By: Dexter Braff
Are we in Bizarro World? Is this the summer of George? Is everything the opposite of what we think?
Well, in a word, yes – at least when it comes to valuation.
Let’s explain.
All valuations come down to three basic factors: income, growth, and risk. Clearly, the greater the income, the greater the growth, the higher valuation. But the opposite is the case when it comes to risk. The greater the risk, the lower the value. When risk goes down, value goes up.
As logical as Spock.
Now let’s turn to health care. Perhaps the greatest, uncontrollable, and potentially ruinous risk a provider faces is changes in reimbursement. Often misinformed, sometimes capricious, a stroke-of-the-pen from Medicare, Medicaid, insurers, or any other third-party payor can quickly change a company’s bottom line from black to red.
Buyers know this. Accordingly, to some degree or another, they factor reimbursement risk into their valuation multiples.
But what would happen if that reimbursement risk went away or was expected to be in hibernation for an extended period? Risk down. Multiples up.
Well, if you think about it, this is pretty much what happens after a meaningful reduction in reimbursement. In the immediate aftermath of a cut, near-term expectations of further reductions fall to a low point and multiples rise to reflect an anticipated period of reimbursement stability.
Examples of this are legion.
When Medicare cut reimbursement for oxygen by 25%, the stock of Lincare, the nation’s largest publicly traded provider of respiratory products and services, hit its all-time high.
When CMS mandated “re-basing” cuts of at least 3.5% for four consecutive years for home health care providers, acquisition interest in the sector rocketed, sending multiples to near market-peak levels.
This is happening right now in residential substance use disorder programs. As a provider’s payor mix shifts from unsustainable out-of-network rates to far more stable in-network rates, valuation multiples are rising 50% to 100%, and in some cases, more.
Now the astute among you might argue that an increase in the valuation multiple may not be enough to offset the loss of profits that often come with a cut in reimbursement, resulting in a net-loss in value.
And this certainly can be the case. But our experience shows that more often than not, within a year or so of a reduction in reimbursement, providers learn to re-engineer their operating and clinical protocols to recapture much of the lost margin – and most, if not all, of the benefit of a risk-reduced, bumped-up multiple.
So, when reimbursement looks like it can’t get any worse, valuation, indeed might not get any better.
So, when you think about it, not so Bizarro Jerry, after all.
Fusilli Jerry, maybe. But not Bizarro.