The following article is written by Blayne Rush, MHP, MBA, president of Ambulatory Alliances.
It's been all anyone can talk about at association conferences: who sold their ambulatory surgery center or radiation oncology center … and who sold for the highest acquisition valuation multiples. This talk of multiples seems to take on a life of its own, but there are major misperceptions in the industry about just what a multiple means. We hear a "7x" multiple, but we almost never hear other important elements of the deal, including just what are those investors multiplying, after all?
Potential radiation oncologist and surgeon clients tell me, "I heard that Memorial Hospital bought Dr. Jones's ASC for 7x and I read where Dr. Smith sold his radiation oncology center for $33 million, which I believe is 9 times, so shouldn't I be able to get between 7x and 9x for my surgery center?" The answer is maybe yes and maybe no, but it will depend on how well you are able to understand what buyers are looking for, and how well you use that information to your advantage.
Even in the most advantageous market, many owners of ASCs leave substantial money on the table when they sell their surgery center — most often because they do not truly have a handle on what they can do to maximize the multiplier basis (the metric buyers use to multiply and get a final price) or they don't want to invest the required time and effort. However, there are both simple and complex strategies you could use to maximize your ASC's valuation prior to selling it, which involve first understanding how an ASC investor goes about valuing a center and then seizing opportunities to enhance your own ASC's valuation.
The first mistake many physician owners and their consultants usually make is believing that multiples of past earnings is a primary method of valuation. Investors are only interested in past performance as an indicator of future earnings. The bottom line is that buyers buy future profits, not trailing earnings.
EBITDA is the most widely represented basis for the multiplier, but the Discount Cash Flow (DCF) method (which uses future cash flow projections) is the most accepted valuation of what investors are actually buying.
Since we know that EBITDA is backwards looking and DCF is forward looking, but both are utilized, we need to understand what we might be able to do to enhance both.
Physician-owners of radiation oncology centers are accustomed to thinking about revenue as minimizing taxable income, while investors are focused on revenue in terms of maximizing profits. While minimizing taxes is good strategy for tax time, it does not accurately represent the financial performance of your center. Your goal when you prepare to sell is to adjust the operations of your center in order to maximize earnings.
If you are doing it after the fact, you will make adjustments for one-time expenses and various unnecessary expenditures. This process is called "recasting" or normalizing earnings. These adjustments to income statements and balance sheets allow buyers to appreciate the maximum profitability of the center and the true value of the assets and liabilities. Keep in mind physicians will want to maximize value capture, and buyers will want to minimize it, so potential investors will scrutinize all add-backs. This tug-of-war will be part of the due-diligence process, and you just want to maximize your profits as a starting point.
To start, use the company's EBITDA for the appropriate period. Then make the adjustments for discretionary items. Doing so will not only remove one-time or extraordinary income and expenses, but also will adjust for accounting anomalies, identify owner compensation, owner "perks" or fringe benefits, non-cash expenses and other items that are common in privately-held businesses.
Below are some of the most common examples of items which could be recasted, but nothing short of going through the income statement line by line in search of profits will do.
1. Compensation, both for owners and employees. Not all of the physician owner's compensation is recasted, but the amount of salary or bonus that a physician owner pays to himself and others is largely discretionary, so it can be adjusted. Compensation above and beyond the typical market value can be added back to your pre-tax earnings. So if your main employee is paid above market rate because of their loyalty to you, normalize their pay. Do the same thing for family members employed by the business.
2. Owner perks or fringe benefits. In addition to cash compensation, most ASC owners receive numerous perks or benefits that are not required for the daily operation of the surgery center. For example, while a vehicle may be required, a luxury automobile or SUV is not normally necessary. There may also be discretionary expenses reimbursed to the physician owner which may not be applicable to a new owner and don't affect the profit performance of the ASC. These include items such as:
- personal travel and entertainment expenses;
- vehicle expenses beyond what is absolutely necessary;
- unearned family compensation, including wages, vehicles, trips or insurance;
- a large life insurance contract or pension plan;
- personal use assets, such as a sailboat, plane or a condo in Hawaii;
- expenses paid to another company owned by the same seller; and
- excess compensation, i.e., compensation beyond what the owner is willing to receive post sale or beyond the amount required to hire competent surgeon.
3. Employee-related items. Certain employee-related items may be changed post-sale, so they can be added back to pre-tax earnings.
4. One-time items. Adding back one-time, extraordinary or non-operating income or expenses is meant to remove items which appear in the financial statements, but which are either unlikely to be repeated in the future or are unrelated to the ASC's operations, so they won't be incurred by a new owner. Common examples include things such as:
- donations;
- bad-debt expenses;
- uninsured losses;
- marketing and trial advertisements; and
- one-time legal lawsuits.
5. Discretionary business practices. Other business expenses which won't typically be incurred by a new owner into the future, and which may therefore be recasted, include:
- business insurance beyond what is absolutely necessary;
- excess rent (pay close attention to this if you own the underlying real estate);
- patient incentives;
- overpaid expenses done to reduce taxes; and
- lump sum bonuses paid to employees.
That was the simple part; now for the time-consuming and complex. DCF analysis is the most accepted valuation method for radiation oncology and surgery centers because it is a measure of future profits (projected net cash flows for a certain number of years) stated as a present value. Potential investors will view the DCF as a valuation basis for the purchase price but will typically represent the purchase as a multiple of EBITDA. So understanding how DCF is measured will help you evaluate what you can do to maximize it.
The expected cash flows earned beyond the projection period are capitalized into a terminal value and added to the value of the projected cash flows for a total value indication. In doing so, the DCF model relies on a major assumption about that string of future cash flows: your revenue growth rate. This determines how that projected string of cash flows grows from year to year, and anything you can do to make it grow larger and faster will get discounted back to the present value number and directly influence buyers' bids.
Basically, DCF analysis is buyers' preferred valuation methodology, and if you use the DCF model to strategize pre-sale changes to your business, your question itself will change from, "Shouldn't I be able to get between 7x and 9x for my surgery center?" to, "What can I do to increase my revenue growth rate?"
So what can you do? Go through some what-if scenarios to identify any changes which could maximize the center's potential future cash flows. For instance, what if you:
1. Lease a fixed block of time (or multiple block leases). If your radiation therapy center has extra capacity, think about leasing a fixed amount of time to other providers' groups, where the group provides services with clear responsibilities for services rendered, i.e., an active practice independent of the radiation oncology services.
2. Form a group practice. You could grow market share by adding physicians or creating a multispecialty group practice ownership, as opposed to the traditional individual physician investment. Any physicians that participate in the continuum of care for cancer patients are potential group practice members for radiation oncologists. For ASCs, one or more group practices (single or multi-specialty) can hold ownership interests in the surgery center. If your surgery center is a pain management center, think about adding orthopedics.
3. Merge with a local competitor. How do synergies of two competing centers affect future earnings? If two centers are coming together, could it be one plus one equals not two, but four? If you have two centers that treat patients in the same market, think about merging the practices, then selling the ASC or radiation therapy center with the combined revenue as a going concern, and sell just the assets of the other center.
4. Syndicate. A syndicate is an association of people or firms formed to engage in an enterprise or promote a common interest. Syndicating an ASC or radiation therapy center entails the selling of a percentage ownership interest to investors.
Valuation professionals understand that physicians and referrals are central to the success of any radiation oncology center. When determining value, valuation professionals' knowledge regarding the source of the referral and its continuation is considered important. A radiation oncology center which has physicians who participate in the continuum of care as equity investors would support this understanding when you go to sell your center.
ASCs that attract additional physician-investors will capture the revenue from other centers. ASCs that have the right mix of physicians could lead to a boost in earnings, which will in turn increase your valuation, thus achieving a significantly greater acquisition price.
Physician syndications followed by a sale to a corporate investor need to have a seasoning period.
Additionally, both radiation oncology centers and ASCs could syndicate by selling units to group practices
5. Undertake a reverse merger. You could form a new entity with partners who supported revenue growth (i.e., form a group practice), then merge the old radiation oncology business with the new entity, getting rid of partners who do not support revenue growth.
6. Do a hybrid or combination of these. It's possible some of these strategic moves won't fit your specific business; it's also possible many of them do. Engage in what-if thinking to determine which strategy, or combination of strategies, could maximize your future cash flows.
Ultimately, the moves you should make prior to selling your center depend on numerous factors, including both state and federal laws, your understanding of what a buyer is buying and the actions you can take to maximize the multiplier basis (EBITDA and/or DCF).
After analyzing operations and revenues line by line, and analyzing referrals and competition, you should be able to identify what could work to improve both your past performance metrics and your future revenue growth or efficiency opportunities. Keep asking these questions: Was this required for the operation of my ASC? Will the new owner require these same amounts? Will this increase my revenue growth rate?
Your willingness to put in the required time and effort will allow you to capture the full value of your center. If you make defensible strategic moves that will result in future revenue greater than past performance, you can justify an increased valuation, which will allow you to realize the maximum sales price.
Blayne Rush is the president of Ambulatory Alliances (www.AmbulatoryAlliances.com) and is a SEC Registered and FINRA Licensed Investment Banker. He specializes in acquisitions, alliances and access to capital markets for surgery and radiation oncology centers. He can be reach though the Ambulatory Alliances web site or by calling (469) 385-7792.
This paper is not intended or offered as legal advice. These materials have been prepared for educational and information purposes only. This paper is not legal advice or legal opinions on any specific matters. No person should act or fail to act on any legal matter based on the contents of this paper. This paper was not written by an attorney licensed in your state. Those seeking legal advice or assistance should contact an attorney.
Securities offered through Bedminster Financial Group, LTD. member FINRA, SIPC, 4920 York Rd., Ste 2DD1. P.O.Box 295, Holicong, PA 18928. Ph (215) 794. 9016