Pricing Announcement Opens the Door to New M&A Activity for HME

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.”