Valuation, the Buy Side of M&A, and Related Due Diligence Considerations Crowe Healthcare Webinar Series Brian Kerby Crowe Horwath LLP Christian Heuer Crowe Horwath LLP Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP
Learning Objectives Today s session will cover: Understanding the process of an M&A Buy-side transaction. Identifying and addressing valuation considerations important to a successful transaction. Identifying and addressing due diligence considerations important to a successful transaction. Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 2
M&A Buy-Side Process Introduction Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 3
M&A Buy-Side Process Step 1: Develop or Set a Strategy Criteria of Target Buyer needs to: Understand acquisition need. Understand financial and qualitative impact. Use objectives to identify acquisition criteria. Identify the industry sectors. Identify size parameters. Identify acceptable structures. Establish acquisition criteria sheet. Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 4
M&A Buy-Side Process Step 2: Identify and Engage Target Buyer will generally identify and connect with a target in a few different ways: Direct reach out to targets. Benefits to the buyer non-competitive bidding process and more flexibility in setting terms of transaction. Benefits to the seller shortened transaction process and less risk of leakage of confidential information. Develop a strong network of referral sources. A competitive auction process. Benefits to seller can help drive up price. Benefits to buyer buyer knows seller is interested in selling company. Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 5
M&A Buy-Side Process Step 3: Perform Preliminary Due Diligence and Assess Valuation Buyer(s) will attempt to better understand the target to identify whether to move forward with the transaction. Conduct a Phase 1 due diligence. Understand high level financial performance, possible transaction structure, identify significant financial and non-financial risks to the transaction. Assess preliminary valuation using some common methodologies. Discounted cash flow. Comparable public company analysis using cash flow multiples. Similar M&A transactions based on comparable sales. If buyer determines it wants to move forward with formal offer, it will submit a Letter of Intent ( LOI ) Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 6
Polling Question #1 Does your organization have a corporate development group to lead transactions and does your organization plan on using an investment bank to seek out future acquisition targets. a. Has a Corporate Development Group b. Does not have a Corporate Development Group c. Use investment bank d. Don t use investment bank Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 7
M&A Buy-Side Process Step 4: Conduct Confirmatory Due Diligence Shortly after the buyer submits the LOI, the buyer will be notified if it has been selected as the preferred buyer to move forward with the transaction. Questions to answer during confirmatory due diligence: Should the buyer do the deal. Is the purchase price correct. How should transaction be structured. How to handle post closing issues. Retain professionals to assist in conducting confirmatory due diligence. Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 8
M&A Buy-Side Process Step 5: Arrange and Secure Financing Buyer will generally want to see proof that buyer financing to support acquisition has been secured. Purchase price generally can be supported by cash, buyer stock, senior debt, subordinated debt and or seller financing. Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 9
M&A Buy-Side Process Step 6: Deliver Definitive Agreement Asset purchase agreement. Stock purchase agreement. Step 7: Negotiate and Execute Definitive Agreement Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 10
Valuation Considerations Current Environment Challenges and opportunities Regulatory impact uncertain Volume to value Risk shifting Volatile capital markets Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 11
Challenges and Opportunities - Examples Impact of Healthcare Regulatory Reform Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 12
Challenges and Opportunities - Examples Volume to Value Bundled Payments for Care Improvement initiative Model 1 began April 2013 all DRGs Models 2, 3, 4 began October 2013 48 episodes Multiple payees Acute care Post-acute care Professional fees Technical fees Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 13
Challenges and Opportunities - Examples Risk Shifting Accountable Care Organizations Capitation Volatile Capital Markets Global economy uncertain US economy impacted by strong dollar, rising unemployment, uncertain Fed policy Overall stock market shed gains over last three months. Healthcare stock performance mixed Low interest rate environment Bond ratings mixed Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 14
Polling Question #2 What would you consider to be the key driver behind your organization s recent or contemplated M&A activity? a. Reducing costs b. Sale of non-core or underperforming organizations c. Reduce competitive threats d. Other Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 15
Valuation Considerations Industry Response Three C s drive industry response Cost containment Core operations focus Competition (reduce or eliminate) Cost containment Continuum of care Market duplication Economies of scale Quality initiatives Population management Volume to value / bundled payments Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 16
Valuation Considerations Industry Response Divest non-core operations Individual markets Entire market segments Real estate Lease/convert beds Reduce competition Both vertical and horizontal integration to gain market share Joint ventures Physician alignment Beware of potential antitrust issues Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 17
Polling Question #3 What best describes the operations of your organization s recent or contemplated M&A activity? a. Acute care provider b. Post acute care provider c. Outpatient facility (surgery center, imaging center, etc.) d. Physician practice e. Health insurance plan f. Other Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 18
Valuation Considerations Deal Structure Traditional transactions Purchase price often a multiple of EBITDA Cash Stock Pre-bankruptcy New paradigm IF there is a purchase price it is cash flow driven Obsolescence Joint Ventures Non-binding agreements Post-bankruptcy Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 19
Valuation Considerations Private Equity Deal Structures Rollover equity Minority interest discounts Complex equity structures Convertible debt Preferred stock Common stock Options Seller financing Face value versus fair value Earn-outs Performance driven Can be challenging to model Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 20
Key Valuation Considerations - Summary Strategic Fit Cost containment Core operations focus Competition (reduce or eliminate) Cash Flow Impact Synergies Competitive advantage Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 21
Common Purchase Price Allocation Challenges Consideration transferred Seller financing / earn-outs / capital commitments Accounts receivable Physical infrastructure Obsolescence Census Intangible assets Certificates of need Trade name Agreements not to compete Trained and assembled work force Contingent liabilities Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 22
Due Diligence Considerations for a Successful Transaction Goal - To understand the risks before signing a definitive agreement. Under healthcare reform, the fundamentals of financial due diligence remain unchanged, but must be performed in the context of healthcare reform and the changing legislative landscape. Understand composition of historical financial statements unchanged. Understand fluctuations and trends unchanged. Understand how healthcare company will change in the near and long-term new. Look beyond the numbers when acquiring a healthcare company. Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 23
Polling Question #4 Does your organization perform due diligence with in-house resources or do you retain professional advisors to assist you with the due diligence. Also, If you outsource these services, what functional areas do you outsource? a. Perform all services in-house. b. Outsource finance and accounting due diligence. c. Outsource legal due diligence. d. Outsource regulatory compliance. e. Outsource other functions (human resources, insurance, etc.) f. Outsource all functional areas of the diligence process. Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 24
Due Diligence Considerations for a Successful Transaction Financial Due Diligence Analyze quality of information. Analyze quality of revenue and revenue sustainability. Understand components of quality of revenue. Understand if there are any joint venture income arrangements or any capitation revenue. Analyze costs and expenses. Perform quality of earnings analysis. Conversion of cash basis financial statements to accrual basis. Non-cash items. Personal expenses. Market compensation adjustments. Out-of-period transactions. Discontinued costs post-transaction. Analyze accounts receivable. Analyze working capital requirements Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 25
Due Diligence Considerations for a Successful Transaction Financial Due Diligence (continued) Analyze working capital requirements (continued) Purchase agreements often contain provisions that the seller will deliver the healthcare company with a normal working capital level. Analyze quality of current assets and current liabilities. Assess whether any short-term incremental financing will be needed to operate healthcare company. Assess if assets are overstated or liabilities are understated. Assess what assets and liabilities you are acquiring Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 26
Due Diligence Considerations for a Successful Transaction Tax Due Diligence Operations/Technology/Integration Payor vs Payer Contract Analysis Insurance Coverage Analysis Contracts and Other Legal Review Corporate Compliance Human Resources Other Due Diligence Considerations Understand sellers motivation Financial distress Pending retirements Administrative headaches Regulatory changes Looming reimbursement cuts Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 27
Due Diligence Considerations for a Successful Transaction Other Due Diligence Considerations (continued) Non-financial factors successful acquisitions rely on more than just making the numbers work. Pending key employee or physician departures. Compensation model both pre and post transaction, especially for physicians. History of fraud and abuse. Cash flow considerations buyer should be aware of potential cash flow issues depending on whether stock or asset purchase. Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 28
For more information, contact: Brian Kerby Direct 312.857.7368 Mobile 312.502.5724 brian.kerby@crowehorwath.com Christian Heuer Direct 615.360.5572 Mobile 615.584.8056 christian.heuer@crowehorwath.com 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. 2015 Crowe Horwath LLP Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 29