Valuing an Out-of-Network Center in 2012: Thoughts from VMG Health's Kevin McDonough

When looking to buy a surgery center, the percentage of out-of-network cases an ASC does is one of the most important factors a buyer considers. In a recent VMG Health survey, 93 percent of buyers said heavy reliance on out-of-network payors had a "very high" impact on the ASC's value. Seven percent said it had a "high" impact."

A high percentage of out-of-network cases results in a lowering of the multiple a surgery center sells for, says Kevin McDonough, CFA, senior manager of VMG Health. The reduction can often be as high as 50 percent. The general trend in surgery center valuation is a widening margin in the multiples, Mr. McDonough says.

"Our observation of the ASC transaction market over the last five-10 years is that the valuation ranges we're seeing and the relative multiples have widened significantly," he says. "With respect to valuation, you simply cannot paint the entire industry with a single brushstroke. We’ve observed almost as many acquisitions occurring at discounted multiples as we have observed at the very top end."

Five to seven years ago, control-interest acquisition multiples fell consistently right around a 7 times EBITDA range. Now, Mr. McDonough says, acquisition multiples are significantly more varied.

"For those ASCs that are deemed high-risk, buyers will either discount the multiple offered or utilize higher multiples however adjust or "normalize" underlying EBITDA to account for significant risk factors."

Of the myriad of headwinds facing the industry, an out-of-network reimbursement strategy can be considered one of, if not the most significant, risk factors for a surgery center.

"Our observation has been that it is significantly more difficult to consummate a transaction with an out-of-network center," Mr. McDonough says. "The primary reason stems from the fact that there's an inherent disconnect between what a buyer believes an out-of-network earning stream is worth and what the seller believes it to be. In general, the seller believes the strategy does not pose an immediate threat to earnings and is unwilling to accept what they perceive to be a below-market offer. Buyer's in today's market are risk adverse and are unwilling to pursue an acquisition without discounting that out-of-network earnings stream.. As you can see, sometimes these two divergent opinions create an impasse that cannot be bridged."

There isn't a magic number for how much an out-of-network surgery center's valuation will be discounted; it depends on a lot of factors, he says. Some of these factors include the difference in reimbursement rates between out-of-network and in-network in a certain market and how difficult the payors are making it to collect on that out-of-network reimbursement and what types of strategies the payors are pursuing to eliminate or obstruct the pursuit of this strategy.

Although widely varied, the standard difference between the out-of-network and in-network rates are about 4-5 times comparable in-market rates, Mr. McDonough says. If the reimbursement rate for out-of-network is significant higher than this, all else being equal, additional risk is present.

Jon Vick, president of ASCs Inc. in Valley Center, Calif., has developed a scale of multiple reductions based on the percentage of out-of-network cases. He says if 75-100 percent of a center's volume is out-of-network, the multiple could be expected to be reduced by 40-50 percent. If 50-75 percent of a center's volume is out-of-network, the multiple could be expected to decrease by 20-30 percent. If 25-50 percent is out-of-network, Mr. Vicks says the multiple would decrease by about 15-20 percent. He recalls an orthopedic and pain management center that did close to 100 percent of its cases out-of-network. The center's multiple fell from 6 times EBITDA to just over 3 — a drop of almost 50 percent.

However, having a high percentage of out-of-network cases is not a deal breaker, Mr. McDonough says. The most important part is to demonstrate to the buyer why it's a sustainable strategy — and in certain cases, it may be.

"The perception in the industry five to seven years ago was that this was a short term strategy that meet its demise in short order," he says. "Each year it's becoming more and more difficult to pursue the strategy, however it's had greater legs as an overall strategy than anyone had thought."

When pitching the strategy to potential buyers or to a third-party valuator, Mr. McDonough says to highlight the reasons they believe the strategy is sustainable. Examples include demonstrating that the center historically has had no problem collecting out-of-network reimbursements and that the difference between in-network and out-of-network reimbursements is not so significant that it creates extreme risk. He also recommends minimizing a center's other risks — of which there are many, he says.

Emphasizing the positive attributes of a surgery center is vital. Physician activity serves as the life-blood of any surgery center. As such, portraying a young, energetic, financially committed and highly active physician base is crucial. Emphasizing the positives is an important step in ensuring that  buyers see beyond the out-of-network risk, he says.

Related Articles on Surgery Center Valuation:

Future Outlook for Selling Your Single-Specialty Center: Thoughts From Jon Vick of ASCs Inc.
How Hospital Employment Will Affect ASC Physicians in 2012: Thoughts From Smithfield Surgical Partners' Dr. Greg Horner
Selling Your Surgery Center? Physicians Alliance Surgery Center's Journey to a "Very Attractive" Offer

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