Since shortly before the Patient Protection and Affordable Care Act became law, hospital and health system acquisitions of physician practices have picked up, driven by changing reimbursement models, the cost of healthcare reform compliance and the push to align care across all providers. The percentage of non-independent, or hospital-based, physicians has risen to just more than 40 percent in 2013 from approximately 35 percent in 2007, according to HealthCare Appraisers, which provides fair market value consulting and healthcare valuation services.
In the midst of all this acquisition activity, valuators have widely differing opinions about the best approaches to use to determine the fair market value of physician practices, said Stuart A. Neiberg, a manager for HealthCare Appraisers. "The valuation analysts are really polarized as far as what methods to use to value physician practices," he said. "There's been no black or white guidance."
During a recent webinar on Sept. 18, Mr. Neiberg offered his professional perspective on key concepts that factor into physician practice valuation.
1. Acquisition structure. Most physician practice acquisitions — more than 95 percent — are structured as an asset purchase and subsequent employment of physicians, Mr. Neiberg said. The buyer will acquire the practice's inventory and tangible assets such as medical equipment. Additionally, the purchaser will acquire any identified intangible assets. "Most of the time, this is manifest in the workforce of the physician practice," Mr. Neiberg said.
He said post-acquisition compensation must factor into the purchase agreement. Most of these compensation models are based on productivity, he said. The majority of models involve work relative value units multiplied by a conversion factor. Other possible compensation strategies include structures based on a percentage of professional collections or pre-compensation earnings.
The purchaser may also choose to pay physicians based on the hours or shifts they work. This generally applies to an urgent care setting involving a practice that's open for a set number of hours daily and handles walk-in traffic, he said.
Hospitals and health systems looking to acquire a physician practice might also want to consider alternate structure models. "Sometimes an outright acquisition of a physician practice is not the ideal situation," Mr. Neiberg said.
One alternative option is leasing the practice's tangible assets and employees while letting the physicians maintain their independence. The purchaser can also "carve out" a certain department or specialty and let the rest of the practice remain independent. There are also ancillary carve outs, which could involve an MRI, for example, Mr. Neiberg said.
2. Fair market value determination and valuation approaches. Fair market value serves as the applicable standard of value for physician practices, according to Mr. Neiberg. In the healthcare world, fair market value is the price at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm's length in an open and unrestricted market. Under the definition of fair market value, neither the buyer nor the seller is under compulsion to buy or sell, and the transaction takes place between well-informed parties who aren't otherwise in a position to generate business for each other.
There are three generally accepted valuation approaches, Mr. Neiberg said. The first is the income approach, which involves determining the value of the practice by converting future economic benefits into a single present amount. This tactic discounts — through discounted cash flow — expected future cash flows to the buyer.
The second is the market approach, which entails comparing the practice to similar businesses, business ownership interests, securities or intangible assets. HealthCare Appraisers generally rules out this approach when it comes to physician practices. "The data available for physician practices is fairly poor," Mr. Neiberg said. "We're unable to identify comparable businesses that trade in the market or have been bought or sold."
The third approach is the asset or cost method, which involves determining the practice's value based on the assets net of liabilities. Using this approach, he says valuation analysts will restate the entity's balance sheet including identified intangible assets such as the workforce in place.
Overall, no one valuation methodology works in all cases, according to Mr. Neiberg. At the onset of every physician practice evaluation, valuators should consider both an income and asset approach.
3. Intangible value generation. The main argument among appraisers concerning physician practice valuation is whether intangible value can fully exist without an income stream that completely supports it, Mr. Neiberg said. Some appraisers of the "cash is king" mindset say income is the sole determinate of practice value, while others identify and value specific intangible assets with no consideration of the practice's income. Mr. Neiberg said his company thinks it's best to find a middle ground between these two philosophies by deciding value doesn't need to be fully supported by an income approach in order for intangible value to exist.
Concerning how to assess physician practices' intangible value, he said it can include profit from employment of mid-level providers and employed physicians by the purchasing hospital or health system. Furthermore, ancillary services such as MRI, physical therapy or durable medical equipment can generate intangible value.
Additionally, practices can have intangible value through performing surgical procedures in office as opposed to at a hospital or ambulatory surgery center, Mr. Neiberg said. In that case, physicians can receive a site-of-service differential.
The final and generally least popular way practices can have intangible value is through physicians' willingness to take a pay cut as part of the acquisition. However, this rarely occurs. "I still haven't met a physician that's interested in this approach," Mr. Neiberg said.
In assessing intangible value, analysts cannot factor in any sort of revenue enhancement or expense reduction that wouldn't exist in the absence of an acquisition, he said. For example, if a hospital employs a medical oncologist, the hospital will likely bill for infusion services at a higher rate than the practice did and benefit from the 340B drug discount program, which allows nonprofit hospitals, community health centers, hemophilia treatment centers, HIV/AIDS clinics and other similar facilities that serve a large proportion of under- or uninsured patients to purchase medications from manufacturers at reduced prices.
That potential value can factor into the strategic or investment value, which encompasses what a specific hospital buyer could accomplish through the transaction. However, Mr. Neiberg said it doesn't factor into fair market value.
Download a copy of the presentation here.
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