Future Surgery Center Transaction & Acquisition Expectations: Q&A With Todd Mello of HealthCare Appraisers

Todd Mello on surgery centersCo-founder and Partner of HealthCare Appraisers Todd Mello discusses current surgery center acquisition expectations and the outlook for transaction trends in the future.

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Q: What are the most important expectations major acquirers have for ASCs?

Todd Mello:
It appears that consistent future growth is the most important expectation. Our 2013 ASC Valuation Survey indicates that 60 percent of ASC acquirers expect earnings to grow 3.1 percent to 6 percent per year while 40 percent of acquirers expect earnings to grow 9 percent or more per year after they buy an ASC. Acquirers typically expect to realize financial "upside" after the acquisition by making revenue cycle improvements, expense reductions, or by adding new surgeons. They look for potential improvements they can make during their due diligence process.

Clearly most major ASC management companies and health systems are subject to stringent capital planning and approvals processes to procure the funds needed for ASC acquisitions. The due diligence process for an ASC acquisition may be long and arduous, particularly if the ASC has not exhibited consistent growth during the years leading up to the sale. The acquirer's due diligence team has to concisely identify the risks and opportunities of investing in the ASC, while their capital planning committee has to compare numerous competing capital projects. The process may be longer for acquisitions involving large dollar amounts or acquisitions of distressed centers which may pose financial risks to the buyer.

It is also important to many buyers that physician owners stay vested in the ASC. Unless the ASC purchase is part of a related physician practice acquisition, the acquirers are going to probably expect most physicians to sell down rather than totally sell out. If physicians are being completely bought out, many buyers require the sellers to sign non-competes prohibiting the physicians from having a financial interest in another ASC for one to two years after they sell their shares. These non-competes typically preclude investment in competing ASCs within five miles.

Q: How can ASC physicians and administrators ensure they meet these expectations?

Clearly communicate your expectations for the continued use of your ASC by each of your major physician users and all users over 60 years old. ASC operators are very concerned about physician retirements and practice sales to hospitals. Many hospitals use physician employment agreements that restrict physicians from having ownership interests in ASCs. From an ASC's perspective, a practice sale to a hospital can be more problematic than physician retirements because hospital employment prohibits all physicians in a group from investing in the ASC. The retirement of a single physician can be easier to deal with because the retiring physician's partners are incentivized to absorb his or her case load. These concerns need to be addressed.

Similarly, if there have been irregularities in case volume, collections or expenses during the last several years, help the acquirer understand what was causing the irregularities and make some educated guess as to whether they were one-time events or fundamental changes that will continue.

Perhaps the most frustrating thing for an acquirer is to be told that an ASC will grow 5 percent to 10 percent per year when that has not been the recent trend, nor is there a clear plan for how such growth will be achieved. Be prepared to go through the case volumes for each physician as well as the reimbursement rates for each major type of case and payor.

Q: What issues might ASC leaders expect after a major acquisition?

Seller disengagement is a major concern for major ownership acquisitions. Buyers have to assess who they are buying from and who they are buying out. We have seen many hospitals buy100 percent ownership of a physician-owned ASC, only to have case volumes decrease immediately following the sale. Sellers should expect non-compete requirements whether they are being partially or wholly liquidated.

Seller disengagement is also a factor for distressed ASCs that have not been distributing cash flow for some time. In a distressed center, some physician investors may be more interested in recouping what they can of their original investment than participating in a long, possible turnaround. With respect to major ownership sales, physician sellers should expect a partial liquidation knowing that they will not be offered a total liquidation for several years.

If it is known that the ASC will procure financing for new equipment or facility improvements after the acquisition, all owners should expect that personal guarantees on such debt will probably be required on a pro rata basis. It is unlikely that a major ASC operator or a hospital will guarantee all an ASC's existing or future debts by itself.

Q: What opportunities do surgery center leaders have to make this transition smoothly?

After a long negotiation and due diligence process that may have lasted six months to a year or more, it is not uncommon for the buyers and sellers to have had some tenuous moments. In fact, many prospective acquisitions do not emerge from the due diligence process at all. During the sales process, capital approval committees or an acquirer's senior leadership may change the terms of their purchase agreement, modify their original offer price, ask for time extensions, request more information from the seller, or back out of the deal altogether. These challenges during the sale process can definitely affect the relationship of the parties after the sale is consummated.

If a sale is completed, sometimes buyers will seek small post-acquisition "wins" to gain rapport based on quick fixes they identified during due diligence. For instance, professional coding and meticulous billing of implantable devices and billable supplies can yield immediate collections benefits. Similarly, setting up direct deposit payment remittances with major payors can also create easy, one-time bumps in cash.

Q: Where do you see ASC acquisition trends heading in the future?

We expect to see more consolidation among national ASC chains as well as locally within communities. Many hospitals systems have established separate ambulatory surgery divisions to operate their ASCs like professional management companies.

The largest surge of new ASC openings was between 2003 and 2008 when over 2,000 new ASCs were Medicare certified. We have found that the typical ASC life cycle is nine to 12 years. We expect to see a healthy volume of acquisition activity as this swell of 2,000 ASCs ages and second generation operators buy many of these ASCs between now and 2020.

Major medical equipment usually needs to be replaced every 10 years too, so we expect many of those ASC owners will be taking a hard look at their risk profile when considering with major purchases. ASC owners who have experienced decreasing volumes or revenues may seek ownership changes as an alternative to debt financing for major equipment replacements.

More Articles on Surgery Centers:

5 Key Technologies for Efficiency & Profitability at Surgery Centers

10 Common Reasons Top ASC Procedures are Unexpectedly Denied
5 Ways to Boost Profits at Cash-Strapped ASCs

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