller sellers are effectively protected from competition by the 36 Month rule, valuations have remained firm in spite of the fact that the ACA has initiated some potentially profound changes for Medicare providers. Hospice Although nowhere near as much as home health, the hospice industry has not been untouched by the ACA. CMS is still considering a complete overhaul of the payment methodology, but shifting to a “U-shaped” model in order to better complement the actual trajectory of typical episodes is a far cry from the radical restructuring home health providers are adjusting to. It’s possible that Bundling into ACOs could be extended to hospice, but providers have more immediate concerns right now. Just like their home health cousins, hospice providers are now receiving more OIG scrutiny and are also having to absorb costs associated with Face-to-Face requirements. However, unlike the home health benefit, CMS feels that hospice is an underutilized tool that can be expanded to create savings for the program while improving the quality of life for terminally ill patients. This portends significant growth for hospice providers. Rules proposed by CMS in Q2 are actually relatively favorable for hospice providers. The small BNAF phase-out reduction is more than compensated for by an almost 3% market basket increase, netting a roughly 2.3% rate increase for hospice providers next year. Also, the Aggregate Cap calculation methodology may be liberalized to a Patient-by-Patient Proportional model that doesn’t punish providers when patients survive into the next Cap year. With the challenges facing Medicare Certified Home Health providers, many are looking to diversify into kindred disciplines to hedge against the risks associated with the coming changes. Hospice is a natural complement to home health and many home health providers are actively seeking hospice acquisitions. Most noteworthy in Q2 was Amedisys’s acquisition of Beacon Hospice in New England. The $125 Million price tag for $80 Million in annual revenue seems like quite a premium above the roughly 80% of revenue that Gentiva paid for Odyssey last year. Home health agencies are not the only providers attracted to the hospice segment. We are hearing from hospitals, nursing homes, and assisted living providers who want access to the hospice market. Given the relatively small number of hospice providers compared to the relatively large number of prospective buyers, hospice opportunities continue to be relatively scarce and expensive. Medicaid Q2 brought some discouraging news for Medicaid homecare providers. Although it was not adopted, the Ryan budget proposed replacing the current entitlement with block grants that would limit the amount of funding for Medicaid beneficiaries and give the states more authority to reduce coverage and cap the number of enrollees. Also, the CLASS Act provisions of the ACA have been under fire and support from the Department of Health and Human Services seems to be waning. If that isn’t enough, many states continue to cut rates in response to weak tax revenue and some governors have threatened to pull out of the program altogether. In spite of proposals for extreme restructuring, expanding chronic care through the Medicaid program is still one of the best strategies for reducing costs of acute care throughout the system. CMS has initiated a pilot program in 15 states to coordinate care for the dual eligible (Medicare and Medicaid) beneficiaries who account for a disproportionate amount of spending. The bottom line is that state tax revenues must increase in order for Medicaid providers to earn bill rates high enough to continue providing care. Most states have been cutting rates to the bone, further compressing some of the leanest margins in the homecare industry. Lean margins require economies of scale, so larger Medicaid providers are in the market for acquisitions to spread their costs over more and more revenue. As always, larger acquisition candidates attract more qualified buyers and command higher premiums than smaller, owner-operated agencies. Private Duty Although economic conditions hardly favor private pay services, we’re seeing some thawing in the market as activity is starting to pick up for private duty homecare providers. Many providers of assistance with the activities of daily living lost business during the recession, but some changed their approach by identifying new referral sources and new delivery models and were rewarded with positive growth trends in spite of the anemic recovery. We are seeing buyers in the segment start to come out of hibernation to resume acquisition strategies to stimulate growth. Although more cautious then they were before the recession, buyers are looking for quality private pay agencies that utilize W-2 caregivers. …and in a segment dominated by mom & pop shops, differentiation by size and professional management certainly yields the highest premium valuations. Conclusions The news from the beginning of Q3 indicates that pressures for efficiency and consolidation will continue to build as the country slowly digests its economic problems. After far too much political posturing, the debt ceiling was raised in time to avert a default, but not in time to prevent a historic credit rating downgrade. While the compromise did result in an additional 5% or so cut to Medicare home health rates, this was fairly modest compared to cuts affecting other Medicare providers and is further evidence of the relative desirability of home health in comparison to other segments of the healthcare services industry. After seeming rather nonchalant for months, the financial markets finally reacted to the debt crises in the US and Europe and stock prices have been hammered. Healthcare service stocks, including home health providers, have been caught in the carnage in spite of the fact that most have fairly good prospects for surviving and thriving in the environment to come. This is why it’s always important to recognize that financial markets do not equal the economy and market capitalization does not equal enterprise value: This is especially true in the home health industry where the few publicly traded companies are not necessarily representative of the thousands of private agencies that comprise most of the market. Valuations are informed by long term market fundamentals, not short term fluctuations in the stock market. …and although healthcare service providers certainly have their fair share of challenges, market fundamentals continue to be very strong and the M&A market continues to be very active. The healthcare services industry is at a crossroads. Economic realities require that providers of all types must do more with less. Efficiency and consolidation will be dominant themes in the healthcare industry for the foreseeable future. The good news is that, unlike with most other industries, healthcare is a necessity and the population of people in need is at the beginning of its largest growth trend in history. Absorbing that growth without bankrupting the country is a challenge for policymakers that presents significant risks and opportunities for healthcare providers of all types and sizes. 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. |
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