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Q1 of 2012 was unusual in that everybody was talking about the future of healthcare. The Supreme Court heard arguments for and against the Patient Protection and Affordable Care Act (ACA) and pundits of all types weighed in on the implications of those arguments. The conventional wisdom before the hearings was that, although it would be a rigorous academic exercise, the law would probably be upheld. Many observers were surprised by the court’s aggressive questioning and now many are saying they won’t be surprised if at least some elements are overturned. The central issue for the court is whether it is unconstitutional for the government to require individuals to buy health insurance in order to ensure that the interstate market for health insurance is functional. This always seemed like a red herring to us because Congress could simply restructure the law to avoid any issues of constitutionality if the political will existed to do so. Since the Democrats have adopted many of the Republicans’ core ideas regarding healthcare reform (not least of which is the individual mandate) but the Republicans still refuse to cooperate to implement any policy, it’s clear that the stalemate is not constitutional nor is it policy related: it’s just politics exaggerated for the election year. The individual mandate doesn’t impact homecare providers directly, but without it many of the core elements of the law no longer make sense. A bigger issue for homecare providers that is under consideration by the Supreme Court is whether it’s coercive for the federal government to require the states to spend more money to increase enrollment in their Medicaid programs. Precedent would suggest that, although the states may not agree with federal policy, they are not required to participate in the Medicaid program and thus must submit to federal requirements if they want federal money. Although most of the attention went to the Supreme Court, annual budget proposals highlighted the two main partisan approaches to the evolution of healthcare reform. The Obama administration more or less proposes staying the course, preserving Medicare and Medicaid as entitlement programs and hoping that increased efficiency and decreased fraud will free up enough money to pay for it all. The other side of the argument was represented by House Budget Chairman Paul Ryan’s proposal to replace the current entitlement programs with block grants and vouchers to assist the elderly and infirmed to access care through private markets. Whichever philosophy one subscribes to, the fact is that we all must do more with less so providers who can deliver the best care with the greatest degree of efficiency will be best positioned to capitalize on changes in the marketplace. We are seeing two forces impacting the M&A market for healthcare service providers right now: first is the drive towards efficiency that attracts investors to the most efficient providers in the continuum of care, second is the political and regulatory uncertainty that scares investors and encourages them to wait on the sidelines until they can better predict the future. The result is that the primary actors in the market today are those who are already committed to the industry and have already mapped out a strategy to succeed no matter what happens in the policy arena. Medicare Medicare Certified home health providers continue to exist at the fulcrum of efficiency and patient coordination. Thus, they continue to gain importance within the continuum of care. None of the primary issues debated by the Supreme Court directly impact Medicare Certified home health providers, but if the law is determined to be non-severable then a finding of unconstitutionality for the individual mandate could jeopardize the constitutional parts of the law that do impact Medicare Certified home health agencies. If the ACA is invalidated, providers may be relieved of the employer mandate to provide health insurance for all employees, but it’s likely that other provisions such as bundling services and creating ACOs will survive in another form, so the Supreme Court decision will probably not drastically change the course of evolution for this segment of the industry. Conversely, the budget debate has much more radical implications for the future. The Obama approach and the Ryan approach present two starkly different philosophies that voters have been considering for the last few elections. Most providers have become very comfortable with the philosophy of entitlements, but if Obama’s efficiency measures can’t cover the spiraling costs of growing programs then radical measures such as those proposed by Ryan will become very real options no matter who wins the next election. With the economic recovery teetering and austerity in the air, at least voters will have the privilege of supporting one direction or another. Either way, the home health industry’s critical role in reducing costs while improving outcomes makes providers attractive acquisition candidates no matter what happens with the Supreme Court or the budget. Although regulatory uncertainty has probably cooled the market temporarily as buyers and sellers wait to find out what happens with the Supreme Court and the election, we are seeing activity among those who are already committed to the industry and who want to be positioned for either a worst case or best case scenario. We’re seeing upward pressure at the top of the market and downward pressure at the bottom of the market as conditions continue to favor larger providers. At the top of the market, we’re definitely hearing from more buyers than sellers but inventory is scarce as any desirable acquisition candidates have a lot to gain from staying off the market and growing themselves as competition from smaller providers continues to weaken. Opportunities abound at the bottom of the market, especially in saturated markets where provider capacity has outstripped beneficiary growth and referral sources dry up as a consequence of consolidation and bundling. Prices at the top have been untested due to a lack of inventory, but at the other end of the spectrum prices seem to have bottomed at the replacement cost of starting from scratch, which hasn’t changed for years. More good news for smaller providers is that we’ve seen some small transactions that were financed by third parties, suggesting that lenders are starting to become more aggressive as the healthcare industry leads what little traction the economic recovery has displayed. As always, what few larger providers do choose to exit can command very respectable premiums and buyers are having no problem securing financing if necessary. Hospice All things considered, it’s been a pretty good quarter for hospice providers. The U-shaped billing model is still being discussed, but hospice providers are facing no new rate cuts and relatively little exposure to the Supreme Court decision. The disproportionate imbalance between supply and demand in the hospice segment combined with unparalleled growth prospects in a relatively favorable regulatory environment has lead many different types of providers to consider hospice as a desirable vehicle for diversification. Home Health Agencies and Skilled Nursing Facilities are probably the most complementary buyers, but we’ve noted interest in hospice from all points on the continuum of care and from financial as well as strategic investors. The rare hospice that does sell seems to fetch such a premium that Irving Levin and Associates warns of a possible bubble. Given the significant growth prospects and limited competition, we expect hospice transactions to continue to set the bar at a fairly high level. Medicaid Medicaid providers have found themselves in the center of the spotlight during the Supreme Court arguments and they have used the opportunity to draw attention to the central role they play in preventing acute episodes that cost so much and compromise the quality of life for so many people. The logic is undeniable: the more we spend on chronic care, the less we’ll need to spend on acute care. The only question is Who pays? The Obama administration has been so aggressive about shifting costs from the Medicare program to the Medicaid program that many states claim it’s coercive. Federal dollars are being used to pay for most of the transition, but eventually the states will be required to contribute a much greater share to care for a much larger eligible population, so the states are fighting to preserve as much flexibility as possible into the future. …and although the CLASS Act has been left for dead by many, it’s still on the books as a potentially new payer for assistance with the activities of daily living. Even without the ACA, Medicaid programs will grow significantly because of their importance to containing costs while preserving the quality of life for beneficiaries. Growth has been constrained because the sick economy hasn’t been able to generate the tax revenue necessary to pay for services. As the economy recovers, states will be in a better position to pay for services and providers should be able to take advantage of their position as the lowest cost alternative to support individuals with assistance with the activities of daily living. If the ACA is upheld, the organic growth of Medicaid will be further augmented. While the market waits for the economy to restore growth, providers are hunkering down and cutting costs to survive the lean times. Economies of scale are necessary, so successful operators are seeking acquisition candidates to help them spread their costs and increase their revenues. Smaller providers are faring the worst because they are least able to absorb rate cuts and compete effectively. We are seeing activity in states with stable legislative environments that have settled on rate cuts and eligibility requirements that efficient providers can live with. Private Duty The part of the ACA that private duty homecare providers object to most is the employer mandate. While not unconstitutional, the employer mandate would disproportionately hurt private duty providers because of the high use of low wage and part time employees. Where Medicaid providers may hope that severability protects them if the individual mandate is declared unconstitutional, private duty providers may hope that a lack of severability protects them if the individual mandate is declared unconstitutional. A bigger regulatory issue for private duty providers is the Department of Labor’s attempt to revoke the companionship exemption from the payment of overtime. This would result in some combination of increased cost and decreased services, potentially placing the most vulnerable at risk. Durable Medical Equipment What could the Supreme Court do to the DME industry that hasn’t been done already? DME providers are settling in for the long haul as hopes for the repeal of competitive bidding have faded. Providers have accepted that they need to adjust to lower margins and new models are being developed to deliver quality products and service at historically low prices. The second round of competitive bidding includes most major metropolitan areas, so a great deal of dust will be settling in the next few quarters. Providers are diversifying their payer mixes to survive if they don’t win the bid and negotiating new supply contracts to survive if they do. What few buyers are braving this segment are either looking for winners to invest in or losers to mop up. Conclusions In the first quarter of 2012, the forces of certainty and uncertainty were playing against each other to keep the market relatively calm. The market is certain that the necessity of efficiency places homecare of all types at the center of healthcare reform, but is uncertain about the political and regulatory environment. In one scenario, the Supreme Court upholds the ACA and President Obama and the Democrats carry the election, in another, the Supreme Court overturns the law and Mitt Romney and the Republicans carry the election: reality will probably be somewhere in between these extremes. While these two scenarios may have radically different implications for the future of healthcare delivery, either way, payers and policymakers will be relying on homecare providers to deliver the highest quality of care for the lowest cost. Many buyers are looking for opportunities to leverage the efficiencies of homecare, but aren’t necessarily finding candidates that warrant a transaction. Some sellers are skeptical of the market, focusing instead on preparing their businesses for whatever changes may occur to best position themselves for an exit in the future. The transactions that are closing are between knowledgeable parties who are executing strategies that make sense no matter what happens with the Supreme Court or the election. If you’d like to discuss how all of this affects you, feel free to contact us any time. We are always happy to discuss market conditions, valuations, and the process we undertake to effect a successful transaction. |
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