Home Care Conference: A Discussion with Mertz Taggart

This article is brought to you by Mertz Taggart. The article is based on an interview that took place during a live Q&A session with Cory Mertz and Bruce Vanderlaan, Managing Directors at Mertz Taggart, and Jeff Wiberg, CEO of Family Resource Home Care. The panel took place at the Home Care Conference in Chicago held on December 9, 2021. The interview has been edited for length and clarity.

Home Health Care News: We are now here to talk about the Home Care deal-making landscape. I’m joined by Cory Mertz, managing partner of Mertz Taggart, along with Bruce Vanderlaan managing director for Mertz Taggart as well; and Jeff Wiberg, CEO of Family Resource Home Care.

Family Resource has been a pretty rapidly-growing home care provider in the Pacific Northwest. Could you tell the folks here a little bit about your home care business?

Advertisement

Jeff Wiberg: Yes, sure. We’re an independently-owned and operated agency, we have 25 locations around the Pacific Northwest. We’re based out of Spokane, Washington. We cover almost all of Washington, Oregon, and Idaho. We’ve been pretty acquisitive over the past seven years, done a lot of transactions in that time, and continue to be so.

HHCN: When did you get started in home care?

Wiberg: Actually, I got into the business 15 years ago when I joined an agency that was predominantly home health. We had a little, small home care agency. We ended up selling off the home health division. Then the buyer at the time, which was Gentiva, didn’t want the home care division. I raised my hand and said, “I want it,” and then we’ve been scaling it ever since.

Advertisement

HHCN: We’ll start a little bit on a high level and then dig into some specific issues and trends that you guys have observed throughout 2021, other trends that you expect to see coming in 2022. Cory, What are you seeing as some of the most significant trends in the M&A world right now?

Cory Mertz: In the home care world, I would say the biggest, most significant trend that we’ve seen this year is really the franchisor transactions. We’ve seen a number of them. And to put it into perspective we’ve tracked these deals pretty carefully over the last several years from 2015 to 2020, there were actually three franchisor transactions. In 2021, we’ve seen five year-to-date so far.

HHCN: Bruce, how about you? What are some of the interesting things that you’ve been following in 2021?

Bruce Vanderlaan: One of the things that I’m seeing is the amount of money that’s really in the marketplace now and financial buyers looking at home care. I think one of the silver linings that’s really come out of COVID is that the rest of the world now knows what we know, and that is the absolute necessity of home care. That, I think, is in part driving the amount of dealmaking that’s happening.

HHCN: Jeff, you’ve been living it. What have been the key trends that have affected your business this year?

Wiberg: I completely agree with Bruce that there’s been a lot of interest within our community from private equity groups because they see all the tailwinds. They can read the tea leaves and know that we really are going to be a sought-after resource and service line going into the future. A lot of the private equity, when they first come up with an investment thesis, they really want to target a certain amount of EBITDA.

In the home care space, we’re so highly fragmented that there’s just not a lot of agencies out there with $10 million-plus in EBITDA. I think that that’s part of the reason that investors have really gone after the franchise organizations because you’re getting more of an economy of scale. Franchisors tend to run a little bit better EBITDA margins than just an individual operator. From that perspective, I think that’s part of what’s driving that end of things.

What I’ve appreciated about having so much investor interest in our space is that they’re starting to take a different look, especially in 2021. We saw multiple additional platform companies being backed by PE. What they’re doing now is instead of just buying a $10 million book of business or a $10 million EBITDA book of business, they’re looking for a platform that has the right kinds of systems and processes and people in place to be able to scale up to that.

They’re basically backing consolidators. If you’re backing a consolidator, then you’re going to see all these people running around very acquisitively. That’s going to drive a lot of transactions because the consolidators will definitely eat up smaller players and that would just give us volume of transactions.

HHCN: Cory and Bruce, does that mirror what you’ve seen?

Mertz: Yes, I would say regarding the franchisors, certainly, the private equity groups, they love it. I think they’re piggybacking on the success of some of the other franchises that have done some acquisitions and have subsequently grown. You have to remember, private equity, when they develop a thesis and when they see a target, they also are looking at an exit. Without that exit, PE doesn’t really make their money. They’re looking three to five to seven years down the road at their exit.

Ultimately, I think if you’re looking at the ultimate consolidators, it’s the publicly-traded home care companies. It’s Amedisys, LHC Group, Addus, Aveanna. Those are the pure players and they’ve all done very well over the last several years. We’ve seen the trading multiples of those companies in the 30s, in the 20s. They’ve come down a little bit over the last few months primarily because of COVID and I think they’ll normalize again.

As long as the investment community likes the publicly-traded companies, which they have over the last several years and it’s reflected in their multiples, private equity, ultimately, has an exit. Because a publicly-traded home care company, if you’re trading in the 30s, a 30 times adjusted EBITDA, you can buy a large private business from private equity. I say “large,” let’s say hundreds of millions and pay in the teens of a multiple of EBITDA and it still will be accretive. As long as the public companies are doing well, private equity will continue to invest all the money that they’ve got.

Wiberg: Let me add something to that as well. I think that what we’re also seeing, whether it’s a public company or even a private company, the availability of capital is really rich right now. Money is very inexpensive. In the home care space, we can get a pretty quick return from a cash-on-cash basis. Lenders are wanting to lend out money because it’s so readily available at the present time.

HHCN: Cory, you mentioned the public companies and a couple of new public companies. Aveanna for example. It seems like whenever there’s a new public player, they try to make a splash and they’re particularly active from an M&A perspective. Bruce and Cory, what are your thoughts on that?

Mertz: Yes, we’ve seen it recently with Aveanna, they went public in April. They acquired Doctor’s Choice down in Florida. The multiple that they paid for that deal was surprisingly rich to most of the community. They had an IPO right on the tail of that at $34, so it was still a relatively easy deal for them to do.

HHCN: It just seems like the public companies, in a lot of ways, help shape the market. Recently, the new public companies have played an even bigger role.

Vanderlaan: I think that’s true. I think to Jeff’s point, one of the best and quickest ways to add EBITDA to your company is to acquire that EBITDA. In today’s marketplaces, particularly with our employment situation, one of the best ways to add caregivers to your organization is through acquisition. I think that’s all working together.

HHCN: Cory, you mentioned how valuations are still high, but maybe we’re starting to see them come down just a little bit.

Mertz: Well, I’m referring to the public companies right now. The multiples have come down from the 30s and the 20s to the 20s and the teens now. I’d like to think it’s a relatively short-term phenomenon and it’ll settle out once we get past COVID. They’re a little bit low right now, but we have not seen that in the private deals.

HHCN: We’ve talked a lot about the labor challenges today. Really, one of the only limiting factors to home care growth right now is labor. Jeff, I’m sure that the demand for your services is through the roof and you could probably grow incredibly rapidly if you want it to, but you’re probably restricted a little bit just by caregiver availability, right?

Wiberg: Yes. From a buyer’s perspective, the way I think of it is that the larger of an organization that I can command and control, the more opportunities and options I have at my disposal to compete for that labor. I can have better and cheaper benefits for my staff. I can have industry-leading wages. I can have the necessary infrastructure to be able to do a lot of value propositions towards culture and components of that nature, which is harder for the smaller companies to compete with because home care is getting a lot more difficult because of the regulatory environment that we’re having to operate in.

Also, these macro factors like COVID have made it just not as much joy as it used to be. From a seller’s perspective, I think one of the trends that is leading towards the M&A activity that we’ve got is because it’s just not as fun anymore. They’re looking at the impending increases to capital gains taxes and such and they’re saying, “Maybe now is the right time to hang up my hat and just sell out and sell into that proverbial sunset.”

HHCN: Bruce, Cory, anything that you like to add to Jeff’s comment?

Vanderlaan: Yes, I think we’re absolutely seeing the same thing. I’m frequently talking to sellers who exhibit burnout and lots of different reasons. It’s the labor and environment. It’s the regulatory environment. We all know it’s a hard job, to begin with. When you add additional pressures onto it, it is driving a number of people to make that decision or to start thinking about an exit strategy.

HHCN: Jeff, what’s in your M&A pipeline? What kinds of deals are you hoping to execute in the coming year?

Wiberg: We’re looking a lot closer at regulatory compliance because what I don’t want to do is buy something that has a bunch of hidden liabilities. We are being a lot more cautious about how the agency performed throughout this crisis.

From my pipeline standpoint, I’m looking to create regional density within the Pacific Northwest, obviously, because I feel like that that’s going to put me in a better position to be an attractive partner for larger healthcare systems or payers because I can be where they need me to be and not just be in just the major metros, for example. I’m going after geography. I’m going after agencies that are healthy and that are not asking for a premium price for a subpar product essentially.

This burnout issue that Bruce was talking about is very real. If somebody has really lost their joy, they haven’t innovated their way through these challenges and the businesses suffered, but they’re also at this stage of what I call “on-the-job retirement.” If they think that they’re going to just turn it around in 2022 or 2023, they may find that their wick has already burned out. I feel bad about this situation, but it just doesn’t come in the same kind of value as it would have potentially a couple of years ago.

HHCN: Bruce and Cory, Jeff just talked about being a more careful consolidator and doing a little bit more due diligence than we would have seen in the past. Is that a trend that you’ve seen with some of the other acquisitions that you work with? I wonder, do things like the Paycheck Protection Program and some of the other COVID-era regulatory changes and rules, affect dealmaking?

Mertz: When we take a company to market – and the buyer will do the same thing- we’ll normalize everything in the financial statements. Spikes from one-time financial aid will be removed. On the flip side, extra labor expenses incurred as a result of that same aid money will also be removed.

HHCN: Jeff explained being a more careful buyer. Do you see most acquirers being similarly more careful?

Mertz: I have seen it. In our experience, the public companies, the private equity companies, the private equity-backed companies, they’re going to do their share of diligence. I haven’t seen it necessarily pick up over the last few years. It’s always going to be smart money and they’re going to do their diligence across the board.

HHCN: Bruce, the home care market is very hot as we’ve talked about. When will it cool down in your view?

Vanderlaan: Well, I hate to prognosticate anything. Typically, if you were asking me for a stock tip, do exactly the opposite of what I tell you. I don’t know. I think that probably at least through 2022, it’s going to remain hot. Depending on what happens next year with the interest rates, that’s going to drive significant change if interest rates rise. Not seeing that.

I’m not sure exactly what’s happening with the whole capital gains tax increase. I don’t know if that needs to be reconciled or where we are with that right now, but that could change the marketplace too. It certainly did over the last year really. It drove a lot of deals to try to get done by the end of 2020 and certainly get done in 2021. I think that it’s going to remain hot for at least the next 12 months.

HHCN: Jeff, what’s your take?

Wiberg: I think that we still have just immense tailwinds as an overall industry. Then we have to recognize that at the end of the day, we are a very fragmented industry. Anywhere from 12,000 to 18,000 agencies, which means that there’s a lot of folks that can sell. I believe that that will drive ongoing volume of transactions as we continue to consolidate as an industry.

When you get pairs like CMS involved, CMS actually incentivizes consolidation. Because for them, it’s a way to be able to drive costs down. If we do see additional payer activity over the course of the next couple of years, which we’ve all been talking about for several years now as being coming down the pipe way, then I think that that consolidation will continue into perpetuity.

Mertz: Just to kind of reiterate and maybe expand a little bit on a couple of points that we’ve hit on already. I think the last two years, 2020 and 2021, we have seen record activity. It was predictable in both years for a couple of reasons. It’s really primarily the same reason. It’s the threat of the capital gains tax rates going up. We saw it last year with the elections approaching and knowing that the Biden administration– and this is not being political, but they intended to raise the capital gains tax rate.

We seem to have gotten past that hurdle for a retroactive January 2021 effectivity. Now, we’re looking at either September of 2021 or January of 2022 when the capital gains tax rate actually does go up or the effectivity. Sellers have been heading for the exits for the last couple of years in anticipation of that in addition to the burnout.

I think we’re going to see a little bit of a drop-off in activity in 2022 because I’m afraid to say that I think the capital gains tax rates will go up a little bit, probably effective January 2022 or September 2021- Those sellers that would have wanted to sell are going to have to hold on for another year just to make up that difference. Longer-term, I’m going to be looking at interest rates. We’ve lived in an environment for the last 20 years where interest rates have been really low.

I think we’re heading into a little bit of an unprecedented time with inflation being what it is. So far, the Fed hasn’t done anything, but they’ve hinted at raising rates starting at the end of 2022. That could all change certainly, but that’s something that I’ll be looking at because if interest rates go up, it becomes harder for private equity to make the returns that they otherwise would have made without reducing the value of the deals that they’re going to do.

HHCN: Jeff, what do you see as the most significant challenges to Family Resource and your future growth as a consolidator moving forward?

Wiberg: The most significant challenges outside of the obvious workforce development issues, I would say, that getting the pricing right. Anytime the industry gets a whiff of blood in the water in terms of, “Oh, well, everybody’s interested in buying home care,” you have a top-line revenue, $3 million business that thinks that they’re going to trade for 8 times. I feel like that there can be some barriers to accomplishing what we want to be able to accomplish by finding what I’ve already described as being a healthy business but that also has a healthy perspective as to what the market would actually pay for that business.

Even though we were talking a little bit earlier about how publicly-traded companies might trade up because they still get that multiple arbitrage on whatever it is that they’re doing, that’s not the case for private buyers. I still have to pay attention to the multiples I’m paying in order to be able to control my ROI. Educating the industry, helping them to understand what real market value really does bear, I talked to all of my friends in this industry that are consolidators as well. I know that it’s not just me that thinks this way. I want to be able to control what that value is and that can be hard.

HHCN: Jeff, when you look to buy a business, what makes it a quality asset? What are you looking for exactly? Then, Cory, Bruce, when you’re advising your clients, what does a quality acquisition look like for you guys?

Wiberg: I have a lot of points to make. A quality business, a consistency of revenue, preferably one that’s growing and the growth is coming from not just one single-sourcing pipeline, meaning that the relationship that the organization has to their local community is diverse and it’s broad. They’re bringing in a host of different kinds of clients that the business is not made up of all 24-hour care that are all on hospice.

Then on the caregiver side, you want to see that there’s stickiness there, that there’s longevity with their caregivers, additionally that they’re not experiencing over 100% turnover every single year, and that there’s some measure of loyalty that exists. If the owner is going to be going away, then I want to know, what was the owner doing? What was their role? How have they diluted their impact if they’re saying, “Okay, I’m ready to move on”? Have they done proper succession planning?

Do they have leadership that can really run the business day-to-day after they leave? They run a clean shop in terms of regulatory compliance issues. They’ve got good command and control over their various different margins, it might be gross margin or EBITDA margin, so that they’re not bloated from an admin staff standpoint or that they’re paying way under-market for caregivers or way over-market for that matter.

“Healthy,” obviously, is a very relative term, but those are the macro indicators that I’ll look at and kick the tires on. If I see that that’s pretty solid, then I’m going to want to dig even further and get into the nuts and bolts of what’s underneath the engine. Usually, if the macros are good, then what you find in the closet is not necessarily a bunch of skeletons. In that case, okay, it’s a healthy business. Let’s talk about what a reasonable price is and how we can make that happen.

HHCN: Bruce, some of the things that Jeff just mentioned: consistency in revenue, diverse service payer mix, proper succession planning, a clean shop. Does that more or less mirror what you would say?

Vanderlaan: Yes, it’s really hard to add anything of value to what Jeff just said.

HHCN: Cory, how about you?

Mertz: I think Jeff touched on a lot of points. If you were to sum it all up, these buyers, whether they’re backed by private equity or family offices or public companies, they’re investors first and foremost. You mentioned consistency, diversity of the referral base. What’s the owner’s role in the company? Are they heavily involved? If they walk away, what might happen? What buyers are most concerned about, yes, they want to see some opportunity for growth. They like EBITDA, they like revenue.

Especially in personal care services, the biggest fear is that the revenue is going to drop off after the closing. Immediately 12 months after the closing, things are going to tank. They’re only concerned about it because they’ve seen it multiple times. All the things that Jeff mentioned are things that give buyers comfort that this is going to continue to generate the cashflow that we’re buying into.

HHCN: Is there a certain type of provider that’s getting more interest on the market? Not just franchise organizations, but maybe a type of home care provider as far as service mix. Are you seeing more acquisition interest around companies that participate in value-based programs?

Wiberg: No, I have never found one in my pipeline that has done anything meaningful on a value-based purchasing basis. I would like to know, are they using CMS Innovation money and doing something that’s like a pilot? That would be super fascinating to be able to see where they are in that type of a relationship.

HHCN: At the same time, if it’s part of a pilot, that could go away at some point?

Wiberg: It absolutely could. You’re absolutely right. How I would value that would be, conceptually, I would like those relationships and I would like the fact that they already think that way because that’s an indication of sophistication. If there’s a bunch of revenue associated with that, which I don’t think that there’s going to be a lot of revenue in really any agency to speak of at this point. I don’t know that I would necessarily adjust that down because that’s already the way we think. That would mean that we have a good cultural alignment, so I would see that as a positive indicator.

HHCN: Cory, is there a type of provider that you’re seeing more interest around? Do you think a value-based care acquisition target would maybe have a higher valuation than somebody that wasn’t in value-based care?

Mertz: I would think, conceptually, someone like that would command a higher valuation. We haven’t really seen it yet first hand on the non-medical side. I think it’s still early. I think those companies that are well-positioned for value-based care are going to be more attractive. We’ve seen it with the skilled agencies and it’s something we highlight when we take a company to market. Here are their quality ratings, patient satisfaction ratings, re-hospitalization rates, etc.

Vanderlaan: Now, Bob, you asked also, is there a type of company based upon payer mix or something of that nature as well? A couple of thoughts with that is market dominance. If you’re the number one, two, or three in your particular geography, that is going to command a better price because that’s a fantastic place to be. Secondly, a diversity of payer mix is much more attractive to me.

If you’re 100% Medicaid or if you’re 100% private pay, although I value the private pay potential a little bit more than Medicaid, I like actually a diversity of payer mix because that shows that you’re able to really meet the needs of a variety of payors. Typically, in most states, there’s a little bit higher regulatory hurdle with Medicaid. That shows again some sophistication. From a business mix standpoint, I like to see it mixed. Maybe a little bit more preference on the private pay.

HHCN: What is one prediction for 2022 related to home care dealmaking activity that you can share?

Vanderlaan: I think probably we’re going to see fewer deals in number but larger in dollar volume and probably better deals, better agencies more likely to close.

Wiberg: I would say that those of us who are consolidators in this space, we’re going to continue to be very acquisitive in 2022.

HHCN: Cory, what does Mertz Taggart see coming for 2022?

Mertz: I don’t see the demand tapering off for sure. Again, as I mentioned before, we probably will see a little bit of a slowdown in just the number of transactions, this being a record year. I can’t imagine it continuing in the next year. Everybody that’s in the deal world is slammed. It’s unsustainable. I think we’ll just see a little bit fewer deals, but probably more high-quality deals.

HHCN: Thank you so much for your time.

Editor’s note: This interview has been edited for length and clarity.Mertz Taggart specializes in home health, home care, hospice, and behavioral health. To learn more visit https://www.mertztaggart.com/ .

Companies featured in this article: