Home health mergers and acquisitions got off to a slow start in 2020, then picked up considerably by year’s end. Home health insiders are now predicting a big year for M&A activity in 2021, especially after COVID-19 relief vanishes and economic realities become clearer.
The Patient-Driven Groupings Model (PDGM) will likewise play a part in the M&A landscape, as will other payment-related changes.
But another major factor will be Certificate of Need (CON) laws in some states and regions. Whether buyers want to enter into those precious territories — and whether prospective sellers are willing to give up their valuable position — will be an intriguing storyline in coming years for home health dealmaking.
A CON program is a state regulatory tool that controls the number of health care resources in a given area. It requires home health operators looking to enter a CON state to prove that there is an indisputable need for more home health services in an area.
In other words, an agency cannot exist in a CON state unless it holds a certificate.
The CON concept began with hospitals. The government wanted to make sure it wasn’t funding too many brick-and-mortar institutions in small geographic clusters.
Since then, the same logic has come to home health.
There are currently 18 Certificate of Need states, plus Washington, D.C. Entering these states organically, and not by way of M&A, may be harder than ever, Mark Kulik, the managing director of M&A advisory firm The Braff Group, told Home Health Care News.
“Today, in 2021, it’s extraordinarily difficult to get a certificate,” Kulik said. “They’re not issuing many, if at all. And when there is an application for a new CON, a home health agency has to go through a process that includes a public hearing.”
At that public hearing, other agencies in the area can argue against a new home health operator’s case that it should be allowed to open up shop. And it’s worth it to keep others out, for agencies already established in a CON state. Keeping supply lower as demand remains high is good for business.
In effect, CON-state providers have an artificial moat built around them in the marketplace. With regulation, there may be four or five providers in an entire county. Without it, there’s more likely to be dozens — or more.
“Agencies in those respective states have been contacted numerous times by myself, my competitors and by other agencies on a direct basis because they are so valuable,” Kulik said. “And I think that the demand is going to spike again for those agencies. It’s just a question of how the owners feel about exiting at that point in time.”
If an operator wants to enter into a CON state that has deemed itself “full” in 2021, it will have to buy in — and that won’t come cheap.
Hypothetically speaking, if there are two identical agencies — one in a CON state and the other in a non-CON state — the one in the CON state will garner a 30% to 75% higher selling price, Kulik said.
But that price hike may not be enticing enough for owners to sell. CON-state agencies are typically larger and healthier. They have a stable competitive landscape and are not forced to worry about new competitors coming into town year after year.
“Theoretically, if you’re in a CON state, you’ve got the same competitors — two, three, four, five years from now,” Kulik said. “If you’re in a non-CON state or area, that’s always top of mind. ‘Who’s moving into my service area? Who’s going out of business? Am I growing or shrinking?’ You have all sorts of other issues at play.”
Once the second phase of PDGM is more firmly underway, Kulik expects M&A activity to pick up considerably after the first quarter. When it does, the CON-state jockeying should be in full force.
Into the weeds of CONs
Buying options in Certificate of Need states are scarcer than they used to be.
Encompass Health Corp. (NYSE: EHC) is now the fourth-largest home health provider in the U.S., according to LexisNexis data. But it wasn’t always a large player.
As it added scale, other large home health players were buying up agencies where in CON states. As a result, there are fewer acquisition options for Encompass Health to go after now.
“I think we find ourselves, if anything, a little behind,” Luke James, the president of Encompass Health’s home health and hospice arm, told HHCN. “That’s somewhat intentional. But in terms of what’s left in some of these states that we’d like to be in, it’s certainly scarcer than it used to be.”
Birmingham, Alabama-based Encompass Health announced recently it is “exploring strategic alternatives” for its home health and hospice business, which brought in a total segment revenue of $1.09 billion in all of 2019, according to company financial filings.
Organic growth and non-CON state acquisitions were enough to get Encompass into the top-five of the home health world.
“We felt like, at the time, that was a better solution — for us to spend less and get a similar outcome, or at least an acceptable outcome,” James said.
But now Encompass Health is a home health behemoth, which gives it the ability to enter into CON states, even if they’re scarce. But the math and logistics look a lot different than they did five to 10 years ago.
Other home health competitors have a stranglehold in some CON regions and can opt to outbid everyone else for any agencies that come up for sale.
Still, if Encompass Health feels an acquisition is feasible and in line with its national strategy, it won’t be afraid to throw a lot of money at a seller to enter into an area it desires.
“Maybe the return metrics [on a CON acquisition] don’t look so good on paper compared to other opportunities we have, but we may think it’s the right long-term decision for our organization to go ahead and do it anyway,” James said.
Encompass Health’s main growth strategy continues to be prioritizing the overlapping of its businesses in areas where it is already present. For instance, if the company has hospitals or other facilities in an area, the home health and hospice arm would like to join them.
Some of those areas are in CON states, and some aren’t.
But James doesn’t entirely agree with the notion that it’s always better to be in a less competitive CON state or area. Encompass Health’s largest footprints are in Texas and Florida, for instance, where CONs are not required.
“In some cases, we enjoy the increased competition, because it allows us to really stand out,” James said. “And whenever there’s tough years — [like with] PDGM or RAPs going away, for instance — I think that what we’ll see is that more concentrated states have a lot more smaller providers trying to get out. With more disruption comes more opportunity for the larger, more sophisticated and better prepared providers in those states.”
Fulton County, Georgia, has about 35 home health providers, whereas Dallas County, Texas, has closer to 700. Encompass Health is located in both of those counties.
“Is it a lot more competitive in Dallas? Absolutely,” James said. “Is it harder to recruit and retain? Yeah, it is. … But in times of uncertainty and disruption, I think there’s more opportunity for a fallout in some of the lower-quality, less prepared providers in Dallas County than in Fulton County.”