ATLANTA--While many HME providers felt they had missed the opportunity to sell their businesses, the release of pricing for round one of competitive bidding may have opened the door for some, say merger-and-acquisition specialists.
Over the past several years, the primary reason for the fall-off in HME M&A activity has been the “uncertainty of future top-line revenue and the bottom-line impact associated with competitive bidding,” said Jonathan Sadock, managing partner of Paragon Ventures, Wayne, Pa. Simply put, buyers didn't have “the necessary data to accurately price acquisition targets.”
But with the round one bid rates established, he said, “buyers will be able to predict the revenue and profitability of the HME business enterprise. Contract-holders will become more attractive as acquisition candidates because their revenue streams and profitability will become more stable and predictable.”
While the announcement of payment amounts may offer some insight on the direction acquisitions take, however, it is still no guarantee.
“I think there will be some spotty reactive activity either on the part of winners or losers, but it won't exactly be a groundswell,” said Bob Leonard, managing director for Pittsburgh-based The Braff Group. “We're already looking at all kinds of activity--winners buying losers and losers buying winners--but it's really too early to tell what the ultimate reaction will be.”
As far as the overall HME market, Leonard said, the round one announcement removes one level of uncertainty: “At least in those markets you know the pricing parameters so you can model what an acquisition might look like.”
But, he continued, “the problem we see is the overhang of the oxygen cap. That's still kind of an imponderable with the continued threats to reduce the rental period from 36 months to 18 or 13. So even though you know where pricing under competitive bidding may be set, the specter of what will happen with the cap is going to limit people's enthusiasm to jump into the market in a big way.”
“The range of possibilities everyone is focusing on is so wide,” added Richard Glass, president of Tarpon Springs, Fla.-based Steven Richards & Assoc. “We are looking at what the pricing will be in the first round, the oxygen rental cap and potential lowering of reimbursement for stationary oxygen. When you apply these types of changes, the results of company valuations sway.”
And for some--particularly small companies that are not accredited--he pointed out, the sales forecast remains pretty glum.
“It is a buyer's market for companies that are not accredited and did not or will not choose to bid,” said Glass.
Although the financial repercussions of competitive bidding and the oxygen cap have not yet been felt, he noted, buyers who are looking for a five-year investment are looking closely at the ramifications.
“This leads to a strong disconnect between sellers and buyers as the sellers look at their cash flow and think it looks pretty good,” Glass said. “On the other hand, buyers look at a company and ask how much they are going to make on it in the future and if they are going to be right and not wrong about that amount. The range of possibilities on how much you can make on an acquisition in the future are tremendous.”
According to Sadock, companies that are Medicare-dependent operations with revenues of less than $5 million and sub-$1 million earnings will find it difficult to gain interest from buyers in the current environment.
“If you analyze the profit-and-loss and balance sheets of these companies, you can see that a 15- to 20-percent reduction in top-line revenue can effectively wipe out their earnings. It becomes a losing proposition with little opportunity for neither buyer synergies nor the ability to mitigate risk from declining reimbursement. There just isn't enough fat in the business to overcome the earnings weaknesses caused by competitive bidding price decreases,” he explained.
However, as competitive bidding extends into rounds two and three, location will become less significant because the impact will be increasingly payer-specific, not MSA-specific, according to Sadock.
“Ultimately, competitive bidding will affect all providers to the extent that they bill Medicare and the impact of the payers that contract at a 'Medicare-related' schedule. If CMS enacts inherent reasonableness based on the result of the first round of competitive bidding, coupled with the accreditation requirements, they would realize their cost savings and provider reduction goals far sooner and at less cost,” he said.
Adding to the state of flux, Sadock said, “some of the actual rules regarding the new competitive bidding contracts have not been clearly defined, implemented nor challenged. The book is being written as we speak. There has been much speculation, analysis, interpretation and wrangling but little definitive, hang-your-hat-on-it clarity on specific M&A issues.”
For example, he said, “traditionally, if an acquirer purchases the stock or membership interests of a company in its entirety, they in essence step into the shoes of the existing ownership. If it is in an asset transaction, then there will be turbulence and the difficulty of assignment of the [National Supplier Clearinghouse] number will be exacerbated.
“With the first-round competitive bidding winners and the rates now announced has come significant new activities on the M&A front. Many of these questions are being worked on right now as buyers and sellers look at how the actual rates will affect their valuation.”
No matter what the circumstances of an individual HME, the M&A experts advise providers to be realistic. No business will command the same market premium that it might have a few years ago.
“The market has matured significantly in the past 24 months, and buyers are aware of competitive bidding and its potential effects on the earning power of these businesses,” said Sadock. “For some businesses, there are specific opportunities that will come to bear because of the competitive bidding process. It is critical to understand these opportunities and the factors that contribute to or detract from the total economic value of your specific business model.
“We are updating valuations on many providers--winners and losers--based on the new information and are urging all providers to avail themselves of an objective, professional and realistic valuation before entering the market.”
”Providers [in round one] need to explore their options,” said Leonard. “If they are not bid winners, they need to figure out if they can subcontract in order to participate or what source other than Medicare they can pursue, because, sadly, for three years, they are out of the game. Once some of the facts come to light, then everybody can more logically sit back and review the options for their business.”
Concluded Glass, “Once the smoke clears, the market will definitely pick up. There is a backlog of people who want to sell and a backlog of those who want to buy once they know what the rules are going to be. We just need to find out what the parameters end up being.”