A recent webinar held by HealthCare Appraisers covered valuation issues impacting ambulatory surgery centers. The webinar featured Todd J. Mello, ASA, AVA, MBA, and Jason L. Ruchaber, CFA, ASA, partners in HealthCare Appraisers.
Definition of fair market value
Mr. Mello reviewed the fair market value standard, which is used in most healthcare-related appraisals and is defined somewhat differently from the standard definition, including what is italicized below. Fair market value is defined as "the price at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller." Both parties would be "acting at arm's length in an open and unrestricted market, when neither is under compulsion to buy or sell … between well informed parties who are not otherwise in a position to generate business for the other party."
Three valuation approaches
Mr. Mello said there is no one correct way to value a center, but rather, three generally accepted valuation approaches can be used. The applicability of each one depends on specific facts and circumstances of the center that is being appraised. The income approach converts anticipated future economic benefits into a single present amount. The market approach involves examining other centers that have sold in comparable transactions. And the asset or cost approach is based on the value of the assets' net of liabilities.
Mr. Ruchaber said there are numerous factors that drive value and risk in surgery centers. Value drivers include growth, specialty mix, payor mix, certificate of need requirements, management oversight and hospital participation. Risk factors include single-specialty status, limited number of owners or users, degree of competition and out-of-network billing.
Valuation multiples
Mr. Ruchaber cautioned against oversimplifying valuation multiples. He said valuation multiples for surgery centers can vary significantly for the majority of deals. The average multiple for a controlling interest in a multi-specialty surgery center is 5-7 times EBITDA less debt and the average multiple for a minority interest is 3-4 times EBITDA minus prorata debt. Both ranges assume the center is exclusively or predominantly in-network with commercial payors.
Moreover, valuation multiples assume earnings are "perpetual," which means earnings should be stable and reasonably estimable. Multiples also implicitly assume a level of growth, and as a perpetual model, there are limitations on growth assumptions that can be built into a multiple. "Most centers cannot sustain growth of over 5-6 percent in perpetutity," he said. Because of this limitation, he said valuation multiples should only be applied to stable businesses.
Mr. Mello said marketability is the ability to quickly convert property to cash at minimal cost. Relative absence of marketability involves applying a discount to the results of the valuation. Most minority investments in ASCs tend to be reasonably marketable, and discounts tend to be lower than with other types of operations.
HealthCare Appraisers has seen a significant increase in ASC acquisition activity in 2010, Mr. Ruchaber said. Multiples paid for controlling interests have shifted slightly upward. The company anticipates stronger pricing for controlling interests in the coming year.
Common valuation challenges
Mr. Mello and Mr. Ruchaber discussed some common valuation challenges. Expected incremental increases in volume associated with syndication efforts cannot be included in the valuation under the fair market value standard. "Value your company as it exists today, without specific consideration of the volumes associated with the potential investor," Mr. Mello said.
In certain instances, however, the circumstances surrounding the purpose of the valuation may need to be considered. For example, if a hospital is a joint-owner seeking to buy out the physician interest in its entirety, the valuation may take into account the incremental risk associated with essentially removing the physicians' economic incentive for performing cases at the center on a go-forward basis. Out-of-network status, which is becoming increasing untenable for ASCs, also has valuation implications. "How long is the gravy train going to last?" Mr. Mello asked. "It's not a question of if but rather when it ends. For example, will it happen within a year or within three years?"
A question and answer session followed the presentation. Some of the questions addressed during that time included:
- What are the biggest mistakes others make when valuing ASCs?
- How do you calculate the ROI and purchase price for a merger or acquisition?
- When you value an ASC that has poor managed care contracts, can you factor in the possibility that these contracts could be renegotiated, significantly improving the revenue stream in the future?
- What are the guidelines for using the market approach?
Learn more about HealthCare Appraisers.
Download the Webinar presentation by clicking here (pdf).
View the Webinar by clicking here (wmv).
We suggest you download the video to your computer before viewing to ensure better quality. If you have problems viewing the video, which is in Windows Media Video format, you can use a program like VLC media player, free for download here.
More Articles Featuring HealthCare Appraisers:
Strategies for Successful Co-Management Relationships With HOPDs
5 Factors That Heavily Influence ASC Value
Healthcare Transactions and Valuation: The Year in Review