Hospitals are increasingly looking to sell, partner or merge to form organizations that are more integrated. Hospital sale values — generally expressed as a multiple of revenue or cash flow in the form of earnings before interest, taxes, depreciation and amortization (EBITDA), or for a non-profit hospital earnings before interest, depreciation and amortization (EBIDA) — have generally been established by objective measures of financial performance. However, industry-wide competition in the M&A market can increase multiple averages. In 2011, the healthcare M&A market reached the highest level of deal making since 2007, with 90 deals targeting 156 hospitals and 24,291 patient beds.
"In situations where there are more potential acquirers — more competition — one could safely conclude that it would be a significant factor in final valuation," says Dan Grauman, president and CEO of DGA Partners.
Hospital multiples on the rise with increased consolidation
Due to the high volume of M&A deals, hospitals are seeing higher multiples in transactions, according to an Irving Levin Associates Health Care Services Acquisition Report. In 2011, the average price-to-revenue multiple for hospital acquisitions was 0.76x, which is an 8.5 percent increase from 2010. The average price-to-EBITDA multiple for hospitals was 9.5x in 2011, a 4.4 percent increase from 2010. The price-to-revenue multiple for critical access hospitals was 0.52x, and the average price to EBITDA multiple was 8.0x, according to Irving Levin Associates. These multiples exclude distressed sales and bankruptcy transactions. However, according to the report, those price-to-revenue multiples for distressed or bankrupt sales would be around 0.3 to 0.4x.
For many hospitals, a transaction is a once in a lifetime opportunity, especially if the hospital is being fully acquired or purchased. For this reason, hospitals often want to optimize the financial outcomes of a sale by increasing their value and essentially, their revenue or EBITDA multiple.
"The EBITDA [or revenue] multiple is just a rule of thumb or initial check of a hospital's 'value.' Generally, [multiples] are merely snap shots or a rear-view look at what happened to the hospital last year," says Joe Lupica, chairman at Newpoint Healthcare Advisors. "Value to the community can be more important than a raw 'price.' In fact, most of our clients trade off monetary value to leverage non-financial commitments from their new partner for things like service preservation and charity care."
In addition to industry competition, other factors — financial and non-financial — can affect a hospital's value multiple.
Recent investments
Recent investments such as medical, clinical and information technology as well as diagnostic or strategic investments can be a crucial factor in a hospital's valuation. Hospitals in need of investments in all areas may garner lower multiples. However, a buyer will sometimes pay a higher multiple for a troubled hospital within a strategic location. Regardless, neglect in this area could lower the possibility of a high multiple offer.
Physician relations
In today's healthcare environment, there is pressure for hospitals to engage and align with physicians, and hospital partners would likely assess future investments in physician relations as part of the hospital's value. "Acquiring practices and employing physicians requires more financial responsibility on the hospital's part. If a hospital totally neglected this area, a buyer would factor that into its valuation and multiple offers," says Mr. Grauman. It is important to note that the ability to prevent or slow down physician out migration may be dependent on the hospital's community. A hospital in a metro or urban area may be able to replace physicians fairly easily, whereas a rural hospital could have more trouble.
Community
A study of a hospital's surrounding community will play a role in how a buyer assesses the hospital, and this assessment could affect the valuation multiple. Usually the community demographics, such as financial stability of residents are assessed. "There is a direct correlation between financial performance of a hospital and the financial profile and payor mix of the community. If more people are employed and have health insurance, it translates to a hospital having a higher likelihood for strong financial performance," says Mr. Grauman. If a community has large, profitable companies employing individuals, there will be more insured patients to pay for services, and the payor mix may be more commercial. In addition, it is more likely that the community will continue to grow, says Mr. Lupica.
While a hospital can monitor the above-mentioned factors to maintain its value, the reality is that many hospitals may not have the foresight to consistently be upgrading facilities, investing in technology and fostering physician relationships for a future transaction. They would need to begin revamping these areas three to five years prior. For this reason, many valuation professionals and healthcare advisors believe that a hospital's ability to increase its multiple in a short period is minimal.
"The biggest determinants of value in a change-of-control transaction are often fundamental factors a hospital cannot entirely control and change. The characteristics of the market and hospital's share of that market are usually the drivers, not short term earnings results," says Rex Burgdorfer, vice president at Juniper Advisory, an investment banking firm that provides the hospital industry with M&A and strategic financial advice.
While many of the factors driving hospital prices are out of a hospital's control, nothing is entirely impossible. Here are some best practices hospital leaders can utilize during a transaction to encourage potential buyers and acquirers to see value in the hospital and offer a higher multiple.
1. Set up a competitive transaction process. Mr. Burgdorfer and another Juniper Advisory vice president, Jordan Shields, recommend a competitive transaction process as the best way to increase price-to-revenue and price-to-EBITDA multiples. "By introducing competition to the process — multiple potential partners — the hospital increases its chances for a partner that sees the value of its market and wants to invest. A competitive process is really the only way to ensure that a hospital is maximizing the financial and nonfinancial outcome," says Mr. Burgdorfer. A simultaneous, market clearing process also allows the board of directors to make the best possible decision for the institution.
"Many hospitals approach a potential partner who they have identified as 'the right partner.' They then try to negotiate the financial features. That is a bad process. A better process would be to simultaneously approach a wide variety of suitors and allow the market to respond. The hospital may review the various offers and multiples for what suits it best. A competitive process is the one thing a hospital can control to maximize both the financial multiples and the non-financial features of the transaction," says Mr. Shields.
2. Place more emphasis on the partner. Along with a competitive process, it is important to include a variety of types of hospitals and health systems to get the best outcomes from a transaction. According to Mr. Burgdorfer, transaction partners drive variances in hospital multiples, so the biggest factor in receiving a high, or appropriate, multiple is the experience of the potential partners. "Experienced suitors tend to understand the value of hospitals they are bidding on, so they make reasonable offers. Inexperienced suitors are often unfamiliar with what constitutes commercially reasonable exchanges of economic consideration," says Mr. Burgdorfer. According to Mr. Shields, it is the job of the investment banker to pull out the best offer from the market. The hospital board can then focus on the non-economic elements of the transaction by finding a partner with the best cultural fit.
3. Accentuate the positive. Beyond the design of the transaction process, a hospital can try to positively position its supposed weaknesses — payor ratio, physician pool, community, lack of recent investments and market share — throughout the search and proposal process. While this may not directly increase its multiple or ultimate valuation, it may help a hospital to secure a valuable outcome. Accentuating the positives works to position negatives as opportunities for investors. "Whether the hospital had high out-migration, bad management or its top neurosurgeon was on disabled leave after a car accident all year; those negatives need to be positioned as solvable problems. A good advisor would make the argument to the other side. 'Despite this problem, look at the cash flow that was produced.' Sell the idea that the hospital could have been more successful with a partner," says Mr. Lupica.
4. Demonstrate value despite financial struggles. According to Mr. Lupica, a hospital should also use its weaknesses or recent troubles as pivots to position itself as a valuable opportunity for an investor, partner or buyer. If the hospital's cash flow has been small, the hospital could demonstrate that its operations are sound despite small revenue. "The hospital can demonstrate its value by highlighting its quality, its patient outcomes, its patient satisfaction etc. Additionally, the hospital should demonstrate it has maintained cash flow — albeit small — with the right techniques (e.g., it didn't fire nurses to raise its cash flow a couple of months ago)," says Mr. Lupica.
5. Emphasize future initiatives. Hospitals should emphasize ongoing and future initiatives to demonstrate to a buyer potential for growth and profit in the future. "Do not look at incomplete initiatives as failures or as embarrassing. Investors may see initiatives that were started but never completed, or that were conceptualized but never implemented, as headroom for growth. Investors want to see headroom. Do not make any promises about the initiatives, but mention them as a demonstration of the hospital's efforts to develop value despite its problems and weaknesses," says Mr. Lupica. It is likely that potential buyers or acquirers would have the capital and management to successfully complete initiatives, using them as platforms for a turnaround.
Many factors such as the community, market competition, investments and physician relationships influence hospital valuations and M&A multiples. The difficulty in quickly increasing a multiple is part of the reason healthcare advisors tend to steer hospitals away from focusing on high multiples.
"We regularly see hospitals turn down higher financial offers for deals with partners that have a better cultural fit, robust infrastructure or that appreciate commitment to community. The outcome [of the transaction] is always more important than the multiple," says Mr. Shields.
However, for hospitals that still want to receive as high of a multiple offer as possible, the above-mentioned best practices during a transaction can help those hospitals position themselves for better valuations. In addition, a focus on the influencing factors can help a hospital improve its value over time.
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Valuation Multiples Paid For Controlling and Minority Interests in Physician-Owned Hospitals
"In situations where there are more potential acquirers — more competition — one could safely conclude that it would be a significant factor in final valuation," says Dan Grauman, president and CEO of DGA Partners.
Hospital multiples on the rise with increased consolidation
Due to the high volume of M&A deals, hospitals are seeing higher multiples in transactions, according to an Irving Levin Associates Health Care Services Acquisition Report. In 2011, the average price-to-revenue multiple for hospital acquisitions was 0.76x, which is an 8.5 percent increase from 2010. The average price-to-EBITDA multiple for hospitals was 9.5x in 2011, a 4.4 percent increase from 2010. The price-to-revenue multiple for critical access hospitals was 0.52x, and the average price to EBITDA multiple was 8.0x, according to Irving Levin Associates. These multiples exclude distressed sales and bankruptcy transactions. However, according to the report, those price-to-revenue multiples for distressed or bankrupt sales would be around 0.3 to 0.4x.
For many hospitals, a transaction is a once in a lifetime opportunity, especially if the hospital is being fully acquired or purchased. For this reason, hospitals often want to optimize the financial outcomes of a sale by increasing their value and essentially, their revenue or EBITDA multiple.
"The EBITDA [or revenue] multiple is just a rule of thumb or initial check of a hospital's 'value.' Generally, [multiples] are merely snap shots or a rear-view look at what happened to the hospital last year," says Joe Lupica, chairman at Newpoint Healthcare Advisors. "Value to the community can be more important than a raw 'price.' In fact, most of our clients trade off monetary value to leverage non-financial commitments from their new partner for things like service preservation and charity care."
In addition to industry competition, other factors — financial and non-financial — can affect a hospital's value multiple.
Factors of influence
Recent investments
Recent investments such as medical, clinical and information technology as well as diagnostic or strategic investments can be a crucial factor in a hospital's valuation. Hospitals in need of investments in all areas may garner lower multiples. However, a buyer will sometimes pay a higher multiple for a troubled hospital within a strategic location. Regardless, neglect in this area could lower the possibility of a high multiple offer.
Physician relations
In today's healthcare environment, there is pressure for hospitals to engage and align with physicians, and hospital partners would likely assess future investments in physician relations as part of the hospital's value. "Acquiring practices and employing physicians requires more financial responsibility on the hospital's part. If a hospital totally neglected this area, a buyer would factor that into its valuation and multiple offers," says Mr. Grauman. It is important to note that the ability to prevent or slow down physician out migration may be dependent on the hospital's community. A hospital in a metro or urban area may be able to replace physicians fairly easily, whereas a rural hospital could have more trouble.
Community
A study of a hospital's surrounding community will play a role in how a buyer assesses the hospital, and this assessment could affect the valuation multiple. Usually the community demographics, such as financial stability of residents are assessed. "There is a direct correlation between financial performance of a hospital and the financial profile and payor mix of the community. If more people are employed and have health insurance, it translates to a hospital having a higher likelihood for strong financial performance," says Mr. Grauman. If a community has large, profitable companies employing individuals, there will be more insured patients to pay for services, and the payor mix may be more commercial. In addition, it is more likely that the community will continue to grow, says Mr. Lupica.
While a hospital can monitor the above-mentioned factors to maintain its value, the reality is that many hospitals may not have the foresight to consistently be upgrading facilities, investing in technology and fostering physician relationships for a future transaction. They would need to begin revamping these areas three to five years prior. For this reason, many valuation professionals and healthcare advisors believe that a hospital's ability to increase its multiple in a short period is minimal.
"The biggest determinants of value in a change-of-control transaction are often fundamental factors a hospital cannot entirely control and change. The characteristics of the market and hospital's share of that market are usually the drivers, not short term earnings results," says Rex Burgdorfer, vice president at Juniper Advisory, an investment banking firm that provides the hospital industry with M&A and strategic financial advice.
While many of the factors driving hospital prices are out of a hospital's control, nothing is entirely impossible. Here are some best practices hospital leaders can utilize during a transaction to encourage potential buyers and acquirers to see value in the hospital and offer a higher multiple.
1. Set up a competitive transaction process. Mr. Burgdorfer and another Juniper Advisory vice president, Jordan Shields, recommend a competitive transaction process as the best way to increase price-to-revenue and price-to-EBITDA multiples. "By introducing competition to the process — multiple potential partners — the hospital increases its chances for a partner that sees the value of its market and wants to invest. A competitive process is really the only way to ensure that a hospital is maximizing the financial and nonfinancial outcome," says Mr. Burgdorfer. A simultaneous, market clearing process also allows the board of directors to make the best possible decision for the institution.
"Many hospitals approach a potential partner who they have identified as 'the right partner.' They then try to negotiate the financial features. That is a bad process. A better process would be to simultaneously approach a wide variety of suitors and allow the market to respond. The hospital may review the various offers and multiples for what suits it best. A competitive process is the one thing a hospital can control to maximize both the financial multiples and the non-financial features of the transaction," says Mr. Shields.
2. Place more emphasis on the partner. Along with a competitive process, it is important to include a variety of types of hospitals and health systems to get the best outcomes from a transaction. According to Mr. Burgdorfer, transaction partners drive variances in hospital multiples, so the biggest factor in receiving a high, or appropriate, multiple is the experience of the potential partners. "Experienced suitors tend to understand the value of hospitals they are bidding on, so they make reasonable offers. Inexperienced suitors are often unfamiliar with what constitutes commercially reasonable exchanges of economic consideration," says Mr. Burgdorfer. According to Mr. Shields, it is the job of the investment banker to pull out the best offer from the market. The hospital board can then focus on the non-economic elements of the transaction by finding a partner with the best cultural fit.
3. Accentuate the positive. Beyond the design of the transaction process, a hospital can try to positively position its supposed weaknesses — payor ratio, physician pool, community, lack of recent investments and market share — throughout the search and proposal process. While this may not directly increase its multiple or ultimate valuation, it may help a hospital to secure a valuable outcome. Accentuating the positives works to position negatives as opportunities for investors. "Whether the hospital had high out-migration, bad management or its top neurosurgeon was on disabled leave after a car accident all year; those negatives need to be positioned as solvable problems. A good advisor would make the argument to the other side. 'Despite this problem, look at the cash flow that was produced.' Sell the idea that the hospital could have been more successful with a partner," says Mr. Lupica.
4. Demonstrate value despite financial struggles. According to Mr. Lupica, a hospital should also use its weaknesses or recent troubles as pivots to position itself as a valuable opportunity for an investor, partner or buyer. If the hospital's cash flow has been small, the hospital could demonstrate that its operations are sound despite small revenue. "The hospital can demonstrate its value by highlighting its quality, its patient outcomes, its patient satisfaction etc. Additionally, the hospital should demonstrate it has maintained cash flow — albeit small — with the right techniques (e.g., it didn't fire nurses to raise its cash flow a couple of months ago)," says Mr. Lupica.
5. Emphasize future initiatives. Hospitals should emphasize ongoing and future initiatives to demonstrate to a buyer potential for growth and profit in the future. "Do not look at incomplete initiatives as failures or as embarrassing. Investors may see initiatives that were started but never completed, or that were conceptualized but never implemented, as headroom for growth. Investors want to see headroom. Do not make any promises about the initiatives, but mention them as a demonstration of the hospital's efforts to develop value despite its problems and weaknesses," says Mr. Lupica. It is likely that potential buyers or acquirers would have the capital and management to successfully complete initiatives, using them as platforms for a turnaround.
Many factors such as the community, market competition, investments and physician relationships influence hospital valuations and M&A multiples. The difficulty in quickly increasing a multiple is part of the reason healthcare advisors tend to steer hospitals away from focusing on high multiples.
"We regularly see hospitals turn down higher financial offers for deals with partners that have a better cultural fit, robust infrastructure or that appreciate commitment to community. The outcome [of the transaction] is always more important than the multiple," says Mr. Shields.
However, for hospitals that still want to receive as high of a multiple offer as possible, the above-mentioned best practices during a transaction can help those hospitals position themselves for better valuations. In addition, a focus on the influencing factors can help a hospital improve its value over time.
More Articles on Hospital Valuation Multiples:
Report: Competition for Hospital Transactions Leads to Upward Pressure on Acquisition Multiples5 Tips for Hospital Valuation in Today's Economy From David Felsenthal of Principle Valuation
Valuation Multiples Paid For Controlling and Minority Interests in Physician-Owned Hospitals