Business Solutions

For Sale by Owner

Mergers and aquisitions will play a larger role in the HME industry what do providers need to know?

• By David Kopf
• Mar 01, 2013

Mergers and acquisitions is a touchy subject in the home medical equipment industry. Most provider business owners and operators are attracted to HME not because of the profits they make, but because of the care they will provide to patients that truly need it. Homecare patients represent a vulnerable group, that depends upon providers’ assistance in order to reap the true benefits of the medical equipment that they have been provisioned, and providers gain satisfaction from giving them that much needed service and assistance. The payoff is as emotional as it is material.

Moreover, just like any other business, HME provider businesses represent the care and long-term commitment to building a healthy and successful enterprise that their owners have invested over the years. Like a painter crafting a historic masterpiece, or a farmer continually tilling the fields until they offer up bumper crops, HME business owners have devoted considerable time, attention and care, as well as blood, sweat and tears.

Suffice it to say, HME businesses are a labor of love. They represent an edifice to the dedication to care and professionalism that providers strive to deliver.

So talking about selling or buying an HME business is a loaded discussion. It represents having to “trade in” so many inestimable and intangible elements. How do you put a price on dedication? How do you value sacrifice?

A Growing Reality

Unfortunately, those are questions that many providers might have to ask themselves in the wake of Round Two of competitive bidding. If Round One is anything to go by, there will be a sizable portion of HME providers in Round Two — which covers 91 competitive bidding areas and essentially brings the program nationwide — that will lose important categories of their business.

If the industry cannot stop the program by the time it is brought to implementation on July 1, then many providers will have to reinvent their businesses to compensate for lost revenue. Moreover, if a provider wins a contract and accepts it, who’s to say they will be able to make that contract work, given the average 45 percent cut to reimbursement per the recently released Round Two bid amounts (see “News, Trends & Analysis,” page 8). These are just some of the facts that could increase the volume and pace of mergers and acquisitions in the HME industry’s near future.

“Round Two is going to shape all mergers and acquisitions in HME,” says Don Davis, president of Duckridge Advisors LLC (Pittsburgh; duckridge.com), a healthcare industry mergers and acquisitions firm that specializes in the HME industry. “It is impacting every aspect of the M&A market in terms of valuation and in terms of consolidation.”

“Up until [CMS’s announcement of the Round Two rates] there really was no market for HME companies who were affected by competitive bidding Round Two,” says Pat Clifford, managing director of The Braff Group (Pittsburgh; thebraffgroup.com), another firm that specializes in HME M&A. “Everyone was in a ‘wait and see’ mode.

“Now we know the rates,” he continues. “But what’s still is unknown, as both prospective buyers and prospective sellers review their bid situation, is that now that we know the rates, what does that actually mean?”

The large national providers are probably examining each MSA and the categories affected in each and determining where they won and where they might want to buy. Similarly, local providers are learning whether or not they have been offered a contract, and deciding what their next plan. This creates a vast amount of uncertainty in the M&A market.

“There are more questions than answers at this point in time,” Clifford says. Additionally, there are companies that are external to the HME industry that might now be game to acquire provider businesses now that Round Two is in motion and appears likely to reach implementation. If providers looking to buy other providers are “strategic buyers,” then lets call these firms “financial buyers,” Clifford says, and these new rates represent and opportunity for those players to enter the HME market space.

And whether strategic or financial, interested buyers are already starting to influence the pace of HME mergers and acquisitions. There is a significant amount of buyers looking to buy assets, Davis says.

“And that is what’s different than what has been occurring in the past several months,” he says. “There have been people looking to buy, but it’s been very methodical … it’s been posturing rather than positioning.

Davis says he suspects that the large nationals and super regional providers knew the prices they were going to have to bid in order to win contracts, but that they would have to form a plan to make the Round Two bid rates work for their businesses. And that plan involves consolidating the market further. There will be various “layers” of HME businesses that could feature into those providers’ plans, Davis says.

“There are the well-managed, larger, local HMEs that will have some value,” he explains. “Because a buyer will be looking to consolidate and will look to build a solid position in the market. Smaller providers will not be as attractive; they’ll be asset-based, patient-based acquisitions. And then there will be some larger players that didn’t get the contracts in the market, and they’ll be looking to be a full-service provider in the marketplace. There’s a lot of interest today in the market in terms of acquisitions.”

“I can tell you that [activity] has already started,” Clifford says. “Will the pace continue to quicken as we get to July 1, or will buyer’s wait until after July 1? I’m not quite sure.

“If we go back to what happened in Round One, we got a lot of calls from buyers saying, ‘I need a bid winner in Pittsburgh, or Cleveland, or Cincinnati, to protect my business,’” he explains. “But just as frequently, we saw buyers wait until after the bid winners were announced.”

If we apply what occurred in Round One to what’s happening now, then we won’t know for a few months until companies accept contract offers and CMS announces the Round Two contract holders.

Additionally, applying what happened in Round One to Round Two, then we can also expect that there will be provider business that win and accept contracts for their CBAs, but then a year or so down the road, realize that they will not be able to make the reduced reimbursement rates pencil out, and will start soliciting buyers. The question is, will they have buyer by then? Certainly a 45 percent cut to the Medicare portion of a business can significant undercut its attractiveness to a buyer, Clifford notes.

Selling an HME Business

So certainly, because of these various factors there are already providers that are considering the sale of their HME business. They are either did not get a contract offer, or they don’t see business under the Round Two reimbursement as a feasible prospect. What are the things they need to consider when assessing their business, the situation, and determining whether they should sell? And, if they decide to sell, what the factors they need to consider to ensure a smooth process and optimal outcome?

“I think the first thing anyone selling should do is to take the portion of their business that is supported by Medicare, and re-run their P&L with the new rates in it, and see what it looks like,” Clifford says, “and see if they can run their business with those new rates.

“Chances are they will have to make some changes,” he continues. “They might have to lay off staff, or close satellite locations, or do whatever they can to ensure that profitability stays in the business. That’s really the first step: to pro forma the new rates into their business.”

Then a provider needs to determine their personal goals and objectives when it comes to owning the business and serving patients, and then decide whether or not the business, under the new rates, can perform in such a way that they can accomplish their objectives. They need to start asking themselves some tough questions: Can they continue to grow the business? If they won the contract, could they survive to re-bid the contract at the end of its three-year term?

“Once you start answering those questions, you get to the point where you can decide if the perceived risk of owning the business outweighs the return on your investment — that you could possibly make somewhere else,” Clifford says.

In terms of the process of selling an HME business, perhaps one of the best places to start is to hire an M&A firm that can acts on the business owner’s behalf. In the same way a homeowner hires a real estate agent to conduct the sale of a home, a small business owner should consider hiring a firm that can help it navigate the ins and outs of transacting a business from one owner to another.

While providers can and do sell their businesses by themselves — just like some owners, to carry the real estate analogy — hiring a firm that can act as a broker not only helps the HME business owner with the process, but it frees that owner up to attend to matters at hand.

“One very important thing is to continue running your business, and to not take your eye off the ball,” Clifford notes. “That’s why you hire someone to do this type of work for you.”

And that can turn into a competitive advantage when there are multiple firms trying the sell-by-owner route.

“There are 91 CBAs,” Davis says. “There’s a minimum of 10 to 20 companies at least in everyone of those markets that doesn’t know what to do [when selling a business]. There are probably hundreds and hundreds of companies that don’t know what to do. And when they show up in the marketplace, they are going to have a hard time to allow for their story to be told and for buyers to understand who they are. If they don’t go through this process, they’ll be short-changing themselves.”

In terms of the broker’s compensation, just like a real estate agent, the fee typically is a commission paid at the close of the transaction.

If a provider decides to hire an intermediary, then the best thing the provider can do is start preparing for the meeting with that broker. Good ways to prepare are to conduct such research as the pro forma application of the Round Two bid rates to their P&L, as well as a breakdown of the business showing key categories and patient groups, so that they can sit down and clearly describe exactly what is for sale, according to Clifford.

The next step is market research. The provider and broker can go out to the broad market of buyers and start collecting information, to draw some educated conclusions about the core market for the business. The provider should look to see which components of the buyers’ market can best help them attain their objectives for the sale of their business.

“So it’s kind of a process to go through to get to the end game of selling your business,” Clifford says.

Valuing HME Businesses

When it comes to putting a price on a business, valuation is going to be very tricky given the announcement of the Round Two bid rates, which Davis notes have forced business values to drop precipitously since CMS broke its news at the end of January.

“Traditional model of our business were based on cash flow and EBITDA revenues,” he explains. “Even if all those multiples stay the same. Even if the EBITDA multiple stays three to four times EBITDA, everybody’s EBITDA has dropped so much that the value of the total business has dropped by that much. So the multiples have stayed the same, but the valuations have dropped considerably.”

So understanding what buyers are looking for and tailoring presentations to meet those needs and expectations will definitely help a company tell a compelling story to a buyer. This includes recognizing how trends related to Round Two and other factors will infl uence the company’s value.

For instance, given the likely trend that large, superregionals will be looking to consolidate in a given geography, they will need to offer a full line. If a provider in the markets served by that large buyer can help it add a key category to get them to that full line, then that seller has a compelling story to tell.

“We are seeing some segmentation,” Davis says. “But for the most part, I think the buying activity is going to be across the board ‘traditional DME-totraditional DME.’”

And when it comes to the traditional, multi-line approach, customer service capability will not play a reduced role in the valuation of an HME business. It represents too much overhead given Round Two’s rates.

“The pricing has taken out the customer service from the equation,” Davis explains. “So the lowest level price has become a transactional, delivery, logistics, compliance model, without really concern about patient care. It’s almost as though the patient care got punted to the hospitals, or wherever else.

“…I think that’s kind of how the next generation of DME companies will have to look at who they are,” he continues. “And that’s what the big guys are going to be doing.”

The Process

A key element in the process is ensuring the seller has all the information that buyers will want when performing due diligence, Clifford explains.

“Buyers have to verify the revenue of the seller,” he says. “They have to go through and review all the patient charts that would support the billable amounts of revenue. So they have to verify. That’s the biggest step.”

Also, the buyer will need to engage in the same sort of pro forma review using the Round Two rates that Clifford mentioned earlier when discussing how a provider might decide whether or not it is time to buy.

“You have to understand the pro forma of a P&L under the new rates,” he explains. “You have to run that P&L on the prospective business, and understand the cash flow that prospective business will generate.”

And in the same way that a buyer is going to perform due diligence on the seller to ensure that the seller is going to be a good buy, the seller will want to do some due diligence on the buyer. This is important when it comes to ensuring that the buyer will be able to provide sufficient patient care and that it will have the financial wherewithal to conduct the transaction, Clifford explains.

“So the due diligence process is also an opportunity for the seller to review the buyer,” he says.

Assuming buyer and seller can make a match, there are various terms under which the deals are usually struck. One common arrangement providers should be aware of up-front is performance-based transactions. Under these terms, the buyer pays a portion of the purchase price up-front, and the remainder after a certain amount of time to ensure the business can perform as expected. Also called an earn-out, such an arrangement is typical, Davis says.

“I haven’t worked on deal where that wasn’t a component for a while,” he says. “It’s usually some sort of percentage of the total compensation that is held back to ensure that there is a smooth transition, that the referral sources do come through, and that the revenues hold up.

“Traditionally, that’s been 15 percent to 20 percent of a deal,” he continues. “That could go higher.”

As for providers’ level of comfort with such an arrangement, that varies. Certainly having a portion of the deal hinging on how a new owner manages the seller’s business can be a little disconcerting to say the least, but if the terms of such an arrangement are properly negotiated, hopefully, this will put both buyer and seller a little more in their comfort zone.

“… Or not,” Davis half jokes. “That’s a huge amount of contention of the negotiation, I can tell you.”

This article originally appeared in the March 2013 issue of HME Business.