Trends in M&A in Healthcare Affect Valuation and Due Diligence

By Christian Heuer, CFA, FHFMA, ASA, and Brian Kerby, CPA
| 1/26/2016
MA Trends in Healthcare

Changes within the healthcare industry since passage of the Affordable Care Act (ACA) have had a significant impact on merger and acquisition (M&A) activity within the sector.

157017355-250x167Factors driving the activity include heightened demands for providers to demonstrate quality, safety, and appropriateness of care; growing patient awareness of the cost of care; and fundamental changes in reimbursement structures, such as the introduction of bundled payments and high-deductible health plans (HDHPs).

In a marketplace undergoing fundamental change, hospitals and health systems are responding by finding new ways to seek efficiencies, develop revenue sources, and meet patient demands, often through M&A.

A variety of trends in hospital M&A activity are affecting best practices in valuation and transaction due diligence. These trends include:

Changes in transaction structure. Among hospitals acquiring other hospitals, professionals have observed a shift from traditional cash acquisitions, often based on a multiple of historical earnings before interest, taxes, depreciation, and amortization (EBITDA), to acquisitions driven by acquirer-specific cash flow synergies. In addition, these acquirers are no longer willing to take on all of the M&A risks but instead opt for arrangements based on cashless affiliations or continued partial ownership retention (rollover equity) by sellers or performance-based (contingent) future payments.

Horizontal versus vertical transactions. Transactions have moved from primarily horizontal acquisitions (such as between competing hospitals) aimed at consolidating fragmented healthcare market areas to vertical acquisitions (such as connecting immediate care clinics to post-acute care) to join healthcare entities across the continuum of care. These transactions are based on the growing need among providers to develop the ability to deliver appropriate, cost-efficient care across the continuum and adapt to bundled payments and other reimbursement shifts.

As a result, acute care hospitals are acquiring entities in post-acute care, such as rehabilitation hospitals, long-term care facilities, assisted living and skilled nursing facilities, physical therapy centers, and home health agencies.

A shift from a sector-specific to a sector-agnostic approach to acquisitions. In the pre-ACA environment, many buyers, especially private equity groups, largely ignored sectors characterized by high reliance on federal payers. However, the passage of the ACA has created more clarity around payments from Medicare and Medicaid, and the increased stability and predictability have reduced perceived payer risk. Deals by private equity buyers and traditional healthcare providers in areas such as long-term care have grown as a result.

Recognition of the importance of the patient in what was previously a healthcare delivery system dominated by payers and providers. The desire among patients to access care in more convenient settings, patients’ rising financial awareness and responsibility, and the growing importance of patient satisfaction ratings in determining how some physicians are compensated have accelerated interest among acute care providers in enhancing the total patient experience across the continuum of care.

Demand for services in traditional settings, such as inpatient hospital care, continues to decline as patients seek medical help in ambulatory settings, freestanding emergency departments, and urgent care centers. Patients also now tend to leave traditional settings earlier to recover in rehabilitation hospitals, skilled nursing facilities, or home care settings.

Increased importance of health information technology (HIT). Patients increasingly are aware of the importance of electronic medical records and other health information technologies in the delivery of safe, efficient care. Awareness among buyers that patients want providers that are keeping pace with new HIT developments, combined with the growing influence of patient satisfaction ratings on viability in the marketplace, have driven due diligence into the IT infrastructure and cybersecurity of a potential acquisition target or joint venture partner. Providers that are not keeping pace with technology are more likely to be at a disadvantage in this regard.

Greater attention to cost. As HDHPs have become more common, the shift of more financial burden onto patients is driving employees to make medical decisions based on the selection of physicians and clinics perceived to provide high value at a reasonable cost. The shift also drives seasonality. Many elective procedures take place at the end of the year, when out-of-pocket maximums already have been reached.

Today’s Environment

In the current environment, potential buyers associate value with potential cost savings that offer financial or other tangible benefits in terms of increased quality and patient satisfaction. These buyers are thinking strategically about acquisitions that have implied benefits, and they are more willing to pay a premium for those types of complementary benefits – for example, a home care service that allows care to be shifted away from higher-cost settings, such as a hospital. In addition, some services – such as home care services – are very localized. If a buyer can achieve some economies of scale, especially in a dense urban area, it might pay a premium for that service.

These trends, and the frequent changes taking place in the regulatory environment, highlight the importance of working with in-house or outsourced legal, regulatory, and other industry professionals who have a thorough understanding of healthcare.

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