Monday, November 10, 2014

Mergers and Acquisitions Marketing Process: Round Up the Usual Suspects or Cast a Wide Net

The famous Humphrey Bogart movie Casablanca bequeaths us the colloquial expression “Round Up the Usual Suspects.” In the film, Captain Renault, the French head of police, played by Claude Rains, watches  Humphrey Bogart shoot Nazi Major Strasser dead to help Victor Lazlo escape.  Renault witnessed the shooting but protects Rick by telling the investigating police to "round up the usual suspects.”  By so doing, he is instructing them to limit the investigation to questioning the common criminals that they see most often and are most familiar with.

In selling a business, it seems that many mergers and acquisitions intermediaries are more often rounding up the usual buyer suspects, rather than doing the hard work of searching the larger universe of potential buyers thoroughly. This can be conducted via emails, web marketing, notices in print media or other ways.

When it comes to selling a business, the marketing process to find and solicit potential buyers is central to the purpose and fulfillment of the job. Two major methods are used. Targeting a select sample of buyers by staying within the intermediary’s comfort zone, or what we call, “Rounding Up the Usual Suspects.” Or, by contrast, canvassing a wide audience of potential purchasers thoroughly, or “Casting a Wide Net” and “leaving no stone unturned.” Each method has its pros and cons. The more targeted approach yields a higher yield of potential bidders because the potential buyer universe is pre-qualified and pre-selected. The casting of a wide net captures a lower percentage of bidders because a large universe of buyers is solicited. I understand that. Indeed, there are cases in which limiting the participation of buyers is applicable, such as when confidentiality or when not-for-profit mission perpetuation is paramount. But this is not about numbers really, such as the capture ratios of bidders and buyers; it is solely about reaching the breadth and depth of the potential buyer universe.

Thus, the Round Up the Usual Suspects method suffers from an inevitable serious defect that is beyond dispute. The intermediary cannot deduce with certainty or with a high level of probability that that the sales process realized the highest purchase price. To conclude this hypothesis would be erroneous, because the intermediary cannot verify that every qualified and interested buyer who might pay more was contacted. While the selective approach may result in a good number of buyers and even result a fair market value for the business, there is no confidence that a buyer who might pay more was left out of the process. Moreover, sellers are not interested in fair market value only. They are interested in maximum value, or as we sometimes say of the purpose of for profit entities - maximizing shareholder wealth. So to be clear, this is not a question of the number of ultimate bidders, but whether the intermediary can say with confidence and even unequivocally, that all the buyers who were notified of the opportunity represent all potential buyers or just the subset of usual suspects.

The healthcare M and A market is very dynamic and fluid, with new capable and financially qualified buyers entering daily, whose geographic targets are not limited to the home office. Today, with awesome computing power and speed abound, where we are all ostensibly connected, it is becoming more feasible to be contact the entire theoretical market of buyers. That is the unique contribution of Big Data. Technology and awesome computing power is rendering limited sampling obsolete because we are approaching the ability to test the entire universe.

I may have long experience in healthcare M&A, but I am not wedded in the past. I am humble and I don’t presume to know everyone. The value of technology to cast a wide a net wide to all potential buyers is actually feasible, so that the intermediary can say to their client that the sales process realized the highest price because all potential buyers were contacted and no one was omitted; no one was left behind. That is why Casting a Wide Net is logically superior to the Rounding Up the Usual Suspects approach, whose results, however salutary, cannot rise to this level of certification.

Sunday, October 12, 2014

Is the Market for Buying and Selling Long-term Facilities in a Bubble?

Is the market pricing for the sale of long-term facilities in a bubble?   That is an important question given the purchase and sale dynamics that exist today.   First, by the measure of per bed and per unit prices, 2013 senior healthcare and housing sale prices set record highs: 

·                 $73,300 per bed for Skilled Nursing Facilities, a 27% Increase over 2012 ($57,909/bed)
·                 $150,600 per unit for Assisted Living Facilities
·                 $191,950 per unit for Independent Living Communities

Depending on which data source you use (Irvin Levin Associates or National Center for Senior Housing and Health (NIC)) Cap Rates hit record lows, but not as striking as the per bed and per unit prices.  The Irvin Levin Cap Rate for the sale of skilled nursing home facilities was 13.0%, the NIC Cap Rate for the sale of skilled nursing home facilities was 12.2%.   At least as it pertains to the sale of skilled nursing facilities, piercing the historic Cap Rate floor of 13% is a historic first.

Second, more than 2,000 people attended the NIC Conference in Chicago last week, showing an exuberant interest and confidence in the senior housing and healthcare industry.   Wall-to-wall lenders and equity sources populated the receptions and networking lounges.  There were many more skilled nursing facility and assisted living and independent living facility buyers than sellers.  The industry is awash is low-cost capital looking for more than a few good long-term care facility sale deals.

Third, one other unprecedented sign is the sale of nursing home and assisted living operating companies sans ownership of the real estate.  I am hearing often about asset-less operating companies on the market whose physical plants are leased from third-parties, often public or private REITs.   To put this into perspective, I am hearing about deals of skilled nursing facility companies that sold their real estate to REITs, for say $125,000/bed or more, and are now asking $50,000/bed for the purchase of the operating company.  Keep in the mind that the operating company has lease obligations with annual rent escalators and there is no purchase option for the real estate.  Owners recapitalized their assets once by selling to a REIT, to employ capital on operations and acquisitions instead of real estate and to take money off the table.  Now, they are going back to the well and trying to sell their operations too.  The deals I am hearing about when you calculate the lease plus the operating company price on a per bed basis approach an aggregate of $200,000 per skilled nursing facility bed.  As the Gershwin song goes:   Nice work if you can get it.  And you can get it if you try

We need to dig deeper into this to decide if the long-term care facility industry is in a bubble.  In the 1990s, when I was working for Integrated Health Services, I was developing a five-year pro forma model of assisting living facilities.  Our model projected nosebleed valuations of $125,000 to $150,000 per assisted living unit.   When I showed the results to Dr. Robert Elkins, cofounder and CEO of Integrated Health Services, his poignant words to me were:  “You’re crazy.  Those are hospital prices.”  That was the end of that analysis.  Now the valuations that he considered crazy are average mundane deal prices for assisted living units, meaning that there are plenty of assisted living sales above $150,000 per unit.  Who would have thought that the Cap Rate for the sale of assisted living facilities would be around 8.5%?

The Wall Street Journal of October 11, 2014 had an article about Nobel-prize meaning Yale University finance professor and economist, Robert Schiller, known for his novel work regarding the valuation of stocks and real estate.  Professor Schiller, who incidentally spoke at the NIC Conference a couple of years back, prophetically predicated the tech stock and real estate bubbles in 2000 and in 2008, respectively.  Professor Schiller’s work on asset valuation essentially contests the efficient-market hypothesis, which predicates that because of efficient and widespread distribution of information about an asset to all potential buyers, market investors rationally determine stock prices on the expected receipt of future dividends, discounted to a present value.  However, Professor Schiller states in WSJ article that:  “The market is supposed to estimate the value of earnings, but the value of earnings depends on people’s perception of what they can sell it again for” to other investors.  Please reread the words of his statement in bold.  This is a stunning admission. Applying this theory to the sale of long-term care facilities, buyers are paying high prices on the expectation that in the long-run they can sell it for more.  This is the norm.  Some of this rationale as it applies to the sale of nursing homes and assisted living facilities is based on the premise that there is added value in better management and in potential synergies realized, thus justifying the incrementally higher price.  Nonetheless, Professor Schiller is correct, no matter the purchaser’s added value justification, there is also a prevailing expectation that they can probably sell it for an even higher price in the future.  As Professor Schiller says, the long-term average is “highly psychological” and that today’s prices “might be high relative to history, but how do we know that history has not changed.”  From my own experience, there were plenty of skilled nursing facility sale deals I closed a mere ten years ago, priced at between $45,000 to $50,000, that at the time seemed astronomically high, that would easily fetch more than $100,000 a skilled nursing facility bed today.

Some would argue cynically that the Professor Schiller’s insight is a sophisticated reconstruction of the “greater fool theory,” upon which bubbles ultimately derive their source.  Restated, the greater fool theory is that although an asset or market is fully valued, the price is justified because there are enough buyers to push prices further upward and resold to at a later date.  Of course, this is synonymous with the standard definition of a bubble.  This phenomenon is not new.  In 1890, The Chicago Tribune, writing about the then mania in real-estate prices, described "men who bought property at prices they knew perfectly well were fictitious, but who were prepared to pay such prices simply because they knew that some still greater fool could be depended on to take the property off their hands and leave them with a profit".

There are genuine value-added opportunities buyers in the skilled nursing and senior housing space who will pay a incremental premium based on the upside potential and improvements that they expect to carry out.  They are not willing to pay for one hundred percentage of what the value they can create; that would be irrational.  On the other hand, there are young and hungry first-time buyers who are willing to pay high prices today on the premise conditions continue to remain favorable, which is not an unreasonable assumption in the nursing home and senior housing industry, they will turn a profit in five years upon resale.  The only concern is that the speculators may be crowding out the value-added owner/operators who are in it for the long-haul, and that REITs are correspondingly  lowering their coverage ratios too, signals that the industry has reached the irrational exuberance phase

I do not know the answer.  But it appears the music continues to play in the skilled nursing and   senior housing industry and the fundamentals look excellent and promising from any vantage point.  When the music stops nobody knows.  “Nice work if you can get it.  And if you get it won't you tell me how?”

Thursday, October 9, 2014

Reflections on the 24th Annual NIC National Conference

I just attended the 24th Annual NIC (National Investment Center for Senior Housing & Healthcare Industry) National Conference in Chicago. It was an intimate gathering of more than two thousand attendees interested in transactions involving sales, development, construction, and financing of skilled nursing facilities, assisted living and independent senior housing. There were lenders, operators, lawyers, intermediary and vendors present. Below are reflections and observations:

  • Press the Flesh – It is hard to believe that in this 24/7 connected digital age in which we live in front of our desktop monitors and handheld cell phones, in which business transacted via email and data rooms, that people still feel the urge to meet in person to source and to advance opportunities and deals. This is a compelling testament to the fact that transactions are a relationship and social experience. It is all about networking. There is simply no substitute yet for shaking hands, sharing a drink and greeting and meeting in the physical confines of the conference. The great thing is while most attendees have a full schedule of meetings, serendipitous nonstop business conducted nonstop in elevators, at the receptions or in the hallways. This was the most well-attended conference ever and a veritable senior housing and healthcare Woodstock without the mud and drugs. Nonetheless, this was all about business, making connections, planting seeds and moving deals forward. This conference alone has a tremendous impact on shaping the direction of the post-acute healthcare and senior housing industry. Oh, there were also educational seminars to attend, but they seem to be a pretext for the meetings and the networking.
  • It was 20 Years Ago Today, Sargent Pepper Taught the Band to Play -Twenty plus years ago, these NIC conferences were sparsely attended. Twenty years ago there was a plenty of doubt in the banking world whether this was a good asset class for loans and capital infusions. There were concerns about regulations, reimbursement and overbuilding. The joke in those days was the conference was an opportunity to meet the lender. One lender, that is, HUD. Today, the Meet the Lenders reception was populated by wall-to-wall capital sources. For sure, the data shows persuasively that this industry is among the best to lend to with the lowest level of default. Accordingly, NIC was awash in capital as there were tons of lenders of all types, REITs, both public and private and equity sources. The industry is no longer up and coming. We have made it and thus capital is readily attracted to it.
  • Big Ideas - Post-conference, I reflected on the broad trends and drivers affecting the senior care and housing industry. Three factors could sum them up: 1 Historically low cost of capital and the abundant availability of this capital, 2. Although it is well-recognized and even platitudinous to recite again, the underlying demographics and demand continue to be compelling and robust; with the aging baby boomers the demand will continue to rise absorbing supply increases, and 3. The availability of government subsidies, i.e., ongoing reimbursement for nursing home care or HUD or other agency loans for acquisition (via bridge to HUD lenders) or refinancing. Over the last twenty years in the industry in satisfying the market need, a vast amount of private wealth has been garnered. In a sense, the entrepreneurs in this industry have slid uphill with the wind behind their backs without much resistance. I expect these trends to continue.
  • More Buyers Than Sellers – There are more buyers of skilled nursing facilities, assisted living and independent living facilities than sellers. This includes consolidation from the top-down from mega-REITs and national chains and from the bottom-up from aggressive operators trying to acquire their first facilities. As a result of the seller’s market conditions, selling prices are high and CAP rates are low and this is further exaggerated for stabilized newly-constructed properties. After listening to attendees, including several lenders, I learned that the market valuation of a new SNF or ALF at stabilized occupancy is high. I now think the Cap Rate premium for new SNF construction at stabilized occupancy is at least 200 basis points or 2% lower, that is, say, a 10% Cap Rate, but I hear that for the AL properties, the Cap Rate premium is as low as 300 basis points or 3% lower. So, as a rule of thumb on the SNF-side, a 10% Cap Rate on the new stabilized occupancy is obtainable and an 8% to 9% Cap Rate is the asking price. For the AL, I would set a 5% Cap Rate for an asking price for new stabilized occupancy properties, which I hear is being realized.
  • New Blood – One phenomenon that was interesting to observe is the large number of young people present. Many are new to the industry working their way up the line. But there also many young hungry entrepreneurs with some operating experience, full of “piss and vinegar” in search of skilled nursing facilities or assisted living facilities to buy were in large supply. With the availability of low-cost capital, they have a chance to make this work. Essentially the next generation has entered the industry and is staking their claims. They definitively have the desire to own and operate at a younger age than many of today’s leaders of the industry, who worked their way up and went on their own after fifteen to twenty years of progressive industry experience. We trail blazed the way to riches and the young folks are impatient for their piece of the pie and want to short-circuit the learning process. This is kind of millennial thing and I hope it does not lead to failures because of arrogance, lack of knowledge and inexperience. When the consumers’ health and well-being is at stake, the risks of disaster are serious and potentially lethal. Hopefully, lenders and investors are still looking at operating capabilities as a major criterion for lending and setting that bar high. That is good for the industry and for end-users. 
Next year the NIC National Conference will be in Washington DC.  I wonder if attendance will set a new record.  By all indications, the only direction is up.

Sunday, September 7, 2014

Book Review: Health Care Mergers and Acquisitions Answer Book 2014, Edited by Andrew L. Bab, Kevin A. Rinker

by Mark Davis, MUP, MBA, President, Healthcare Transactions Group, Inc.

Health Care Mergers and Acquisitions Answer Book 2014, Edited by Andrew L. Bab, Kevin A. Rinker, Debevoise & Plimpton LLP, New York: Practising Law Institute, 2014. 1,154 pages, $255.00 (print)

As a healthcare mergers and acquisitions intermediary, I am often kidded that I practice law without a license.  If you are a true healthcare M&A advisor, then toiling in the weeds of contract negotiations is part of the job.  Anyone who has experience with this knows it is a demanding exercise.  Resolving questions of structure, elements, risk and benefits of a healthcare business deal requires significant understanding and negotiation between parties, plus industry-specific knowledge.  Memorializing a mutually agreeable and legally binding document with all of the requisite terms, conditions, promises and obligations is required to achieve a successful transaction.  This begs the question of how business types and their advisors can interpret and agree on matters they may not understand.  As a result, you regularly hear, "let the lawyers work it out," as if esoteric mysteries should best be left to the cognoscenti, but this is a mistake.  The devil is in the details, and the business people or advisors need to learn more about transactions and healthcare regulations to function effectively.

At the outset, owners and M&A advisors need to realize that consensus on price is just the beginning.  Everything is negotiable until the pens are silent and parties finally execute the documents.  I have been in deals where the parties quickly agreed on fundamental economics, but then spent months of haggling over the contract, either by meeting face-to-face, by conference call or by email.  In so doing, there are arguments, gambits, impasses and adjustments for GAAP accounting or regulatory compliance, with iterations of the document going and back and forth multiple times.  If the business people are unfamiliar with or have a superficial understanding of the legal concepts, they may be overwhelmed and unable to evaluate and decide what to accept and to reject.  Alternatively, non-healthcare lawyers hired for their contracts expertise may be insufficiently versed in the healthcare language, regulations and reimbursement that inform and permeate the whole deal.  Now there is a trustworthy guide to the perplexed on healthcare M&A that does not cost $500 or more per hour.

Health Care Mergers and Acquisitions Answer Book 2014 is a complete compendium of information, issues, concepts and parameters in formulating health care transactions, which involve sales, purchases, mergers, joint ventures, license agreements and other arrangements.  This work provides expert summations of the customary contractual provisions used in mergers and acquisitions and the corresponding healthcare-specific professional or regulatory issues such as reimbursement, changes of control, licensing, fraud and abuse, changes of ownership, penalties, anti-trust safety zones, provider numbers, patient care, successor liability and privacy, to name but a few.  The book is distinctively organized in a didactic question-and-answer format in digestible kernels of knowledge, handy to practitioners seeking instant reference.  The answers are concise and are about one-half to a page and a half long of text on average.  This volume provides answers from seasoned lawyers and professionals to everything you always wanted to know or should know about healthcare transactions.

Health Care Mergers and Acquisitions Answer Book 2014 is edited by Andrew L. Bab and Kevin A. Rinker, attorneys with Debevoise & Plimpton.  Counsels Bab and Rinker contributed to nine of the forty-four chapters.  There are about fifty chapter contributors, mainly lawyers, although the chapters on valuation, finance, tax and accounting are written in whole or in part by accomplished professionals in these respective fields.

The book's forty-four chapters are divided into four parts:  I. Structuring the Health Care M&A Transaction, II. Due Diligence, III. Transaction Documentation, and IV. Special Topics.  The volume leads with an overview of healthcare M&A trends in 2014 and a review of the Affordable Care Act.  Part I is an analysis of the elemental ideas undergirding health care transactions, such as deal structures, purchase price adjustments, non-profit vs. for profit issues and valuation, tax, financing and accounting considerations.  I appreciated the inclusion of questions and answers on state notification and approval requirements for sale of non-profit organizations because these regulations are generally not well-known.

Part II focuses on Due Diligence and obligatory and potential areas to scrutinize such as licenses, compliance notifications and investigations, litigation, material contracts, employee benefits and intellectual property.  Part III is dedicated to Transaction Documentation, which encompasses the nuts and bolts of contracts.  Part III is, as expected, a polished section that manages to explain complex legal matters in a readable and lucid fashion.  I now understand more of the nuances of representations, warranties and indemnities, an area that normally accounts for the heavy lifting in deal negotiations.  In particular, distinctions between indemnities for breaches of representation and warranties, and indemnities for losses (with related caps, scope and survival periods), independent of representations and warranties, are well-clarified.  And, of course, the differences between indemnity "tipping baskets" and "deductible baskets" (Question 38.6) are mentioned.

Part IV includes Special Topics chapters on healthcare M&A in France, Germany and Russia and on acquisitions of non U.S. companies by foreign buyers.  Part IV is useful if you are lucky enough to land a foreign engagement.  If you are, after a quick read, you can opine on the characteristics of the healthcare and legal systems of these countries to pass the interview.  These chapters might also offer interesting nuggets for cocktail discussions.

I have used other Practising Law Institute (PLI) volumes on Mergers and Acquisitions and on Health Care M&A before.  Those books were loosely organized, often disparate collections of PowerPoint presentations and boilerplates of uneven quality.  They were helpful, but lacked cohesiveness.  By contrast, Health Care Mergers and Acquisitions Answer Book 2014 is a serious and rigorous production.  It is systematic in format by chapter topic and corresponding numbered questions and answers.  Mirroring a numbered legal contract, each question has an individual number prefixed by a chapter number.  The authors supplement certain answers with instructive practice tips, examples and proposed contract language.  The volume is encyclopedic in scope (1,154 pages), covering a large universe of healthcare M&A variables.  It is intelligently organized, and well-edited, with minimal overlap, although useful cross-references dutifully noted abound.  I compliment Messieurs Bab and Rinker's editing for ensuring that the writing is clear and lucid throughout the volume, and for their commitment to high standards by completely integrating the contents into a unified whole.  Health Care Mergers and Acquisitions Answer Book 2014 is an excellent healthcare M&A bible for beginners or generalists who wish to enter this growing and vibrant sector, or for deal junkies and pros who wish to reinforce or enhance their knowledge.  I also recommend it for business principals who could use it to comprehend what their lawyers are talking about and what is at stake.

The major challenge of this volume is striking a balance between providing enough detail and covering all the bases.  Consequently, while the book is unabridged and inclusive, explanations vary by depth.  Also a major fault line is how to cover public company deals, usually stock transactions, versus private, middle market deals, usually asset transactions.  As such, Health Care Mergers and Acquisitions Answer Book 2014 consistently highlight these differences while not necessary going into details in each case.  If it had to expound on features of public vs. private, stock vs. asset deals for every question, it would conceivably require another thousand pages.  Health Care Mergers and Acquisitions Answer Book 2014 appears more heavily weighted toward stock transactions involving public companies.  Accordingly, much attention is devoted to pharmaceutical and medical device transactions involving public companies, and on FDA and SEC compliance.  In a volume this large and ambitious, editors have to select what to exclude and to include and thus some chapters are more expansive and filled out than others.  I would have liked a more complete chapter on Real Property (Ch. 33), which is important in healthcare facility transactions, such as for the sale of hospitals and skilled nursing facilities.  Nonetheless, environmental due diligence and compliance are covered effectively and these are key parts of real estate assessments.  In addition, there was only a cursory explanation on setting earn-outs, common in sale of contract therapy and home care businesses.  By contrast, much attention is given to permutations of contingent value payments, common in pharmaceutical and life sciences transactions, consistent with volume's skew toward public company transactions.  I also expected to find more information on the change of ownership (CHOW) regulations for healthcare facilities and companies.  Inclusion of a table of the CHOW requirements by state would have been useful.  Maybe PLI should sponsor another volume dedicated to the regulatory requirements of healthcare changes of ownership, facility licensing and certificates of need?  Despite these are minor criticisms, the book is educational and valuable for any type of healthcare transactions participant, and I recommend it enthusiastically.

Most important, as stated, Health Care Mergers and Acquisitions Answer Book 2014 is written in plain and clear laymen language, which is a major triumph considering that the book is primarily written by and targeted to attorneys.  The book can be a trusted go-to desktop manual and quick-reference for healthcare M&A transaction intermediaries, lawyers, accountants and prospective buyers, sellers or joint venture partners.  There is a Table of Contents of the chapters, a Table of Contents of numbered questions within each chapter, a large Glossary and Abbreviations for regulatory agencies, laws and practices, and a thorough Index, which collectively enable readers to find items right at their fingertips.  For any practitioner in the healthcare M&A field, this book is an authoritative primer of basic and advanced topics and factors that comprise and affect transactions in this space.  This is a welcome addition to the field, and an indispensable tool for any healthcare M&A practitioner committed to their craft.

There is a discount link for readers of this blog for 20% off the regular purchase price of Health Care Mergers and Acquisitions Answer Book 2014.  The link to the discount is below:

Thursday, July 24, 2014

Information, Non-Manipulative Selling and the Role of the Mergers and Acquisitions Intermediary?

In considering this question, the first thought that comes to mind, is a story my first boss shared with me early in my career. He asked: "Did you ever hear of the woman who remained a virgin despite being married three times? Well, the first husband she married was for money and he was too old to do anything. Her second husband was asexual and was not interested at all. Her third husband was a business broker, who just kept telling her how good it was going to be."

The biggest offense of brokers or intermediaries is they over-promise and under-deliver. Why do they over-promise? The answer is simple: to secure the engagement by projecting inflated valuations, that is, selling the sizzle without regard to the steak. The strategy is to get the potential client whipped up dreaming of sipping Polynesian cocktails on a beach, so that their next question is "where do I sign?" Call me old-school, but in my book this is classic manipulation. I believe in selling and promoting my services and strengths vigorously but our approach is based on the facts. I let the information speak for itself and collect and disclose all the data necessary and wanted, to inform the process and the participants. I call our approach "Non-Manipulative Selling,” whether we apply this to potential clients or to potential buyers in one of our sales processes.

Recently I heard a broker in this sector talk about "Pushing the Agenda," concerning his approach to valuation and to the healthcare mergers and acquisitions sales process. Truthfully, I never heard this term before. I had to Google it to learn its meaning. Apparently, "pushing the agenda," means to promote something vigorously, including, as expedient, garbling the facts and contorting the sale process to "jam" interested parties. It is an "in your face" by any means necessary approach. One definition for pushing the agenda I found was "forcing your opinion or your plan." The thinking is by "jamming" the prospective buyers into a compressed sales process and by not disclosing all the facts, buyers are "ju jitsu-ed" into committing to a higher than expected offer price. “Animal Spirits” will carry the day. As a result, the humdrum role of compiling thorough information to enable reasoned and thought-out (not instant) analysis and evaluation is secondary and perfunctory. Why let facts get in the way of sales maneuvers?

Maybe because I started my career doing the scut work of researching, collecting and crunching the numbers, that I contend the "pushing the agenda" approach is fraught with potential problems. First, my approach is to collect as much historical and current information on a healthcare facility's or company's performance, characteristics and results. I respect and admire clients, buyers and decision-makers. I want to help them arrive at a good decision and thank me years later because of how well the deal turned out. I think that decision-makers are rational economic actors and as such, seek to understand and evaluate the business for sale at a very deep level to justify the acquisition strategy and the purchase price. Comprehensive analysis involves modeling of pro formas under various operating scenarios, criteria and conditions. Without reliable information, this analysis cannot be conducted and good decisions cannot be realized.

I know the maxim "of being lucky, rather than smart," but relying on luck instead of information to justify a multimillion business decision, is reckless and dangerous. I understand that ultimately buyers cannot possess absolute certainty when considering a potential acquisition. There are always risks and uncertainties. Indeed, they do have to bite the bullet and make a bold decision. But our job, as intermediaries, is to ensure that the decision-makers, that is, the buyers, are provided with a thorough data base and to have sufficient time to review the materials and ask questions, so they can fully discern the current conditions and trends and to measure the risks versus the rewards. Simply put, to make an educated and non-forced judgement.

Second, in the sale of healthcare businesses, there is a practice known as "re-trading" by which a buyer: (1) purports to agree to a price; and (2) then seeks to reduce the price during the "due diligence" period by purporting to discover information concerning the business that allegedly reduces its value. As a result, a seller and their intermediary that does not provide accurate financial statements before accepting a buyer's bid is acutely vulnerable to re-trading. They are setting themselves up for a re-trade.  Moreover, if the seller has signed an agreement requiring it to negotiate exclusively with the buyer, then the buyer has more leverage in re-trade negotiations. Under such circumstances, re-trading can result in a reduction of more than 30% of the original sale price. Again, to avoid re-trading, the seller's intermediary must collect and disclose as much accurate information as possible to potential buyers and allow them sufficient time (not "jam them”) to analyze and evaluate it.   If all the information is made available at the outset of the sales process, then trumped-up claims of not knowing an important kernel of information, are rendered false and inappropriate.

Knowledge is power and as intermediaries we should empower clients and buyers to make better decisions and choices. In a world where information access is cheap and instantaneous, failure to collect and disclose all the facts “to push an agenda” is clear manipulation and downright anachronistic.

Wednesday, July 23, 2014

Healthcare Mergers and Acquisitions Jargon, Part 2

• “Bandwidth” – buyer has ability to review and evaluate multiple deals

• Indemnity – What seller has to provide to stand behind statements represented and warranted in a sale contract

• MAC Provision – part of purchase contract that deals with material adverse events before closing

• “CHOW” – In healthcare industry, there is typically a licensure or change of ownership application process.

• Pro Forma – Financial Model of Projected Revenues and Expenses, incorporating buyer’s operating assumptions and plans often testing multiple scenarios.

• TLM – Trailing Twelve Months of Financial and Statistical Data

• Re-Trade –Buyer’s Renegotiating Purchase Price Reduction After Agreeing to Purchase at a Higher Price Buyer Signs Deal That They Don’t Intend to Honor. Bait and Switch

• Earn-Out - An arrangement in which sellers receives additional future payment, usually based on future earnings.

Tuesday, July 1, 2014

Healthcare Mergers and Acquisitions Jargon, Part 1

• Middle-Market – Transactions generally under $1 billion and involve non-publicly-traded companies.

• One-Off Deal – Purchase of a single facility or entity, not a multiple entity deal

• Portfolio Deal – Multiple facility or service sale

• “Deal Has Hair” – a complexities and complications of selling company

• ‘’Tuck-in’’ Deal – small niche deal that fills hole in company’s portfolio

• “The Ask” – A term or condition of the business deal that one side is requested

• "Open Up the Kimono” – seller is willing to disclose confidential company information

• Data Room – online virtual cloud where confidential due diligence is stored

• “Cratered” – as in the deal crated…fell apart

Friday, May 16, 2014

Cap Rates Used In Skilled Nursing Facility Valuations

The baseline metric for the valuation of a skilled nursing facility is the amount of Net Operating Income generated by operations, or more specifically, EBITDAR, consisting of Earnings before Interest, Taxes, Depreciation, Amortization and Rent, divided by rates of return specific to the nursing home industry (known as the “Capitalization Rates” or “Cap Rates”).  Cap Rates are derived from historical nursing home sales data.  In addition, the practice in nursing home valuations is that EBITDAR is calculated net of a management fee computed at five percent (5.0%) of revenue.  (EBITDAR is thus EBITDARM less the management fee.)  While the management fee percentage applied could vary from 3% to 5%, by buyers’ assumptions of synergies from the business combination, 5% is the heuristic benchmark.  This formula is known as the Income Capitalization Model.  It is based on the premise that asset value is predicated on the amount of free and clear cash flow a business generates per year.  In other words, the Income Capitalization Model translates Net Operating Income into value.  Consequently,

Value = Business Income/Capitalization Rate

The Capitalization Rates (denominator) for skilled nursing facility valuations are derived from historical nursing home sales data, so that:

Annual EBITDAR/Sale Price = Capitalization or Cap Rate


Prospective Valuation    = Annual EBITDAR/Historical Cap Rate(s)

For Example,

Prospective Pricing at a 13% Cap Rate = 

    Annual EBITDA/Historical Cap Rate: $1,000,000/0.13 = $7,692,231

Earnings Multiplier is Inverse of Cap Rate:   

13% Cap Rate = 1.00/0.13  =  7.69 X, or
7.69 x $1,000.000 = $7,692,231