The PE Playbook: A Checklist for Investing in Healthcare Services

Transcription

1 The PE Playbook: A Checklist for Investing in Healthcare Services Audit Tax Advisory Risk Performance

2 Today s Healthcare Services Playing Field The healthcare industry offers considerable opportunity for private equity investors equipped to seize it. While the passing of the Patient Protection and Affordable Care Act (PPACA) leaves some ambiguity, it has provided ample clarity to restore confidence in the healthcare industry. The continued need for clinical integration and cost control, the increase in demand for healthcare services, favorable capital markets, and growing consumerism in healthcare have all set the stage for considerable market growth. In addition, revenues are becoming more diversified as providers are pushed to cover a broader continuum of patient care. Even so, hidden risks can blindside even the most proficient investors, jeopardizing investment execution and the prospect of maximizing returns. Historical PE investment theses, growth assumptions, and profit improvement strategies may no longer be appropriate. Consequently, prudent investors are reassessing yesterday s playbooks to validate alignment with today s environment and adjusting their approaches where warranted.

3 What s in Your Playbook? Crowe Horwath LLP, one of the largest public accounting and consulting firms in the United States, has a strong reputation in both the private equity and healthcare services industries. Our qualifications include: A PE client base with a combined total fund size of nearly $200 billion. More than half of our top 50 clients are PE groups. More than 3,000 clients in the healthcare services industry. Healthcare-specific solutions delivered by financial, clinical, and technology specialists. One relationship manager for each PE firm. With more than 20 years of experience in private equity and healthcare, our professionals possess the insight and expertise healthcare services investors need to tackle transactional risk factors and maximize the return on their investments. Crowe also provides resources and technology tools to help address complex tax, compliance, financial, and operational issues related to your portfolio companies. Crowe HC Automated Time Studies Credit Balance Management Credit Income Recovery Healthcare Suite Solutions That Work for You Tax Compliance Reinvented (C-TRAC ) Denials Management Internal Audit Outsourcing (CHAN) Net Revenue Reporting (Crowe RCA ) Outpatient Charge Capture Revenue Cycle Improvement Unclaimed Property Underpayment Detection Wage Index Navigator

4 PE Investment in Healthcare Services Healthcare Investment Considerat The healthcare industry is very broad, and investment opportunities vary depending on sector-spe and can help private equity firms validate investment theses and strategies that clarify the risks an Health information technology. Companies that have reduced or eliminated costs while improving efficiency will be attractive to buyers. Under healthcare reform, however, healthcare companies are required to track patients and outcomes under pay-for-performance. Monitoring this activity will require information technology infrastructure and investment. Disease prevention and management. A focus on preventive and wellness services lowers costs and creates M&A opportunities. More employers are providing incentives to employees who meet certain health standards, such as quitting smoking or losing weight. Additionally, healthcare reform expands the scope of preventable services that are reimbursed by Medicaid. Clinical outpatient centers. The ever-changing landscape that has seen deteriorating net revenue per case, lower reimbursement rates, higher deductibles, and a cost-conscious consumer has resulted in a race to build effective economies of scale. This sector is providing ample M&A opportunities but will require an efficient M&A process. Physician practice management. Healthcare reform makes it difficult for smaller physician offices to compete because larger practice groups are better positioned to achieve payment incentives for cost and quality. It also increases demand for primary care physicians to meet the growing number of patients as uninsured Americans become insured. This change creates opportunities for companies in the practice management field. Behavioral health. Healthcare reform calls for increased reimbursements for treatment of mental illness. States must provide expanding coverage for these services nationwide.

5 ions cific risk factors. Crowe Horwath LLP understands these distinctions d opportunities within the various healthcare sectors. Hospitals. Hospitals need to consider mergers to gain cost synergies to offset reimbursement pressures and regulatory requirements. Small hospitals with less access to capital and fewer comprehensive services will create M&A opportunities. Health insurance plans. Mandated coverage requirements including the removal of pre-existing conditions, limitations on premiums, and extension of coverage to certain nondependent children who remain on their parents policies are creating opportunities for acquirers to consolidate insurance plans and reduce costs. Home health services. Many patients shuttle between home and hospital before they ultimately move into long-term care or nursing homes. Despite the uncertainty of patient outcomes, M&A activity is most likely to remain active because home health services take costs out of the system. Long-term care. Long-term care is more cost-effective than acute care and specialty hospitals for patients who can be treated in a nursing home. In addition, an aging population certainly would suggest an increase in demand for nursing care. M&A opportunities in this sector remain stable but hinge on investors appetites for government payer risk. CASE IN POINT: #1 In a recent due diligence engagement, Crowe found that an emergency room physician staffing and management services company had significantly overstated its accounts receivables and revenue. Further discussion with the company s audit firm resulted in validation of the error and a restatement for the healthcare company s most recent financial statements. After conducting due diligence, the company and private equity firm client hired Crowe as the company s new financial auditor. CASE IN POINT: #2 A study conducted in 2013 of revenue cycle operations identified technical and operational nuances leading to $9.2 million to $12.9 million of lost cash. Breakdowns in patient access, business office operations, and receivables mismanagement caused unnecessary write-offs and receivables bottlenecks. Crowe helped this private equity firm client repair the breakdowns and realize new revenue streams.

6 Formulating the Investment Thesis When evaluating potential acquisitions in the healthcare services industry, investors would be wise to pay as much attention to third-party reimbursement, revenue sustainability, and other industry-specific issues as they do to traditional metrics. As strategic and financial buyers look toward participating in mergers and acquisitions in these sectors, they will need to answer several crucial questions. Opportunity and Strategy Identification Does the specific healthcare sector face direct or indirect cuts? Will volumes increase or decrease under the PPACA? Will the payer mix (government vs. private insurance) improve or not? What cost pressures does the sector face? Will it benefit from scale? What is the market demand for healthcare clinicians? Will the sector need to hire personnel or increase compensation? Will the sector reduce cost for customers? Will the sector improve quality from a cost-effectiveness standpoint and, therefore, benefit from healthcare reform? CASE IN POINT: #3 During a recent revenue cycle assessment, Crowe identified a significant error rate in a healthcare entity s coding and charge capture processes. While performing the assessment, a statistically valid sample size of encounters was obtained and assessed by certified professional coders. The error rate identified was more than 40 percent. The identification of these errors alerted the private equity firm to a potential acquisition risk due to the inaccuracies identified. CASE IN POINT: #4 During a recent due diligence engagement, Crowe assessed an organization s recovery audit contractor (RAC) activity and potential risk related to RAC denials. This assessment identified approximately $2 million in potential RAC denials during a three-year time frame. The organization was a significant target for RAC denials due to the billing processes in place. Crowe was able to assign a value to this risk and provide detailed information as to the potential revenue loss. In addition, Crowe provided suggestions for improvement in billing and coding to avoid future RAC denials.

7 Validating Healthcare M&A Investments The ever-changing and complex healthcare landscape has produced numerous financial and operational challenges to healthcare transactions. Market trends, earnings and quality concerns, operations, and people and culture all require a closer look to analyze value and detect weaknesses and strengths in these core areas. Financial and IT Diligence and Assessments How do the financial statements stand up to a rigorous qualityof-earnings analysis? Is the transaction priced at fair market value? What is the LTM quality-ofearnings effect of the company s month-end soft close? What are the immediate and future tax compliance and structuring issues that need to be assessed? Are revenue and earnings overstated due to improper coding as well as billing and reimbursement issues with payers? Do the financials contain understated liabilities or overstated assets (i.e., patient accounts receivable) that may not convert to future cash flow? Are there healthcare-specific intangible assets on the balance sheet that will need to be properly valued and amortized? Are there hidden future IT expenses that could affect the true cost of the transaction? Regulatory and Compliance Assessments Are there current compliance plans and policies in place? Are the IT systems and policies in compliance with regulations such as HIPAA, HITECH, and ICD-10? Is there a lack of accurate coding, documentation, and adherence to specific payer requirements? Will future goodwill impairment testing be needed? Do current compensation agreements or complex capital structures comply with ASC 718 and Section 409A of the Internal Revenue Code? Is physician compensation in compliance with Stark regulations and anti-kickback laws?

8 Make the Call For more information about our transaction experience in the healthcare services industry, contact one of our professionals. John Kurkowski Managing Partner, Private Equity Services Brian Kerby Director Todd Spaanstra Partner To sign up to receive Healthcare Insights, a periodic publication which features articles from our healthcare specialists that will help healthcare business executives stay on top of the industry s emerging business issues, visit today. crowehorwath.com/hcinsights Crowe Horwath LLP is an independent member of Crowe Horwath International, a Swiss verein. Each member firm of Crowe Horwath International is a separate and independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Crowe Horwath International or any other member of Crowe Horwath International and specifically disclaim any and all responsibility or liability for acts or omissions of Crowe Horwath International or any other Crowe Horwath International member. Accountancy services in Kansas and North Carolina are rendered by Crowe Chizek LLP, which is not a member of Crowe Horwath International Crowe Horwath LLP TS14034