PYA Principal Carol Carden presented “Fundamentals of Healthcare Valuation” at the American Society of Appraisers (ASA) 2015 Advanced Business Valuation Conference. The presentation explored unique characteristics of the healthcare industry, particularly those relevant to appraisers for avoiding common mistakes in assessing risk and projecting cash flow.

1. Fundamentals of Healthcare
Valuation
October 21, 2015
Carol Carden, CPA/ABV, ASA, CFE

2. Agenda
2
Healthcare Industry OverviewHealthcare Industry OverviewHealthcare Industry OverviewHealthcare Industry Overview
Healthcare Valuation ApproachesHealthcare Valuation ApproachesHealthcare Valuation ApproachesHealthcare Valuation Approaches
Healthcare Valuation Considerations and TrendsHealthcare Valuation Considerations and TrendsHealthcare Valuation Considerations and TrendsHealthcare Valuation Considerations and Trends
Recent Reform InitiativesRecent Reform InitiativesRecent Reform InitiativesRecent Reform Initiatives

3. HEALTHCARE INDUSTRY
OVERVIEW
3

4. Understanding the Context
4
What makes a healthcare valuation
different than any other company?
What makes a healthcare valuation
different than any other company?
• Highly regulated environment
• Less access to market data
• Significant fluctuation in trends between years –
constantly changing and evolving
• Complex interplay between patients, providers,
insurers and the government – can be tricky to
get your arms around

5. Regulatory Environment
5
Healthcare
Regulations
Stark Law
IRS 501 (c)(3)
Private
Inurement
Rules
False Claims
Act
Anti-
Kickback
Statute

6. Fair Market Value
6

7. FMV vs. Commercial Reasonableness
7
FAIR MARKET
VALUE
COMMERCIAL
REASONABLENESS
Overall
Arrangement
“WHY?”
Range of
Dollars Only
“HOW
MUCH?”
ScopeScope
Key QuestionKey Question

8. Commercial Reasonableness
8
Department of Health and Human Services Definition1
• An arrangement which appears to be “a sensible, prudent business agreement,
from the perspective of the particular parties involved, even in the absence of
any potential referrals.”
Stark Definition2
• “An arrangement will be considered ‘commercially reasonable’ in the absence of
referrals if the arrangement would make commercial sense if entered into by a
reasonable entity of similar type and size and a reasonable physician of similar
scope and specialty, even if there were no potential designated health services
(“DHS”) referrals.”
OIG Threshold 3
• Compensation arrangements with physicians should be “reasonable and
necessary.”
1
63 Fed. Reg. 1700 (Jan. 9, 1998).
2
69 Fed. Reg. 16093 (March 26, 2004).
3
“OIG Compliance Program For Individual and Small Group Physician Practices,” Notice, 65 Fed. Reg. 59434 (Oct. 5, 2000); OIG Advisory Opinion No. 07-10,
September 20, 2007, pg. 6, 10; “OIG Supplemental Compliance Program Guidance for Hospitals,” Notice, 70 Fed. Reg. 4858 (Jan. 31, 2005).

9. Factors in Determining CR
9
Business Purpose
Provider Analysis
Facility Analysis
Resource Analysis
Independence & Oversight
Commercial
Reasonableness
Determination
Commercial
Reasonableness
Determination

10. HEALTHCARE VALUATION
APPROACHES
10

11. Asset Approach in Healthcare
11
• Can be challenging as many physician practices are cash
basis of accounting
• If dealing with a hospital department, common to not even
produce a balance sheet
• Used currently for many physician practice valuations
because hospitals are not paying for goodwill or other
intangible assets because profits of the practice are
generally consumed in the form of compensation to the
physician
• Common for working capital to be excluded from the
transaction
Asset ApproachAsset Approach

12. Economics of a Physician Practice
12
Practice staff expenses
Practice supply expenses
Practice overhead expenses
CollectionsCollections
Therefore:Therefore:
Use of the asset approach is commonUse of the asset approach is common
even when normalized for
productivity

13. Income Approach for Healthcare
13
• Used most frequently for healthcare companies
• Critical to appropriately project cash flows and assess risk
• This approach is not without regulatory risk
• Use of the discounted cash flow method more common as the
healthcare industry can be volatile and the past is not
necessarily a good predictor of the future
Income ApproachIncome Approach

14. Projecting Cash Flows
14
Common Mistakes in HealthcareCommon Mistakes in Healthcare
Unrealistic growth rates
Not factoring in
reimbursement trends
Consideration of post-
transaction factors
Inadequate assessment
of risk factors
x
x
x
x

15. Projecting Cash Flows
15
Contributing Factors to Unrealistic Growth RatesContributing Factors to Unrealistic Growth Rates
Analysis of
the payer
mix is a
must!
Identification
of industry
reimbursement
trends
Failure to
analyze
capacity
constraints
What does
perpetuity
really mean?
Failure to
assess
referral
sources
Concentrated in
a few
individuals?
Where are they
in their career
life cycle?

16. Projecting Cash Flows
16
• Increased regulation
• Possible criminal penalties
• Concentration of referral
sources or payers
• Technology can become
outdated very quickly
Inadequate Assessment of Risk FactorsInadequate Assessment of Risk Factors
==

17. Projecting Cash Flows
17
Analysis of Reimbursement TrendsAnalysis of Reimbursement Trends

18. Projecting Cash Flows
18
Consideration of Post-Transaction FactorsConsideration of Post-Transaction Factors
Bear in mind the definition of FMV, particularly as
the regulators define it
There is more at stake in healthcare,
up to and including criminal charges!
Be careful about volume assumptions as well as
expense efficiencies and contract improvements
For physician practice valuations, post
transaction compensation must be considered

19. Which Method is Appropriate?
19
…does not have
remaining profits
after physician
compensation
the NAV method
will likely be
appropriate and
should be used.
…has profits
remaining after
FMV physician
compensation
an income
approach will
probably be
required.
IT DEPENDS…
If the
Practice…
IT DEPENDS…
If the
Practice…

20. Market Approach for Healthcare
20
Market ApproachMarket Approach
• Not used very commonly in healthcare
− Not many publicly traded healthcare companies
− Lack of reliable transaction data involving companies that are sufficiently similar
− Even when they exist, it is difficult to translate a business with multiple segments
across multiple geographies to a single location, single-specialty company
• Private transaction data is scarce
• Healthcare delivery is so market-specific, it is difficult to translate
transaction data from one market to another

21. Illustration of Market Approach
21
AMSURG ASC
LOCATIONS Many Usually one
GEOGRAPHIC SPAN National Usually one
ACCESS TO CAPITAL Extensive Limited
ECONOMIES OF SCALE Extensive Very limited

22. Common Approaches
22
Common Approaches
(based on our experience and in order of preference)
Common Approaches
(based on our experience and in order of preference)
AssetAsset IncomeIncome MarketMarket
Physician Practice + +
(if there are ancillary
services or significant
physician extenders)
-
Hospital + + +
Imaging Center + + maybe
Dialysis Clinic + + +
Cancer Center + + maybe
Hospital/Physician Joint Venture - + -

23. HEALTHCARE VALUATION
CONSIDERATIONS AND TRENDS
23

24. Largest Trends in
Merger & Acquisition Activity
24
• Single largest acquisition trend right now
• Involves primary care and specialty practices
• Generally only paying for tangible assets
unless large practice
• Post-transaction compensation is a key
assumption
• Generally involves ancillary service lines like
ASCs, imaging, or cancer centers
• Likelihood of cash distribution is a key driver
• Many are structured as pass-through entities
so this becomes an important component of
the valuation
Hospital
Acquisition of
Physician
Practices
Hospital/
Physician
Joint
Ventures

25. “Buy and Employ” Transactions
25
Typical Transaction:
• Hospital buys the practice at FMV
o Usually structured as an asset purchase
o Cash and AR normally excluded
o Net after-tax proceeds can be substantially
different depending upon the deal structure
“Buy and
Employ”
Transactions

26. “Buy and Employ” Transactions
26
• Physicians employed by the hospital
o Generally under some type of productivity-
based compensation arrangement
(wRVUs)
o Generally involves a period of guaranteed
compensation (assuming productivity does
not decline substantially)
o Often includes other types of arrangements
as well (e.g., co-management, call pay,
quality incentives, etc.)
“Buy and
Employ”
Transactions

27. Compensation and Regulatory Issues
27
• Post-transaction compensation structure factors in to the
practice valuation
­ Health systems cannot pay for a revenue stream twice – once
with the “purchase” and then on-going in the physician
compensation plan
• Fair market value and commercial reasonableness must
also be considered with regard to physician
compensation

28. RECENT REFORM INITIATIVES
28

29. Key Healthcare Reform Provisions
29

30. Key Healthcare Reform Provisions
30

31. Key Healthcare Reform Provisions
31

32. Hospital Readmission Penalties
32
Even more costly
•Negative perception in community
•Commercial insurance/employers
FY2013
1%
Reduction
2,200
hospitals
penalized
$280 million
FY2013
1%
Reduction
2,200
hospitals
penalized
$280 million
FY 2014
2%
Reduction
2,225
hospitals
penalized
$227 million
FY 2014
2%
Reduction
2,225
hospitals
penalized
$227 million
FY 2015
and
going
forward
3%
Reduction
FY 2015
and
going
forward
3%
Reduction

33. Physician Value Modifier –
2017 Quality Tiering
33
Low Quality Average Quality High Quality
Low Cost 0.0% +2.0x* +4.0x*
Average Cost -2.0% 0.0% +2.0x*
High Cost -4.0% -2.0% 0.0%
*Eligible for an additional +1.0x if reporting clinical data for quality measures and
average beneficiary risk score in the top 25% of all beneficiary risk scores.
Based on 2015 Performance

34. 34

35. Contact Information
35
Carol Carden, CPA/ABV, ASA, CFE
Principal
(865) 673-0844 ext. 213
ccarden@pyapc.com
http://twitter.com/carolcardenpya