5 Major Trends Impacting the ASC Marketplace in 2009

There will be many opportunities but also hurdles in the ASC market in 2009, according to industry experts. Here are five of the most significant trends facing surgery centers in 2009.

1. Credit crunch, likely legislation changes will slow down the recent flurry of ASC acquisitions. While the last 6–12 months have seen a flurry of ASC acquisition activity, this will slow down in the coming months as the credit and financial markets continue to break down, predicts Kenneth Hancock, president and chief development officer of Meridian Surgical Partners.

"As the credit crisis continues, banks will be more conservative with the amount of debt financing provided to companies purchasing ASCs, thereby restricting the amount of cash available to complete these transactions," Mr. Hancock says.

"As the credit crisis continues, banks will be more conservative with the amount of debt financing provided to companies purchasing ASCs, thereby restricting the amount of cash available to complete these transactions," Mr. Hancock says.

"In anticipation of a likely capital gains tax increase enacted after the presidential election, ASC physician owners are selling off ASC interests now to avoid a large tax liability later," says Brett Brodnax, executive vice president and chief development officer of United Surgical Partners International.

Currently, long-term capital gains are generally 15 percent of the capital gains net total.

"An increase in the capital gains tax could potentially devalue an ASC physician-investor’s investment income," says Michael Weaver, vice president of development at Symbion. "Without knowing the increase, many physician investors would rather sell now than pay capital gains taxes later on, which may be far greater than the taxes being paid currently on investment income."

However, "a tax event should not supersede an ASC’s goals of finding the right partner whose culture and experience will allow an ASC to fulfill its growth strategy and legacy of providing high quality care," Mr. Weaver says.

Anticipatory fear of potential adverse legislation is also at play, says Jon Vick, president of ASCs Inc.

"If adverse legislation prohibiting or restricting physician referrals to physician-owned ASCs is passed in any state, the value of all ASCs would be significantly reduced," he says. "Some physician- owners are selling now to protect their investment."

2. Turnaround opportunities abound. While low-risk, large ASCs will be harder to find or priced too high for most buyers in the coming year, there will be ample opportunity for companies to buy into a struggling center.

"Some ASCs are in difficult financial and operational situations and are looking for partners to stabilize and improve their business," says Mr. Brodnax. "These centers have experienced declining reimbursements, seen considerable decreases in out-of-network payments, suffer from inefficient operations, have had difficulty contracting with payors or have challenging partnership issues to overcome."

In some cases, ASCs have been undercapitalized or overbuilt. Mr. Hancock has seen reports that indicate over one-third of all ASC partnerships are marginally profitable or are losing money.

"Because new projects are harder to find due to the maturity of the industry, companies will attempt to find investment opportunities in struggling partnerships where they can deploy capital to satisfy debt, deliver focused management to enhance and/or reengineer operations plus recruiting expertise to fuel growth," he says.

With the current credit and the economic turmoil, a turnaround investment may be a better buy-in than a new (de novo) ASC for many corporate investors.

"The timeline to market with a takeover is substantially shorter for the management company than with a de novo project," says Mr. Hancock. "Provided a successful operations plan is executed and cash flow is created, the partners will soon begin to receive checks versus having to write checks to the partnership."

3. De novo deals becoming harder to close. Experts contend that de novo ASCs will be much more difficult to develop in the coming year. The first challenge is there are fewer independent physicians available to create a de novo center, says Mr. Weaver.

"In the past decade, there has been an astounding growth of new ASCs and currently there are approximately 6,000 operating in the United States; therefore, many physicians are already affiliated," he says. "In addition, as in the 1990s, today many more new physicians are taking hospital positions and thereby restricting themselves from investing in an ASC by non-compete clauses. Given these conditions, it is more difficult today to get a group of 12 physicians together and build a new ASC."

Note: See "Growth of ASCs Outpace Number of Available ASC Physician Owners" for Deutsche Bank statistics on the limited supply of physicians.

There are other obstacles as well, Mr. Hancock says.

"Credit is tight and marginal deals are unlikely to receive financing," he says. "For this reason, de novo projects will have to raise more equity and expect individual investor guarantees in addition to their cash invested." There will also be additional challenges with regards to case mix and volume, insurance contracting and reimbursement, growth prospects and competition, he adds.

4. Seller scrutiny at a high. ASC sellers are looking more carefully at a potential buyer’s corporate track record for "same-center growth" in order to partner with the right company and maximize their profits.

"Sellers will more seriously scrutinize all potential buyers to ensure that the corporate partner will be able to grow the ASC at or above a 10–15 percent annual EBITDA (earnings before interest, taxes, depreciation and amortization) margin growth," says Mr. Vick. He explains that if the physicianinvestors sell 51 percent of their ASC to a company, they will want to make sure that their distributions will return to their previous levels within three to five years.

"Many ASCs have seen their profit growth slowing and are seeking a sale to take some money off the table; at the same time, they want to attract a professional management company that will keep their pro rata distributions growing," he says.

In evaluating a company, astute ASC physicianowners will look at the ASCs owned by the company as well as the track record of the company itself. In looking at the owned ASCs, they will assess, amongst other factors:

• annual financial growth;

• partner satisfaction;

• case referral numbers;

• average revenue per case;

• EBITDA margins;

• quality; and

• growth potential.

In looking at the company itself, physician-owners will review:

• the number of ASC deals completed annually;

• the number of partnerships dissolved;

• the strategic plan for going public or putting itself up for sale;

• record for renegotiated ASC contracts; and

• overall EBITDA margin.

Mr. Weaver says that sellers will also evaluate the continuity of a buyer’s corporate culture, as well as its ability to close a transaction. An evaluation of these factors will help ensure physician-owners that a new corporate investor will keep their distributions growing.

5. Healthcare real estate remains a profitable asset. Despite the economic challenges, the healthcare real estate market is still a viable means by which physicians can diversify their holdings.

"Healthcare real estate values have held up very well and we are obtaining very good offers for our clients," says Mr. Vick. "As a result, physicians owning medical office buildings/ASC real estate can sell it at an attractive price and free up capital to further diversify their investments

"There are some very desirable sale/leaseback deals offered by medical real estate investment trusts and private equity firms for physicians who own their ASC real estate and are interested in further diversification by selling their underlying real estate," he says. "These sales are sometimes done at the same time as the sale of the ASC or separately, albeit to completely different buyers."

Investment diversity is also part of physician owners’ desire to sell interests in their ASCs.

"Senior physicians, overweight in their ASC business and real estate investments, realize that selling a portion of their interest will help them diversify their assets so that upon retirement their retirement savings will be adequately diversified," says Mr. Vick. "It is far better to sell an interest well before retiring to avoid significant discounting of a retiring partner’s value to the center."

Ms. Kulvin (mrbones@the-beach.net) is a freelance writer based out of Surfside Fla.

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