BDO PE Activity in Healthcare Report: How Bundled Payments Will Impact Healthcare Investment

May 2016


Download PDF Version
With the healthcare market’s shift to value-based reimbursements underway, the Centers for Medicare and Medicaid Services (CMS) has been aggressively rolling out initiatives to support its goal of tying 90 percent of traditional Medicare payments to quality or value by 2018. Investors who wish to succeed in healthcare, particularly in the post-acute provider space, will need to understand the broader financial impact of these alternative payment methods, which stand to significantly alter business models and the competitive landscape.

The BDO PE Deal Activity in Healthcare report, powered by PitchBook, compiles data from the PitchBook Private Equity Database and insights from The BDO Center for Healthcare Excellence & Innovation to evaluate the latest trends and opportunities for private equity investments in the healthcare industry.
One game-changing alternative payment model, CMS’ first mandatory bundled payment program, was rolled out in April 2016. The program holds hospitals responsible for all costs, processes and outcomes for Medicare-covered hip and knee replacements from surgery through 90 days after the initial hospitalization—and it caps the price Medicare will pay for the sum total of that care, from hospital to post-acute facility to home. This “bundled payments” approach is a major shift in how care is managed and reimbursed, impacting, most significantly, decisions about where and when patient care is delivered. Hospitals, for the first time, are being incentivized to cull their lists of preferred post-acute care providers to those that offer the best outcomes and most cost‑effective care, and that have higher ratings on the CMS five‑star system: In 2017, facilities with three or more stars will qualify for a cost-saving Medicare hospital length-of-stay waiver.

While the first CMS-mandated bundled payment program is fairly narrow, affecting hip and knee surgery patients at nearly 800 hospitals in 67 metropolitan statistical areas (MSAs), additional mandatory programs are expected to follow. Since commercial payors have been known to follow CMS’ lead on successful new payment methods, the ripple effect of mandatory bundled payments is expected to be great, and operators and investors in the post-acute care space would be wise to assess their portfolios and prepare for the program’s impact.

Post-Acute Care: A Changing Investment Landscape

As these and other regulatory changes continue to influence the business of healthcare, investor interest in long-term care facilities, rehabilitation facilities and home health agencies has been growing, with 79 deals reported in 2015, up slightly from 71 deals in 2014. The value of the deals climbed significantly year over year from $1.67 billion to $5.92 billion. As new requirements, including mandatory bundled payments and other value-based payment models emerge, BDO anticipates investor interest in this area to continue to increase.

Capital Invested and Deal Count for All M&A Types

While overall interest has remained fairly consistent, PE deals in the sector have been more sporadic. There were fewer deals in 2015—only 19 compared with 29 the year prior. However, average deal size was up dramatically, totaling $2.37 billion in 2015, compared with $208.4 million in 2014.

Capital Invested and Deal Count for PE Deals

Trend Analysis: A Q&A with BDO’s Patrick Pilch

To discuss the trends behind this data, PitchBook spoke with Patrick Pilch, managing director and Healthcare Advisory practice leader with The BDO Center for Healthcare Excellence & Innovation, to learn what investors need to know during this time of changing reimbursements and shifting network alliances.

PitchBook: Given the increased dollars moving into the post-acute care space, are you seeing increased investor interest in these companies and in regulatory changes like bundled payments?

Patrick Pilch: Definitely—as recently as December, we had spoken with a manager of a large hedge fund who was interested in skilled nursing facilities. At the time, he asked us, “Why would I care about bundles and star ratings?”

Now that the first mandate is upon us, operators and investors are beginning to ask how they can better understand CMS’ Comprehensive Care Joint Replacement Model (CJR) and its follow-on impact, including the implications star ratings will have on referrals and revenue. We predict interest in bundles will continue to grow well into 2017, as we expect more mandatory programs to surface.

PB: If it’s a growing concern, what actions are investors taking to re‑evaluate their portfolio companies and protect their assets?

PP: Investors are researching to get a better understanding of the drivers that will make them successful under bundled payments, especially concerning their long-term care assets. Private equity firms not only realize the importance of star ratings; they are also getting savvier about how they respond to those ratings.

As reimbursements shift to measurement based from activity, hospitals will cut poor-performing facilities out of the supply chain. Investors know this, and, one by one, they are getting proactive. Some lenders with very large portfolios are asking us to help them look closely at their portfolios and their local markets—which diagnoses hospitals most commonly discharge to post-acute care, how much post-acute care facilities are paid for those referral patients and their competition in the space—to find where there are weak links so that they can shut off the pipe in those locations. This chopping-block strategy doesn’t only apply to investors: One operator with more than 100 facilities asked us to help him sort the wheat from the chaff so that he could close facilities that were likely to become unprofitable.

That’s not to say that a one- or two-star facility can’t be saved. Investors are also beginning to realize it’s not just about flipping an entire organization from a one-star performer to an all-around, five-star, great-at-everything performer. Instead, they may buy a two-star facility that’s good at one thing and focus on that, putting only the dead-weight service offerings on the chopping block. Perhaps a facility is terrible at total joint replacement rehab, but it could optimize its already-great rehabilitation efforts for other diagnoses. Rather than attempting to raise the bar universally across all services, they are cutting out offerings that are holding down performance and honing what they do best. Facilities that can successfully do that will be able to stay in their local market’s network and become well known (and get paid) for their niche service. In this environment, even five-star facilities need to find their strongest area of focus. The lesson: Do what you do well; don’t dabble.

PB: The 2015 data shows a slight dip in the number of deals, but the amount of capital invested rose. How do you explain the increased dollars invested in the post-acute care space?

PP: In 2013 and 2014, we were seeing a rising number of deals, but values were low. That was a time of rolling up and selling off smaller organizations. To succeed, the facilities had to have the electronic nursing records and other technology needed to get useful data—and of course, they needed the resources to get that equipment. For one- and two-facility operators, it was too expensive to invest and more appropriate to roll up.

This is a time for scaling up. Larger organizations have the ability to grow in this changing environment; they have the resources to evolve and to take part in these higher-value deals. The ability to improve clinical care and outcomes will result in better valuations and financial results, which we have experienced with our clients.

Smaller operators, as they had before, aren’t able to keep pace with the changes. Some smaller operators have been in business a long time and are perhaps run by a family member who no longer even wants to keep the family business; for that type of entity, the changes in the industry and the increased administrative and transformative obligations to stay in business are too burdensome.

Deals are also getting bigger because strategic investors and private equity are coming together. We believe 2016 will mark a combination of private equity, LBO, MBO and strategics. And bundled payments are likely to be a major driver of deals in 2016. TeamHealth, for example, is currently known well in urgent care but is buying national hospitalist and post-acute provider IPC Healthcare to become known in post-acute care and gain exposure to the bundling program.

Overall, we expect 2016 to be a time of rising valuations for those that can prove they’re performing at high levels—and a falling knife for others.

PB: What other kinds of post-acute investment opportunities still exist for PE firms?

PP: There are still prospects in certain markets for rollup strategies. If 30 percent of skilled nursing facilities in a large MSA are three-star facilities or above, that means that 70 percent of facilities are low performers, and investors may have the chance to buy low and sell high if they understand the market nuances. In a market where hip and knee replacements are prevalent, there may not currently be enough three-star or better facilities to serve capacity. If that’s the case, investors may have a great turnaround opportunity.

Though it’s still likely that up to 20 percent of long-term care facilities may close their doors because of the recent and upcoming changes, players in the post-acute care space have more than just a sink-or-swim decision. There is an opportunity for operators to shine, if they can figure out what they’re good at, hone it and don’t let hospitals in the network spread their referrals around.

And of course, joint replacement surgeries are just the first foray into these mandated bundles. As we see bundles extend into other areas, investors could see new opportunities, too. The key, in any case, is the development of the network—that the hospital, ambulatory care and post-acute care providers are all aligned. Like the facilities that are honing their skills, investors cannot dabble. They have to know where they are in the food chain at all times, and they have no choice but to dig into all of these clinical, regulatory and market issues if they hope to succeed.

For more information on BDO USA's service offerings to this industry, please contact one of the regional service leaders below: