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Hospital M&A: Due Diligence Considerations Evaluating Transaction Risks, Liabilities and Pricing for Buyers and Sellers

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WEDNESDAY, JUNE 20, 2012

Presenting a live 90-minute webinar with interactive Q&A

Thomas J. Cuccia, CFA, ASA, Managing Director, Valuation Services, Reimbursement and Advisory Services Division

Altegra Health, Los Angeles

Charles P. Sukurs, Atty, Hall Render Killian Heath & Lyman, Indianapolis

Roger D. Strode, Partner, Foley & Lardner, Chicago

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HOSPITAL M & A : DUE DILIGENCE CONSIDERATIONS

Evaluating Transaction Risks, Liabilities and Pricing for Buyers and Sellers

June 20, 2012

Thomas J. Cuccia, CFA, ASA Managing Director

[email protected] 5

mailto:[email protected]

Forces Driving M & A Activity

Healthcare Reform – Patient Protection and Affordable Care Act (PPACA) March 21, 2010

– Health Care and Education Reconciliation Act of 2010 March 30, 2010

Government Regulation – CMS Audits (Recovery Audit Contractor)

– Stark

– AKS

– Fraud & Abuse

– Reporting requirements

Great Recession – Greater number of uninsured patients & indigent care

– Delay in elective procedures

6


Competition

– Specialty hospitals on the rise

– Ambulatory surgery centers (ASCs)

Difficulty Recruiting Personnel

– Doctors

– Nurses

– Skilled Technicians

7


Reimbursement

– CMS 2012 increases for both in-patient & out-patient

services.

– CMS cuts if not successful with quality programs (up to 2%)

– Concern over reimbursement decreases for Disproportionate

Share Hospitals (DSH)

» 2014 CMS reductions up to 75% are scheduled

» Medicaid decrease of approximately $18 billion 2014-2020

8

Current Trends In Hospital M & A

What the Hospitals are Doing

– 78% of organizations are exploring or have M&A deals under way

– 56% of organizations have specific teams dedicated to hospital-physician practice acquisition opportunities

– A clear majority of organizations are using M&As to strengthen what they're already doing, only secondarily to explore new opportunities:

– 65% use M&As to strengthen existing markets; 52% to acquire physician practices to strengthen current service lines

– 43% use M&A to expand into new markets; 37% to acquire practices to strengthen new service lines

– 48% say their organization is likely to pursue an acquisition in the next 12–18 months

Data provided by: Media Intelligence, M & A: Hospitals Take Control, January 2012.

9


What the Hospitals are not Doing – 6% say their organization has no M&A strategy

– 13% say their organization’s strategy is to maintain independence and enter into no M&A activity

– 21% expect no M&A activity in the next 12–18 months


10


M & A Acquisition Targets – 18% of hospital and health system organizations

have a high interest in the insurance, payor plan sector

– 50% or more cite hospitalist, cardiology, orthopedics, and primary care as most relevant to their M&A strategy


11


Top Three Reasons Deals are Terminated

– 58% of respondents have terminated an M&A over the past

12-18 months

» Culture (49%)

» political/governance considerations (41%)

» agreement on valuation (39%)


12

Hospital M & A Market Activity

Historic M & A Activity

Data Provided by Irving Levin Associates, The 2011 Health Care Services Acquisition Report, Seventeenth Edition,.

Year Done Deals Hospitals

Acquired

2006 57 249

2007 58 149

2008 60 78

2009 52 80

2010 72 125

13


Deal Pricing

Data Provided by Irving Levin Associates, The 2011 Health Care Services Acquisition Report, Seventeenth Edition,.

Year Price to

Revenue

Price to EBITDA

2006 .73 8.5

2007 .60 8.9

2008 .70 6.4

2009 .77 8.6

2010 .65 7.4

14

Valuation Due Diligence Activity

What Contributes to Risk? – Degree of regulation – more difficult to forecast cash flows

– Important to ID reimbursement trends that aren’t sustainable » Nuclear medicine cuts of 2009 drastically cut reimbursement for

technical component of certain CPT codes

– Payors

– Coding

– Conversion to ICD 10

– Compliance

– Contracts with physicians

– For profit vs. non-profit

– Transaction Structure

15


What Drives Value – Competition in primary market area

– Population demographics

– Types of services offered » Primary vs. specialized

– Types of physicians » Employees or contracted through professional services agreements

(PSAs)

» Ease of recruiting new physicians

– Pricing power in hands of hospital or commercial payors » Managed care contracting

– Location, Location, Location » Age and curb appeal of hospital campus

16


Due Diligence Key Financial Metrics

» Admissions (inpatients)

» Number of inpatient days and growth of inpatient days

» Length of stay

» Daily census

» Occupancy rates

» Outpatient visits and growth in visits

» Adjusted patient days

» Case mix percent of volume (inpatient and outpatient) • Commercial, self pay, Medicare, Medicaid

» Medicare outpatient cost to charge

17


Due Diligence Key Financial Metrics

– Income from operations

» The greater the operating income greater the value

– Expenses influencing operating income

» Salaries and benefits – easily the largest expense

» Bad debt expense

» Medical supplies

18


Non-Financial Due Diligence

» ICD 9 conversion to ICD 10

» Compliance & risk management programs

» Physician contracting

» Revenue Cycle

» Coding

» Purchasing and supply management

» Information technology

» Patient experience

19


Ways to Increase Value

– Reduce salaries & benefits

– Reduce medical supply costs

– Improve efficiency

» Especially operating rooms and emergency room

– Increase revenue

» Critically evaluate revenue cycle from time patient is admitted to

discharge to time fees are collected

– Improve physician alignment

20

Hospital M&A: Due Diligence Considerations Evaluating Transaction Risks, Liabilities and Pricing for Buyers and Sellers

June 20, 2012

Charles P. Sukurs

Hall, Render, Killian, Heath & Lyman, P.C. Indianapolis, IN

Phone: (317) 977-1452 Email: [email protected]


22

A Word About Purpose

• Q: What is the purpose of legal due diligence?

• A(1): Generally, the purpose is to identify any legal concerns that may have a material or significant impact on:

– the decision to acquire; and/or

– the purchase price to be paid; and/or

– the legal structure of the transaction and issues to be addressed in the purchase documents.

• A(2): Sometimes, the Acquirer will have specific purposes and those need to be taken into account in structuring the due diligence process and conducting the actual review. Example: Information gathering to assist in operational transition planning, preparation of schedules to definitive agreements, or post-closing integration.

23

FOCUS - Issues That Are Unique to Hospitals • Proper legal due diligence must include issues common to any

M&A transaction (regardless of industry). For example:

– General Tax Compliance

– Environmental and Real Estate

– Pending and Threatened Litigation

• Question for this presentation: What legal due diligence issues are unique to hospital M&A transactions?

24

How is Health Care Different?

• Hospital mergers and acquisitions are unique: – Threats to future cash flow (at least a majority of business comes from

one payor - Medicare/Medicaid)

– Potential for successor liability

– Complex revenue sources and customer relationships

– Regulation of referral source relationships (due diligence issues separately discussed by Roger Strode)

– Importance of regulatory compliance

– Multiple regulatory oversight bodies

– Must be able to assess identified risk

25

Typical Due Diligence Areas of Inquiry • Organizational Matters

• Contracts and Commitments (including Referral Source Relationships – separately discussed)

• Corporate Compliance Matters

• Litigation / Claims / Investigations

• Financial Information

• Insurance

• Tax Matters

• Properties and Equipment

• Licensure and Accreditation

• Employment and Employee Benefit Plan Matters

• Information Systems

• Medical Staff

26

Corporate Compliance: Billing and Coding • Q: Does the Target have billing and coding practices that raise any

questions/concerns about the decision to acquire, the purchase price to be paid, or the structure of the transaction?

• Due diligence often includes a review of a target’s billing and coding compliance:

– Depending on the form of the transaction, the Target’s billing and coding compliance “history” may be inherited by the Acquirer.

• Example: Membership interest acquisition where Target keeps its Medicare provider ID#.

– Regardless, the Acquirer may want to know the level of compliance to determine whether pre-closing education is needed.

• Typical scenario:

– Third party billing expert reviews a sampling of inpatient and outpatient claims, along with the hospital records that support those claims

– Lawyer asked to advise the Acquirer on the results of that review.

27

Corporate Compliance: Billing and Coding (cont.) • What happens if a problem is discovered?

– Review is not protected by the attorney-client privilege.

– If an “overpayment” is identified, knowledge on the part of the target hospital creates an affirmative obligation to repay within 60 days under the federal False Claims Act.

– If the overpayment is somehow related to a financial relationship with a referring physician, the federal Stark Law and Anti-Kickback Statute can also be implicated.

– To avoid these potential risks, review is sometimes limited to claims not yet billed by the Target.

• More and more, we are recommending to our clients that any discovered issues be resolved prior to the transaction being closed.

28

Litigation / Claims / Investigations

• Q: Is the Target the subject of any governmental proceedings or investigations that might raise any questions/concerns about the decision to acquire, the purchase price to be paid, or the structure of the transaction?

• Goals for the due diligence review:

– understand the nature of the investigation/proceeding and the issues involved

– understand the Target’s potential exposure – legal, financial, public relations, etc.

– attempt to quantify the potential risk to the Acquirer

29

Litigation / Claims / Investigations (cont.) • Examples of issues that are sometimes identified:

– Target is the subject of a formal Corporate Integrity Agreement with the Office of Inspector General. OIG negotiates corporate integrity agreements (CIA) with health care providers and other entities as part of the settlement of Federal health care program investigations arising under a variety of civil false claims statutes. Providers or entities agree to the obligations, and in exchange, OIG agrees not to seek their exclusion from participation in Medicare, Medicaid, or other Federal health care programs.

– Target is the subject of a pending industry-wide Department of Justice investigation (e.g., kyphoplasty investigation, implantable cardiac device (ICD) investigation)

– Target is the subject of an individual regulatory investigation or proceeding (state or federal)

30

Tax Matters (That are Unique to Nonprofits) • Q: Does the Target engage in any activities that may have an adverse

impact on its tax-exempt status (if applicable) or the tax-exempt status of the Acquirer (if applicable)? Would any such issues raise any questions/concerns about the decision to acquire, the purchase price to be paid, or the structure of the transaction?

• Tax Issue #1: Private inurement, private benefit, and Intermediate Sanctions compliance

– Are there any activities that may constitute impermissible private inurement or private benefit?

– Does the Target’s Board (or a committee of the Board) review and approve compensation arrangements with “Disqualified Persons” in a manner that establishes the “rebuttable presumption” of reasonableness?

31

Tax Matters (That are Unique to Nonprofits) (cont.) • Tax Issue #2: Appropriate Use of Facilities Financed with Tax-Exempt

Bonds (Revenue Procedure 97-13)

– If the Target has issued tax-exempt bonds or if the Acquirer will finance the acquisition with tax-exempt bonds, need to assess the Target’s use of bond-financed space for compliance with Rev. Proc. 97-13.

– Rev. Proc. 97-13 provides “safe harbors” pursuant to which outside management companies and service providers can conduct activities within space that is financed with tax-exempt bonds

– Goal: Identify any management or service contracts that may need to be amended to comply with Rev. Proc. 97-13, either to ensure compliance under Target’s existing bond issuance or to ensure compliance on a post-closing basis under Acquirer’s consolidated bond issuance.

32

Tax Matters (That are Unique to Nonprofits) (cont.)

• Tax Issue #3: Restrictions on Lobbying and Prohibition against Political Campaign Activities

– Federal tax law places significant restrictions on the ability of a tax-exempt organization to conduct lobbying, and has an outright prohibition against a tax-exempt organization engaging in political campaign activities

– If the Target is tax-exempt or is joining a tax-exempt organization, due diligence review should include an inquiry into past lobbying and political activities of the Target

– Goal: Identify any activities that may threaten Target’s tax-exempt status or need to be stopped or significantly modified prior to closing to protect the Acquirer’s tax-exempt status on a going-forward basis.

33

Licensure and Accreditation • Q: Does the Target have any accreditation limitations or licensure issues that

raise any questions/concerns about the decision to acquire, the purchase price to be paid, or the structure of the transaction?

• Accreditation and licensure related information submitted by the Target typically includes:

– accreditation certificates (e.g., Joint Commission, department-specific accreditations)

– institutional licenses (e.g., state hospital license)

– equipment licenses and registrations

– CLIA certificates

– DEA registration

– State Department of Health surveys

– Compliance with Medicare Conditions of Participation (COP)

• Purpose of the review is to generally identify whether licenses and accreditations appear current and in good order. Additionally, these items should be logged for later “Change of Ownership” notices and development of schedules that may be required in connection with signing and/or closing.

34

Medical Staff • Q: Does the Target have any past or present medical staff matters that

raise any questions/concerns about the decision to acquire, the purchase price to be paid, or the structure of the transaction?

• Peer review generally - Has the Target “managed” its peer review process in a manner to preserve the peer review privilege and qualified federal immunity? Are there any pending or threatened actions where this is in question? (Poliner case)

• Physician billing/coding:

– Frequently a physician’s billing or coding practices “surface” at the hospital through the medical staff peer review process

– Actions of even a private physician on the Target’s medical staff can have significant implications for the Target’s own billings associated with that physician’s activities.

©2012 Foley & Lardner LLP • Attorney Advertising • Prior results do not guarantee a similar outcome • Models used are not

clients but may be representative of clients • 321 N. Clark Street, Suite 2800, Chicago, IL 60654 • 312.832.4500

Business and Legal Due Diligence Issues

in

Hospital Mergers & Acquisitions

Roger Strode

Foley & Lardner, LLP

321 North Clark Street

Suite 2800

Chicago, IL 60654

312.832.4565 (Direct)

414.202.8717 (Cell)

[email protected]

35


©2012 Foley & Lardner LLP

Material Diligence Issues

Physician-Hospital Relationships

Business Issues

Issues Relating to Operating Authorities

36



Often creates the greatest controversy during transactions

Stark Law and Federal Anti-Kickback issues are the usual focus

The issues that arise can result in:

– Self-disclosures to OIG (prior to closing)

– Inability to close a transaction due to scope of potential liabilities

– Specific and significant indemnity obligations

37



Medical directorships

Income support arrangements

Space and equipment lease agreements

Arrangements regarding Designated

Health Services, e.g., imaging

Physician employment agreements

38



Are payments consistent with fair market value and/or supported by valuations?

Are written agreements in place? – Only employment arrangements don’t need written agreements

Are agreements current, e.g., have they expired by their terms?

Are the appropriate types of physicians party to each agreement, e.g., are there orthopedic surgeons who are parties to an equipment lease agreement?

Do the economic terms comply with relevant Stark Law exceptions and Anti-Kickback safe harbors?

39



Why should Seller’s counsel ferret out

these issues?

– Ability to represent and warrant in the

purchase agreement

– Issues could impact the purchase price and,

thus, understanding the issues prior to deal

negotiation is important

40


Business Issues

Receivables – How strong are the receivables?

– Current deal structures—receivables stay with the seller and are collected by buyer for a fee.

Payer Agreements – Are payer agreements assignable?

– If assignable, do the contain any retro changes to reimbursement?

Material Agreements with Change of Control Provisions

Internal Approvals

41


Issues Relating to Operating

Authorities

Hospital Licenses

Certificate of Need

Other Operating Authorities

42

Documents

Hospital M&A: Due Diligence Considerationsmedia.straffordpub.com/products/hospital-manda-due-diligence... · » Critically evaluate revenue cycle from time patient is admitted to