The past few years have been good times for ASC physician-owners as both ASC management companies and hospitals have shown heightened interest in acquiring minority or majority interests in surgery centers. Physician-owners have benefited from increased competition between buyers that has resulted in more choices of partners, higher prices and better terms.
What determines the value of your center: Several key elements contribute to the value of a center. These include: medical staff, earnings, cash flow, growth potential, cash on hand, long-term debt, the “quality” of earnings, the amount you want to sell (minority or majority interest), the level of desire of the buyer to acquire your center and your ability to negotiate.
What is fair market value: FMV is the price a center will bring if freely offered on the open market with both a willing buyer and a willing seller. Fortunately, in the ASC industry there are currently over 30 willing buyers and it is still a seller’s market, although money is expected to be tighter than in 2008. Competitive offers solicited from several of the right companies (the ones with capital and a track record of helping centers grow and become more profitable) can be leveraged so you will end up with a very attractive selling price and a partner that will increase your distributions.
How is value calculated: There are three main approaches to arrive at a market value for a center: 1) sales comparison approach; 2) income approach; and 3) cost approach. The sales approach (also called similar transactions or market approach) depends on recent sales of comparable centers, adjusted to take differences, such as growth potential, into consideration. The income or discounted cash flow approach calculates the potential net income of the business over a number of future years and then discounts the future income to determine its present value, plus a terminal value. The cost approach depends on the cost to build and/or to replace the center, adjusted for the depreciated cost of the improvements.
Sales comparison (similar transactions or market) approach: Most transactions with ASC management companies are valued by comparing what has been paid in transactions for similar centers. Under this approach, valuation multiples are: (i) derived from transactions involving selected similar centers; (ii) evaluated and adjusted based on the strengths and weaknesses of the subject center relative to selected comparable centers; and (iii) applied to the subject center to arrive at an indication of value. The center value is then determined by multiplying the trailing–twelve month (TTM) cash flow or EBITDA (earnings before interest, taxes, depreciation and amortization) by the valuation multiple, subtracting long-term debt, and adding cash. The most commonly used formula is:
TTM EBITDA x (multiple) – long-term debt + cash = ASC value
Here’s an example surgery center FMV analysis based on the sales comparison (market) approach (multiple of EBITDA):
| 2008 | |
| Total revenue | $4,500,000 |
| Total expense | $2,500,000 |
| Net income | $2,000,000 |
| Interest | $50,000 |
| Taxes | – |
|
Depreciation & Amortization |
$100,000 |
| EBITDA/Cash flow | $2,150,000 |
| Multiple of EBITDA | 6.5* |
| EBITDA X multiple | $13,975,000 |
| Less long-term debt | $600,000 |
| Plus cash | $500,000 |
| Valuation | $13,875,000 |
| Value of 51 percent |
$7,076,250 |
*2008 market average for majority interests in multi-specialty surgery centers
Typical multiples range from 4-6 times EBITDA for minority interests, and 6-8 times EBITDA for majority interests. Some companies will purchase a minority interest initially and give the physicians an option to sell more in 12-24 months when the center is worth more. Factors that impact the multiple include: how many physicians and cases are available to recruit, how much future growth potential your center represents, restrictions to market entry (i.e. CONs), local competition, which company is making the offer and how good a deal you (or your representative) can negotiate. Other factors can include the “quality” of the earnings, referring to the sources and sustainability of your revenue. Too much (i.e. 20 percent or more) out-of-network revenue, or revenue from anesthesia services or manipulation under anesthesia, for example, can significantly lower the perceived quality of your revenue and earnings. If your center is very profitable and fully utilized, it may not represent a growth opportunity so the time to sell is when there is still significant growth capacity remaining.
Internal sales; forced sales: If the sale is an “internal sale,” such as to new physician-partners, the multiple is typically discounted by up to 50 percent, based on the valuation theory of “discounts for fractional interests.” The small (usually 5- 20 percent) minority interest purchased by a new physician-partner with no management control is presumed to be worth up to 50 percent less than a larger minority or majority interest purchased and accompanied by a management contract and management control. This makes it easier to attract new physician-partners and results in a very good ROI for the new partners.
Many ASC management companies include a clause in their operating agreement stipulating that the company will buy the physicians’ shares at a discounted multiple (typically about 50 percent of the purchasing multiple), less long-term debt, if legislation is passed that prohibits or restricts physician ownership or that forces the physicians to sell.
Income (discounted cash flow) approach: Some not-for profit hospitals have protocols for purchase of physician-owned centers that require the use of the income or discounted cash flow approach to valuation. This approach focuses on the center’s expected future cash flow available for distribution for a finite period of years, usually 5-7 years. Cash flow available for distribution is defined as the amount of cash that could be distributed as a dividend without impairing the future profitability or operations of the center. The cash flow available for distribution and the terminal value (the value of the center at the end of the estimation period) are then discounted to present value to derive an indication of the value of the center. Interest bearing debt, if any, is subtracted from the center’s value to arrive at an indication of the shareholders’ equity value. While the income or discounted cash flow approach is theoretically a valid valuation approach, it is usually difficult to project accurately the future cash flow of a center and thus this approach is not used by most potential buyers to determine a value or purchase price.
Cost approach: The cost approach (or adjusted net assets method) represents a methodology employed in valuing centers that are only slightly profitable, are breaking even or that are losing money. In this method, a valuation analysis is performed for a center’s identified fixed, financial and other assets. The derived aggregate value of these assets is then netted against the estimated value of all existing and potential liabilities, resulting in an indication of value of the shareholder’s equity, less depreciation. Basically, this approach determines the cost to replace your center, less depreciation.
Who’s buying; buying strategies: There are now more than 30 ASC management companies interested in buying interests in surgery centers and it is important that you solicit companies that are interested in your type of center, that have the capital to consummate your deal and that have a track record of operational success with other similar centers. Our recommended selling strategy includes the following 12 steps to get the best partner, terms and price:
- Write down the specific goals of the physician-partners.
- Determine and quantify the center’s growth opportunities.
- Prepare a sales prospectus that includes the preliminary due diligence material.
- Identify 3-4 ASC management companies that meet the seller’s criteria.
- Solicit interest from them and sign confidentiality agreements.
- Interview at least three competing companies with all the partners present.
- Interview these companies’ physician-partner references.
- Confirm the “same-store growth” experienced by the companies’ other centers.
- Have each company develop a five-year proforma for your center.
- Review term sheets and proposals from at least three companies.
- Negotiate (or have your representative negotiate) terms that are best for you.
- Sign a letter of intent with the company that is the best fit (not necessarily the company that offers the most money) and that will help you achieve your objectives.
Following these steps has resulted in successful sales and long-term successful corporate-partner relationships for hundreds of surgery centers.
Three-way deals: Here’s a strategy that may be of interest to owners of surgery centers: partner with an ASC management company and a hospital in a three-way partnership that results in the center receiving HOPD rates that are 40 percent higher than ASC rates while retaining efficient and economical management. The hospital relationship will boost revenues (and distributions) from existing cases and the ASC management company will add growth strategies to the business while maintaining an efficient and economical workplace. If you are contemplating this strategy, to get the highest price and to expedite the transaction, it is strategically important to partner with the ASC management company first and the hospital second.
What about your medical real estate: If you own the MOB/ASC real estate, there is a very good market if you want to sell. The key to getting the best price is to have high rent and a long-term lease that makes the property an interesting investment for buyers of specialty medical real estate. While the market for residential and commercial real estate has tanked, medical real estate with high rents and long-term leases is considered a very stable investment and is still attracting very good offers.
Mr. Vick (jonvick2@aol.com) is the founder and president of ASCs Inc., and has assisted in development, merger, and acquisition transactions for more than 200 physician-owned ASCs, endoscopy centers and surgical hospitals since 1984. He founded and was a principle shareholder of Surgery Center Development Corporation (90 ASCs) in 1984 and Surgery Center Affiliates (20 surgery center partnerships) in 1994. He participated as a corporate partner for a national network of surgery and endoscopy centers that was acquired by a national ASC management company in 1995. Learn more about ASCs Inc., which offers a complimentary service to determine the current market value of your medical real estate, by visiting www.ascs-inc.com or call (760) 751-0250.
