Win Win: Understanding Provider Mergers and Acquisitions
Is a merger or acquisition right for your business strategy?
- By Joseph Duffy
- Oct 01, 2015
Mergers and acquisitions have become a reality in today’s increasingly competitive home medical equipment marketplace. This means smart providers need to understand how M&As work, and how they might ultimate fit into their business strategies. In fact, there has been a 17 percent decline in the number of HME supplier businesses during the past seven years, and more than half of that contraction resulted from merger and acquisition activity, according to Mike Mallaro, chief financial officer for member service organization the VGM Group Inc. Transaction activity has accelerated over the past 24 months relative to the prior few years, and Mallaro says it is a good time to buy.
“If you have a medium to long-term perspective, and valuations of an asset are at or near low levels relative to history and to other assets, then the laws of economics tell you this is an opportune timeto acquire,” he says.
From a strategic perspective, mergers or buyers of provider businesses should consider scale, which is an important financial and competitive advantage, Mallaro says. A supplier’s ability to leverage fixed cost infrastructure over a larger revenue base has the effect of lowering cost per unit of activity. “Said differently,” he says, “cost categories such as billing and reimbursement, systems, compliance, purchasing, dispatch, and many others, consume a smaller portion of each dollar when you are able to spread them over a higher revenue base.”
Sellers, he explains, are usually driven by risk, fear or fatigue.
“There are risks in being in the HME business and there is a value in being able to sleep at night knowing you took some of the gains off the table, gains you’ve worked very hard to accrue,” Mallaro says. “Sometimes, even knowing you’re selling at a low point in valuations, that’s in the best interests of the seller. Fatigue is certainly an issue in our market today and it drives many transactions on the sell side.”
Jeffrey S. Baird, Esq., is chairman of Health Care Group, Brown & Fortunato, P.C. The Health Care Group represents HME companies, pharmacies, hospitals and other healthcare providers throughout the United States. Baird says to understand what is driving the mergers and acquisitions market today, you first have to realize that there is a transformation going on:
- The industry, as we know it today, has been around since the mid to late 1970s.
- The industry grew up relatively unregulated. Nobody on Capitol Hill and nobody with CMS (then HCFA) knew what DME suppliers did. This is because while young, healthy people go to physicians, hospitals and pharmacies, as a general rule, DME suppliers serve the elderly. And so unless the 28-year-old legislative aide on Capitol Hill had helped take care of an elderly relative, there would be no reason for the legislative aide to walk into a DME store. The same is true with the elected representative and senator. And the same is true with the Medicare regulators. Because the industry was unregulated, the suppliers did the best they could. Unfortunately, there was a minority of fraudulent players that garnered headlines and gave the industry a bad name.
- As the government almost always does, it overreacted. The industry is now caught in the ‘perfect storm’ of competitive bidding, stringent documentation requirements and aggressive audits.
- Adding to this perfect storm is the fact that there is a limited amount of Medicare money to be distributed to physicians, hospitals, home health agencies, pharmacies, labs, SNFs, DME suppliers, etc. Also adding to the perfect storm is that while Medicare grew up with 23 million of the Greatest Generation (the World War II folks), Medicare is now facing 78 million baby boomers, who are retiring at the rate of 10,000 per day.
- And, thus, we have the immovable object (limited money) meeting the irresistible force (the aging boomers).
- In short, the old Medicare fee-for-service model, which the DME industry relied upon for 35 years, is dead.
- Back in the old days, it was not terribly hard for a DME supplier to generate a profit. Medicare reimbursement was high and the supplier did not have to ‘look over its shoulder’ and worry about money being ‘clawed back’ by Medicare.
- All of that has changed. The DME industry is now in the ‘new
- There will be a two-tier system. Those on the lower end of the socio-economic scale will have no choice but to accept whatever Medicare pays for. Those with some financial means will be willing to pay cash in order to obtain the highest quality of product and in order to avoid having to deal with coverage requirements.
- The future of DME is selling items for cash at retail. Typical boomers know that when they turn 75, the most precious asset is time. They know that they will likely be dead in 10 years. And so boomers will be willing to pay cash for a quality item that they can obtain now.
- All of these factors are driving the increase in sales and mergers. If a DME supplier wants to play in the competitive bid space, then it needs large volume to compensate for the low margins. This is motivating a number of DME suppliers, which are competitive bid winners, to purchase companies that were not awarded CB contracts.
- Interestingly, we are not seeing just your standard 100 percent sale transactions in which ABC Medical Equipment, Inc., purchases 100 percent of XYZ Medical Equipment, Inc. We are seeing transactions in which XYZ sells certain business lines to ABC and XYZ retains other business lines. For example, XYZ might sell its Medicare FFS line of business to ABC while keeping its commercial insurance and Medicare Advantage business.
- In short, some sales exist because the seller is simply closing its doors. At the same time, we are seeing partial sales as DME suppliers remake themselves. For example, Supplier A may want to play aggressively in the CB market; Supplier B may want play aggressively in the Medicare advantage market; Supplier C may want to aggressively play in the TRICARE or VA market; Supplier D may want to play aggressively in the state Medicaid market; and Supplier E may want to aggressively play in the cash/commercial insurance market.
“If Supplier A was not awarded a CB contract, then it can buy its way into competitive bidding by purchasing the assets or stock of Supplier B (a CB winner),” Baird says. “The desire of bid losers to be involved in competitive bidding is driving a number of the bid losers to purchase the assets or stock of bid winners.”
Buying and Selling an HME Business
Mallaro says that HME providers that want to acquire another business should have a growth strategy, perform due diligence, understand the risks and how to mitigate them, and plan for and execute on the integration.
“Remember, never fall in love with the deal,” he says. “There is another one down the road if this one isn’t right.”
Baird says that if a DME supplier wants to go on an acquisition spree in order to build up its CB business (high volume compensating for low margins), the purchaser needs to keep in mind that CB contracts are only good for three years. And so the purchaser’s business can disappear overnight if it is not awarded a future CB contract.
“There are two basic ways to purchase a DME supplier: asset purchase or stock purchase,” he says. “In an asset purchase, Supplier A will sell its hard assets to Supplier B and Supplier A will transfer its patient files to Supplier B. In an asset purchase, Supplier B will not take on Supplier A’s liabilities. However, because Supplier A’s patients will be switching suppliers, then Supplier B will need to obtain new physicians’ orders for Supplier A’s patients that transfer to Supply B.
“On the other hand, in a stock purchase,” Baird continues. “John Smith — the shareholder of Supplier A — will sell his stock certificate to Supplier B, resulting in Supplier A becoming a wholly-owned subsidiary corporation of Supplier B. Because Supplier A’s patients are not switching suppliers, then there is no requirement for new physicians’ orders. However, the liabilities of Supplier A that existed before closing will remain with Supplier A after closing.”
When selling, Mallaro says to make sure you understand the fiveyear value of owning your company compared to what someone is willing to pay you now and determine if that makes sense for you.
“Be as rational as you can, getting outside help if you need it,” he says. “There is tremendous emotion in selling your business, so be careful to keep it in check. Be cautious about talking yourself into how things are going to be post-deal. You’ll no longer own it, so you will no longer be making the big decisions.”
Baird says to consider the following when selling:
“Let’s say that Supplier A desires to sell its assets to Supplier B,” he explains. “After all of the dust settles, John Smith (the owner of Supplier A) will continue to own Supplier A. However, Supplier A will have no hard assets; all it will have will be the money paid to it by Supplier B. Supplier A will continue to be liable for audits for the time period prior to the sale. The audit liability should stop at Supplier A and should not flow upstream to Smith, personally. Smith will want to make sure that the Asset Purchase Agreement does not impose personal liability on him to indemnify Supplier B for anything other than a ‘breach of reps and warranties.’
“Now let’s switch gears and talk about a stock sale,” Baird continues. “If Smith sells his stock certificate in Supplier A to Supplier B, resulting in Supplier A being a wholly-owned subsidiary corporation of Supplier B, then, as with an asset sale, Smith will want to make sure that the Stock Purchase Agreement does not impose personal liability on him to indemnify Supplier B for anything other than a ‘breach of reps and warranties.’ The seller will want to get as much of the purchase price as possible — 75 percent to 80 percent — at closing, so that only a small portion of the purchase price is payable after closing.”
There is no buying of selling formula that fits every business, and, of course, timing can overshadow everything. Mallaro says that he feels that merger and acquisition activity will remain relatively strong over the next few years. But before you jump in, make sure you educate yourself and if needed, seek guidance before buying or selling your business.
This article originally appeared in the October 2015 issue of HME Business.