Home health care and hospice companies are still popular targets for mergers and acquisitions. This highly fragmented sector bounced back from the lull it experienced a few years ago, as private equity firms put their money to work building local and regional platforms. Hospitals and health systems are looking to either purchase or partner with home health care companies to extend their continuum of care into the post-acute segment.
HealthCareMandA.com covers today’s home health care and hospice merger and acquisition market, not just what’s covered in major media, including M&A transaction data, statistics and valuation multiples. In this discussion, industry experts Eugene Goldenberg, Vice President, Cain Brothers; Mark Kulik, Managing Director, The Braff Group; and Les Levinson, Partner and Co-Chair of the Transactional Health Law Group, Robinson + Cole, examine the state of home health care care and hospice M&A markets. Topics include current market trends, who is buying and who is selling, valuation multiples and how they’ve changed, and what to expect going forward.
Market Trends
What is the current market for home health care and hospice, and what is the outlook for the rest of this year?
Mark Kulik: Overall, fewer home health care deals are occurring, and this is largely due to the serial buyers backing off acquisitions. Six to ten years ago, every time The Braff Group took a client to market, they would receive a high level of interest from the four major public companies at that time, as well as from the strategic buyers.
What used to be a land grab has dialed down to very selective buying, which is something that is reflected in the acquisition data. “One-off buyers” have taken the place of strategic buyers.
I think a lot of that is focused on compliance. If I had to pick one thing that’s changed dramatically in due diligence, compliance has hugely spiked as a level of concern from a buyer perspective.
Les Levinson: I agree. In the transactions I’ve been involved in, I’m seeing regulatory compliance become a much more important part of the diligence package. People are viewing it much more aggressively early in the deal cycle, putting more resources to it and bringing additional external resources into their own diligence exercise.
If you go where the market is today, compared to maybe four or five years ago, it’s more fulsome than it was then. It was definitely more of a squeeze-down then. But I would agree that the market isn’t as vibrant as it was, maybe 10 or 12 years ago.”
Eugene Goldenberg: I was an equity research analyst before joining Cain Brothers on the banking side. I covered the publicly traded home health care and hospice operators on the research side during the “golden decade” for home health care, roughly from 2000 to 2010.
Starting in 2011, the market felt significant pressure from the Centers of Medicare and Medicaid Services. These pressures were on both the reimbursement front, where a nearly 15% rate cut was put into place over the next four- or five-year period, as well as the regulatory front, where several hurdles were put into place that put a restriction on volume.
Consequently, the organic volume growth dipped down into the low single digits from the low double digits where it was previously.
A combination of these headwinds caused a great period of uncertainty where, from 2011 until 2014, there was absolutely no private equity involvement in the homecare space. “That entire period of M&A was predominantly driven by strategics, who are very much involved in what Mark called a land grab. They were the only buyers out there and they were paying up for those assets.”
But, due to the lack of reimbursement clarity, a lot of the financial community and the private equity firms were not able to value companies appropriately since they could not get a handle on projections. Thus, private equity activity didn’t return until the latter part of 2013. Since then, I would say private equity has been extremely active at times, even more so than the strategics, probably over the last two years.
LL: In all processes that you see, private equity is clearly showing up in robust numbers to participate in these processes. Less aggregation in the market is due to those serial acquirers, like Gentiva or Compos, being bought by another company. For this reason, they have rolled into a different model than they were executing when they were independent, resulting in less deals.
Regarding private equity’s role in home health care and hospice, Mark claims that they account for roughly 30% to 40% of all the deals being done, whether platform or add-ons or sponsored by private equity.
What are the key drivers that make home health care/hospice an attractive investment/acquisition target (or not)?
EG: Previously, buyers were just looking to buy upscale and gain volume to offset the rate cuts during that period. But when you look at the transactions that have taken place over the last 24 to 36 months, there’s been significantly more of a strategic angle to these deals than just getting scale.
Scale is still an important factor, but at the same time, home care and hospice are very local businesses, and the definition of scale has changed significantly over the last couple of years. Now, there is a lot more emphasis put on density in a particular market, defined as scale, versus having 10 dots across the entire country. While that may give you a larger geographic presence, you don’t get the specific density in any one particular community.
I’ve seen several providers diversifying beyond their traditional focus in the skilled homecare market. Providers have started entering the para-professional and Medicaid homecare businesses, as well as looking at the private-duty franchise models that have been very popular with sponsors, as well as diversifying into hospice.
MK: Reimbursement models are evolving, too. The market is currently transitioning from treating more episodes of care to treating actual conditions. It’s no longer a matter of doing more volume; it’s a matter of treating the condition and looking for better outcomes. These changes place more emphasis on home health care and hospice, because it’s a desirable and cost effective place to be for individuals.
And that’s also placing home health care and hospice in the center of the target, because it’s a desirable place to be for most individuals. It’s also a cost-effective place to treat patients. So that definitely has brought the market into a preeminent position as far as acquisitions go.
How are state budget issues affecting the home care/hospice market?
LL: New York State just adopted its budget. And while there were changes, some additional dollars were allocated towards the Medicaid program in New York, in contrast to other states where the cuts are going deeper. The market is in a period of uncertainty regarding state budgets. There is also uncertainty regarding Washington, as the Congress and the president continue to figure out what they want to do with the Affordable Care Act.
California, as well as states in the Midwest and the South, are examples of other states that are providing more support to their Medicaid programs.
EG: What we’ve seen is quite a mixed bag too, because it really depends on which state you’re looking at. To Les’s point, when people are looking to make investments in a Medicaid homecare asset, they really do a significant amount of diligence on the particular health and financial kind of healthiness of that state.”
Texas and Oklahoma have recently gone through issues on that front, specifically with their entire budget for Health and Human Services being cut by about 4% to 6%. So they look at state budget cycles. Texas is one of the few unique states that runs on a two-year cycle, so there is a bit more clarity once a decision is made. But again, the state budget issue is predominantly skewed toward the Medicaid homecare, and probably a lot less so on Medicare.
MK: As I’ve tracked it over the years, I’ve found that the states’ economic fortunes lead the Medicaid expenditures by about two or three years, meaning as the states’ revenues come down, it takes a couple years for that to manifest into the Medicaid program. And as the state economic health grows, it takes a year or two for it to come back into the program as well, creating a leading-lagging indicator. “But I’m with Eugene on, it’s not really an issue on the Medicare side. It’s more of a Medicaid issue, and it is state by state, no question.”
So obviously labor costs are affecting all providers. What should investors, and people who are thinking of getting into homecare, be looking for? How much of a headwind is this in the homecare and hospice industries?
MK: It’s been a tough challenge. There is a huge demand, particularly in the private-duty side, non-skilled side. It’s not a matter of the business not being there; it’s a matter of finding the labor pool that will be able to step in and fill all those hours.
In that sector of business, the recruiting issue is number one on most owners’ minds. There have been some creative ideas to try and minimize the economic impact to the owners. For example, on the private-duty side, owners have looked at the total take-home pay for a given employee, and as it relates to overtime. They then reduce the hourly pay down to minimum wage and then factor in the north of 40 hours a week. So if they work 60 hours a week total, they factor in the overtime pay so that they keep the employee whole at the end of the week, relative to what they were receiving prior to that change.
So they’re getting creative and looking at how to remain legal, because there are requirements now from DOL as well as to the employees’ perspective: how do they keep that employee whole on their paycheck without economically killing their own business. It’s been a delicate balance over the last 12 to 24 months.
LL: Several states, like New York and California, have fairly aggressive wage parity rules. What some of the states have tried to do is subsidize some of that wage differential, and appreciate that there’s additional margin pressure on the operators as they are required to pay higher wages. “So I think that’s just another area where we’re going to have to be mindful and try to navigate your way around that path.
EG: I think we’ve seen agreement in principle between some of the providers and the managed care organizations. New York is a very good example of this notion, which is one of the states that has both wage parities and overtime requirements. Although there will be funding provided to the operators to give them some relief on the wage front, that relief is very irregular.
So even though things may be right from a timing perspective, this could create an immediate cash crunch for some operators. And in some instances, it’s causing companies to change their entire business model. Eugene recounts a recent and applicable example of a company called Home Hero, which had funding from a couple of venture capital firms and was a disruptor in the space.
For the company to grow beyond its home state of California, as it had envisioned, the growth strategy was dependent upon partnering with health systems once the minimum wage requirements were set in place. However, health systems were not going to do business with a company unless it had W-2 employees, and one of Home Hero’s competitive advantages was that most its workforce, if not all, were 1099 contractors, which was very attractive to both them and the employees, and that gave them an advantage that they no longer had.
Then, about a month or two ago, the founder and CEO of Home Hero put out a lengthy post to the investors and employees, saying that given the change in the environment, they were just not able to move on with the initial plan.
What other reimbursement/regulatory changes are you seeing that are impacting the home care/hospice M&A market?
LL: A few things happening on the regulatory front have gotten a lot of press lately, and there’s been a change in tone coming out of Washington. There’s been a delay in Illinois on the pre-claim review for at least 30 days, as well as a delay being implemented in Florida. Final amendments to the Conditions of Participation (COP) rules for Medicare have been delayed to January 2018. And, there have also been some potential delays in the bundling programs. But, Les believes that the new administrator from CMS will be willing to have conversations about some rules that the industry has struggled with. “So we may just be seeing a lot of different directional movement on the regulatory front, the three areas I mentioned, but certainly big concerns to the industry. And I wouldn’t be surprised to see more things coming down as the year progresses.”
EG: Some changes are ongoing, the first being the home health care moratorium that’s been renewed several times since its inception, and again about three years ago. The moratorium targeted high-fraud areas in states like Florida, Texas, Illinois and Michigan. CMS continues to see the benefit of some of these crackdowns on what they deem to be high-fraud areas. So, we’re seeing that continued vigilance by CMS in some of those markets.
Regarding the pre-claim review demonstration (PCRD) pilot, several providers, particularly strategic providers, have cooled their M&A appetite in those markets as they await further clarity. So, if you’re bringing an asset that is not in those five targeted states, oftentimes it gets a bit of premium in a buyer’s mind, because they’re not going to be subject to that pilot. But given the delays and the changes to PCRD, more of that remains to be said.
There is also an increasing amount of transparency that’s now become available to the market in general. CMS has published the most recent public use file (PUF) from both home health care and hospice. Now providers can look and benchmark themselves against other providers in the community, state, and country, to see how they stack up on a myriad of metrics, as well as the CMS star ratings, which are increasingly getting more headlines. “I think it’s just a matter of time before some sort of carrot or stick is going to be tied to those star ratings.”
MK: I’d just echo the last two comments. At the macro level, we’ll see a continued trend of quality being linked to payments, which will be overarching, regardless of who makes up the rules. Since that is going to be a common theme going forward, one must design their business around that fact.
If Trump and Price have their way with the HSA plans, the star ratings will become more of an issue because the public will be making decisions about where they’re spending their money. Those rating systems are important whether you’re on Amazon or you’re going to look at buying a TV set at Best Buy and certainly in healthcare as well. So, I think those are two macro trends that I expect will get more and more traction going forward.
Who are the buyers of home health care/hospice companies? Why?
MK: There’s more diversity among buyers that are stepping in. In the past eight years, some active buyers of home health care and hospice have been The Ensign Group with 20 deals, Kindred with 18, Brookdale Senior Living with eight, Heart and Healthcare with six, and Covenant Care with five. These are examples of senior living facility companies stepping into the market. They’ve gotten very active during this timeframe.
In that same time, local buyers are doing one-and-done deals. I’ve tracked 28 one-and-done buyers that made one acquisition in their marketplace. These buyers are selling out their continuum of care capability, and are not buying serially. So the composition of buyers has changed more in the past six or seven years than it did during the heyday that Eugene referred to earlier.
EG: “I would definitely agree with that. Strategics were very active maybe five years ago. And, given the great consolidation that’s taken place both in the home health care and hospice, it’s not that strategics are buying less. It’s just that there are less strategics to go around now, because a lot of these guys have been gobbled over in some cases two or three times over.”
Look at Gentiva, which acquired Healthfield Group back in 2006 and then eventually Odyssey, which in turn bought VistaCare and is now a part of Kindred. This is an example of about half a dozen platforms that have been swallowed up by a single entity. But even with all this consolidation, the community remains highly fragmented, with over 12,000 providers across the United States.
LL: The acquisitions done by private equity firms several years ago have become more attractive. Also, there is more trading between private equity firms, something that wasn’t the case four or five years ago. As Eugene and I mentioned before, some of the big acquirers have themselves been acquired by somebody else. So it’s just sort of changed the dynamic of who the ultimate buyer really is.
We’ve seen Epic Health Services sold to Bain Capital, and Bain then bought PSA Healthcare which specializes in pediatric home health care care; a huge niche platform. Do you see more consolidation among the niches, such as pediatrics, within the home health care services industry?
LL: It depends on who the potential buyer is, and the strategic paths they are pursuing. For example, Amedisys has been more active in the private-duty area, in addition to buying more hospice assets. Almost Family has been diverse and just made a large acquisition of properties out of a hospital company. These two companies may be pursuing different strategic paths based on the vision from the leadership. Then, there are the companies that are simply trying to consolidate and build some scale, an example of this is The Ensign Group trying to build out a platform under their Cornerstone brand.
EG: Bain Capital’s acquisition of Epic Health Services was an interesting deal, due to the sheer size of Bain Capital.
Approximately $30 to $35 billion is spent between Medicare hospice and Medicare home health care. And surprisingly, there are fairly large sponsors looking to cobble together a platform in the sector. Approximately 90% of homecare providers are under $10 million in revenue across the U.S., and for a company of scale like Bain to come in and try to cobble together hundreds of these small providers doesn’t make any sense.
Instead, these larger sponsors are evaluating two or three deals simultaneously to see if they could bring them together in a close timeframe, to essentially emerge with a platform. That’s exactly what Bain did with Epic and PSA.
The other trend I’ve seen pertains to hospitals. While hospitals have not traditionally been acquirers of home health care assets, they have transitioned from being pure sellers to doing more joint ventures. Many standalone providers see the joint venture model as a very powerful avenue of growth.
LHC Group is the most well-known provider of joint venture models within rural health systems across the country. But joint ventures tend to be small, given the markets that they are in, unlike some of the recent joint ventures that have been announced by a company named AccentCare, Inc. based out of Dallas, Texas. AccentCare, Inc. just announced a very large joint venture with Baylor Scott & White, in addition to another one they have out in California with UC San Diego.
Other national companies like Almost Family did a large joint venture with Community Health Systems, and LHC did the biggest JV in their history with LifePoint. There’s another probably half a dozen or so kind of forward-thinking homecare providers across the country that are doing these kind of joint venture models with fairly large health systems. I’ve rattled off a few, but there are probably a dozen others.
Valuations
How have valuations changed, if at all, in recent years?
MK: My firm tracks valuations carefully. As of late, valuations have been in the 75th to the 100th percentile, one of the highest levels in the last 15 to17 years. Relatively speaking, its been a strong marketplace.
Uniquely, there’s been interest on buyers to buy, and there’s been interest on sellers to sell, and that’s not always an equilibrium that occurs. Within that mix, there’s even been some large providers that have decided to sell, even though they’re $90 million to $100 million in size. Some examples of this are Residential Home health care, Celtic Healthcare and Encompass Home health care.
The last 3 to 4 years have been a unique period; cost of capital has been relatively low, and reimbursement, especially on the Medicare side, has been certain because of The Affordable Care Act. And buyers have the mentality that, if they’re in the business, they must keep getting bigger. And some other owners that are saying, gosh, I thought being 20 or 30 or $40 million was safe in size. And they’re now saying, maybe I should go ahead and exit while there’s still a strong exit market. So there’s been that perfect storm that has bolstered the valuations and has supported high valuations at the last two, three, four years.
LL: I’ve been seeing a stratification in multiples. Multiples are less robust at the lower part of the market than they are with platform-type properties or companies that are generating $10 million or more in EBITDA. There isn’t a lot of differentiation on the small properties that are continuing to command lower multiples.
EG: As a banker, you love to see this type of aggressiveness by some of the buyers in the market. But in terms of multiples, for a home health care and a hospice asset of size (north of $10 million of EBITDA) 8 to 10x is a reliable measuring stick. There is always the occasional outlier that exceeds 10x mark from a multiple perspective.
In terms of the smaller assets, 3x to 5x EBITDA is the general range. But so many people get so focused on the multiple that they lose sight of what that multiple gets applied to, which I believe is just as important. A seller may think he’s getting 10x, but to the buyer it looks more like 6x because of the synergies and other potential initiatives that are in place. So the value to the buyer and seller is very different, and one asset can have different values to different buyers. “So I think you are seeing a very robust marketplace, and the multiples from my perspective are probably as high as I can remember them.”
Valuations haven’t necessarily peaked, but they may begin to plateau, and will probably correlate very closely to availability of credit in the marketplace. Right now, the lending community is very well educated on the homecare and hospice front, and comfortable with the reimbursement profile and the reimbursement risk involved with government-focused payers.
So I think right now, we’re comfortably seeing that 4x to 4.5x leverage readily be available, and oftentimes north of 5x. Although I’m not advocating any provider putting that much debt on a business.
What is the average EBITDA multiple you’re seeing in home health care?
EG: It will vary drastically, depending on the size of the organization. Once you surpass the $10 million EBITDA threshold, you tend to move up into a higher range of valuation multiples. Assets that are less than $5 million of EBITDA are usually in the 3x to 5x times range.
Mark, you may have a lot more insight on that part of the market. But again, once an asset cracks that kind of $10 million threshold, I think 8x to 10x is very reasonable, and a market multiple that’s been paid on a fairly consistent basis.
MK: I would agree with everything that Eugene said. I think the one thing we haven’t touched upon is just CON states. You look at CON states and then multiples go askew, just because they’re CON states. So that’s probably the one exception I would circle around all the comments that were made so far.”
Why is the $10 million EBITDA threshold such a dramatic cutoff for valuation? They seem to suggest that anything lower than that is worth 50 percent less. “Sounds extreme,” says one listener.
EG: These numbers are primarily from a private equity perspective. If you look at the four publicly traded operators, their current margin profile is about 8%.
That number is up from about 5% to 6% a couple of years ago, during the trough. During that time, there were reimbursement cuts that caused average EBITDA margins to fall from about 16% to approximately half. They’re just beginning to recover.
If 8% or 10% is a normalized EBITDA margin for home health care today, then in order achieve a $10 million EBITDA number, you must be about a $100 million book of business. Even so, there are $100 million plus businesses that are still unprofitable, and it could be from a myriad of different issues.
I’m not saying there’s nothing in between 3 to 5 and an 8 to 10. But there is a sliding scale, and there’s several factors that will tweak that valuation up or down. The $10 million threshold is not a magic number.
Ten million dollars is typically the break point where larger banks want to step in and fund deals. These banks tend to get aggressive, causing PE firms to get more aggressive in response. So $10 million is kind of the threshold of breaking through that high-level, high-visible lender, like a GE or CIT, those folks.
Do niche platforms or niche companies get higher multiples?
EG: Pediatric home health care, for example, may receive some sort of premium because it is a more insulated market and the prospect of a potential reimbursement cut is often viewed as less likely. However, it has happened before. He cites a home health care company named ResCare as an example. It dealt with fragile children and people with autism. It was always thought that it would be a politician’s suicide to cut reimbursement rates to that population. But, we’ve seen states do it. So it certainly can happen.
Currently, there is a tremendous imbalance between the demand and supply of assets of size. Almost any time a scarce asset comes into market, it is likely to extract a higher multiple simply because there are very few assets of that size that will allow a buyer to get immediate scale.
EG: Although they’re not a “niche,” franchisors consistently trade their assets in the low double-digit multiple range, which is much higher than a traditional Medicare homecare provider. This is largely due to their recurring revenue model and high margin profile.
MK: A lot of valuation premiums are a result of size. That’s a niche because, to Eugene’s point, there’s not a lot of sizable providers left out there.
Another factor that heavily influences valuations is the payer mix. A heavy commercial or heavy managed-care payer mix has a detrimental effect on valuations for a given business. And when you get into Medicaid’s effect on valuations, it becomes a state-by-state, local issue. Texas is an example of a state that recently experienced huge Medicaid reductions on the pediatric side.
So is scale more important than niche when it comes to valuations?
EG: I agree that scale, in conjunction with growth, is an important valuation factor. Companies that prove their ability to grow and increase market share (e.g.: growing 12% y-o-y when the industry is only growing 7%) can more easily extract and justify an above-market multiple. But again, it also goes back to the law of large and small numbers. If you’re a $10 million agency, it’s a lot easier for you to grow 20% than if you’re a $100 million agency. So I think all of those things have to get taken into context.
MK: If you try to drive the value of your business, compliance is number one, two and three. If you have a strong compliance program and it’s evident to a buyer, and you’re in strong ongoing compliance, that’s valuable. Being able to show how you’re managing your business and having strong financial and management tools are also differentiators. Potential sellers should focus on strengthening their compliance programs and having stronger tools to run their business. It largely eliminates the issue of buyer risk, and multiples are inverse to perceived or real risk from a buyer’s perspective.
LL: I agree that buyers are spending more time on compliance issues, and using more resources to spread those questions from the sellers. As a general proposition, the more prepared a company is when going through a due diligence exercise, the less likely they are to get numbers shaved off the valuation multiple.
EG: Compliance is arguably the most important part of a business. You can have all the growth and all the margin profile you want, but if it’s not done in a compliant fashion, people will see that, and they will walk away because there’s just no trust factor in what they’re buying.
How do multiples differ between home health care and hospice?
MK: I’d say that is as close to apples-to-apples as you can get. But, with all factors accounted for, hospice has maintained a higher multiple versus a home health care business. If one were to compare a pure hospice business and a pure home health care business, both Medicare-certified, both similar size and in the same marketplace, there will be a stronger, higher multiple for the hospice business.
EG: I agree. It’s normal to see a premium assigned to a pure-play hospice provider.
Why do hospice companies get higher valuations relative to home health care companies? It’s a shorter time period, perhaps?
MK: The hospice business is simpler. Unlike home health care, there’re only four billing codes, reimbursement is per-diem versus per-episode, there are potentially shorter time periods involved, and the margins are a bit stronger, from the gross margin all the way down to the EBITDA.
Also, at the macro level, the adoption of the hospice benefit is still growing. In other words, 42% of all U.S. deaths were funded the hospice benefit, meaning there’s still 60% yet to be had from a provider perspective. So the utilization of the benefit hasn’t peaked yet either within the marketplace.
EG: From a reimbursement perspective, there has historically been more variability with home health care reimbursement than hospice. He claims that many people, including himself, who’ve had a loved one cared for by the hospice benefit had a positive experience with it. “
And I think that benefit is also very well known to folks in Congress who themselves have gone through that. So I think cutting reimbursement to hospice providers is again more insulated than home health care.
Looking Ahead…
Does anybody expect to see any large platforms change hands this year or in the next few years?
EG: There are a few platforms that are currently in the market, both in the homecare and hospice space, and presumably others that are preparing to come to market. And every year about one or two seem to trade hands. Since the current market environment remains robust, in terms of reimbursement and availability of credit, it wouldn’t be surprising to see at least two or three get done over the course of 2017.
MK: Another important thing to look at are the portfolios of private equity groups. As the portfolio companies run through their cycle, between four and seven years, PE firms are looking at exiting and getting out of that fund. This drives some of the exits for these large roll-up companies.
What do you see looking ahead for this market? Fewer regulations perhaps, from the Trump administration?
LL: There’s the prospect of a favorable regulatory environment coming out of Washington, especially at the macro level. Moratoriums on regulations, delaying the implementation of regulations, and emphasis on listening to what the provider community has to say are all proof of this coming environment.
I think we’ll continue to have a pretty active year. Last year was strong, and the second half of 2015 was strong. So while there may be some peaks and valleys, I think generally we should continue to see good activity.
Homecare and hospice will continue trying to bend the cost curve and provide the kinds of care that patients want to have in the non-hospital setting. With all these positive factors, there is a favorable outlook for the industries.
MK: I think Les summed it up very well. Home care and hospice are ideally positioned for any changes in the future. Most people want to receive home care at home and hospice at home versus in brick and mortar. And it’s cost-effective. It all comes down to the regulations and what comes out of Washington.
