Zeroing in on the value drivers in healthcare: What’s
hot, what’s not, and what’s going to pot
Part 2 of 2 (View Part
1)
By Don Barbo, CPA/ABV, Hill Schwartz Spilker Keller, LLC
Carol Carden, CPA/ABV,
ValuePoint Consulting Group, LLC
Mark Dietrich, CPA/ABV, Dietrich & Wilson
Members of the Financial Consulting Group
Published in Shannon Pratt's Business Valuation Update, February
2006
Ability to exploit profitable ancillary technologies
Imaging
is generally paid for in two parts, a professional component for
physician interpretation of the image, and a technical (or facility
for hospitals) component for ownership of the equipment and provision
of the technologist, supplies and other overhead items. The growth
in high tech imaging utilization (see Exhibit 1) and profits has
been staggering in the last several years, leading to exceptional
profits for imaging facilities and providers who own such equipment.
With the decline in costs of lower-power Magnetic
Resonance Imaging (MRI) units to $1.0 million or less,
larger group practices of physicians, such as orthopedic
surgeons who are traditionally intense users,
have been able to acquire the machines for their own
practices. Used units are available at a lesser cost.
Assuming they read their own images, orthopedists
can retain both the professional (typically around 15
percent of the total) and technical components and
substantially enhance their incomes. Cardiology and
neurology practices have also pursued this strategy.
Analysts need to study carefully the sources of income
when undertaking a valuation.
MRI and CT Scanning have led the way in unit
volume increases, notably in the Medicare population.
This has caught the attention of the Medicare Payment
Advisory Commission (MedPAC), however. In
its March 2005 annual report, MedPAC advised Congress
to “reduce the technical component payment for
multiple imaging services performed on contiguous
body parts.” This suggested that there was likely to be
a government crackdown on payments in the foreseeable
future—something analysts should not lose sight
of when forecasting future cashflows.
And, in fact, in the Proposed Rule published in the
Federal Register on August 8, 2005 for 2006 provider
reimbursement under Medicare Part B, the Centers
for Medicare and Medicaid (CMS) proposed radical
changes consistent with the MedPAC recommendation.
In the authors’ view, any valuation done after the
March 2005 publication of the MedPAC report should
have reflected the increased risk associated with the
uncertainty such a change would be adopted. Exhibit
2 shows the projected reduction in payments for various
modalities from the Proposed Rule. The Final Rule
issued November 2, 2005 phases in these changes
over two years, with the first half effective January 1,
2006 and the remainder in 2007.
Click image for larger view
The chart in Exhibit 3 looks at the price performance
of Alliance Imaging, Inc. following the March
MedPAC report and the August 8 preliminary rule.
Alliance is a public company with “465 diagnostic
imaging systems, including 352 MRI systems and
57 PET or PET/CT systems [that] served over 1,000
clients in 43 states at June 30, 2005. Of these 465
diagnostic imaging systems, 62 were located in fixedsites,
which constitute systems installed in hospitals or
other buildings on hospital campuses, medical groups’
offices or medical buildings, and retail sites. Of these
fixed-sites, 55 systems and 3 systems were included in [the company’s]
MRI and PET or PET/CT systems
count” as described in its most recent 10-Q.
Click image for larger view
Factors besides Medicare reimbursement may
contribute to the stock’s price movement, of course,
but it was not until July, when knowledge of the
impending CMS announcement may have leaked,
that a significant decline occured, despite the March
MedPAC recommendation and well-known concerns
stretching back years about the rapid growth in imaging
utilization. This suggests that market price may
lag reasonably foreseeable events.
PET (Positron Emission Tomography) scanners,
which utilize anti-matter electrons, have also been
multiplying—and MedPAC has taken note of this as
well, recommending that PET (as well as nuclear
medicine) be covered by the Ethics in Patient Referrals
Act, or Stark law: a recommendation included by
CMS in the aforementioned November 2 Final Rule,
with an effective date of January 1, 2007. This will
basically preclude providers (physicians) from referring
patients to PET Scanners in which they have
a broadly defined “financial interest,” and follows a
21 percent cut in Medicare reimbursement effective
January 1, 2005.
PET was one of the rare technologies not covered
by Stark, which accounts in large part for the rapid
growth in such scanners. The addition of PET to Stark
will also require divestiture by any physicians owning interests in equipment
to which they refer patients—or
the termination of such referrals. This will surely have
a significant impact on the value of such facilities.`
More importantly, MedPAC recommended that
Stark be expanded to cover physicians or entities
that own or provide equipment and services used
in imaging centers. This might eliminate “per click”
lease arrangements that have become increasingly
problematic and potentially abusive in the eyes of the
government.
Noncompete agreements
The authors continue to see significant activity in
the area of payments for noncompetes. Noncompetes
typically originate at the time of a transaction to protect
the transfer of intangible assets from subsequent
competition by the seller, or at the time of employment
to protect intangible assets of the employer from
subsequent competition by an employee. Additional
noncompete payments subsequent to the relationship
seem more problematic, particularly if a noncompete
provision was included in the original agreement.
Due to the risk that such payments could be construed
as a violation of the federal Anti-Kickback Statute
(AKS) (1) if not consistent with fair
market value and not paid in connection with referrals, analysts should
consider the circumstances of such payments carefully.
For example, the law in some states considers
continued employment to be adequate compensation
for a requirement not to compete; a noncompete
may be unenforceable in other states. (This raises
the question: What is the value of an unenforceable
agreement?) Payment of an additional amount for
a noncompete in these circumstances, in excess of
fair market value for employment services, may be
problematic.
Another common occurrence is a relationship
between a hospital or healthcare facility and a physician
group that provides services as an independent
contractor. The facility entity may seek to provide
additional compensation to physicians to induce
them not to provide services at competing facilities.
Although not controlling for AKS purposes, the Stark
regulations Phase I defi nition of fair market value offers
some invaluable insight to the analyst:
Usually the fair market price is the price at which bona
fi de sales have been consummated for assets of like
type, quality, and quantity in a particular market at
the time of acquisition, or the compensation that has
been included in bona fi de service agreements with
comparable terms at the time of the agreement. (2)
This suggests that unless other independent
contractor service agreements in the target market
include a separate payment for a noncompete, it may
be problematic. The government’s concern in such
a case is that the additional noncompete payment
may be a disguised payment for referrals as it could
induce the physicians to utilize the facility of the payor
as opposed to some competing facility; this is problematic
for medical director positions for ambulatory
surgery facilities, nursing homes, dialysis facilities
and cath labs. Another spin on the noncompete provision
is paying a physician(s) participating in a joint
venture with a hospital for the fair market value of the
noncompete, so as to reduce the capital investment
required of the physicians in the joint venture. Again,
the Stark defi nition quoted above offers the analyst
critical insight.
Alternatively, if the physicians are simply (nonreferring)
radiologists reading fi lms, for example, the
noncompete payment would be designed to induce
them to remain in place, presumably because of a
heightened likelihood that referring physicians would
continue to send cases to the facility and those radiologists.
Analysts need to review these type of arrangements
in the context of the general requirements
of fair market value.
Bear in mind that the Medicare Part B (or physician)
fee schedule splits the fee for imaging into professional
and technical components. Analysts should
check not only for the presence of noncompete
agreements with additional consideration in the target
market area, but also compare actual compensation
paid to the professional component received for the
images interpreted. It may be ordinary in multi-modality
settings for the high-income modalities such
as MR Magnetic Resonance Imaging to subsidize
the professional component for modalities such as conventional mammography
(as opposed to digital
mammography) because of poor reimbursement, but
the extent of the subsidy bears evaluation.
NOT SO HOT
Dialysis Clinics
Dialysis clinics are still an excellent source of ancillary
revenue and cashflow. This is particularly true
if: 1) the facility is located in a geographic area with
favorable demographics; and 2) if the facility has the
support of the nephrologists in the community.
Medicare is typically the largest single payor for
dialysis services, many times as much as 75 percent
of patient volume. This concentration results primarily
from the fact that renal failure frequently occurs later
in life (over the age of 50), and the fact that younger
patients, after facing renal failure for 30 months, become
eligible for Medicare as an End Stage Renal
Disease (ESRD) patient.
Medicare typically reimburses a per visit amount for
dialysis treatment. Additionally, there are significant
drug costs associated with dialysis services. These
drugs are primarily pharmaceutical agents that prevent
drug clotting as a result of the dialysis treatments.
Medicare reimburses for this type of drug through a
cost reimbursement mechanism. As a result, many
clinics are at least made whole on this significant
expense item.
The nation’s largest dialysis providers are coming
under increased scrutiny regarding how they have
billed and collected reimbursement from the Medicare
program. In December 2004, Gambro, the third largest
provider of dialysis services in the U.S., agreed
to pay a $310.5 million civil penalty and an additional
$15 million to settle potential claims of billing fraud in
several states. In August 2005, Renal Care Group
received a subpoena from the U.S. Attorney’s office
in St. Louis (the same office responsible for the
Gambro investigation) requesting documents dating
back to 1996.
There is speculation that this segment of healthcare
may be a target for billing fraud investigation for some
time to come as the U.S. Attorney’s office capitalizes
on information they learned about the industry during
the Gambro investigation. Therefore, it will be important
to gain an understanding of billing processes and
controls when valuing any dialysis provider.
This segment of healthcare has seen extensive
Zeroing in consolidation. Most healthcare ownership and delivery
is very fragmented, whereas the dialysis clinic industry
is well-consolidated and continues to move in that
direction. Take, for example, the recently announced
acquisition of Renal Care Group by Fresenius Medical
Services. Fresenius, a German company, originally
entered the U.S. market with the acquisition of National
Medical Care, at the time the largest dialysis
provider in the country. Renal Care Group and Fresenius
were both clearly in the top five providers of
dialysis services in the country. In addition, Davida,
Inc., another public dialysis company, is currently in
the process of acquiring Gambro. As of today, three
companies control more than 75 percent of the delivery
of dialysis services in the United States. As a
result, analysts need to seriously consider market
share in a given geographic area before reaching a
valuation conclusion.
Obviously, this type of concentration poses significant
challenges for a local clinic trying to compete successfully.
One of the positive aspects of operating a
profitable and, therefore, valuable dialysis clinic is that
by securing the support of a significant nephrology
practice, owners can compete with the big players.
However, they can expect larger providers to make a play for the support
of their nephrology group if the
clinic is located in an attractive market. The large providers
will generally have better economies of scale in
operations and will typically have stronger insurance
contracts as they can contract on a national basis.
The analyst should also review any medical director
and similar agreements between the dialysis center
operator and key nephrologist referral sources to see
if they meet a fair market standard.
NOT HOT
Buy-ins to medical practices in limited-supply specialties
Reversing the temporary trend in the mid-1990s,
which was driven by primary care and multi-specialty
practice acquisitions by Physician Practice Management
Companies (PPMC) bent on pursuing capitation
or ancillary technology opportunities, specialists are back in control
of the healthcare dollar. On the surface,
one would conclude that these higher incomes lead to
higher practice values. In fact, the increase in demand
for services and physicians in many specialties has
led to a buyer’s market for many physicians exiting
residency programs. This is one critical reason that
historical averages from such sources as the Goodwill
Registry is of limited use.
Data on annual recruiting engagements from such
firms as Merritt Hawkins and Delta Medical indicates
that the specialties in highest demand include orthopedic
surgery, gastroenterology, dermatology, interventional
and general radiology, and interventional
cardiology. Hospitals or existing practices looking to
recruit such physicians typically find the starting salary
very high and the structure of a future buy-in on
the table from the outset.
It is not uncommon for a well-informed physician
exiting residency to base his or her employment decision
on competing buy-in opportunities—and the
lower the better. For example, orthopedic surgeons
are often looking for practices with Ambulatory Surgery
Centers (see discussion of ASCs, above), which
offer significantly enhanced incomes and better working
conditions; and the buy-in opportunity has to be
affordable.
Primary care physicians in Internal Medicine and
Family Practice are also in high demand, bucking
the specialist trend, making it difficult or impossible
in many markets to sell an interest in a practice at a
significant price. Some speculate that the shortage
of specialists is driving the demand for Internists and
Family Practitioners, who may provide higher-level
adult medical care when specialists like cardiologists
are not available.
Conclusion
The healthcare industry and its numerous sectors
represent one market where historical data is nothing
more than yesterday’s news. The reimbursement
market is volatile and dynamic, subject not only to the
normal rigors of the free enterprise system, but also
to constant interference from government regulators
and political forces. In addition to taking into account
the factors detailed in this article, valuation analysts
working in healthcare should monitor the progress of
the Medicare Prescription Drug Benefit, which is effective
in 2006 and promises to place severe strains
on an already bloated budget for healthcare.
(1) Anti-kickback Statute Section 1128B(b)
of the Social Security Act.
(2) Stark Regulations, Part II, Phase
I, Federal Register January 4, 2001 42 CFR Parts 411 and 424.
Stark Regulations, Part II, Phase II, Federal Register March
26, 2004 42 CFR Parts 411 and 424. (Emphasis added)
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