CMS Rescinds '36-Month Rule' On The Sale of Any Home Care Agency

As a result of ongoing discussions with the National Association for Home Care & Hospice (NAHC) and its member organizations, the Centers for Medicare & Medicaid Services (CMS) has withdrawn Transmittal 318/Change Request 6750 containing problematic policy on what's become known as the "36-month rule," and will limit the rule's application to full changes in ownership only. NAHC has been working with CMS officials on a number of concerns regarding this rule since last fall.

The rule states that the Medicare provider agreement and billing privileges of a home health agency will not be transferred to the new owner if the agency is sold within 36 months of its enrollment in the Medicare program. The concerns conveyed to CMS centered on the broad application of the "36-month rule" to ownership changes including a full change of ownership (CHOW); an acquisition/merger; a consolidation; a 5 percent or greater ownership change (e.g., stock transfer or asset sale); or a change in partners, regardless of the percentage of ownership involved.

What does all this mean? Any agency may be able to go through a "Change of Ownership" resulting from a sale regardless of when it was certified!

Winter 2010 HealthCare M&A Observations

King of the Jungle: Medicare home health agencies continue to rule our industry as the most sought after targets for strategic and equity buyers.

Franchisees Disenfranchised: Non-skilled private duty franchise agencies continue to flood the market due to oversupply and disproportionate inventory of unsold outlets. Franchisors are unable to stimulate new business and franchisees are treading water waiting for the rising tide to recapture market share lost to the economic downturn and the big-boys.

DME on the Rise: With the government backpedaling on its edict to force competitive bidding, existing DME companies are experiencing a new resurgence, especially in the mobility and oxygen arenas as our population continues to age. Competitive bidding, as mandated, is illegal since it is a form of price fixing and a direct violation of the Sherman Antitrust Act. Trade organizations, including NAHC, are lobbying federal and state legislators to eliminate competitive bidding as a predatory first line of defense against it possibly rolling over to Medicare healthcare recipients and providers. If enacted in the home health space, competitive bidding would certainly diminish the quality of service that all Americans are entitled to.

Staffing Companies Still Flat: With the earlier exodus of nurses returning to the workforce on a fulltime basis to supplement income lost by their unemployed spouses, staffing companies are replenishing  their loss revenues by providing staffing services to the less desirable sectors such as convalescent facilities, clinics and schools. There is a stalled effort to expand upon the catalog of skills staffing companies are now offering. This broadening of services seems to be paralleling the temporary employment agency business model. Recovery is going to be in tandem with the rest of our economy. Soon!

The Long-Term Care Wait Is Over: The real estate moguls and REIT's who exercise control over the long-term care industry are currently in an upswing to recapture any lost values previously sustained. The lack of new construction will trigger higher rents which will be passed on to government programs and the paying renters. Location, Location, Location!

Taking the Temperature of HealthCare for 2009

From a purely financial perspective, the last twelve months have been turbulent months. Our representatives in Washington have no doubt been busy trying to get us all back on the right course. Recent economic data suggests that we have turned the corner; however, this is not to say that our leaders have consistently made the right decisions. The stimulus money provided by the government, for example, is a farce to smaller companies- especially those doing less than $5 Million a year in revenues. It seems that the larger the company wanting to borrow capital, the easier it is for them to make use of cheap money!  This is an inequity to the small independent operator who basically can’t borrow at any rate to sustain or grow their agency. It reminds me of “Reaganomics” and its trickle down deployment again, only worse! Through it all, the healthcare services industry has remained fairly isolated from meltdowns in the larger economy. I, for one, am glad to be part of an industry that forges people’s passions in exchange for an equitable profit.

Healthcare Reform in Washington

After attempting to read the 2,000 page healthcare bill, I came away with the following observations. First, it doesn’t prescribe anything material as it relates to reimbursement. It did, however, devote 300 pages to providing healthcare to our Native Americans, whose casinos apparently don’t provide healthcare coverage to employees. It never uses the word “Doctor” and only talks in the vernacular “shall”. Despite its problems, I suspect that some modified iteration will eventually pass!

Directly or indirectly, our 40 Million uninsured Americans will soon be eligible for healthcare insurance, which will benefit all providers of medical services. The government will use State Medicaid programs as their overseer and delivery system to those who qualify. Yes, there are more efficient methods of implementation, but it seems that our Congress has only self serving agendas and no business acumen. Either way we still win!

The Vital Signs of the Healthcare Industry Continue to Show Encouraging Results Despite Predictions of Calamity

The M&A market for 2009 has been robust and I expect this trend to continue on through all of 2010. The behemoths of healthcare companies continue to strategically acquire businesses with sustainable revenues, growth and profits. Further, they continue to pay a premium for their acquisitions using 4 to 6 times EBITDA as their formula, which is inline with what their stocks are currently selling for as publicly traded companies. I believe that publicly traded healthcare companies are currently trading at a significant discount due to uncertainties about what congress will or won’t do. When the healthcare industry stabilizes, I expect that healthcare stock prices will potentially double in the next 12 to18 months.

While Valuations of Healthcare Service Companies are Holding Up, Prices Continue to Vary According to Segment

Homecare: Medicare providers continue to be the most sought after companies for acquisition followed by private pay operators (excluding Medicaid as the payor source). Medicare companies usually command 5X EBITDA if they are profitable and have organic growth. When a Medicare home health company has sufficient critical mass (over $25 million in revenues), or is located in a CON state, it can demand a 6X multiplier. Medicaid continues to be very consistent at attracting buyers at a 4X multiplier. Geography is the main driver for Medicaid agencies with California being the least desirable and Kansas being the most desirable state to buy Medicaid agencies in.

DME: DME is looking for a lifesaver to cure its uncertainties. Competitive bidding is again getting some discourse in Washington, creating unnecessary unrest in the industry. My feeling is that competitive bidding is illegal because it is a form of price fixing and a direct violation of the Sherman Anti Trust Laws as well as being “unhealthy” for the industry as a whole. The “big-boys” don’t want competitive bidding because it would materially affect their bottom line by winning contracts that have previously paid  more in fees and possibly decrease the market share they are already enjoying. Additionally, it diminishes the quality of goods and services they would provide, which should not be the objective of our government.

Staffing: The staffing industry seems to have been hit the hardest for reasons that don’t make any sense to me. This sector of the healthcare industry should have grown rather than contracted.  It will have its own resurgence in 2010 and improve itself even though gross profit margins will continue to stay between 18 and 22 percent with very few exceptions.

Conclusion

Although we do participate in other modalities such as diagnostics, which is going through its own renaissance, our world consists mainly of home care agencies, including physical therapy and social services. Our M&A volume is up 50% over last year’s figures with the completion of 70 closed transactions in 2009 versus 50 closed deals in 2008. We expect business in 2010 to be even better than 2009 and we are gearing up accordingly by expanding our reach, hiring more people and increasing our presence in the market.

My prediction for next year is that there will be significant consolidations over last year’s mergers and a serendipitous windfall in business for all who choose to remain by providing discounted fees under the changes in healthcare that are about to take place. It’s going to be all about who can operate more efficiently relative to competitors. Look for diversification as companies try to find additional strategic fits as add-ons to their mainstay.  It is logical that PT, MRDD, O&P and specialty healthcare related providers will become the new acquisition targets for the aggressive companies wanting to expand their overall presence in the market on a national, regional or local basis.

HealthCare Maintains Steam While Economy Searches For Bottom

Economic fundamentals of an aging population continue to drive growth and consolidation in the healthcare services industry. Difficult economic conditions and potential regulatory changes pose challenges for healthcare providers, but the promise of sustained long term growth across the healthcare services industry continues to attract investment in successful companies that can capitalize on the need for services across the full continuum of care.

The healthcare services industry remains fairly isolated from meltdowns in the larger economy, making it attractive to lenders who want to make credit available to qualified borrowers that can withstand stricter underwriting standards. Lack of access to credit has constricted growth and M&A activity for weaker providers, but stronger operators have cash and credit with which to make strategic acquisitions. Several publicly traded healthcare service companies have maintained respectable stock prices as overall equity markets have crumbled. Credit is loosening as certain specialty healthcare lenders are aggressively marketing loans for refinancing, operations, and acquisitions.

The economic and regulatory challenges facing the healthcare services industry will create winners and losers that have yet to be determined. The 2010 budget proposed by the Obama administration would eliminate the Medicare home health benefit as we know it by cutting 80% of the expenditure within 5 years and bundling home health services with acute care facilities who would be expected to provide or subcontract post-acute care to patients they discharge. While it may seem counterintuitive to promote the generally high cost acute providers at the expense of the generally low cost home health providers, this is what has been proposed. Home health beneficiaries, providers, and trade groups such as the National Association for Home Care are trying to educate administration officials, legislators, and other policy makers about the benefits of community based care for patients and payers alike.

While valuations of healthcare service companies are holding up, prices continue to vary according to segment.

Medicare Certified Home Health Agencies may yield the position they have held at the top of the valuation hierarchy since the prospective payment system was introduced in 2000 as they face the possibility that they may end up with the short end the stick when Medicare reforms are implemented. Given that home health is the most cost effective healthcare delivery channel, it's also possible that the home health benefit could be expanded to include chronic care in an effort to use prevention to reduce hospitalizations in the first place. Clean, profitable home health agencies continue to sell for premium prices, but buyers have become more selective as overall economic conditions force them to be as conservative as possible with operating and investment resources.

Ironically, the same federal budget that threatens Medicare Certified Home Health Agencies could be a boon to Medicaid providers in many states. Normally, reduced state tax revenues would translate into reduced payments to Medicaid providers. However, the Obama budget directs significant stimulus funding toward the states which will have the effect of supporting various Medicaid and Medicaid waiver programs. This should preserve valuations of Medicaid homecare agencies through this recessionary period.

The Durable Medical Equipment and Respiratory Therapy segments continue to be impacted by challenges such as competitive bidding, rental caps, rate cuts, and now the implementation of a new surety bond requirement. Operators who are committed to the industry for the long term are still making strategic acquisitions to position themselves for an eventual rebound. Weaker providers who have not adapted to changing conditions can be bought at discounted prices.

Perhaps the most promising segment for the foreseeable future is the private pay provision of non-medical care to the elderly and disabled. Although weak overall economic conditions make it harder to sell private pay services to families, the population of eligible affluent seniors is growing fast enough to stimulate significant growth and consolidation in the industry. Since it's harder to grow market share in this down economy, critical mass is valued that much more by buyers and sizeable private pay non-medical homecare companies are fetching top of the market, all-cash premiums.

Even with some of the worst economic conditions on record, the healthcare services mergers and acquisitions marketplace continues to be very active. Good companies are selling for premium prices and those that are struggling are selling for discounted prices. The important thing to note is that transactions are closing. American HealthCare Capital still has not had a single transaction fail due to lack of financing. In fact, we closed more transactions in Q1 of 2009 than we did in Q1 of 2008!

Healthcare Industry is Pillar of Strength in Otherwise Weak Economy

Although the Federal Bailout has done nothing to alleviate the nationwide credit crisis, the healthcare services mergers and acquisitions marketplace continues to be robust. On January 10, 2009, the Wall Street Journal reported that, although the economy lost 2.5 million jobs in 2008, the healthcare services industry is the rare exception where jobs are still being created. The healthcare services industry remains one of the brightest spots in an otherwise gloomy economy.

Economic fundamentals continue to drive growth and consolidation in the healthcare services industry. Since credit is not as available as it has been in the past, buyers who rely on external financing are being as conservative and strategic as possible so as to avoid the necessity of refinancing in these unfavorable conditions. Sellers are wary of prospective buyers who are still relying on significant leverage to fund transactions. As always, cash is king and buyers with cash are in the best position to secure and close transactions.

The bottom line is that there is still more money chasing good deals than there are good deals on the market. Thus, prices are holding in the 4-5xAEBITDA range for smaller transactions. Due to the relative strength of the healthcare services industry, several types of buyers are in the market for acquisitions including large publicly traded companies, private regional operators, and private equity groups seeking platform and add-on acquisitions.

Public companies are often a reliable barometer of the relative strength or weakness of any given segment. Some publicly traded healthcare service companies are being hurt by external conditions (O2 Therapy, Long Term Care) while others seem to be benefiting from the malaise (Home Health). Public companies whose stock prices have been hammered are still in the market for highly strategic opportunities while those that are doing well are being more aggressive about pursuing acquisitions in order to position themselves to best capitalize on the eventual rebound.

Privately held regional operators are very actively pursuing acquisition candidates to facilitate strategic growth. They are taking advantage of the cash on their balance sheets to secure transactions with no financing contingencies. Typically, this type of buyer is looking for a smaller acquisition candidate upon which they can build something larger.

Private equity investors are as interested in healthcare services as they ever have been. With almost every other industry in the economy suffering a contraction, healthcare services is one of the only industries that can offer private equity investors the promise of continued and steady growth for the foreseeable future. Generally speaking, acquisition candidates must have an adjusted EBITDA of at least $1.5 Million in order to qualify as platform investments. However, since many providers have recently been recapitalized by private equity investors, smaller opportunities are attractive as add-ons to facilitate the strategic growth of portfolio companies.

Valuations of healthcare service providers continue to be a mixed bag. Medicare certified home health agencies lead the pack as all three types of buyers continue to bid prices up to their historic highs. We’ve seen some signs of life in the healthcare staffing segment, but prices are still down from what they were a few short years ago. The DME and O2/Respiratory therapy markets are still relatively sluggish as the industry deals with the uncertainty associated with the false start of competitive bidding, the 36 month cap and relentless cuts to reimbursement. Although under some pressure due to weak economic conditions, demand is still high for private pay non-medical homecare providers and valuations are commensurate with those of Medicare agencies.

While the overall economy is experiencing some scary turbulence, the healthcare services industry is riding out the storm on the strength of market fundamentals. Regulatory changes down the line could present new obstacles for some providers to overcome, but for now this is one of the best sectors in the entire economy.

We still have not had a single transaction terminated for lack of financing since the beginning of the financial crisis (knock on wood!!!). To the contrary, we closed 16 transactions in the final quarter of 2008 and have many more scheduled to close in the first quarter of 2009.

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