Payment reform will shift home health agency valuation parameters

Healthcare Financial Management, Dec, 1998 by Allen D. Hahn

Due to the predominance of Medicare in the payer mix of most home health agencies, a valuation using a "stand-alone" income analysis often produced very different results from a valuation using a comparable transaction analysis. This anomaly was attributable to the traditional payment mechanism for home care services. Under Medicare's cost-based payment system, most home health agencies earned little, if any, profit. In PricewaterhouseCooper's database, more than 75 percent of home health agency acquisitions involved agencies that recorded losses. Estimating an agency's value based on cash flow alone could not justify the market prices paid for most agencies.

Market evidence suggests that valuations under the cost-based system were driven by the expectation of payment benefits to a specific buyer rather than by cash flows generated by the agency targeted for acquisition. In other words, transaction prices took into account the value to allocate overhead costs to the acquired agency. On a "standalone" basis, an income analysis could not account for the cost-allocation benefits of acquiring these agencies. Acquisition multiples from comparable transactions were more likely to reflect the value of this benefit and better approximate a home health agency's fair market value.

As such, a home health agency's value has been expressed as a function of a price-to-revenue or price-per-visit multiple. From 1994 to mid-1997, the price-to-revenue multiple for acquisitions in the home care sector averaged about 0.8 x (eg, on average, the price of an agency with $10 million in annual revenue would be $8 million.) During this time, increased acquisition activity by facility-based providers and publicly traded companies caused prices to rise from $12 to $13 per Medicare visit in 1994 through 1996 to about $15 by early 1997. The price-to-revenue multiple for home health agencies providing home nursing services averaged 0.55x, whereas valuations placed on specialized home health agencies (eg, respiratory and infusion therapy providers) ranged from about 0.8x to more than 2.0x (see Exhibit 2, page 32).(h)

During the past 12 to 18 months, valuation multiples have been declining. The payment limits imposed by the IPS have significantly reduced the ability of most facility-based buyers to allocate overhead costs to acquired home health agencies. Moreover, the PPS is expected to completely eliminate this benefit, which, therefore, will no longer be a factor in assessing an agency's market value. Historical market benchmarks are less useful measures of value under the IPS and PPS. Due to the limitations imposed by the IPS, expected cost synergies have replaced the benefits of allocating overhead as a primary driver of many home health agency acquisitions. The ability to consolidate administrative operations, leverage information systems, and control patient services typically results in enhanced cash flow after an acquisition and should be reflected in an assessment of a home health agency using an income analysis.