Hospital merger and acquisition activity is on the rise across the country due, in part, to a lingering recession that crippled weaker hospitals as well as a move toward regulations and payment structures that favor large, powerful systems. As a result, small hospitals are considering more seriously than ever sales, mergers or other partnerships, while larger systems — both for-profit and non-profit — are looking to scoop up these struggling facilities and expand market share. In these deals, both buyers and sellers need to be aware what determines a hospital's value. For buyers, it can help a system or operator determine if an acquisition will bring about desired benefits. For sellers, understanding these concepts will help the hospital better understand the cash offer or guarantees it is able to demand. Here are five of the most important factors for determining a hospital's value, according to hospital valuation and M&A experts.
1. Financial health. A hospital's financial performance is often the most important factor a buyer considers when evaluating and determining a bid for an acquisition. A hospital's overall financial health can be determined by examining its balance sheet — which includes the hospital's assets and liabilities — and its income and cash flow statements.
To get a quick, holistic view of a hospital's overall debt leverage in conjunction with its operating performance and margin, buyers often examine the hospital's credit rating, which is determined by the combined indications of various financial ratios, says Bill Baker, partner at KPMG and head of its healthcare transactions services practice. When hospitals don't have bond or credit ratings available, buyers typically apply the same methodologies credit rating agencies use to better understand the hospital's financial position.
Revenue, income, cash flow and EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) help buyers determine the true performance of a facility. "A hospital may show a profit, but if it has tremendous capital needs, it may not have the cash flow," says Bruce Den Uyl, managing director in the Financial Advisory Services group at AlixPartners.
The debt owed by the hospital also plays a major role in the value of a facility. Large unfunded pension liabilities, for example, greatly reduce the value of a hospital. "In this type of situation a buyer would be assuming debt instead of paying a large sum of money to acquire the facility," says Mr. Den Uyl.
Profitability may be less of a concern for buyers who operate in the same market as the seller, says Philip Gassel, JD, a senior attorney at EpsteinBecker Green in New York. "Profitability is driven by managed care rates, but exactly what a hospital currently gets from [a payor] may matter less to buyers because they expect to negotiate new rates or extend their own rates to the acquired hospital," he says.
2. Capital needs. Next, a buyer is likely to look at the capital needs of a hospital. Even if a hospital is fairly profitable with low current debt levels, the capital needs required to sustain the viability of a hospital could be great enough to ruin a potential deal.
"If you're trying to sell a hospital with an old building that's falling apart, that's a bad [situation] that will need significant capital commitment," says Mr. Gassel.
In some cases a seller might attract bids with a lower purchase price and a commitment of capital to improve physically ailing facilities or upgrade equipment and information technology systems. For-profit Vanguard Health Systems, for example, recently pledged $850 million of capital and agreed to cover nearly $280 million in liabilities to acquire eight-hospital Detroit Medical Center. While the entire deal was valued at roughly $1.5 billion, the cash purchase price of DMC was only $391 million.
3. Market characteristics. The characteristics of the market where a hospital is located also greatly determine its value. A hospital in a market with future growth potential is more likely to increase in value, meaning it can demand a higher multiple (of EBITDA or revenue, for example), says Mr. Den Uyl.
The payor mix of a market also plays a role in a hospital's value. While an acquirer can renegotiate managed care rates, if a hospital is located in an area with a population that is predominately covered by Medicare or Medicaid, increases in managed care contracts may not be enough to significantly increase a hospital's performance, says Mr. Gassel.
Workforce characteristics also play a role. For example, if a market has a particularly strong union presence, it may be less attractive to a buyer because unionized markets typically demand higher wages and benefits, adds Mr. Gassel.
4. Physician integration. "A hospital lives or dies by its medical staff," says Mr. Gassel. As such, a hospital's relationships with its physicians greatly influence a hospital's attractiveness to a buyer.
Healthcare reform introduced several initiatives — such as bundled pricing and accountable care organizations — that financially incentive hospitals to integrate and better coordinated care, and, as a result, buyers concerned with the future environment view closely aligned physician relationships as a competitive advantage, says Mr. Den Uyl.
Hospitals that have already established physician hospital organizations, management service organizations or joint ventures or have used bundled rates and/or developed systems the distribute shared savings from meeting incentives to physicians are likely to command higher prices, says Mr. Gassel.
Mr. Gassel adds that buyers will examine hospital-physician relationships closely to ensure compliance when examining this factor as acquiring a facility with non-compliant relationships could cost the buyer down the line. Physician contracts must meet fair market and commercial reasonableness tests and be compliant with Stark and anti-kickback statues. As part of this, Mr. Gassel says buyers should examine a hospital's contract management program to ensure contracts are always in writing and haven't expired.
Non-complaint relationships don't necessarily kill a deal, but a buyer may require the seller to settle outstanding litigation before the transaction is finalized. For example, just a day before it was sold to Vanguard, Detroit Medical Center agreed to pay $30 million to settle non-compliant relationships with physicians resulting from agreements that were not in writing or were not at fair market value.
5. Level of management. A less concrete, but important, factor influencing its value is how well or poorly it was managed. A strong management team that did its best in light of what may have been a difficult financial situation is likely to give a buyer confidence in the facility, says Mr. Gassel.
Hospitals with sound business and revenue cycle practices, robust compliance programs and high quality are worth more than hospitals lacking in these areas.
"You may not be able to change your market, but what you can do is give the buyer a solid facility," says Mr. Gassel.
1. Financial health. A hospital's financial performance is often the most important factor a buyer considers when evaluating and determining a bid for an acquisition. A hospital's overall financial health can be determined by examining its balance sheet — which includes the hospital's assets and liabilities — and its income and cash flow statements.
To get a quick, holistic view of a hospital's overall debt leverage in conjunction with its operating performance and margin, buyers often examine the hospital's credit rating, which is determined by the combined indications of various financial ratios, says Bill Baker, partner at KPMG and head of its healthcare transactions services practice. When hospitals don't have bond or credit ratings available, buyers typically apply the same methodologies credit rating agencies use to better understand the hospital's financial position.
Revenue, income, cash flow and EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) help buyers determine the true performance of a facility. "A hospital may show a profit, but if it has tremendous capital needs, it may not have the cash flow," says Bruce Den Uyl, managing director in the Financial Advisory Services group at AlixPartners.
The debt owed by the hospital also plays a major role in the value of a facility. Large unfunded pension liabilities, for example, greatly reduce the value of a hospital. "In this type of situation a buyer would be assuming debt instead of paying a large sum of money to acquire the facility," says Mr. Den Uyl.
Profitability may be less of a concern for buyers who operate in the same market as the seller, says Philip Gassel, JD, a senior attorney at EpsteinBecker Green in New York. "Profitability is driven by managed care rates, but exactly what a hospital currently gets from [a payor] may matter less to buyers because they expect to negotiate new rates or extend their own rates to the acquired hospital," he says.
2. Capital needs. Next, a buyer is likely to look at the capital needs of a hospital. Even if a hospital is fairly profitable with low current debt levels, the capital needs required to sustain the viability of a hospital could be great enough to ruin a potential deal.
"If you're trying to sell a hospital with an old building that's falling apart, that's a bad [situation] that will need significant capital commitment," says Mr. Gassel.
In some cases a seller might attract bids with a lower purchase price and a commitment of capital to improve physically ailing facilities or upgrade equipment and information technology systems. For-profit Vanguard Health Systems, for example, recently pledged $850 million of capital and agreed to cover nearly $280 million in liabilities to acquire eight-hospital Detroit Medical Center. While the entire deal was valued at roughly $1.5 billion, the cash purchase price of DMC was only $391 million.
3. Market characteristics. The characteristics of the market where a hospital is located also greatly determine its value. A hospital in a market with future growth potential is more likely to increase in value, meaning it can demand a higher multiple (of EBITDA or revenue, for example), says Mr. Den Uyl.
The payor mix of a market also plays a role in a hospital's value. While an acquirer can renegotiate managed care rates, if a hospital is located in an area with a population that is predominately covered by Medicare or Medicaid, increases in managed care contracts may not be enough to significantly increase a hospital's performance, says Mr. Gassel.
Workforce characteristics also play a role. For example, if a market has a particularly strong union presence, it may be less attractive to a buyer because unionized markets typically demand higher wages and benefits, adds Mr. Gassel.
4. Physician integration. "A hospital lives or dies by its medical staff," says Mr. Gassel. As such, a hospital's relationships with its physicians greatly influence a hospital's attractiveness to a buyer.
Healthcare reform introduced several initiatives — such as bundled pricing and accountable care organizations — that financially incentive hospitals to integrate and better coordinated care, and, as a result, buyers concerned with the future environment view closely aligned physician relationships as a competitive advantage, says Mr. Den Uyl.
Hospitals that have already established physician hospital organizations, management service organizations or joint ventures or have used bundled rates and/or developed systems the distribute shared savings from meeting incentives to physicians are likely to command higher prices, says Mr. Gassel.
Mr. Gassel adds that buyers will examine hospital-physician relationships closely to ensure compliance when examining this factor as acquiring a facility with non-compliant relationships could cost the buyer down the line. Physician contracts must meet fair market and commercial reasonableness tests and be compliant with Stark and anti-kickback statues. As part of this, Mr. Gassel says buyers should examine a hospital's contract management program to ensure contracts are always in writing and haven't expired.
Non-complaint relationships don't necessarily kill a deal, but a buyer may require the seller to settle outstanding litigation before the transaction is finalized. For example, just a day before it was sold to Vanguard, Detroit Medical Center agreed to pay $30 million to settle non-compliant relationships with physicians resulting from agreements that were not in writing or were not at fair market value.
5. Level of management. A less concrete, but important, factor influencing its value is how well or poorly it was managed. A strong management team that did its best in light of what may have been a difficult financial situation is likely to give a buyer confidence in the facility, says Mr. Gassel.
Hospitals with sound business and revenue cycle practices, robust compliance programs and high quality are worth more than hospitals lacking in these areas.
"You may not be able to change your market, but what you can do is give the buyer a solid facility," says Mr. Gassel.