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Two factors are having a substantial impact on home health care M&A right now — one affecting the seller and one affecting the buyer.
Each is largely out of home health providers’ hands. The first is interest rates and general market conditions, and the other is the U.S. Centers for Medicare & Medicaid Services’ (CMS) ongoing efforts to cut reimbursement rates.
While the amount of total deals is unlikely to plummet in 2023, market conditions are making the pre-sale process much harder.
Home Health Care News wrote in November about the “valuation gap” between buyers and sellers that had begun to hinder deal talks after last year’s proposed payment rule for home health care.
While sellers are pointing to past margins, buyers are more concerned about future margins, the latter of which may not be as fruitful. Meanwhile, buyers have less ammo to complete purchases with debt, as that is costing more during this inflationary time period.
Those two realities will have an effect on M&A in the year ahead. How much, and in what ways, is the topic of this week’s exclusive, members-only HHCN+ Update.
The valuation gap
Enhabit Inc. (NYSE: EHAB) spent its first six months on the public market finding its footing. Now, however, the company is working on accelerating growth.
The vast majority of the company’s business is home health care, with hospice accounting for a much smaller piece of the pie. Still, the current market conditions have the company focused on hospice growth and less so home health expansion in the year ahead.
“I think it’s fair to say that our pipeline is full and that the current pipeline is skewed a little bit more towards hospice,” Enhabit CFO Crissy Carlisle said last week. “The reimbursement uncertainty in home health is putting some pressure on that.”
Instead, when it comes to home health care, Enhabit is focused on de novo locations, as well as improving its Medicare Advantage (MA) business.
Enhabit is likely just one of the many companies that have adjusted their growth and M&A plans recently due to external – and internal – market forces.
“Buyers are looking at things and saying, ‘I’m going to have several more months, or a year, of a challenging business environment. I can’t afford to pay as much,” Mark Kulik, senior managing director of The Braff Group, told me. “Buyers typically look forward and project, sellers look backwards. That’s where the gap comes in. Because the buyer is saying, ‘I can’t pay more, I’m going to have a tougher time running the business going forward. The sellers are saying, ‘I don’t care what you’re looking at. I’m looking backwards, and I’m hearing about people that got this price or that price, and my company is great.’ That’s where the chasm comes in.”
Even though companies like Enhabit are acknowledging some of the difficulties attached to home health M&A right now, strategic buyers are less likely to be affected.
The difficulties will be especially pronounced for private equity players, which often rely on debt to complete large transactions.
“That higher interest rate puts downward pressure on the ability to offer a superlative price for a company,” Kulik said. “And that’s the private equity formula.”
The inflation rate currently sits at 6.45%, lower than previous months, but still extremely high.
If the interest rate is higher for debt-backed purchases, buyers cannot make the same type of offers to sellers, as it will cost them more over time to pay back that debt.
This is already playing out, as 2022 was the first year in nearly a decade that the amount of PE deals fell in health care services, Kulik added.
Margin compression
Unlike other industries, home health buyers can’t pass down inflationary costs to the consumer after a transaction because of government-set rates.
For all intents and purposes, home health providers are already experiencing rates cut this year. Though an inflation-adjusted “bump” technically got the CY 2023 rate to 0.7% above the 2022 rates, providers aren’t excited about it.
“It’s important to understand some of the politics of what happened in this final rule,” National Association for Home Care & Hospice President William A. Dombi said in November. “CMS went with a headline saying they were cutting over $800 million — in one year alone — from home health care spending to a headline that now says they’re increasing spending by $125 billion. That was a strategic, tactical move by CMS to put out a positive headline.”
So while inflation and interest rates remain high, margin pressures are coming down on home health businesses from CMS.
“Once you have a reduction or shrinking of your margins, that falls down to your EBITDA, and EBITDA is what is used in our business to determine the valuation of a company,” Kulik said. “The [more] you have inflation expenses, the higher your operating expenses go up, the more your margins shrink, the more your EBITDA shrinks, and that puts pressure downward pressure on the valuation for a company.”
That could also mean that – even if there are willing buyers – fewer owners may want to sell their companies at a time when buyers are not as interested in past performance and have less money to dish out.
The chances of M&A decreasing
Despite all the aforementioned challenges, a significant drop in the total number of deals in home health care in 2023 is unlikely.
Buyers – whether they are PE firms, hospital systems, managed care organizations or home health agencies themselves – still generally believe the tailwinds outweigh the headwinds.
“I do think deal activity [will still be strong],” Kulik said. “I think that 2023 will probably be equal to 2022 in terms of activity, despite these environmental, economic issues, which I think are temporary. There’s the bigger picture, the megatrends. Boomers are getting older and are going to want to have access to care in the home. It’s still the least expensive venue to provide health care.”
Even in a quieter 2022 compared to 2021, home health and hospice remained one of the most active sectors in health care, according to PwC’s Health Research Institute.
Specifically, 114 home health and hospice deals took place in the 12 months that PwC examined, which ended on Nov. 15 of 2022.
But even if 2023 sees a similar number of deals, they may look different than they did in past years.
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