As hospitals and providers work to keep up with an influx of COVID-19 patients, many healthcare executives are looking to the future and wondering how the pandemic will affect transactions. For organizations in the middle of a transaction, how do the effects of this crisis impact the expected future cash flows or the EBITDA multiple that is being paid—or worse, will the deal be canceled? What about future transactions that may be in the pipeline? Should organizations hit the pause button and try to better understand what future operations will look like?
Although deal volume is likely to slow down in the short term, ECG expects transactions to continue through the second and third quarters of 2020. Additionally, due to the increased uncertainty and risk in the market, the transaction sales multiples will be depressed. Parties are likely to see transaction multiples decline by up to 50% compared to the levels experienced prior to the COVID-19 outbreak. However, the more substantial reductions are expected at the higher end of the multiple range.
Recent history indicates that transactions typically continue during unstable times, though at a slower pace. Despite the uncertainty created by the financial crisis and resulting recession at the end of 2008, there were 368 healthcare service transactions in 2009, which represented a 21% decrease from 2008 and a 25% decrease from 2007.
Deal volume over the past 10 years would suggest that it is always possible to find a willing transaction partner in the market, depending on their appetite for risk.
The most recent comparable event to the current downturn is the recession in 2008. Although there are fundamental differences in market conditions from that period, it serves as our best data comparison to what the world is experiencing today. When including all healthcare technology, equipment, services, biotechnology, life sciences, facilities, supplies, distributors, and managed care transactions, but excluding hospitals, there was a large decline in median EBITDA multiples from 15.5x to 8x between the pre-recession and recession time periods, respectively, suggesting a 50% reduction in valuation due to the risk environment. The EBITDA multiples did eventually increase to near-pre-recession amounts of 15x by 2016.
The market impact on hospital transactions is less clear. A review of hospital transactions revealed that EBITDA multiples declined during the financial crisis but have also declined during other periods when there was greater financial stability. Other factors may be more closely correlated to EBITDA multiples for hospitals, including market-specific payer mix and competition.
Businesses with strong balance sheets may have an opportunity to purchase a strong asset at a discount. In particular, this is a good time to acquire physician practices and ancillary services, since EBITDA multiples could decline in the short term. Recently some private equity firms were paying 11x to 15x EBITDA for “platform” physician practices. We are unlikely to continue to see these multiples paid in the current market.
Low Volume Weakens Practices
Physician practices have minimal revenue coming in, as elective procedures are on hold and patients are delaying unnecessary care. These services are typically profitable. Continued operating deficits through the middle of 2020 are likely to drive physicians, who previously had not considered it, to seek employment at a health system in order to maintain a stable income through base salaries and guarantees.
Even Brighter Future for ASCs after COVID
Now is also the time for hospitals to consider a joint venture with an ASC. With some ASCs shutting down for the time being and pausing acquisitions, surgery center operators might be looking for a hospital partner and be willing to accept a lower price. Bear in mind that ASCs are likely to be affected only for the very short term, given recent waivers that will enable them to perform hospital functions. The waivers are likely to boost ASC volume, making them an attractive option for buyers.
Services on the Upswing
While COVID-19 has been disruptive for many parties looking to complete a transaction, it has been a boon to some parts of the healthcare industry. For example, telehealth companies are seeing an increase in their volume as regulation becomes more relaxed. Home health visits may likely increase as well for those who cannot put off medical care. Lastly, wearables and web-enabled healthcare monitoring devices are also drawing interest from health systems, as these offer another means to safely monitor patients’ care. Multiples for these types of entities might warrant a premium, but this is still a good time to purchase, as the value will likely only continue to increase.
Be Quick, but be Cautious
While today’s crisis is unprecedented in the history of our financial markets, we can glean some lessons from prior downturns in the market. It is likely that transaction multiples will decline temporarily, and cash flows will be viewed as more risky. However, transactions don’t need to stop. Rather, buyers need to proceed with caution as they incorporate the additional risk and uncertainty into their valuation analyses. Transactions will likely significantly increase after the crisis, and there may be fewer buyers at the table if you act now.