Carol Carden, CPA/ABV, ASA, CFE Page 0
Agenda Healthcare Industry Overview Healthcare Valuation Approaches Healthcare Valuation Considerations and Trends Recent Reform Initiatives Page 1
Healthcare Industry Overview Page 2
Understanding the Context What makes a healthcare valuation different than any other company? Highly regulated environment Less access to market data Significant fluctuation in trends between years constantly changing and evolving Complex interplay between patients, providers, insurers and the government can be tricky to get your arms around Page 3
Overview of the Healthcare Industry Stark Law False Claims Act Healthcare Regulations Anti- Kickback Statute IRS 501 (c)(3) Private Inurement Rules Page 4
Fair Market Value Fair Market Value the value in arm s-length transactions, consistent with the general market value; General Market Value the price that an asset would bring as the result of bona fide bargaining between wellinformed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement. Page 5
Compliance Issues Regarding Hospital-Physician Financial Relationships COMMERCIAL REASONABLENESS SENSE FAIR MARKET VALUE CENTS Overall Arrangement Scope Range of Dollars Only WHY? Key Question HOW MUCH? Page 6
Commercial Reasonableness Department of Health and Human Services Definition 1 An arrangement which appears to be a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals. Stark Definition 2 An arrangement will be considered commercially reasonable in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician of similar scope and specialty, even if there were no potential designated health services ( DHS ) referrals. OIG Threshold 3 Compensation arrangements with physicians should be reasonable and necessary. 1 63 Fed. Reg. 1700 (Jan. 9, 1998). 2 69 Fed. Reg. 16093 (March 26, 2004). 3 OIG Compliance Program For Individual and Small Group Physician Practices, Notice, 65 Fed. Reg. 59434 (Oct. 5, 2000); OIG Advisory Opinion No. 07-10, September 20, 2007, pg. 6, 10; OIG Supplemental Compliance Program Guidance for Hospitals, Notice, 70 Fed. Reg. 4858 (Jan. 31, 2005). Page 7
Factors in Determining CR Business Purpose Provider Analysis Facility Analysis Resource Analysis Commercial Reasonableness Determination Independence & Oversight Page 8
Healthcare Valuation Approaches Page 9
Asset Approach in Healthcare Asset Approach Can be challenging as many physician practices are cash basis of accounting If dealing with a hospital department, common to not even produce a balance sheet Used currently for many physician practice valuations because hospitals are not paying for goodwill or other intangible assets because profits of the practice are generally consumed in the form of compensation to the physician Common for working capital to be excluded from the transaction Page 10
Economics of a Physician Practice Collections Practice staff expenses Practice supply expenses Practice overhead expenses Therefore: Use of the asset approach is common Page 11
Income Approach for Healthcare Income Approach Used most frequently for healthcare companies Critical to appropriately project cash flows and assess risk This is approach is not without regulatory risk Use of the discounted cash flow method more common as the healthcare industry can be volatile and the past is not necessarily a good predictor of the future Page 12
x x Projecting Cash Flows Common Mistakes in Healthcare x x Page 13
Projecting Cash Flows Contributing Factors to Unrealistic Growth Rates Analysis of the payer mix is a must! Identification of industry reimbursement trends Failure to analyze capacity constraints What does perpetuity really mean? Failure to assess referral sources Concentrated in a few individuals? Where are they in their career life cycle? Page 14
Projecting Cash Flows Inadequate Assessment of Risk Factors Increased regulation Possible criminal penalties Concentration of referral sources or payers Technology can become outdated very quickly = Page 15
Projecting Cash Flows Analysis of Reimbursement Trends What has happened to this particular sub-sector in the past few years? All healthcare industry segments are not created equal imaging for example What is out there regarding healthcare as a whole and the particular segment you are appraising in particular Page 16
Projecting Cash Flows Consideration of Post-Transaction Factors Bear in mind the definition of FMV, particularly as the regulators define it There is more at stake in healthcare, up to and including criminal charges! For physician practice valuations, post transaction compensation must be considered Be careful about volume assumptions as well as expense efficiencies and contract improvements Page 17
Which Method is Appropriate? IT DEPENDS If the Practice has profits remaining after FMV physician compensation does not have remaining profits after physician compensation an income approach will probably be required. the NAV method will likely be appropriate should be used. Page 18
Market Approach for Healthcare Market Approach Not used very commonly in healthcare Not many publicly-traded healthcare companies Lack of reliable transaction data involving companies that are sufficiently similar Even when they exist, it is difficult to translate a business with multiple segments across multiple geographies to a single location, single specialty company Private transaction data is scarce Healthcare delivery is so market-specific, it is difficult to translate transaction data from one market to another Page 19
Illustration of Market Approach AMSURG ASC LOCATIONS Many Usually one GEOGRAPHIC SPAN National Usually one ACCESS TO CAPITAL Extensive Limited ECONOMIES OF SCALE Extensive Very limited Page 20
Common Approaches Common Approaches (based on our experience and in order of preference) Asset Income Market Physician Practice + + - (if there are ancillary services or significant physician extenders) Hospital + + + Imaging Center + + maybe Dialysis Clinic + + + Cancer Center + + maybe Hospital/Physician Joint Venture - + - Page 21
Healthcare Valuation Considerations and Trends Page 22
Largest Trends in Merger & Acquisition Activity Hospital Acquisition of Physician Practices Single largest acquisition trend right now Involves primary care and specialty practices Generally only paying for tangible assets unless large practice Post-transaction compensation is a key assumption Hospital/ Physician Joint Ventures Generally involves ancillary service lines like ASCs, imaging or cancer centers Likelihood of cash distribution is a key driver Many are structured as pass-through entities so this becomes an important component of the valuation Page 23
Buy and Employ Transactions Buy and Employ Transactions Typical Transaction: Hospital buys the practice at FMV o Usually structured as an asset purchase o Cash and AR normally excluded o Net after-tax proceeds can be substantially different depending upon the deal structure. Page 24
Buy and Employ Transactions Buy and Employ Transactions Physicians employed by the hospital o Generally under some type of productivity based compensation arrangement (wrvus) o Generally involves a period of guaranteed compensation (assuming productivity does not decline substantially) o Often includes other types of arrangements as well (e.g., co-management, call pay, quality incentives, etc.) Page 25
Compensation and Regulatory Issues Post-transaction compensation structure factors in to the practice valuation Health systems cannot pay for a revenue stream twice once with the purchase and then on-going in the physician compensation plan Fair market value and commercial reasonableness must also be considered with regards to physician compensation Page 26
Recent Reform Initiatives Page 27
Key Healthcare Reform Provisions Bundled Payments Value-based purchasing Accountable Care Organizations Clinically-integrated networks Page 28
Key Healthcare Reform Provisions Individual insurance mandate States were given the option to either form their own state-run exchange or partner with federally-run exchanges To date, only 17 states have set up their own exchanges Cuts to Disproportionate Share Hospital (DSH) payments Expansion of Medicaid program Expansion is voluntary To date, 29 states and the District of Columbia have elected to expand Medicaid Page 29
Key Healthcare Reform Provisions Restrictions on physician-owned hospitals No new physician-owned hospitals allowed under Medicare Existing physician-owned hospitals limited Aggregate physician ownership percentage cannot increase Cannot add beds, surgical suites or procedure rooms unless an exception applies Page 30
Hospital Readmission Penalties FY2013 1% Reduction 2,200 hospitals penalized $280 million FY 2014 2% Reduction 2,225 hospitals penalized $227 million FY 2015 and going forward 3% Reduction Even more costly Negative perception in community Commercial insurance/employers Page 31
Physician Value Modifier 2017 Quality Tiering Based on 2015 Performance Low Quality Average Quality High Quality Low Cost 0.0% +2.0x* +4.0x* Average Cost -2.0% 0.0% +2.0x* High Cost -4.0% -2.0% 0.0% *Eligible for an additional +1.0x if reporting clinical data for quality measures and average beneficiary risk score in the top 25 percent of all beneficiary risk scores. Page 32
Healthcare Reform What about healthcare reform? Current thinking is that it will continue to spur consolidation in the industry between hospitals, physician, and ancillary providers At a minimum it will continue to make projection of revenues significantly more difficult due to the bundling of payments Page 33
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Contact Information Carol Carden, CPA/ABV, ASA, CFE Principal (865) 673-0844 ext 213 ccarden@pyapc.com http://twitter.com/carolcardenpya Page 35