After Health Care Reform: Developing Merger and Acquisition Strategies

With the U.S. government’s Affordable Care Act (ACA), the initiative equates health care as one of the inalienable rights of U.S. citizens—the right to life, liberty and now affordable health care. The dichotomy of that quest and the government’s ability to fund it have created one of the most invasive and divisive initiatives of the modern era. It has also further fueled the investment community interest in health care while creating new opportunities and strategic options for health care providers.

The Affordable Care Paradox

It is unprecedented that health care has become such a political issue in our lives. Health care, along with its clinical and fiscal pathways, has been studied, analyzed and predicted with amazing accuracy. A report on the ACA implementation found that current health care providers in the U.S. don’t have the capacity or enough resources to treat the additional masses joining the health care markets. However, rapidly advancing technology and pharmacology will continue to improve both clinical outcomes and administrative processes. Once fully commoditized, the efficiencies created will enable health care providers to not only manage the demographic growth but also to succeed, profit and thrive.

Change Is Not New

Business owners in the current market have options to consider as their businesses evolve to meet the challenges and opportunities presented by health care reform and the ACA. With tightening reimbursements and a restrictive regulatory and compliance environment, it is vital for health care providers to prepare their businesses for the realities of rapid growth, scale and expansion. For acquirers of businesses with a preponderance of government related revenues, uncertainty has absolutely affected the M&A climate. Any time there is proposed change that could affect revenue, growth or profitability, there will be a correlating effect within the M&A markets. It is difficult for an acquirer to value a business whose profitability may be negatively impacted soon after the acquisition. Once the effects of reimbursement on profitability are known, then acquirers are able to get a handle on valuation. There is another side to the ACA coin. Some providers stand to significantly increase the size of their businesses as a result of ACA. Although the per-patient valuation may decrease, overall they stand to increase revenues and profitability if they are strategic in their implementation and abilities to scale operations. Historically, changes in health care reimbursement—and their effects on the M&A market—go in cycles. For buyers and sellers, the key is to deal with reality and manage risk. That should be reassuring to those who are proactively managing their businesses to take advantage of the resulting opportunities.

The ACA Unknown

With any new governmental initiative, the implementation can be long and complex. Most programs are refined over time; therefore some assumptions must be made when assessing the ramifications of implementing growth initiatives. With an initial 300 percent increase in possible new beneficiaries under the ACA, the inherent growth opportunities are obvious. The number of new beneficiaries who will actually become customers are what is less reliable—and the cost/profit margin is unknown. Although there are risks, there are many ways to mitigate the risks while exploring your options.

Valuations

The first step in exploring your strategic options is to understand the current market value of the business. This benchmark will aid in assessing goals and setting direction for equity and growth. There are many methods used to value a health care business, and most buyers protect their strategy as part of their negotiation tactics. The most common metric used in business valuation discussions is Earnings Before Interest Taxes Depreciation and Amortization (EBITDA). The EBITDA metric is indicative of the fiscal health and performance of the business. In valuations, a multiple is applied to an adjusted or normalized EBITDA to ascertain a valuation benchmark. This multiple can be influenced by many factors including buyer synergies, sustainability of the business model and strength of profit margins. With the early stages of health care reform, certain assumptions of future performance need to be assessed. These assumptions, primarily around scale and volume, need to be carefully analyzed, realistic and achievable. While a new contract or referral source may promise access to substantial new revenue, the business capacity, scale and margins need to be evaluated. Once you know what you have and what it’s worth, you can begin exploring the strategic options for your business.

Balancing Options and Opportunities

Every privately held health care business ever created will, at some point, be sold, merged, bequeathed or closed. Along the way, the business owners have many options to consider as they map and execute their business plans. The strategic options outlined below will fall into one of two categories—equity options or growth. In each of the equity options, the business will be evaluated, presented and a change in ownership pursued. Strategic growth options are designed to enhance the current business operations, revenue streams and, 
ultimately, profitability for the business owner. The first step is to clearly understand the strategic business plan, available resources, liabilities and stakeholders’ personal goals for the business. Selling the business—At some point, most business owners look to reap the rewards from the many years of hard work through a sale of their companies. The reasons why a business owner may seek a sale are many, and the most common are retirement, strategic positioning or wealth management. In order for a strategic sale transaction to consummate, a business needs to be properly prepared in advance. Each of the business’ critical components, ranging from revenue and referrals to employees, contracts and operations, must be critically evaluated and assessed. Comparable transaction analysis and live market assessment will then confirm and reinforce the business valuation. From this vantage point, a business owner will have an eagle-eye view of how the business will perform in the current market. This performance assessment is important to match the owner’s expectations and goals with the realities of valuation from a sale. Growth acquisitions—It’s more difficult to grow organically, and it takes a lot longer to get to the same scale than if you were to acquire a company. A business owner considering growth acquisitions needs to be informed of the inherent risks and rewards associated with integrating a new business into their existing operations. It is critical to remember to “protect the mother ship.” Even the best acquisition, improperly implemented, can disrupt cash flow and negatively impact valuation. A strategic acquisition with well implemented integration can be accretive to earnings and provide expansion and valuable synergies for the buyer. This can add to the EBITDA and, ultimately, the valuation of the surviving entity. Recapitalization—This simply means that value and equity ownership are being shifted within your company. Typical objectives might include reducing debt, generating liquidity for a shareholder, raising cash to fund growth or a combination of all three. By taking some, but not all, of your investment off the table today and reducing the financial leverage of the business, recapitalizations allow 
you to benefit from future growth with much less personal risk. Typically, recapitalizations are offered by private equity firms or “sponsors” with access to committed capital and vast expertise in finance and business management. Often they bring operating synergies and significant relationships which can enhance the growth trajectory, profitability and valuation of the recapitalized business. For the business owner, a private equity transaction can offer a second bite of the apple after the next stage of growth. Growth options—Every business owner should be focused on their growth options on a daily basis. The decisions you make to pursue new revenue, maximize efficiencies and hurdle challenges will ultimately effect the valuation of your business and your strategic equity options in the future. When assessing growth options, not unlike considering acquisition opportunities, it is important to “protect the mother ship.” You have worked hard to build and grow your business, and you need to make certain the growth initiatives are accretive to the enterprise. There are many growth options you may consider, and each needs careful analysis along with realistic assumptions and projections. Traditional growth options include new geographic expansion, adding fresh product lines 
and improving marketing penetration. Other growth options have emerged from the advent of ACA. These include opportunities to expand and scale your business through retail offerings, social networking and private concierge care. In some circumstances, a provider may look to participate in closed contracts through subcontracting or joint venture arrangements. However these arrangements require an extra degree of caution and careful execution as the impact can be far reaching and impact future strategic equity options. Future growth options will likely include components of population-based health care initiatives. Any population-based care involves a new way of seeing the masses of individuals seeking health care—looking at patients not just as individuals but also as members of groups. This approach does not detract from individuality but rather adds another dimension, as individuals benefit from guidelines developed for respective populations.

In Closing

The best health care business sale is a transaction that closes! A transaction closes because the buyer and seller agree on a valuation of the business and each takes the steps necessary to consummate a successful closing. Now is the time to be proactive in the management of your business and execution of your strategic options. At this point, doing nothing is not a strategic option. This article is part of the 6-4-18 series of Medtrade presentations highlighting six sessions that will provide HME dealers with strategic information for success and survival over the next 18 months.