Fundamentals of Healthcare Valuation

March 10, 2015
Fundamentals of Healthcare Valuation
Fundamentals of Healthcare
Valuation
March 10, 2015
Kathryn A. Culver, CPA

March 10, 2015
Agenda
Valuation Overview
Healthcare Valuation Approaches
Healthcare Valuation Considerations and Trends

March 10, 2015
Valuation Overview

March 10, 2015
Overview
• What is value and what is a valuation?
• Why is a valuation performed?
• How does one perform a valuation?
 Approaches
 Standards of value
 Premise of value
 Assessment of risk

March 10, 2015
What is Value and
What is a Valuation?
• What is value?
 The amount of money that something is worth. The price or
cost of something.1
• What is valuation?
 An independent, unbiased opinion of value for businesses
and business interests of all sizes.
1 Merriam-Webster Dictionary

March 10, 2015
Why is a Valuation Performed?
Mergers and acquisitions
Divestitures
Joint ventures
Estate and/or gift planning
Regulatory compliance purposes
Dispute-related valuation services
Tax-related valuation services
Divorce
Lost profits analyses
Buy-sell agreements

March 10, 2015
How does one value a business?
• Typical Business Valuation Approaches
– Cost / Asset Approach1
o Net asset value method
– Income Approach2
o Discounted cash flow method
o Single period capitalization
– Market Approach
o Guideline public company method
o Guideline transactional / mergers-and-acquisition method
1 The entity is not necessarily assumed to be a going-concern.
2 Assumes the entity is a going-concern.

March 10, 2015
Cost / Asset Approach
• Based on the principle of substitution
– Cost to replace
• Usually involves separate valuation of each item on the
balance sheet
– Adjust tangible assets, intangible assets, and liabilities to their
market values

March 10, 2015
Income Approach
• Present value of all future benefits
– Direct correlation between the amount of income a property will
earn and its value
• Requires:
– Projection of future income stream
– Determination of an appropriate discount rate (or cost of capital)
• Market risk
• Size risk
• Company-specific risk
• Industry risk

March 10, 2015
Market Approach
• Also based on the principle of substitution
– Prudent buyer will pay no more for a property than it would cost to
acquire a substitute property with the same utility
• Compare subject property to similar properties that have
recently sold
• Use of guideline company transaction data to develop market-
based multiples
– Publicly traded companies
– Acquired / merged companies
– Prior transactions in company’s stock

March 10, 2015
Standards of Value
• Intrinsic Value
• Investment value (synergy)
• Fair value
• Fair market value

March 10, 2015
Fair Market Value
• Hypothetical willing buyer
• Hypothetical willing seller
• Reasonable knowledge of the relevant facts by both
parties
• Neither party is under compulsion to buy or sell
• Arm’s-length transaction in an open and unrestricted
market
• Presumed ownership transfer as of a specific date

March 10, 2015
Healthcare Valuation
• Why is Valuation Important for the
Healthcare Industry?
• Reasons for Healthcare Valuation
• Key Regulations
• Fair Market Value in Healthcare
Valuation

March 10, 2015
Understanding the Context
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

March 10, 2015
Approaches

March 10, 2015
Mechanics of the Asset Approach
• Derives an indication of value based on the anticipated cost
to replace, replicate, or recreate the asset
• Often considered a “floor” value
• Used when company is not profitable enough to result in a
value greater than tangible assets
• 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
• Net Asset Value Method
Asset Approach

March 10, 2015
Mechanics of the Asset Approach
Can be complicated as many
smaller healthcare companies
are on a cash basis
Very common for many working
capital assets to be excluded,
so important to understand the
terms of the acquisition
Asset Approach

March 10, 2015
Mechanics of the Income Approach
• Based on the entity’s earning power (i.e., ability to generate
positive cash flow in excess of the physician’s fair market
value compensation).
• Used most frequently for healthcare companies
• Critical to appropriately project cash flows and assess risk
• This approach is not without regulatory risk
• Primary methods include:
 Discounted Cash Flow Method
 Capitalized Income Method
Income Approach

March 10, 2015
Discounted Cash Flow
(DCF) Method
• Value is based on the entity’s projected net cash
flows discounted to present value
• Requires projections of revenues, expenses, capital
expenditures, etc.
• Risk of the cash flows is factored into the discount
rate
• Typically are used for large practices with substantial
ancillary revenue and/or mid-level providers

March 10, 2015
Capitalized Income Method
• Relies upon a single period earnings stream as a
proxy for future years (as opposed to projections)
• Value is determined by capitalizing the earnings
stream
• Generally difficult to use for physician practices –
past is not always a reliable indication of the future
for most practices

March 10, 2015
…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.
Which Method is Appropriate?
IT DEPENDS…
If the
Practice…

March 10, 2015
Mechanics of the Market Approach
Market Approach
• Determines an indication of value-based multiples derived from similar
businesses/interests that have been bought/sold
• 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

March 10, 2015
Considerations and Trends

March 10, 2015
Hospital/Physician
Alignment Transactions
#
• Hospitals and physicians are actively
seeking ways to strategically and
financially align themselves.
• Successful alignment transactions can
result in substantial benefits to all parties
including patients.
– Improved efficiencies and quality of care
– Reduce costs and waste
– Better bargaining power with third-party
payers

March 10, 2015
“Buy and Employ” Transactions
• 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

March 10, 2015
“Buy and Employ” Transactions
– 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

March 10, 2015
FMV Compensation
• Required for any transactions in which a financial
relationship exists between parties with the ability to refer
patients
• Not very prescriptive
– Use of multiple, objective compensation surveys
– Attributed clinical compensation rates for clinical services and
administrative compensation rates for administrative duties
• Relationship with commercial reasonableness (to be
discussed later)

March 10, 2015
Compensation and Regulatory Issues
• Post-transaction compensation structure factors into 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
(addressed hereafter) must also be considered with
regard to physician compensation

March 10, 2015
Fair Market Value Appraisals
• Physician Compensation
– Employment
– Call Coverage
– Medical Directorship
– Hospital-Based Services
Financial Assistance
– Professional Services
Arrangements
– Clinical Research
– Consulting Services
• Management Agreements
• Clinical Co-Management
Agreements
• Shared Savings
Arrangements
• Employee Leasing
Arrangements

March 10, 2015
FAIR MARKET
VALUE
Compliance Issues Regarding
Hospital-Physician Financial Relationships
COMMERCIAL
REASONABLENESS
Overall
Arrangement
“WHY?”
SENSE CENTS
Range of
Dollars Only
“HOW
MUCH?”
Scope
Key Question

March 10, 2015
Commercial Reasonableness
• 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).

March 10, 2015
Factors in Determining CR
Business Purpose
Provider Analysis
Facility Analysis
Resource Analysis
Independence & Oversight
Commercial
Reasonableness
Determination

March 10, 2015
Contact Information
Kathryn A. Culver, CPA
kculver@pyapc.com
http://twitter.com/kculvercpa
http://www.linkedin.com/in/kculvercpa
Pershing Yoakley & Associates, P.C.
865-673-0844
www.pyapc.com
http://twitter.com/pya_pyahc
http://www.linkedin.com/company/84085
ATLANTA | NASHVILLE | KANSAS CITY | KNOXVILLE | TAMPA

Fundamentals of Healthcare Valuation

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