Upload
others
View
1
Download
0
Embed Size (px)
Citation preview
Issues Raised by the Purchase of a
Physician Practice
First Illinois HFMA Accounting and Reimbursement Program
October 20, 2011
Overview As hospitals continue to acquire physician practices,
an understanding of valuation and relevant compliance considerations is critical for management.
This presentation will provide an overview of these concepts and help management be aware of valuation pitfalls that could result in compliance risks.
Presentation Summary
Objectives Articulate the differences between alternative standards of
value including investment value, fair market value and fair value
Gain a general understanding of the key value drivers to consider when evaluating a purchase or sale of a healthcare entity including: The relationship between future compensation and
practice value. The factors that support a payment for an intangible
asset. Understand the impact of new purchase accounting
standards to a hospital’s financial statements following an acquisition
Presentation Summary
Standards of Value Fair Market Value Investment Value Fair Value
Appropriate standard is driven by purpose of engagement
Standards of Value
Fair Market Value “The price at which property would change hands
between a hypothetical willing buyer and a hypothetical willing seller, both being adequately informed of the relevant facts and neither being under any compulsion to buy or sell” – IRS Revenue Ruling 59-60
Required standard of value stipulated by IRS and OIG
Further clarifications under Stark Law and the Anti-Kickback Statute
Standards of Value
Fair Market Value (continued) “Commercially Reasonable” concept for transactions
involving physicians An arrangement will be considered commercially
reasonable in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice) of similar scope and specialty, even if there were no potential DHS referrals
Hospitals cannot pay physicians for referrals –outpatient, inpatient or ancillary services
Standards of Value
Fair Value Required standard of value for accounting matters “The price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market participants at the measurement date” – Accounting Standards Codification (“ASC”) Topic 820 (formerly SFAS 157)
“Exit Price” Concept Typically, fair value is assumed to be equal to fair
market value although the values could be different
Standards of Value
Investment Value Considers the attributes of a
specific buyer or situation Can be significantly higher than
fair market value Often seen in mergers and
acquisitions involving strategic buyers – may include synergies
Hospital management may be interested in calculating investment value for internal planning purposes
Standards of Value
Value Differences Each standard can result in a different value for the
same asset/interest Fair market value versus investment value in an
acquisition of a physician practice Due to Stark Law and the Anti-Kickback
Statute, the value cannot be tied to the value or volume of future referrals
Value associated with referrals can be significant for many specialties
Standards of Value
Publicly-Traded Stock
Levels of Value
Non-Marketable Minority Value
Marketable Minority Value
Financial Control Value
Strategic Control ValueStrategic Control
Premium
Marketability Discount
Financial Control Premium
Minority InterestDiscount
Fair Market Valueof 100% Interest
Investment Valueof 100% Interest
Primary Valuation Approaches Asset Approach Income Approach Market Approach
Nature of asset or interest will influence selection of approaches
Income and/or asset approaches typically used in healthcare valuations
Valuation Approaches
Asset Approach Net Asset Value method Asset context Cost to create exact or similar asset
Business context Value of equity = value of assets – value
of liabilities (both at fair market value) May require appraisal of equipment and real
property Establishes minimum value for asset or
business Orderly liquidation vs. value in use
Valuation Approaches
Income Approach Value determined based on present value of future
economic benefits of ownership Considers market rates of return for similar investments Methods: Discounted Cash Flow Multi-year projection discounted to present value
Capitalization of Cash Flow Multiple (or capitalization rate) applied to
representative cash flow
Valuation Approaches
Market Approach Identify exchanges of similar
assets/interests in the marketplace Draw inferences for use in deriving
estimate of value of subject asset/interest Methods: Guideline (Public) Company Merger & Acquisition Transactions of public and private
entities Transactions in company stock / bona
fide offers for purchase
Valuation Approaches
Considerations Asset Approach Only quantifies the value of tangible assets unless
other approaches are utilized for intangible assets Income Approach Adjustments to operating expenses – physician
compensation, rent, etc. Medical Group Management Association
(“MGMA”) data Predictability of future operating results Determination of an appropriate discount rate
Valuation Approaches
Considerations (continued) Market Approach Availability of relevant financial detail needed for
analysis Changes since transactions occurred Comparability to company being valued Payer mix Size / geographic location Service diversification / specialties
Valuation Approaches
Physician Integration – Practice Acquisitions
Physician integration trend is fueling physician practice acquisitions
Each practice has unique attributes Must evaluate recent trends in
performance: Payer mix Volumes and procedure mix Physician compensation Staff turnover
Physician Integration – Practice Acquisitions
How motivated are the physicians? Fear factor - future
reimbursement Value expectations
Are all physicians on board with selling?
Are you interested in employing all physicians following the acquisition?
Physician Integration – Practice Acquisitions
Key questions for management: Is payment for an intangible asset
supportable? The answer depends on whether or not a
premium price over tangible asset value can be supported under the fair market value standard of value
The following examples will help demonstrate when a premium over tangible asset value may be supportable
What level of compensation should be paid to the physicians? How should the compensation arrangement be structured?
Practice Acquisition Examples
Practice Example #1 Cardiology Practice High physician turnover Physician compensation below levels supported
by MGMA data High operating expenses and history of operating
losses No significant change in operating performance
was expected
Practice Example #1 (continued)
Practice Acquisition Examples
2008 2009 2010Revenue 3,482,487 3,578,226 4,028,932
Operating Expenses(1) Physician Compensation 1,315,000 1,116,154 1,330,481
Other Operating Expenses 2,211,871 2,453,018 2,742,427 Total Operating Expenses 3,526,871 3,569,172 4,072,908
Operating Income (Loss) (44,384)$ 9,054$ (43,976)$
(1) Actual physician compensation was below levels expected to be paid by the prospective hospital acquirer andlower than levels supported by the MGMA data.
For the Year Ending December 31,
Practice Example #1 – (continued) The level of physician compensation that the
practice’s operations could sustain were below levels supported by MGMA data
The standard compensation package to be offered by the prospective hospital acquirer was expected to result in compensation in excess of the levels historically paid at the cardiology practice
Since the cardiology practice was not expected to generate positive cash flows under the hospital’s compensation structure, no intangible value was indicated
Practice Acquisition Examples
Practice Acquisition Examples
Practice Example #2 Surgery Practice
Generates revenue from surgical procedures and ancillary services
Physician compensation at high end of range indicated by MGMA data
Positive cash flow No significant change in operating performance
was expected
Practice Acquisition Examples
Practice Example #2 – (continued)
2008 2009 2010Revenue 4,259,317 4,060,522 4,341,484
Operating Expenses(1) Physician Compensation 2,131,174 1,881,589 2,010,541
Other Operating Expenses 1,967,383 2,105,245 2,180,039 Total Operating Expenses 4,098,557 3,986,834 4,190,580
Operating Income (Loss) 160,760$ 73,688$ 150,904$
(1) Actual physician compensation was above levels expected to be paid by the prospective hospital acquirer andat the high end of the range indicated by the MGMA data.
Historical Operating Results
For the Year Ending December 31,
Practice Acquisition Examples
Practice Example #2 (continued) The surgery practice generated positive cash flow
while paying its physicians compensation near the upper end of the range included in the MGMA data
The anticipated compensation package to be offered by the prospective hospital acquirer was expected to result in physician compensation below the levels historically paid at the surgery practice
Since the surgery practice was expected to generate positive cash flows under the hospital’s compensation structure, intangible value was indicated
Practice Acquisition Examples
Practice Example #3 - Neurosurgical Practice ABC Hospital was considering an
acquisition of a neurosurgery practice ABC Hospital anticipated an increase in
admissions from new referrals generated from the neurosurgery practice
The fair market value of the practice was determined without regard to the incremental contribution margin the new referrals were expected to generate at ABC Hospital
The investment value to ABC Hospital was in excess of the fair market value of the practice – ABC Hospital could have supported a purchase price in excess of fair market value
Practice Acquisition Examples
Practice Example #4 – In-Vitro Fertilization Practice XYZ Hospital acquired an in-vitro fertilization
practice XYZ Hospital engaged a valuation firm to
determine the fair market value of the practice The fair market value analysis reflected a
“market” level of compensation for the primary physician of $400,000 per annum
Following the transaction, XYZ Hospital paid the primary physician $800,000 per year
XYZ Hospital could be at risk if the transaction is investigated by IRS or OIG
Valuation analysis should reflect compensation that is expected to be paid by acquiring hospital
Practice Acquisition Considerations
Professional vs. Technical Component Revenue Is revenue sustainable?
Who is a potential buyer in the marketplace? Hospitals / Practices / Other
Does the analysis reflect assumptions that only one potential buyer could achieve or only the current owner could maintain?
If yes, the value may not be consistent with Fair Market Value
The target entity must be expected to provide a reasonable return on investment for the “hypothetical” acquirer Cash flows (without regard to referrals) must support any premium
paid over the value of tangible assets If cash flows do not support a premium, the net asset value of
tangible assets should be the basis for the purchase price
Practice Acquisition Considerations
Level and Structure of Compensation Arrangement If a payment for an intangible is not supportable, many hospitals
are choosing to offer generous compensation arrangements to physicians The following charts compare median compensation for
hospital employed and private practice physicians for selected specialties. Data was compiled from MGMA physician production and compensation surveys.
Many arrangements are tied to production (work RVUs or collections)
It is important to understand the likely increase in compensation to the physicians that will result from the contemplated arrangement An attractive compensation arrangement may motivate
physicians to finalize a transaction even if the purchase price excludes a payment for an intangible asset
Hospital vs. Private Practice Compensation
$351,960
$367,500
$414,223
$439,967
$468,970
$459,168
$376,663
$367,704
$409,204
$424,458
$396,738
$369,156
$300,000
$320,000
$340,000
$360,000
$380,000
$400,000
$420,000
$440,000
$460,000
$480,000
2005 2006 2007 2008 2009 2010
Med
ian
Com
pens
atio
nCardiology: Noninvasive
Hospital Owned Non-Hospital Owned
Hospital vs. Private Practice Compensation
$49.93
$53.11
$54.50
$55.82
$55.35
$59.14
$52.98
$52.30
$49.34
$53.46
$51.28
$55.33
$44.00
$46.00
$48.00
$50.00
$52.00
$54.00
$56.00
$58.00
$60.00
2005 2006 2007 2008 2009 2010
Med
ian
Com
pens
atio
n pe
r W
ork
RVU
Cardiology: NoninvasiveHospital Owned Non-Hospital Owned
Hospital vs. Private Practice Compensation
$404,987 $404,612 $398,905
$469,989
$516,413 $526,398
$417,352
$429,540
$455,619
$450,086 $452,128
$482,928
$350,000
$370,000
$390,000
$410,000
$430,000
$450,000
$470,000
$490,000
$510,000
$530,000
$550,000
2005 2006 2007 2008 2009 2010
Med
ian
Com
pens
atio
nOrthopedic Surgery
Hospital Owned Non-Hospital Owned
Hospital vs. Private Practice Compensation
$55.08
$56.60 $56.36
$60.91
$61.71
$62.96
$53.73
$57.95
$55.21
$58.36 $58.02
$57.56
$48.00
$50.00
$52.00
$54.00
$56.00
$58.00
$60.00
$62.00
$64.00
2005 2006 2007 2008 2009 2010
Med
ian
Com
pens
atio
n pe
r W
ork
RVU
Orthopedic SurgeryHospital Owned Non-Hospital Owned
Hospital vs. Private Practice Compensation
$155,932
$160,332
$167,231
$177,311
$183,152
$186,048
$169,566
$168,877
$185,273
$183,084
$185,234
$195,027
$150,000
$155,000
$160,000
$165,000
$170,000
$175,000
$180,000
$185,000
$190,000
$195,000
$200,000
2005 2006 2007 2008 2009 2010
Med
ian
Com
pens
atio
nFamily Practice without OB
Hospital Owned Non-Hospital Owned
Hospital vs. Private Practice Compensation
$38.78
$40.83
$38.60 $38.80
$39.04
$39.73 $39.03
$41.80
$39.40
$39.84 $39.52
$42.79
$36.00
$37.00
$38.00
$39.00
$40.00
$41.00
$42.00
$43.00
$44.00
2005 2006 2007 2008 2009 2010
Med
ian
Com
pens
atio
n pe
r W
ork
RVU
Family Practice without OBHospital Owned Non-Hospital Owned
New Purchase Accounting Guidelines As of December 15, 2009, all acquisitions
completed by not-for-profit entities are subject to the purchase accounting guidelines outlined in ASC Topics 350, 360, 805, 954 and 958 Prior guidelines included SFAS Nos.
141R, 142, 144, and 164 The standard of value to be used for
financial reporting is fair value, which is governed by ASC Topic 820
For-profit entities have been subject to these guidelines since 2002
Purchase Accounting
Requirements A purchase price allocation must be performed after the
transaction closes pursuant to ASC Topics 805, 954 and 958 The fair value of all tangible and intangible assets need to be
determined Potential intangible assets include:
Assembled workforce Trademarks Certificates of need Non-compete agreements Physician guarantees Goodwill
Lives will need to be assigned to each intangible asset
Purchase Accounting
Long-Lived Assets Tangible assets are subject to the
purchase accounting guidelines presented in ASC Topic 360 Real estate Equipment
Intangible assets are subject to the purchase accounting guidelines presented in ASC Topic 350 Non-compete agreements Patents Favorable leases
Purchase Accounting
Long-Lived Assets (continued) Impairment testing is only required if a
triggering event has occurred Triggering events include:
Decrease in market price Adverse change in extent or manner of
use Adverse change in legal factors or
business climate Accumulation of costs in excess of
amount originally expected Current operating cash flow loss
combined with history of operating cash flow losses or a projection of continued losses
Sale or disposal well before useful life ends
Purchase Accounting
Long-Lived Assets (continued) If a triggering event takes place, impairment testing is a two-step
process Step 1 – Recoverability test
Develop cash flow projections for asset (or asset group) Projections should only include cash flows that could
be generated from existing asset base If the sum of UNDISCOUNTED cash flows exceed the
carrying value of the asset (or asset group), the asset is considered “recoverable” and no impairment is recorded
If the sum of UNDISCOUNTED cash flows are less than the carrying value of the asset (or asset group), proceed to step 2
Step 2 – Determine the fair value of the asset and record impairment (if any exists)
Purchase Accounting
Indefinite Lived Assets Intangible assets are subject to the
purchase accounting guidelines presented in ASC Topic 350 Trademark / trade name Certificate of need
At a minimum, testing for impairment must be completed annually
Determine the fair value of the asset and compare it to the carrying value If the fair value of the asset exceeds the
carrying value, no impairment exists If the fair value of the asset is less than
the carrying value, impairment is recorded
Purchase Accounting
Goodwill Goodwill is subject to the purchase accounting guidelines
presented in ASC Topic 350 At a minimum, testing for impairment must be completed
annually Goodwill impairment testing is now a qualitative and quantitative
process New standard issued in September 2011 allows an entity to
first assess qualitative factors to determine necessity of prior two step quantitative impairment test. Effective for fiscal years beginning after December 15, 2011
If after considering all relevant events and circumstances, it is “not more likely than not” (meaning a likelihood more than 50 percent) the fair value is less than carrying value, then two step process is not necessary
Purchase Accounting
Goodwill (continued) Step 1
Determine the fair value of the entity and compare it to the carrying value If the fair value of the entity exceeds the carrying
value, no impairment exists If the fair value of the entity is less than the carrying
value, proceed to step 2 Step 2
Prepare a “hypothetical” purchase price allocation based on the fair value of the entity calculated in Step 1
The goodwill value resulting from the hypothetical purchase price allocation is then compared with the carrying value of goodwill to determine the amount of impairment (if any exists)
Purchase Accounting
Fair market value is the relevant standard of value – investment value to a hospital may not be equal to fair market value
Expected cash flows are key to supporting a premium over the value of tangible assets and must reflect the physician compensation arrangement that is expected to be paid following the acquisition
Be cautious about compensation arrangements that are expected to result in physician compensation well in excess of the level that the physicians historically earned (for the same level of production)
Be mindful of the financial reporting guidelines that require fair value analysis for acquisitions at the date of purchase and impairment testing in subsequent reporting periods
Final Thoughts
Questions?
Contact Information
Matthew J. Wescott, ASA1111 Michigan Ave., Suite 100 East Lansing, MI 48823Phone: 517-336-7525Email: [email protected]
Ed Slack, CPA2155 Point Boulevard, Suite 200 Elgin, IL 60123Phone: 847-628-8796Email: [email protected]