This article is sponsored by the Braff Group. This article is based on a Home Health Care News discussion with Mark Kulik, Senior Managing Director of the Braff Group. The discussion took place on September 15, 2022 during the Home Health Care News FUTURE Conference in New York City. The article below has been edited for length and clarity.
Home Health Care News: Mark, how is the potential payment cut having an effect on M&A in the home health care space?
Mark Kulik: It’s put a pause on it because obviously, that was a surprise. I never saw it coming. I don’t think anyone in the industry saw it coming. Especially after COVID. We stepped up big time during COVID, and to think they would come back out knowing inflation was high, labor shortage issues. That was a complete surprise and a cold bucket of water. It paused the momentum that was in place. I think we’ll see what happens come November 1st when it’s finalized.
I would also say anecdotally added an element of risk because if you look back over the prior years going back to 2019, we really enjoyed a 6.7% increase in rates. We had a 1% or 2% increase per year. This came out of the blue with that size of a cut so we’ll see what happens.
HHCN: What’s going to change when it does come out? Do you think activity picks up no matter what afterwards because people know the rate of the environment moving forward?
Kulik: Absolutely. Once that rate is finalized–it depends what the solution is. If we’re successful as an industry and it’s pushed off to 2026, that gives a level of consistency and predictability in the industry, and from M&A, that’s the most important thing, is that predictability, that reliability, or the absence of risk. If that’s the solution, I think we have a fertile environment for the next several years from an M&A perspective. If it comes out with a negative 2.1% cut or whatever the cut is, the question becomes, okay, is that just for this one year? Will it happen again next year? There’s an element of question.
HHCN: PDGM was supposed to be this big driver of consolidation. Then COVID happened and there was this excess money coming in that shielded some of these providers that may have gone out of business because of PDGM because of provided relief funds and other sort of funding. What has been the impact of PDGM on M&A, and is there still more realized impact to come?
Kulik: Yes, so it was the best of times and the worst of times. I think PDGM pre-COVID was going to be cold summer months here for implementation for a couple of years because of the unknown, but the cash that came in covered up all the stumps and people felt good and the industry did well relative to cash and profitability.
The other surprise, I think during that two-year time, is if you talk to owners, a lot of well-run home health agencies actually improve their EBITDA by a point or two. I was surprised when I talked to people across the country. People thought it was going to be this major cut. Industry-adjusted and the better-run agencies actually showed a 1% or 2% bump in their profitability. If you look at our results, we track results very carefully across the country. 2021 was a record year. 83 home health transactions took place nationwide. As we sit here today, if you annualize the first half of 2022, we’re at 74 on an annualized basis so we’re close. We’re within 10%, 11% of last year’s record activity, which is an all-time record activity.
HHCN: COVID has added effect on a lot of things in the home-based care space with M&A. What has been the biggest impact of COVID there, specifically within the M&A space?
Kulik: For the past couple of years, it was just the messiness of COVID because people were focused on keeping their staff and taking care of patients. Not really thinking about “how do my financial statements look” or “how do my referral reports look” or “how does my contract performance look?” It was a messy couple years for record keeping. Of course, if a buyer’s coming in, they want to see accurate numbers and accurate reports so there was some noise built into all those numbers that made it a bit more difficult to assess.
I think if you look at it from a bigger picture, I believe it brought a spotlight to our industry that we are vital to the healthcare system in America. Now if you look at it in the bigger picture, you see large players and huge movements taking place that involve home health care.
You have Amazon stepping into the industry big time with their One Medical purchase. Then you look at other players like Walmart, they’ve been around the hoop for a long time and they’re going to be aggressive. They announced the new partnership this past week as well. Then on the consumer product side, you’ve got Best Buy looking at home health and making acquisitions and investments in that space as well so I think it’s been a good couple of years in the near term that will have benefits for the long term for the industry.
HHCN: This is a hypothesis of mine so you can shoot it down and tell me I’m stupid if it’s a bad one. With an uncertain rate environment, or even if it’s a bad one for next year, do you see more M&A between a buyer and seller in the industry as opposed to, maybe, private equity outside investors? Do you think it would still make sense for more M&A, for maybe a bigger provider and smaller provider, because they know what they’re getting into?
Kulik: Well, certainly the strategic buyers that are in the marketplace know the issues, they know where to look, they know the reality of the business, so I would say that due diligence process, goes a bit more smoothly because there’s the understanding of I operate in this marketplace, I know what’s going on. Private equity takes a very financial look. It’s a return on investment look for them so they’re being very pragmatic and they’re looking at trying to buy an organization that is pristine. If they have the 20 most important things to them, they want to check off all 20 boxes if they’re going to pay a superlative price for that agency. I think they come at it from a bit more of a financial viewpoint, but they still want to see a high-quality, high-performing, well financial performing agency as they make their decisions to acquire or not to acquire.
HHCN: What impact, if any, will the rising interest rates have on home care M&A?
Kulik: Certainly cost of capital. As rates go up, the cost of capital to buy something becomes more expensive whether you’re strategic or whether you’re private equity. Private equity directly because part of their formula is to attract debt to a given transaction so the cost of that debt goes up and as the debt cost goes up, the ability to pay more for the same agency is pushed down. That is one element.
The second element, though, is leverage because we’ve seen some high levels of leverage by private equity these last couple of years, adding more debt to the same EBITDA dollars. There’s downward pressure now on that as well because of higher interest rates. The strategics typically have lines of credit and those are pre negotiated terms so it’s a bit more predictable for them, but for new transactions, private equity has to step back up, check with the lenders, check on the current marketplace, and it’s gone up dramatically. We’ll see here in a couple of weeks. I think on the 20th, the Fed comes out with the next announcement about that 75 basis point rate increase that’ll go into the calculation for debt going forward. That will, again, put downward pressure on valuations for agencies.
HHCN: What are the average multiples you are seeing now versus last year?
Kulik: Wow, that’s the question. I wish I had the answer. This sounds trite, but it just depends. It depends upon the size of the agency. If it is CON state, what’s the performance spin? I had a conversation with a private equity group six years ago that said, “Mark, I bet as much on the jockey as I bet on the horse.”
The leadership of the agency is just as valuable, if not more so, than the agency, because what they’re buying is future revenue streams, future growth. 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.
HHCN: You’ve mentioned some of the big retailers earlier. Do you think that Amazon is going to acquire a more traditional agency in order to get into the home more because Amazon Care is shutting down at the end of the year?
Kulik: Yes. I guess it’s coming out now they’re going into this One Medical. They’re shutting that down but reinventing themselves. I would think so. If you buy into this thesis that people want to be treated in the home, that its technology is providing more acute care in the home. There’s more acute care patients coming to the home setting, higher level of acuity for care.
Then, thirdly, it’s the cheapest place to provide care. You’ve got a lot of tailwinds that are certainly making home healthcare more visible to the bigger guys. Personally, I’d be surprised if we didn’t see Amazon trying to do that after making the big acquisition into One Medical. They want more control.
HHCN: Is there anything else going on, Mark, that you think is noteworthy for the audience in terms of people that may be in a seller position or anything just M&A related?
Kulik: Yes. If you’re in the market and you’re selling. I think this typically creates a period of evaluation gap because, for the most part, because of the rate changes and because of inflation, buyers typically look forward in their evaluation, so they factor in rate changes and they try to estimate different depressants to a business. Sellers typically look backwards.
I talked to a lot of owners. They’re saying, “Well, I just talked to my friend. He got 13x for his business and the other friend got 14x. My brother-in-law got 17x.” They tend to look backwards in their evaluation and that difference of forward versus backwards creates that valuation gap that I think we’re going to see here for a period of time.
The Braff Group is the leading mergers and acquisitions advisory firm specializing exclusively in health care services including behavioral health, home health, home care and hospice, health care staffing services, home medical equipment, pharmacy services, urgent care, digital health and ancillary health care services. To learn more, visit: https://thebraffgroup.com/.
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