The Health Care Investor : Healthcare Lawyers & Attorneys for Life Science Companies & Investors

Healthcare providers are often the first to feel the effects of Medicaid funding shortfalls.  Economic turmoil, federal law and political pressures leave states few options but to slash the rates they pay to providers or take other actions regarding program eligibility discussed in Part I of our Medicaid Budget Crisis series.  A recent Kaiser Family Foundation study found that 39 states cut or froze provider rates in 2010 and 37 states have either planned or implemented rate restrictions in 2011.   Yet, because Medicaid covers approximately 68 million beneficiaries nationwide, many providers continue to rely to varying degrees on Medicaid reimbursement.  As John Iglehart's piece in the New England Journal of Medicine describes, in 2010 the program spent approximately $406 billion on acute and long term care, representing one sixth of the United State’s overall healthcare spending.  Assuming that the requirements of the healthcare reform law, The Affordable Care Act (aka PPACA) continue to take effect as scheduled, these numbers are expected to continue to grow, some estimate by over 16 million people. The challenge, particularly for healthcare investors, is determining which providers can benefit from Medicaid programs despite state budget cuts.  In a continuation of our series on the Medicaid budget crunch and its affect on healthcare investing, this post will consider some of the healthcare providers that are well positioned to flourish (or at least emerge relatively unscatched) as states and the federal government assess strategies for Medicaid budgets. 

The first type of business that are more likely than others to emerge as winners, or perhaps more accurately at least not be cast as losers, from the Medicaid budget crunch are those that do not rely heavily on state legislatures for their reimbursements.    A few provider types that fall in this category are as follows.

• Dialysis Providers: The best example of this is dialysis providers who receive the majority of their payments from the federal government’s Medicare program. 

• Preventive Care/Disruptive Healthcare Initiatives:   We have discussed in the past certain healthcare thought-leaders' perspectives on the value of disruptive healthcare initiatives, a philosophical shift in the macro system of orienting care and incentivizing clinical outcomes.  As providers focusing on preventive healthcare and those geared toward different stages in the healthcare continuum flourish, those that are typically self pay or commericial-reimbursed rather than  government-reimbursed could be "winners" in the Medicaid budget crunch.

• Primary Care Providers: As a result of PPACA, primary care providers are another group that should enjoy some insulation from state budget issues.  Assuming that PPACA is not repealed or rendered unconstitutional, the legislation calls for a temporary, federally funded two-year increase for payments to primary care physicians starting in 2013.  The increase would pay primary care physicians 100% of the rate that Medicare pays primary care physicians, rather than the historically lower Medicaid rates that each state sets.   At least in the short term, this enhancement should insulate primary care physicians from the volatility in state budgets and, at least for providers in some states, give primary care physicians a significantly enhanced reimbursement rate for each patient that they treat.   
  • Unfortunately, the extent to which this enhanced reimbursement will benefit primary care physicians depends on the state in which a physician practices. While state Medicaid programs have historically reimbursed primary care physicians at lower rates than Medicare, the degree of difference varies dramatically between states.  In 2008, states like New York and California reimbursed primary care physicians at less than half the rate of Medicare.  Therefore primary care physicians in these states stand to gain significantly from the PPACA’s rate enhancement.  On the other hand, states like Alaska, Wyoming and Idaho had Medicaid reimbursement rates that exceeded the Medicare reimbursement rate. Thus, at best primary care physicians in these states will likely see their rates remain the same or possibly even decline as state Medicaid directors reduce their reimbursement rates to bring them into line with Medicare.
  • Finally, primary care physicians must consider whether or not a two year rate enhancement is enough to entice them to open their clinics to Medicaid patients.  In 2008 only 42% of primary care physicians nationally were accepting new Medicaid patients. This compared with 61% of primary care physician accepting Medicare patients and 83% accepting privately insured patients.  For further detail on historical rates and primary care government program activity, see these publications by Stephen Zuckerman and Dennis Smith.

Other potential winners in the Medicaid budget crunch are those businesses who can provide better care with fewer resources and the vendors who will provide the tools to help healthcare providers reach these cost and quality improvement goals.

• Managed Care Organizations:  A number of states are trying to overcome their Medicaid budget issues by pushing more of their Medicaid beneficiaries into privately run managed care plans.  In 2010 13 states and in 2011 20 states expanded their Medicaid managed care programs.  These plans at least purport to save states money and encourage more efficient care because they allow states to pay an insurance company a set fee for each Medicaid patient that a health insurer covers.  A recent USA Today article highlights the business opportunities that the recent state expansion of managed care, combined with the PPACA’s expansion of Medicaid, offers large healthcare payers like Aetna and UnitedHealthcare.  While many industry participants disfavor MCOs because of the manner in which they control costs, at least one state, Florida, is giving hospitals and doctors groups the chance to set up their own managed care networks and compete directly with traditional MCOs.  In theory at least, under this plan, providers will be able to take advantage of some of the business opportunities that MCOs see in the expansion of Medicaid managed care. 

·        Health IT:  Health information technology is another area that has received significant government investment over the past two years.  The American Recovery and Reinvestment Act of 2009 (ARRA) included approximately $27 billion worth of incentives for Medicaid and Medicare providers who “meaningfully” use electronic health records.  The incentives are substantial. Clinicians with at least 30% of their patients (20% for pediatricians) on Medicaid can qualify for up to $63,750 in grants. 

Ultimately, who wins and who loses as a result of a particular state's Medicaid budget crunch largely depends on the state in which a provider practices.  Not every state is experiencing the same level of budget problems and not every state is exacting deep rate cuts to Medicaid providers.  For example, states like Oregon and South Carolina, with large Medicaid budget shortfalls, are resorting to large provider rate cuts, while states like Virginia may be able to avert any rate cut for the upcoming fiscal year other than for outpatient hospital care.  Healthcare providers and investors would be wise to consider the particular circumstances of their states and the providers’ reliance on Medicaid reimbursement when assessing the likely impact of the Medicaid budget crunch on their businesses.

*** The authors would like to thank Tim Hoppe, McGuireWoods LLP summer associate, for his significant contribution to this post. ***

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Last week a three-judge panel of the 11th Circuit heard arguments in the 26-state lawsuit challenging the healthcare reform law, The Patient Protection and Affordable Care Act (aka PPACA or The Affordable Care Act or even the ACA to add yet another moniker). The United States had appealed the decision by Judge Vinson of the U.S. District Court for the Northern Division of Florida, which we have discussed in prior posts.  Judge Vinson had ruled that the individual insurance mandate portion of PPACA is unconstitutional and that because the provisions requiring the individual mandate could not be severed from the rest of the law, the entire law was void.  The issues of interest in the appeal are not only the constitutionality of the individual mandate requirement and PPACA at large, but also whether the District Court correctly held that the federal government can force states to expand their Medicaid programs as a precondition for continuing to receive matching federal funds for their Medicaid programs.  McGuireWoods attorneys Shayna Bowen and Amita Sanghvi have published a more detailed description of the June 8^th oral arguments accessible here.

The 11^th Circuit case is one of several cases pending before Federal courts regarding the constitutionality of all or part of PPACA.  The 4^th Circuit heard arguments in mid-May in cases brought by the Commonwealth of Virginia and Liberty University challenging the individual mandate and PPACA generally.  With a surprising three-judge panel comprised of all Democratic appointees, many experts expect the 4^th Circuit to uphold the constitutionally of PPACA in its entirety and the U.S. Supreme Court to then consolidate the 11^th and 4^th Circuit cases for unusually expeditious hearing this fall.

It is also important to note that in the 5^th Circuit, on May 27^th Physician Hospitals of America (PHA) and Texas Spine & Joint Hospital (TSJH) filed an appeal of the ruling by Judge Schneider in the Eastern District of Texas upholding the constitutionality of Section 6001 of PPACA.  We have discussed in several prior posts the key elements of the PHA and TSJH arguments in the 5^th Circuit case, in which a team of McGuireWoods attorneys lead by Scott Oostdyk and Victor Moldovan are representing PHA and TSJH.   If the Supreme Court voids all of PPACA upon hearing one or both of the more global PPACA cases now  pending in the 11^th and 4^th Circuits, the PHA-TSJH case will become moot.

At the same time that the Federal government is defending legal challenges to PPACA through the courts, a variety of legislative challenges are pending as well, including repeal legislation introduced by U.S. Congressmen Sam Johnson (TX-3) and Doc Hastings (WA-4).

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Selling a healthcare company is a daunting task that requires significant foresight, planning and expertise in addition to the tremendous amount of time required to consummate a deal. For a first time seller, the process is especially intimidating as the owner begins the process that will ideally lead to a sale of the business at a price that accurately reflects the value of the business. With that in mind, I had the pleasure of interviewing Bill Siren of AlixPartners, LLP to discuss issues the owner of a healthcare business should consider when he or she has decided to sell their company.

MW: What is the first step that an owner should take to prepare the company for sale once they have made a decision to do so?

Siren: Once the owner decides that the time is right to sell the company, the owner should prepare the company so it can be shown to prospective buyers in the best possible light. These preparations include: (i) obtaining an initial valuation, (ii) conducting an independent, in-depth audit of the business and (iii) identifying areas where improvements can be made that will positively impact the company’s bottom line and operating metrics that prospective buyers use to evaluate a possible acquisition.

MW: What resources are available to assist the owners of a company to perform the initial valuation, conduct the initial audit and identify areas to improve performance?

Siren: Preparing to sell a company can be a very nuanced and delicate exercise. That is why it is important to hire a team of experts with industry specific knowledge to help guide the process and not just finance professionals. The ideal team should blend operational experience in the healthcare field with expertise related to financial modeling and the evaluation process undertaken by prospective buyers. Accredited valuation professionals with operational experience in the healthcare field will have the appropriate industry-specific knowledge as well as the expertise to perform an accurate valuation and audit and identify areas for improvement. These skills are critical in being able to increase the company’s attractiveness to prospective buyers.

MW: How does the initial valuation shape the process of selling the company?

Siren: The initial valuation serves as the starting point in negotiations with prospective buyers. A low valuation could be a sign that the company has room to improve its earnings performance; a metric typically measured by EBITDA.

MW: What are preliminary steps owners can take to improve earnings performance as measured by EBITDA?

Siren: If a company’s initial valuation is below the owner’s expectations and is a result of poor EBITDA, there are several steps an owner can take to improve earnings performance and, in turn, improve the company’s EBITDA. The first is to control expenses. The most common expense drivers that can be improved include supply agreements and pharmaceutical contracts, staffing, benefit levels for employees, overtime usage, etc. The next step is to review the revenue cycle. The improvements gleaned from creating efficiencies to get from patient registration to payment collection more quickly and reduce revenue leakage will fall directly to the company’s bottom line. Third, the company may need to improve its payor mix (if this is controllable). Depending upon the type of business, it is always advantageous to have a high percentage of commercially insured patients. Next, examine and evaluate the physical premises. The owner should make all necessary improvements. Prospective buyers will look for potential money pits and lower their offer accordingly if any exist. A buyer may also find additional value in an operationally efficient company supported by a physically sound infrastructure. Finally, rigorous due diligence should be conducted to ensure the thoroughness and accuracy of the company’s financial records. The company’s financial information should be completely transparent to any potential buyer. While not an exhaustive list, these are steps that can be taken to improve a company’s earnings performance and its attractiveness as a target to prospective buyers.

MW: How will any improvements made to the business improve the owner’s chances of selling or the purchase price for which he or she is able to sell the company?

Siren: The steps to improve performance, most notably EBITDA, not only make the company more attractive to buyers, but may also increase the price for which the owner is able to sell the company. The purchase price is often a multiple of EBITDA. Thus, a boost in EBITDA is augmented by the EBITDA multiplier and exponentially increases the purchase price. The business efficiencies that lead to stronger earnings need to be demonstrated and sustained for several months before the EBITDA number becomes reliable and can reasonably be expected to prompt a higher offer from a prospective buyer. With EBITDA as the dynamic variable, the purchase price can increase even if the multiple remains constant. However, the EBITDA multiple is not always constant. Improving the company’s operational efficiency may lead to a higher multiple where the buyer is willing to pay for an operationally sound company that it can easily fold into its operations without the added task of improving the company’s operations or upgrading its facilities.

---- To be continued.

For more information, please contact Bill Siren at AlixPartners, LLP at (615) 312-8292 or Geoffrey C. Cockrell at McGuireWoods LLP at (312) 849-8272.

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