This article is a part of your HHCN+ Membership
Rising staffing costs and unfavorable reimbursement dynamics in the home-based care space have created a seller-buyer pricing misalignment that has had ill effects on mergers and acquisitions.
After a record-breaking 2021 for M&A in home-based care, the space has seen a sharp decline in deal activity. Although many experts are mostly optimistic about the long-term prospects of home health care and home care deals, there seems to be a disconnect between parties when it comes time to make a deal.
“Buyers typically look forward in their evaluation,” Mark Kulik, senior managing director of The Braff Group, said during Home Health Care News’ FUTURE event. “They factor in rate changes, and they try to estimate different depressants to a business. Sellers typically look backward. That difference of forward versus backward creates a valuation gap that I think we’re going to see for a period of time.”
One of those factors is the home health final rule from the U.S. Centers for Medicare & Medicaid Services (CMS): an estimated increase to 2023 home health payments of 0.7%, or $125 million, compared to 2022 aggregate payments.
The agency had initially proposed a 4.2% aggregate decrease in 2023, which would have marked one of the steepest home health Medicare cuts in years. At the same time, CMS is still phasing in other cuts and permanent adjustments related to the rebalancing of the Patient-Driven Groupings Model (PDGM).
In a new report from Pitchbook, Barry Freeman — managing director of health care at Lincoln International — outlined how home health, home care, hospice and other personal care businesses had been fetching multiples in the mid-to-high teens in PE-backed acquisitions.
Many sellers, Freeman pointed out, are still seeking multiples at 2021 levels. At the same time, buyers are seeking adjustments to account for uncertainty about future EBITDA and margin projections.
That disconnect could impact how sellers and buyers operate during the rest of 2022 and beyond.
“I definitely think that there’s a carryover from last year when valuation was very, very strong and expectations were that sellers were going to be rewarded with strong value,” Les Levinson, co-chair of the transactional health care practice Robinson & Cole LLP, told HHCN. “That certainly has moderated a bit. However, you will always find some set of sellers who for personal, strategic or other reasons, do need to transact.”
That is why the industry continued to see activity amid some uncertainty even before the home health final rule was published.
Evaluating the gap
The increase in staffing costs in home-based care, particularly in home care, also continues to be a tricky hurdle to navigate for buyers.
The home care space has been particularly hard hit with staffing shortages due to its reliance on non-medical care workers. Those caregivers, Pitchbook said, are more likely to leave health care altogether for more attractive work in other industries.
Home care providers, in turn, have tried to recruit and retain those workers with higher pay.
Some home care providers will be able to weather this storm, but smaller home care agencies may struggle to fill authorized hours and maintain profitability. That’s where PE and larger operators may come in.
But it’s important for those smaller providers to do their due diligence. That’s particularly true in home health care, as some of the dust continues to settle following the final rule, Levinson said.
“If you’re a seller who’s not really sure what to do in the short term, you can use this time productively and wisely, particularly if you are looking to transact at some point when some of the clouds sift away,” Levinson said. “Now may be the time when you have greater visibility as to what a transaction might look like for you from a valuation perspective, and when it would be reasonable to think you could conclude that.”
To narrow that valuation gap, Levinson said agencies should be living in the “batten down the hatches” period.
“Run your own internal due diligence process,” he said. “Try to anticipate the kinds of things that a buyer — whether it’s a strategic or private equity buyer — is going to be looking for. If you don’t have a banker, it’s probably a good time to engage with a banker because all of this preparatory work will clearly pay dividends for you in the longer run.”
Medicare-focused home health and hospice businesses are also seeing staffing costs rise, though not to the extent of Medicaid and private duty home care companies, Pitchbook reported.
However, home health care has to grapple with uncertain reimbursement dynamics.
With lingering uncertainty over how additional cuts from CMS will be implemented in 2024 and beyond, there are several factors that may negatively affect deal flow.
Yet there are silver linings for possible sellers, especially as the industry shifts toward value.
“Home health providers that can succeed under risk-based contracts will see enhanced partnership and exit opportunities with health systems, pay-providers and primary care aggregators looking to extend MA-focused senior primary care into the home,” the report said.
A prime example is Frontpoint Health, a brand new home health agency that specifically caters to MA and does not rely on Medicare fee for service as its main revenue source.
As mentioned above, it is important to remember that while sellers like to look to the past when considering value, buyers look to the future. Sometimes in very untraditional ways.
“I had a conversation with a private equity group years ago and they told me, ‘Mark, I bet as much on the jockey as I bet on the horse,’” Kulik said. “The leadership of the agency is just as valuable — if not more so — than the agency. What they’re buying is future revenue streams, future growth and it’s the leadership that determines that, for the most part. Those are all critical components that come into play when you look at private equity and their mentality going forward of what they’re looking for in an agency.”
Looking ahead
M&A experts are still bullish on deal flow in home-based care for 2023. Private equity interest is still strong and the demand for home-based care should remain steady.
However, it’s important to understand the current valuation gap and how buyers and sellers could close it.
As providers continue to adjust to an environment with new staffing expectations and reimbursement changes, deal activity will likely heighten again in late 2022 or 2023 at lower multiples, Pitchbook projects.
The valuation gap, at the same time, will persist until a pricing consensus emerges. There is still optimism, considering the demand and some of the certainty that comes with the need for high-quality and convenient health care.
“I feel like we’re going to be reasonably flat out through the end of the year,” Levinson said. “The general theme – considering macro issues at present like the potential continuation of economic uncertainty, rising interest rates, the war overseas – is that investors are looking around to see where they can invest dollars in a reasonably stable market. It’s hard to get away from health care when it generally fits that criteria.”
Companies featured in this article:
