A Growing Appetite for Post-Acute Care Companies

It’s a great time to be an owner and operator of any company in the health care space. That’s especially the case for owners of home medical equipment (HME) companies. During the past few years, there have been many noteworthy developments that have only served to make an already hot HME marketplace even hotter. Buyers are aggressively pursuing acquisitions, with intense competition for HME companies driving up prices. In short: It’s a good time to sell your HME company, or to at least begin looking into whether selling sooner rather than later would be in your best interest.

This article will help you gain a better understanding of the HME marketplace and how it got where it is now. We’ll start by recapping historic HME mergers and acquisitions (M&A) information, highlight some key macroeconomic and microeconomic trends, and then look at the qualities of companies that buyers are looking for and what they are likely to pay for HME companies.

Historical Performance

The onset of Medicare competitive bidding in 2008 greatly depressed HME valuations. This was due to the uncertainty brought on by competitive bidding and the negative impact on the pricing that came with the bids. These two factors dragged the entire HME vertical down into low valuations and created a plethora of failing small providers. A silver lining of the COVID-19 pandemic is that this enormous weight on HME has largely been lifted.

Key Macroeconomic Factors

What is currently happening is a confluence of events in the broader M&A landscape in the United States. Here are three of the most significant macroeconomic factors to understand.

1. Private equity has money.

Lots of it. There is a large amount of liquidity; in fact, there is more than $1 trillion of capital overhang in the market right now. Private equity is looking to spend that money and buy companies, but it won’t all be deployed any time soon. It’s a monumental task to put that much money into good companies.

With that said, a lot of that money is expected to end up in health care and HME. Why? Private equity has pegged health care as a recession-proof and, more importantly, a pandemic-proof area to invest in. There is an increased concentration of companies looking to deploy capital into HME and other facets of homecare, and, more specifically, into good quality companies and operators.

2. Baby boomers keep working.

Many expected the baby boomer generation to transition out of their companies over the last decade or so. Some of that has happened, but most boomers have not yet retired. They are holding onto their businesses for much longer. It’s still common to see owners operating their companies full time into their 60s, 70s and even 80s. This will continue to drive a robust M&A market for at least the next decade.

3. Cash is cheap.

Interest rates are very low. How low? This will likely be the lowest we see in our lifetimes. With cash so inexpensive and easy to obtain, this will fuel the M&A market for the next decade. The industry may experience a little bit of a slowdown depending on what happens with capital gains’ rates, but that will be short lived. The low cost of accessing cash will further drive M&A.

Key Microeconomic Factors

Now let’s look more closely at three of the most substantial microeconomic factors affecting HME.

1. There’s a big emphasis on investing in post-acute care practices.

Post-acute care businesses—whether HME, home health or others—are highly desirable. The primary reason is because the Medicare Part A side of the business is so expensive. For whatever reason, it has taken about half a century for federal agencies like the Centers for Medicare & Medicaid Services (CMS) to figure out that it’s more expensive to treat patients on the Medicare Part A acute side of the business versus the lower cost to treat them in the home. People have finally realized that there are avenues to deliver great, cost-effective care and treatment in the home. This is motivating people to gravitate toward the market.

The number of new applicants filling out the Medicare 855S form, which is essentially the way to create a new Medicare entity, has hit its highest rate in at least a decade. People are opening de novo businesses in the space because of its perceived strength and viability.

2. Medicare competitive bidding seems over.

As noted earlier, Medicare competitive bidding, for the most part, went away with the pandemic. The off-the-shelf orthopedic brace competitive bidding program still exists, but that’s only a small segment. The industry is still waiting on a proposed rule from CMS regarding what the next round will look like, whether it is delayed or providers only bid on the bracing category again. Competitive bidding greatly contributed to consolidation of markets and players.

Large players in the market have always used the strategy of buy and build, either to buy up geographic territories or invest in new segments in existing markets. This was the case before competitive bidding. During the years of competitive bidding, which started in 2008 and essentially ended in 2020, mid-size providers also grew through acquisition. Competitive bidding has largely gone away, but these players still have that appetite  and business strategy of growth through acquisition. And small providers are also getting into the mix.

So now you still have the bigger players making acquisitions, but they are being joined by regional and even local players. There are smaller HME companies doing $10 million a year in business that are identifying a company in the same or adjacent market doing $2 million in revenue and pursuing an acquisition. Growth through acquisition is no longer just an avenue for growth for the largest players.

3. Skilled nursing presents additional challenges.

More buyers are interested in HME due to the multitude of challenges currently facing skilled nursing. This includes everything from the risk of future lockdowns due to COVID-19 or other pandemics, the ongoing spread of COVID-19, vaccine mandates and testing requirements that are motivating some staff to pursue other careers, and hardline immigration policies that have shrunk the available pool of workers.

In addition, patients and their caregivers are increasingly opting to receive care in the home, not just for comfort but also because the services there tend to be significantly less expensive than those provided in skilled nursing facilities.

What the Future Looks Like

There may be a slight slowdown in Q1 and Q2 of 2022 as people work to figure out how to navigate potential tax implications and changes from the Biden administration. Once they figure that out, the industry will return to a flurry of activity that should continue into the foreseeable future.

Since the onset of COVID-19, there has been a substantial supply and demand issue for HME businesses. The market fundamentals are off in that there is much more demand than supply. That demand is coming from private equity, the capital markets, and from national, regional and local players. If you have a strong and healthy HME company, it will transact for a lot of money—the highest multiples seen in 20 years. If you have an okay company that’s perhaps antiquated and needs help growing, it will still transact for a high amount because the supply is lacking. These trends are not likely to change any time soon.

What Buyers Want: Key Attributes

When HME buyers are researching potential acquisition targets, the most important quality in a prospective HME company is profitable growth. Buyers want to feel confident that they can take what an HME organization owner has created and build on it, ultimately making the new owner more money from the acquisition.

In a risk/reward analysis, HME buyers will be looking to see that a company’s strengths far outweigh its weaknesses. When buyers analyze a prospective company, they usually do so with a checklist mentality, looking to see if a company has the attributes that the buyer feels are most important to both the short- and long-term success that will drive up what the owner can earn. In addition to profitable growth, one of the most important attributes is a strong, capable management team—one that will work with the new owner to sustain the company’s current growth and profitability and then help build upon those factors. This is also why buyers look for a tenured, experienced workforce with low employee turnover.

Solid in-network relations with payers and long-term payer contracts help a buyer feel more confident that a company’s financial prospects are viable and sustainable. Diversity is a highly sought-after attribute—more specifically, diversity in regards to a company’s physician and non-physician referral network and its payer mix. Meanwhile, a large population base with good client demographics is appealing to buyers because such qualities tend to lend themselves to achieving growth.

Finally, buyers will also look closely at other key financial attributes, such as good revenue growth and earnings before interest, taxes, depreciation and amortization (EBITDA) margins typically in the 10% to 20% range.

Determining a Price

When buyers are weighing how much they want to spend to acquire an HME company, they are looking for rewards—that is, upsides—from their potential purchase. These upsides are the ways that the buyer will generate a strong return on investment (ROI), with many buyers looking for short-term wins.

Such upsides come from positive industry market conditions that give a company a competitive edge and/or unique position in a market. These tend to include the following:

• Expanded in-network coverage
• Increasing revenue on a per-client basis with overlapping products and services
• Client treatment demand not affected by economic cycles
• Niche products or services with high usage and reimbursement rates
• Skilled employees (e.g., assistive technology professionals, respiratory therapists, billers)

As a buyer works to value a company, they will typically gravitate towards a trailing EBITDA. EBITDA is the easiest and most direct way to determine an ROI. Buyers tend to go through a risk/reward analysis to come up with a purchase price. The price is usually based on a multiple of normalized or adjusted earnings before EBITDA. A one times (1x) of EBITDA is equal to one year of earnings. This means that a company transacting for 4x EBITDA is four years of forward earnings. Public companies are valued in the same manner—for example, Lincare is trading at 19.90x forward earnings and Amazon at 60.63x. Adjustments to EBITDA include nonrecurring expenses (e.g., one-time legal fees), discretionary expenses (e.g., charitable contributions), and owner-related personal expenses (e.g., excess owners’ salaries and vehicle lease expenses).

Understanding Market Multiples

Now let’s look at the market multiples for HME. Market multiples refers to the estimated purchase price relative to EBITDA. The typical range of market multiples for HME providers is 3x to 5x EBITDA. Whether an HME company falls within that range is based on quantitative factors, such as historical and projected financial performance, as well as on the qualitative factors highlighted above. Not surprisingly, larger revenue providers tend to attract more buyers than smaller revenue providers.

Here are estimated market multiples for HME providers by revenue:

• $1 million to $3 million in annual revenue: 2x to 4x EBITDA
• $3 million to $5 million in annual revenue: 3x to 5x EBITDA
• $5 million to $10 million in annual revenue: 4x to 6x EBITDA
• More than $10 million in annual revenue: 5x to 10x EBITDA

While the information provided here should serve as a reasonable shortcut if you are interested in estimating the value of your company, it is important to understand that there are outlier market multiples in transactions in which more optimized buyer/seller synergies can push valuations above the norm—sometimes well above it.

Moreover, don’t forget that market multiples, like any financial projection, change over time. Influencing factors include the overall state of the economy, regulatory and reimbursement modifications, and industry trends such as those discussed earlier in the column.

Speak at least annually with an advisor familiar with the HME market and broader health care trends that affect HME who can serve as a guide about these concepts. This will allow you to better understand the market and the options for your HME company.