ASC Mergers and Acquisitions and a Health Care Industry/ASC Private Equity Update

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1 ASC Mergers and Acquisitions and a Health Care Industry/ASC Private Equity Update Jerry J. Sokol, Esq. Partner & Program Chair, McDermott Will & Emery LLP FEBRUARY 24, 2012

2 2 ASC Mergers & Acquisitions ASC mergers & acquisition trends ASC Transactions101 (with a twist) Transactions du jour Hospital ASC Transactions Mergers of existing ASCs (and other in-market consolidation) Mergers and acquisitions of ASC Management Companies

3 3 ASC Mergers & Acquisitions - Trends 2009 Volume decreased dramatically from 2008 Multiples decreased from 7+ to 5-6 Buyers fewer buyers, many buyers slowed down or even sat on side line, decreased development teams 2010 Volume steady increase with activity really increasing in late 2010 Multiples crept back up to 6 range Buyers increased, as those on the side line got back in the game and health systems came on strong 2011 Volume steady activity consistent with 2010 levels, with perhaps even a slight uptick Multiples multi-specialty has been ticking up-north of 6 and in the right circumstances materially so; certain single specialty multiples stayed around 6ish due to reimbursement issues Buyers Even more buyers as health systems dramatically increased interest in ASC transactions

4 4 ASC Mergers & Acquisitions 2012 (Predictions) Volume of Transactions Based on physician fear about uncertain future and impending increased capital gains tax rate, and health systems increased focus on acquisitions as part of a global consolidation strategy, volume of transactions should continue to be robust Purchase price multiples Expected to stay at current high levels

5 5 ASC Acquisitions 101 (with a twist) Purchase Price = [EBITDA (Earnings Before deducting Interest, Taxes, Depreciation, and Amortization) x purchase price multiple long term debt] x percentage acquired

6 6 ASC Acquisitions 101 (with a twist) Management Fee Management Fees are being factored into purchase price calculations Typically a percentage of revenue (4% - 7%), although trending down Historically: Purchase Price was computed applying historical EBITDA to the formula and ASC Management Company received the management fee with no impact on purchase price This effectively reduced the multiple paid, because the ASC management Company received 100% of the management fees (as opposed to only 51% of the higher EBITDA that would have resulted if there was no management fee as part of the transaction)

7 7 ASC Acquisitions 101 (with a twist) Realizing that post-closing EBITDA will be reduced by the ongoing management fee, some buyers are taking that decrease into consideration by calculating the purchase price with two components to more accurately reflect what is being acquired: (1) Equity price = [([historical EBITDA pro forma management fee] x purchase price multiple) long term debt] x percentage acquired (2) Management fee price = [management fee x management fee multiple] Management fee multiples are lower than equity multiples, but this methodology still may provide a higher purchase price because the acquirer is paying for Management fee instead of getting it for free.

8 8 ASC Acquisitions 101 (with a twist) Management Fees other issues ASC physicians are often pressing ASC companies more to justify fee Negotiation of percentage trending down Limitations: fee caps and decreasing percentages as revenue increases ASCs often ensure that ASC management company cannot charge corporate overhead to ASC

9 9 ASC Acquisitions 101 (with a twist) Percentage Acquired Percentage Acquired/Dilution Standard 51% Sometimes physicians try to push higher and ASC Companies will acquiesce in the right circumstances Sometimes will push down below 51% if consistent with ASC Management Company strategy Dilution Negotiated business term: who gets diluted and order of dilution Some management companies hold line that they won t go under 51%, so once they get there all dilution is from physicians

10 10 ASC Acquisitions 101 (with a twist) Other Key Deal Terms Control: Corporate partner typically gets it, but super majority protection, and doctors control business at the end of the day Redemption Prices: Continue to be pushed down (@ 2 Multiple) - ASC not a retirement vehicle Equity to new doctors: Requires super majority of docs Dead weight issue: Best remedy is without cause termination

11 11 Hospital ASC Transactions Drivers Reimbursement, reimbursement, reimbursement (commercial and possibly Medicare HOPD) Hospitals want to be aligned with doctors (always have) easier than physician employment strategy Doctors fear of future and getting left out, and reimbursement ASCs fear of having hospital pick-off doctors by employing them and reimbursement

12 12 Hospital ASC Transactions Most Common: Hospital ASC Joint Venture Transactions De novo-hospital only De novo-hospital/asc company Hospital/ASC company joint venture acquisition of existing ASC Hospital acquisition of existing ASC company joint venture

13 13 Hospital ASC Transactions HOPD Conversion Only if Hospital buys 100% Problem - Physician Skin in the Game Physician Employment substantial undertaking on both sides Management contract post conversion regulatory limitations on amount that can be paid to physician management company Sounds great in theory, but difficult to do and leave everyone comfortable (greed and fear are obstacles)

14 14 Mergers of Existing ASCs Two (or more) ASCs in close geographic proximity each have excess capacity. Merging the facility fee revenue of the physicians into a single facility and eliminating all of the expenses associated with operating the second facility dramatically increases the collective distributable/saleable profits and is a win for all owners increased profits per physician can be substantial Bonus is sale of empty, licensed ASC facility - value is particularly high in states with barriers to entry (e.g. CON, moratorium) With market saturation there are abundant opportunities to effect these lucrative deals, but they require heavy lifting to get the deal done; unless tied to a sale to a health system or ASC company, there is no liquidity to fund expenses Regulatory issues associated with giving equity to physicians of closed center (i.e. What are they contributing for equity other than referrals?)

15 15 In-Market Consolidation Including Health System Multiple ASCs and Health System in the same market combine to accomplish objectives of: Higher Reimbursement Consolidation for managed care contracting and other health reform driven consolidation Removing excess capacity and duplicative overhead Can be done alone or in conjunction with an ASC Management Company to provide enhanced liquidity and ASC management expertise

16 16 Mergers & Acquisition of ASC Management Companies Consolidation of the Consolidators 2011 (examples) Surgery Partners acquired NovaMed AmSurg acquired National Surgical Care USPI acquired Titan Health USPI acquired Health Mark 2012 Additional Company to Company transactions are expected to continue as there are a number of additional regional and national smaller companies that are ripe for considering exit strategies and liquidity events.

17 17 Mergers & Acquisition of ASC Management Companies Two types of buyers Strategic (another ASC Company or even a health system) Financial (private equity making a platform investment) Economies of Scale Consolidation of corporate overhead can be significant (synergies) Contracting advantages Enhanced purchasing efficiencies

18 18 Mergers & Acquisition of ASC Management Companies Complex Transactions Need Appropriate Investment Banking/ Legal Sell side diligence is key to address and mitigate any fraud or abuse, reimbursement, managed care, and licensing issues that can impede the deal. Need to understand potential discounts to EBITDA (e.g. out of network, managed care contracting risk) Strength of legal documents (may need pre-transaction clean-up to avoid closing contingency clean up, which may empower docs to squeeze you if their consent is required for essential amendments).

19 19 Steps of the process Engage investment banker IB prepares CIM as part of an auction process and perform self due diligence (e.g. third party/governmental consents required) Provide CIM to qualified potential buyers that are under CA requesting indications of interest After receipt of indications of interest (which included a purchase price range) determine which perspective buyers will remain in the process Provide qualified buyers with (i) access to the electronic data room, (ii) management presentations (if applicable) and (iii) form purchase agreement After receipt of marked-up purchase agreements with final purchase determining what party(ies) to continue with Negotiate and execute transaction documents Close/celebrate

20 20 ASC M&A Summary Continued M&A of individual ASCs Health Systems increase involvement with ASCs Transaction volume/pricing strong Mergers of existing ASCs Continued consolidation of ASC companies

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