StraightTalk Webinar Series–April 29, 2021

Healthcare Valuation 2021 Update

The COVID-19 pandemic has impacted nearly all businesses and is poised to continue to do so through at least the end of 2021. In healthcare, there has been additional issues due to the industry’s unique position at the crossroads of the front line of care and policy response. As of January 19, 2021, important updates have gone into effect concerning the two most significant laws in healthcare transactions and valuations: the Stark Law and the Anti-Kickback Statute (AKS). In this webinar, the guest speakers, Don Barbo and Brad Parker, examined the pandemic-driven financial statement and valuation concerns unique to the healthcare industry, as well as how the 2021 final rules for Stark and AKS will affect healthcare valuations and what analysis analysts will need to consider.

This article provides an overview of the April 29, 2021, VPS’ StraightTalk Webinar: Healthcare Valuation 2021 Update hosted by Jim Hitchner, featuring Don Barbo and Brad Parker.

The COVID-19 pandemic has impacted nearly all businesses and is poised to continue to do so through at least the end of 2021. In healthcare, there has been additional issues due to the industry’s unique position at the crossroads of the front line of care and policy response. As of January 19, 2021, important updates have gone into effect concerning the two most significant laws in healthcare transactions and valuations: the Stark Law and the Anti-Kickback Statute (AKS). In this webinar, the guest speakers, Don Barbo and Brad Parker, examined the pandemic-driven financial statement and valuation concerns unique to the healthcare industry, as well as how the 2021 final rules for Stark and AKS will affect healthcare valuations and what analysis analysts will need to consider.

In this healthcare update, Don Barbo and Brad Parker discussed the following:

• The unique financial statement impacts imposed upon healthcare entities by the pandemic, both direct and indirect;
• Examples of actual valuations and their recommended treatment of pandemic impacts in healthcare valuations;
• Provide updates to Stark and AKS as a result of the 2021 final rules; and
• How the updated Stark and AKS laws may affect healthcare valuations in 2021.

Webinar participants were provided PowerPoint slides and access to a video of the recording of the program.

COVID-19 Healthcare Impact

The COVID-19 surge and corresponding containment efforts included several CARES Act programs that specifically affected healthcare entities. As the virus proliferated, these programs provided grants to address the disruption in revenue to hospitals, clinics, skilled nursing facilities, and Indian Health Services. Significantly, the CARES Act, Provider Relief Fund, included in Phase I, $30 billion distributed to providers based on their proportionate share of 2019 Medicare fee for service payments and $20 billion distributed based on the most recent tax year gross receipts. Phase II included payments of up to 2% of annual patient revenue to those entities that did not receive an initial payment. Phase III provides an additional $4 billion in grants to providers, to cover up to 88% of their reported losses due to COVID-19. The eligibility continued to expand throughout the program, as Phase III verticals included behavioral health, dental, and assisted living in addition to professional practices.

The CARES Act enabled HHS to also target distributions. HHS distributed $22 billion to COVID-19 high-impact distribution hospitals in COVID-19 hotspots, $11.3 billion to rural hospitals, $500 million to Indian Health Services, and $4.9 billion to skilled nursing facilities. HHS was also provided a $14.7 billion safety net for hospitals.

In addition, the CARES Act included $100 billion funding to reimburse healthcare providers at Medicare rates for COVID-19 related treatment for the uninsured.

The above grants and funding ensured that the healthcare sector could financially withstand the drop in traditional revenue streams and ensure healthcare providers could treat those affected by COVID-19.

Testing and Hospital Admissions: March to May 2021

Both Barbo and Parker provided context to enable the audience to understand the proverbial size of this problem and opportunity. In March 2021, confirmed COVID-19 infections increased by 190,000, bringing the total to 27.5 million. At this point in time, the Institute for Health Metrics and Evaluation reported 576,026 COVID-19 deaths. In addition, as of February 2021, 322.7 million tests had been administered; the total tests administered for March and May 2021 were projected at 49.6 million and 52.4 million, respectively. At this juncture, mean daily hospital admissions declined from 93,600 in March 2021 to approximately 25,800 in May 2021. Hence, on the one hand, traditional and routine procedures dropped, yet other opportunities arose in connection with vaccination and testing.

As people became vaccinated and the number of people testing positive and requiring hospitalization dropped, the unknown questions in the healthcare industry included how quickly would volume recover? Was there sufficient staff in place to manage recovered volumes? Whether blanket Stark and AKS waivers—relaxed during COVID-19—which provided temporary revenue boosts, would continue? If, so, for how much longer? How A/R and bad debt would be impacted by the slower self-pay rates and relief programs?

COVID-19 Impact on Healthcare Services Public Markets and M&A

While the share price of healthcare market companies dropped in February 2020 with the broad market sell-off, that slide was temporary. Congress responded. Shares in ASC companies were the big winners, followed by Acute Care Hospital shares 

Despite the impressive returns of stocks in the healthcare sector, the financial impact of the pandemic weakened some providers. Forty-four percent of healthcare CFOs opined that the pandemic is expected to drive an increase in partnerships in the second half of 2021. Forty-two percent of CFOs added that they expected an increase in consolidations with an emphasis on bolt-on acquisitions for efficiency and scale, and smaller acquisitions rolled-up into platforms. The increased acceptance and adoption of virtual medicine by physician groups with quality technological infrastructure are considered popular acquisition targets.

Balance Sheet Impacts  

With respect to business valuations, the speakers observed that they had seen several healthcare practices with excess cash flows and lower A/R as compared to what they had historically seen. Here, they advised business valuation practitioners to conduct due diligence to determine whether the excess cash flow was tied to Phase I or Phase II grants, PPP loans, or some other factors, or a combination of these.

They also observed that a number of physician practices had engaged in bulk buying and that the inventory values, relative to the historical balance sheets, was distorted by bulk purchases.

With respect to liabilities, valuation practitioners need to determine whether SBA loans had been booked? Whether a liability for PPP funds had been booked? Reversed? Were expected to be forgiven? Whether a contingent liability for unused HHS grant revenue had been recorded?

Profit and Loss (P&L) Impact

As for the impact of COVID-19 on P&L, the speakers emphasized that healthcare revenues are a three-component equation. This equation consists of volume, charges, and collections. As noted earlier, COVID-19 reduced the volume of non-emergent outpatient procedures. For example, ASCs, which provide elective procedures, saw a significant reduction in volume. Many ASCs closed temporarily. Using ASCs as an example, the business valuation professional will need to determine whether these procedures/visits were rescheduled? Whether there is a pent-up demand which will unwind as restrictions are relaxed. This will require the valuation professional to review geographical data and variances in in volume. If the healthcare facilities have seen an uptick in COVID-19-related volumes, are revenues-per-unit higher or lower for COVID-19-related volumes than for the entity’s standard procedures mix?

They also observed that operating expenses had been impacted. Some facilities laid-off staff, other facilities did not cut staff. Were staff laid-off? A critical question is how soon can the facility re-hire and whether they have that capability given that some facilities increased employee wages. Here too, they noted that PPP funds were recorded as a contra-expense against employee salaries and wages and that if that indeed occurred, practitioners need to normalize the P&L by reversing the contra-expense entry.

Stark Law and Anti-Kickback Statute (AKS)

With respect to Stark and AKS, the speakers provided an overview of the recent final rules that overhauled the regulations governing the federal Physician Self-Referral Law (Stark), AKS, as well as the Civil Monetary Penalty (CMP) Law. These rules were formally published in the Federal Register on December 2, 2020, and became effective January 19, 2021. These rules were intended to facilitate value-based arrangements in healthcare.

They noted that Stark, as compared to AKS is a strict liability law. Significantly, under Stark, intent does not need to be proven for overpayment.

The exceptions under the final rule contain a requirement that the payments or compensation for space, equipment, or services be at “fair market value.” Fair market value is defined in Stark as “the value in arms-length transactions, consistent with the general market value.” See 42 C.F.R. 411.351. There are additional requirements for rentals or leases that “the value of rental property for general commercial purposes (not taking into account its intended use) and, in the case of a lease of space, not adjusted to reflect the additional value the prospective lessee or lessor would attribute to the proximity or convenience to the lessor where the lessor is a potential source of patient referrals to the lessee.” The Final Rule modifies the definition of “fair market value” generally, and more specifically, modifies the definition of fair market value applicable to the rental of equipment and rental of office space. This modification provides clarity to the statutory language. Here, practitioners need to recognize that Rev. Rule 59-60 is not appropriate, the Stark and AKS definitions of fair market value are unique to healthcare transactions.

The general market value definition also impacts compensation and asset purchases.

The speakers concluded discussing the new “commercial reasonableness” definition and the “volume and value” requirement. Under the new definition, the reference to “volume and value” is eliminated from the new “general market value” definition for compensation arrangements, and now treated as a separate requirement for physician compensation arrangement, in addition to the general market value and commercial reasonableness requirements. Considering the above, the speakers emphasized to be careful using wRVUs in valuation engagements given the above developments.

Conclusion

Jim Hitchner’s webinar provides mid-level and new valuation practitioners an opportunity to hear from a seasoned professional regarding legal, regulatory, and financial developments that practitioners must consider when preparing valuation reports. This webinar provided the attendees with practical insight to apply in a valuation engagement and underscored the importance of understanding how the final Stark and AKS rules are impacting the healthcare industry.

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Roberto H Castro, JD, MBA, MST, CVA, is Managing Member of the Law Office of Roberto H Castro, PLLC and Legal Compliance counsel for Equilus Capital Partners, LLC, a closely held LP Fund. He is also Technical Editor of QuickRead and a member of NACVA’s CUV team.

Mr. Castro can be contacted at (509) 679-3668 or by e-mail to rcastro@rcastrolaw.com.