Private Healthcare Valuations: Multiples and Other Factors

Photo by N.G.

Starting Point: Apples, Oranges, and a Fresh “Pair” of Eyes

According to a 2015 KPMG report, mergers and acquisitions (M&A) are making a dramatic return to and beyond pre-recession figures.

The most active sector this year is projected to be healthcare, with 84% of surveyed respondents stating that pharmaceuticals and life sciences will lead the way.

The challenge presented to both sellers and buyers in private healthcare services is how to properly and accurately determine the value of particular entities. A seller will naturally reflect on the great efforts put in to the business in the past, and what they genuinely believe it could be worth in the future. Buyers are focused on the present, trying to determine a real-time snapshot of strategic value.

There are standard financial valuation techniques, and it is advisable for either side to ascertain the EBIT (earnings before interest and taxes) or EBITDA (and depreciation and amortization) of the company in question. Sellers and buyers could even use a costly subscription service to determine industry multiples. In fact, data driven discovery is very important, but the sole use of analytics takes out the crucial element of the keen sense of experience.

In truth, each company is different, and simply using multiples to compare them is a lot like comparing apples to oranges. What if a fresh pair of eyes with a wealth of vision was brought in to help plan an exit or entrance strategy? What if an advisor were to use both data and real-world expertise to assist in determining business value and arrive at a formal recommendation to buy or sell—and at what price?

First: A Look into the Numbers

Valuation multiples are largely set in stone and are easily located or even tabulated. In other words, there is not wide variance in the private healthcare industry in terms of multiples, as long as two companies of similar size and in the same sub-sector are compared.

For smaller companies providing similar services, generally expect the multiples to range from 5.0x to 7.0x; for mid-sized companies, the multiples grow from 7.0x to 9.0x; finally, for large companies, the multiples rise to 9.0x and beyond.  But these figures could be misleading if they are not placed in the appropriate context.

For example, a business that services facilities will generally have a much lower multiple (and maybe even three times as low) than a business that provides medical software. It is not unheard of to see 20.0x multiples for companies that provide cloud software agreements. As a trend, insurers and providers demonstrate smaller multiples than pharmaceutical companies and health information and software companies.

The financial reports are an important part of the acquisition process, but the challenge is finding a way to assess the company in question as it relates to the market as a whole. The data is a valuable starting point, and if you are able to find peer companies and determine a narrow multiple range, you are still left to determine whether to buy or sell—and at what price. In the end, the range gets all of the stakeholders on the same page before they sit down at the table. But who will you consult to look beyond the numbers and see the other determining factors?

Then: A Look beyond the Numbers

Two companies will often appear quite similar on a budget sheet, and when the numbers have all been crunched, might share the same multiple. In addition, they might share several other characteristics as well, including structure or even the number of future orders. But sometimes an expert can look at a factor that was never even noticed by a potential buyer. Dexter W. Braff uses an excellent example in an article posted on The Braff Group website.

Mr. Braff briefly describes two home care companies that share similar financial numbers. However, in one case, the company “derives its referrals from 25 different sources,” and in the other case, the company gets its referrals from a single source. Mr. Braff’s point is clear: although the data looks the same, the risk for a potential buyer is substantially greater if the intention is to purchase the single referral-sourced business. Therefore, there is more to consider in an exit or entrance strategy than the EBIT and EBITDA, and it is imperative to seek out professional advice.

An expert advisor is continually learning and reading and noticing. An expert advisor draws on experiences and applies them to the present. An expert advisor relies on data to inform decisions. An expert advisor finds a way to explain what separates one company from the next in terms of human elements. And an expert advisor is able to see and consider all of the factors when recommending a sale or purchase. Who is going to pose all of the vital questions?

Next: Other Factors That Add Meaning to the Multiples

• Government regulations. An advisor could determine how governmental policies could affect the vitality of a given company. The expansion of Medicaid under The Affordable Care Act is a ubiquitous example. What types of healthcare companies will see gains (or losses) from the legislation?

• Size. It is generally accepted that as the size of a company expands, their multiple rises as well.

• Growth rate. You could be very confident about the valuation multiple of a certain business, as you have carefully found similar companies and made accurate calculations. But what if the whole sector is growing rapidly expanding? For a software company that provides cloud subscriptions, how could Meaningful Use Requirements of electronic medical records (EMR) buoy business going forward?

• Service offerings. Two businesses might be comparable in terms of multiples, but one might have a narrow focus, whereas the other could be haphazardly expanding services and therefore slipping into mediocrity. Do you know how to evaluate a company’s product offerings to determine how they influence the overall brand as a whole?

• Brand Management. As a buyer, you might be very impressed with the potential you see in a certain product, and have the conviction to put your faith and money behind it. Do you know how to put a price on the “risk of the unknown” in terms of public brand acceptance? In other words, how do you figure out if the purchasing public will embrace a product?

• Leadership. It is important to understand how the business is structured and how it functions. By conducting one-on-ones with managers, an advisor can determine the sources of the vision and the strength of the business? Based on decades of expertise, what if the outside advisor determines that a certain company will deteriorate after the owner (and chief leadership voice) vacates the top post?

• Start-ups and Lack of Information. An experienced advisor can determine how close a business is to bringing a desirable product or service to market. With little financials upon which to rely, it might be futile to attempt to seek out a true peer company. But what if it was determined—based on a complete investigation of the inner workings of the company—that a certain multiple is a starting point, and as the likelihood of viability increases, so will the multiple?

• Future Inventory. It is important to test the stability of a company in terms of relationships and future orders. What if a certain business has a backlog of orders that ensure its revenue stream for months or even years to come? Who is going to assess customer satisfaction to predict whether or not the client base is unhappy and a mass exodus is about to occur?

 Finally: It Is All About People

Maybe the most important piece of information is also the most elusive: what is the motive behind the sale or purchase? The answer is found by an expert with years of experience who enters from the periphery by examining subjective human factors. The bottom line is that business is “all about people” and not simply data, and bringing in the right person will be a small price to pay. The costs associated with hiring an advisor are a short term investment that may be returned five times over by the time a sale is completed. Who do you have in mind?