Healthcare Valuations in an Era of Reform and Uncertainty

#AICPAhealth

Healthcare Valuations in an Era

of Reform and Uncertainty

November 12, 2015

W. James Lloyd

Principal,

Pershing Yoakley & Associates, P.C.

American Institute of CPAs #AICPAhealth

Speaker Biography – W. James (Jim) Lloyd

Mr. Lloyd is a Principal with Pershing Yoakley & Associates (“PYA”), an

accounting and consulting firm specializing in the healthcare industry. He has

valued hundreds of entities and regularly advises clients in connection with

mergers and acquisitions, affiliation arrangements, and other types of

transactions.

He has substantial healthcare industry experience spanning a broad range of

medical service providers, managed care companies, pharmacies, and

pharmaceutical manufacturers, among others.

Mr. Lloyd also has substantial expert testimony experience in connection with a

wide range of disputes including antitrust, diminution of value, intellectual

property, lost profits, post and/or failed acquisition transactions, and

shareholder oppression matters.

In addition to being a Certified Public Accountant (“CPA”), Mr. Lloyd has

earned the following professional credentials: Accredited Senior Appraiser

(“ASA”), Accredited in Business Valuation (“ABV”), and Certified Fraud

Examiner (“CFE”).


Agenda

Reform and Current Environment Highlights

Healthcare Transactions and Affiliations

Valuation Considerations

Regulatory Issues

Questions


Healthcare Reform and Environment

Highlights

Significant consolidation activity across multiple segments

including providers and managed care companies.

Affiliation arrangements occurring at a torrid pace.

Growing whistleblower cases highlighting the significant

regulatory risks associated with hospital/physician

transactions.

Moving from “fee-for-service” to “risk-based” payment

models.

Significant pressure on revenue with rising operating and

capital costs.

Fiercely competitive in many markets.



Highlights

Bundled Payments for Care Improvement Initiative (BPCI)

• New CMS payment model that began in 2013. “Awardees” enter into

a contractual arrangement with CMS and assume financial liability for

clinical episodes of care. Episode Initiators trigger BPCI episodes of

care.

• Four broadly defined care models which bundle payments for multiple

services beneficiaries receive under an episode of care.

Hospital Value-Based Purchasing Program

• Hospital Inpatient VBP Program adjusts Medicare payments to

reward hospitals based on quality of care.

• Base DRG payments reduced by 1% starting in 2013 and increase to

2% by 2017.

• Payment reductions used to fund value-based incentive payments

based on performance. Total Performance Score is comprised of four

types of quality measures referred to as “domains:” 1) clinical process

of care, 2) patient experience, 3) outcomes, and 4) efficiency.



Highlights

Hospital Market Basket Update for FY 2016

• Hospitals that successfully participate in the Hospital Inpatient Quality

Reporting (“IQR”) Program and demonstrate meaningful use of EHR

technology can expect a .9% increase in IPPS rates for FY 2016;

whereas, hospitals that do not successfully participate in the IQR

Program will receive a one-fourth reduction in the market basket

update.

Disproportionate Share Hospital (DSH) Payments

• Medicare DSH payment methodology changed in 2014. Hospitals

now receive only 25% of the amount they would have previously

received under the statutory DSH formula. Remaining 75% is

aggregated nationally and distributed to hospitals based on their

relative share of total uncompensated care.

• CMS will be distributing an estimated $6.4 billion of uncompensated

care payments in FY 2016, which is a decrease of $1.2 billion from FY

2015.



Highlights

Hospital-Acquired Conditions

• HACs are reasonably preventable conditions that patients did not have

upon admission to the hospital.

• Performance measured by the hospital’s Total HAC Score.

• Hospitals that rank in the quartile with the highest Total HAC Score

(poorest performance) will receive 1% reduction in Medicare payments

starting in 2015.

Hospital Preventable Readmissions

• Reduces Medicare payments that would otherwise be made to

hospitals for preventable hospital readmissions.

• Readmission defined as within 30 days of discharge (certain

exceptions apply).

• Medicare readmission payment adjustments: FY 2013 = 1%, FY 2014

= 2%, 2015 and beyond = 3%.



Highlights


Favorable Neutral Unfavorable Unclear

Selected providerbusiness models

Potential impact of healthcare reformComments

Profitability Growth Risk Marketability

Primary Care Practices

ACO's and physician alignment; PPACA did not include physician payment formula fix

Specialty Care Practices

Recent reimbursement dollars shifting more to primary care services; strong acquisition activity in certain specialties (cardiology)

General Acute Care Hospitals

Cuts in reimbursement phased in at increasing rates began in 2011 and are expected to continue through 2019; increase in insureds

Rehab Hospitals

Cuts in reimbursement phased in at increasing rates began in 2011 and expected to continue through 2019; increase in insureds

Physician Owned Hospitals

No new hospitals allowed; limitations on future growth of established hospitals


Highlights


Selected providerbusiness models

Potential impact of healthcare reformComments

Profitability Growth Risk Marketability

ASCs

Reimbursement pressures expected to continue; May be required to submit cost data to CMS and participate in value-based payments; volume could increase; high transaction activity expected to continue over the next few years as market matures.

Imaging CentersReimbursement pressures may continue; volume could increase

Home Health Agencies

Large reimbursement cuts over 4 years beginning 2014; volumes expected to increase with more insureds; consolidation activity being observed

Hospice AgenciesReimbursement cuts began in 2013 and areexpected to continue through 2019; consolidation activity being observed

Favorable Neutral Unfavorable Unclear

Healthcare Reform and Environment Highlights


Most healthcare transactions today are very strategically

motivated. (e.g. larger hospitals acquiring or doing JVs with

smaller community hospitals as part of their outreach

initiatives).

Many smaller hospitals are under pressure to merge or

affiliate with a larger system due to lack of resources

needed to “go at it alone” and remain competitive.

Physicians concerned that lower reimbursement rates and

rising costs will result in reduced compensation if remain

independent.

Substantial consolidation occurring across several sectors

and private equity firms showing growing interest in

healthcare.




“… our exclusive local affiliation

with MD Anderson Cancer

Network ® strengthens the Saint

Francis Cancer Institute’s

commitment to providing

exceptional local cancer

care. Experts at MD Anderson

have developed disease-specific

guidelines for cancer treatment,

cancer prevention, early

detection and follow-up care that

allow MD Anderson Cancer

Network-certified physicians to

bring new hope and

knowledge to local cancer

patients.” MD Anderson

Trusted experts in the field


Healthcare Transactions and Affiliations -

M&A Activity

Source: Dealogic M&A StatShot


Healthcare Transactions and Affiliations –

Hospital M&A Activity

Source: Irving Levin Associates. The Health Care Services Acquisition

Report, Twentieth Edition, 2015

5272

90107

88100

80

125

156

244

296

178

0

50

100

150

200

250

300

350

2009 2010 2011 2012 2013 2014

Number of Deals

Number of Hospitals


Source: Irving Levin Associates. The Health Care Services Acquisition Report, Twentieth Edition, 2015.

0.73

0.60

0.68

0.55 0.56 0.57

0.40

0.50

0.60

0.70

0.80

Median Price to Revenue

9.9

8.3

10.1

7.9

9.2

7.2

5.0

6.0

7.0

8.0

9.0

10.0

11.0

Median Price to EBITDA

Healthcare Transactions and Affiliations –

Hospital Transaction Multiples



Non-M&A

Source: The Advisory Board



Non M&A

Vidant Health, Wake Forest Baptist

and WakeMed Health• Formed shared services operating

company in 2014

• Combines back-office operations and

some quality initiatives.

Duke Medicine • Duke LifePoint – 11 facilities in NC, VA & PA

• Cancer programs affiliations

• Heart program affiliations

• Hospital patient safety and quality affiliations

CVS/Caremark• Entered into clinical affiliations with nearly

60 major health systems to provide patient

care information including medication

adherence to relevant healthcare provider

to assist with chronic care management.

Mayo Clinic• Announced first affiliation in September

2011

• Since then approximately 30 health

systems have joined the network all over

the U.S.


Types of Affiliation Options



Valuation Considerations –

Clinical Affiliations

Example: affiliations between local hospitals and

organizations with nationally known brands such as MD

Anderson, Mayo Clinic, Cleveland Clinic, etc.

Substantial valuation issues such as the value of the

“brand” and possibly other intangible assets that will be

utilized by the joint venture.

Licensing fees can be expensive; therefore, cost/benefit

analysis typically required in connection with the decision

making process.





Valuation Considerations –

Regional Affiliations/Collaboratives

Example: Academic medical center enters into a cancer

center JV with rural community hospital.

Valuation issues will vary based on the terms of the

arrangement and deal structure.

“Brand values” commonly come into play with these

transactions as well.

Process for monitoring quality and protecting brand

value will be important.

Potential cannibalism is a common issue.

Other “services” types arrangements typically involved.











Navigating the

Regulatory Environment


Road100 m

Menu

STARK LAW

Prohibited self-referrals for Medicare

and Medicaid patients.

ANTI-KICKBACK STATUTE

Known and willful offers, payments, or

receipts for referrals. Particularly

important if a hospital is involved in the

transaction.

IRS-NFP REQUIREMENTS

IRC Section 501(c) 3 requirements.

Particularly important when valuing

joint venture transactions involving a

not-for-profit clinic or venture partner.

Navigating the Regulatory Environment


Fair Market

Value___________________________________________________________________

Cents___________________________________________________________________

Scope: Range of Dollars

Only

Key Question: “How Much?”

Commercial

Reasonableness___________________________________________________________________

Sense___________________________________________________________________

Scope: Overall Arrangement

Key Question: “Why?”

Two Key Compliance Issues



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 • 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).



Fair Market Value DefinitionIRS Definition1

• Fair market value (“FMV”) is defined as the amount at which property would change hands between a willing seller and a willing buyer when neither is under compulsion and both have reasonable knowledge of the relevant facts

OIG/Stark Definition2

• The value in arm’s-length transactions, consistent with the general market value

• 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, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement

1Estate Tax Reg. 20.2031.1-1(b); Revenue Ruling 59-60, 1959-1, C.B. 237.2Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules and Regulations.



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