Fair Market Value Issues in Converting Ancillaries to

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Fair Market Value Issues in Converting Ancillaries to

  1. 1. Fair Market Value Issues in Converting Ancillaries to Free-Standing Joint Ventures Curtis Bernstein, CPA/ABV, CVA, MBA January 27, 2009 HFMA Region 11 Healthcare Symposium
  2. 2.  Standard of Value  Valuation Approaches  Secondary Adjustments  Applications to ancillary services including:  Ambulatory Surgery  Cancer Care  Diagnostic Imaging January 27, 2009 HFMA Region 11 Healthcare Symposium Outline of Presentation
  3. 3. January 27, 2009 Standard of Value  Per AICPA Statement on Standards for Valuation Services (SSVS No. 1):  “The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”  Stark II (CMS) definition:  “…the price that an asset would bring, as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party…” HFMA Region 11 Healthcare Symposium
  4. 4. January 27, 2009 Scope Definition Conclusion of Value Information Considered Procedures Performed to Collect and Analyze data Valuation Approaches (Cost, Market, Income) APPRAISAL Single Amount or Range ALL Relevant Information Available APPROPRIATE Procedures to ALL Relevant Information ALL Relevant Approaches LIMITED APPRAISAL Single Amount or Range LIMITED Relevant Information LIMITED Procedures to NECESSARY Information MOST APPROPRIATE Approach(es) as Determined by Appraiser CALCULATION OF VALUE Single Amount or Range ONLY LIMITED Relevant Information LIMITED Procedures AGREED UPON with Client Engagement Planning HFMA Region 11 Healthcare Symposium
  5. 5. January 27, 2009 Appraisal Scope of Work  Intended use  Complexity of subject arrangement or transaction  Regulatory compliance considerations  Best Practice: The greater the need to be certain about FMV, the higher the scope level HFMA Region 11 Healthcare Symposium
  6. 6. January 27, 2009 Valuation Approaches  Asset Approach – Restate book value of assets and liabilities to Fair Market Value; consider intangibles not otherwise recorded (e.g. work force, CON, etc.); establishes a “floor” of value; not typically relevant for profitable, going-concern entities  Market Approach – Determine value of subject business based upon comparable public company multiples and/or sales of private businesses; while most “intuitive”, comparable data often difficult to identify. Use of market multiples (e.g. multiples of EBITDA) is typically difficult to utilize as primary valuation approach.  Income Approach – Determine value of subject business based upon present value of a future economic benefit stream; one methodology, Discounted Cash Flow, is commonly utilized in BV. HFMA Region 11 Healthcare Symposium
  7. 7. January 27, 2009 Profitable Stable Earnings Unprofitable Going Concern Risk Profitable Trending Earnings Income approach Discounted Cash Flow Income approach Capitalization of earnings Depending upon standard of value, apply discounts Asset approach Compare value to market transactions Adjust for atypical working capital Use asset approach to establish floor of value Valuation Approaches HFMA Region 11 Healthcare Symposium
  8. 8. January 27, 2009  The Asset-Based Approach is premised upon the idea that the value of a business or business interest can be determined with reference to the underlying assets owned by the business.  Typically this is approach is most appropriate for asset- holding companies or for distressed companies with marginal profitability.  Generally considered a floor of value. Asset Approach HFMA Region 11 Healthcare Symposium
  9. 9. January 27, 2009  The Market Approach is premised upon the idea that the value of a business or business entity can be reasonably determined with reference to the prices paid at arms- length for similar interests in the open and unrestricted market.  According to Revenue Ruling 59-60, this approach may yield the best indication of fair market value of a closely held asset.  Care must be taken to ensure that the companies used for comparative purposes are truly comparable to the subject interest. When an insufficient number of comparable companies can not be found, or if the companies are only loosely comparable to the subject entity, this approach should be excluded. Market Approach HFMA Region 11 Healthcare Symposium
  10. 10. January 27, 2009  The Income Approach is premised upon the idea that the value of any business or business interest can be valued with reference to the future economic benefits expected to accrue to the owner of that interest.  These future economic benefits are discounted to their present value using a rate of return commensurate with the risk of the investment. Income Approach HFMA Region 11 Healthcare Symposium
  11. 11. January 27, 2009  Starts with projection prepared by either client or by valuator with client’s significant involvement  Projected for a period in which cash flow is not “stable” to the period in which cash flow stabilizes.  5-year projection is commonly used because 5 years represents a business cycle in most industries. Income Approach - Projection HFMA Region 11 Healthcare Symposium
  12. 12. January 27, 2009  Capitalization of Earnings Method  Cash flows are stable and will grow at a constant rate into perpetuity.  Discounted Cash Flow Method  Cash flows are changing.  Project until cash flows stabilize. Income Approach - Methods HFMA Region 11 Healthcare Symposium
  13. 13. January 27, 2009  Discount cash flows back to present value based on the risk of the investment  Discount rate also called cost of equity or weighted average cost of capital Starts with return on large publicly traded stocks at 10%. Add increased risk for size (not as big or diversified at GE). Subtract risk for industry (healthcare a safer investment than technology). Add company-specific risk not factored above. Income Approach – Discount Rate HFMA Region 11 Healthcare Symposium
  14. 14. January 27, 2009  Generally in the range of 4% to 10%  Given factors:  Limited market – generally focused on local area  Individual factors:  Limited experience at management level  Less checks and balances  Key man factor  Heavy reliance on a single customer Income Approach Company-Specific Risk HFMA Region 11 Healthcare Symposium
  15. 15. January 27, 2009  Theory – if I want to receive X amount annually, how much money must I invest today at Y percent?  X is the projected cash flow stream  Y is the discount rate  The higher the discount rate, the lower the value  The lower the projected cash flows, the lower the value Income Approach - Present Value Formula HFMA Region 11 Healthcare Symposium
  16. 16. January 27, 2009  Discount for lack of control  An adjustment made to reflect the fact that, all things being equal, investors prefer to have control over their investments.  A minority interest holder in a closely-held business does not have the same rights and privileges as a controlling interest holder, and will therefore demand a discount to the otherwise pro-rata value of his or her interest.  Because shares of publicly held corporations trade at minority interest values, price premiums paid in controlling interest acquisitions are easily observable.  Over time, these premiums have averaged 30 to 50% in most industries.  Most appraisers consider the inverse of the control premium a reasonable proxy for the discount for lack of control.  Discount for lack of marketability / liquidity  An adjustment necessary to reflect the simple fact that unlike shares in publicly held corporations, there exists no ready market for the shares of closely held businesses.  The empirical studies indicate marketability discounts ranging from 30% to 50% for minority interests, the discount applicable to controlling interests should be considerably less.  No empirical studies for controlling interests exist but the courts have generally found discounts ranging from 0% to 30% are appropriate.  Block specific  Market specific Discounts HFMA Region 11 Healthcare Symposium
  17. 17. VALUATION PROCESS January 27, 2009 HFMA Region 11 Healthcare Symposium
  18. 18. January 27, 2009  Operating Agreements  Control Provisions  Non-compete agreements  Limitations on ownership  Restrictions on transfer  Financial Statements  Historical earnings and distributions (not always a predictor of the future)  Non-recurring revenues and expenses (e.g., ALJ Hearing)  Non-operating revenues, expenses, assets, and liabilities (e.g., excess or deficient working capital, rent in excess of market value) Data Collection HFMA Region 11 Healthcare Symposium
  19. 19. January 27, 2009  Billing and Collection Reports  Change in net revenue per case by payor over time Also reviewed in relation to case mix  Change in collections as a percent of charges over time Reviewed to determine if charges have increase, reimbursements have increased without charges keeping pace, or center experienced a one-time large collection  Change in case mix and reimbursement by case for each specialty over time  Utilization Reports  Reviewed to determine physician practice patterns (e.g., if a physician is near retirement, if a physician is ramping up) Data Collection HFMA Region 11 Healthcare Symposium
  20. 20. January 27, 2009  Projection  Generally preferred that provided by client  Other data collected (and notes from site visit) used to test veracity of projection (or create projection) Data Collection HFMA Region 11 Healthcare Symposium
  21. 21. January 27, 2009  Meetings with administration from center and health system (if have any ownership)  Include medical director and any other physicians on governing board if available  Discuss financial statements and operations  Review data received  Discuss local market in relation to competition, reimbursement, demographics, etc.  Discuss future goals and plans to meet goals  Review patient flow through center Site Visit HFMA Region 11 Healthcare Symposium
  22. 22. Revenue and Expenses of Certain Ancillary Services Surgery Centers January 27, 2009 HFMA Region 11 Healthcare Symposium
  23. 23. January 27, 2009 CPT CODE DESCRIPTOR 2008 OPPS PAYMENT 2008 FULLY IMPLEMENTED ASC PAYMENT 2009 OPPS PAYMENT 2009 FULLY IMPLEMENTED ASC PAYMENT 66984 Remove Cataract $1,453 $977 $1,520 45378 Diagnostic Colonoscopy $539 $426 $564 62311 Inject Spine $391 $323 $449 52000 Cystoscopy $399 $312 $380 64721 Carpal Tunnel Surgery $1,097 $521 $1,150 Comparison of Surgery Medicare Reimbursement Source: Centers for Medicare and Medicaid Services (CMS) HFMA Region 11 Healthcare Symposium
  24. 24. January 27, 2009  Medicare added 819 procedures as approved for performance in a freestanding ASC in 2008 and 27 in 2009.  ASCs were paid 65% of Hospital OPPS transitioned over four year: 2008 to 2011.  For 365 “procedures performed frequently in physicians’ offices”, ASCs are paid the lesser of 65% of HOPPS of the Medicare standard physicians’ practice schedule.  For 2009, proposed that ASCs are paid 59% of HOPPS.  Result of 3.6% annual inflation for HOPPS but no inflation adjustment for ASCs.  Valuation issue: Valuator must confirm that all procedures can be performed in a freestanding setting and that reimbursement is adjusted and projected under current reimbursement methodology. Ambulatory Surgery: Medicare Reimbursement HFMA Region 11 Healthcare Symposium
  25. 25. January 27, 2009 HealthCare Appraisers Valuation Survey HFMA Region 11 Healthcare Symposium
  26. 26. January 27, 2009  Using data from data collection and site visit to apply market approach  Per HAI survey, purchasers in ASC market:  Value potential acquisitions based on earnings before interest, taxes, depreciation, and amortization (EBITDA) less interest- bearing debt  Value based on trailing 12 months earnings  Multiple is effected by certificate of need, hospital involvement, and out-of-network contracting strategy  Higher multiples for opportunities for growth, nature of specialties, and extent of physician ownership HealthCare Appraisers Valuation Survey HFMA Region 11 Healthcare Symposium
  27. 27. Revenue and Expenses of Certain Ancillary Services January 27, 2009 Cancer Centers HFMA Region 11 Healthcare Symposium
  28. 28. January 27, 2009 Projected Number of Cancer Cases By Age Group Source: American Cancer Society HFMA Region 11 Healthcare Symposium
  29. 29. 3D-CRT Payment per Physician January 27, 2009 Source: Centers for Medicare and Medicaid Services (CMS) HFMA Region 11 Healthcare Symposium
  30. 30. January 27, 2009 Rad Onc 1 % Rad Onc 2 % Rad Onc 3 % Rad Onc 4 % Net Revenue $5,680,334 100.0% $2,603,124 100.0% $834,415 100.0% $3,432,645 100.0% Salaries 1,485,432 26.2% 674,246 25.9% 309,254 37.1% 1,062,284 30.9% Benefits 353,458 6.2% 210,388 8.1% 75,928 9.1% 82,911 2.4% Medical Supplies 192,821 3.4% 8,887 0.3% 23,098 2.8% 37,453 1.1% Other Supplies 55,270 1.0% 9,062 0.3% 4,438 0.5% 14,485 0.4% Other Expenses 415,295 7.3% 124,047 4.8% 229,291 27.5% 1,519,463 44.3% Total Operating Expenses 2,502,276 44.1% 1,026,630 39.4% 642,009 76.9% 2,716,596 79.1% Average % Median % Net Revenue $3,137,630 100.0% $3,017,885 100.0% Salaries 882,804 28.1% $868,265 28.8% Benefits 180,671 5.8% $146,650 4.9% Medical Supplies 65,565 2.1% $30,276 1.0% Other Supplies 20,814 0.7% $11,774 0.4% Other Expenses 572,024 18.2% $322,293 10.7% Total Operating Expenses 1,721,878 54.9% $1,764,453 58.5%  Valuation Issue: Valuator must make sure allocation of overhead is appropriate in a freestanding setting. Allocation of Overhead HFMA Region 11 Healthcare Symposium
  31. 31. January 27, 2009 Revenue and Expenses of Certain Ancillary Services Imaging Centers HFMA Region 11 Healthcare Symposium
  32. 32.  Deficit Reduction Act of 2005:  Capped reimbursement for diagnostic imaging procedures at HOPPS  Reduced payment for multiple scans from 75% to 50% Modality Percent Impact CT -9.4% CTA -36.7% MRI -35.2% MRA -25.1% US -8.5% Nuclear Medicine -3.8% January 27, 2009 Diagnostic Imaging Reimbursement Source: National Average per American College of Radiology HFMA Region 11 Healthcare Symposium
  33. 33. January 27, 2009 HFMA Region 11 Healthcare Symposium 858 Happy Canyon Road, Suite 240 Castle Rock, Colorado 80108 303-688-0700 www.HealthCareAppraisers.com Curtis Bernstein, CPA/ABV, CVA, MBA cbernstein@hcfmv.com

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