The hospice mergers and acquisitions market has been exploding in recent years, continuing to gain momentum despite pandemic-related pitfalls. Still, hospices need to tread lightly and keep a close watch on where they measure up in the highly competitive market, with quality and compliance posing the greatest risks to their value propositions, according to M&A experts.

The three biggest risks for hospice providers during transactions lie in the details of their clinical compliance, quality of earnings and business model, according to David Berman, managing principal of health care mergers and acquisitions for SimiTree Healthcare Consulting.

“Those are the three main areas we look at, because all of these equal diligence for investors, and this is done for one reason or another in identifying potential risk. The higher that risk evaluation — especially on the compliance side — then that diligence intensifies, and a strategic buyer is going to look at that risk differently than other types of information,” Berman told Hospice News during the recent National Association for Home Care & Hospice (NAHC) Financial Management Conference. “Ultimately, we’re trying to get to what is essentially a clawback and environment of at-risk volume provided on each side of that transaction.”

The hospice M&A market has been riding high thus far in 2021, leading the charge compared to other health care sectors in terms of investor interest and valuations. A little more than 1,300 transactions occurred in the health care sector during the 12-month period ending May 15, 2021, according to a report from PricewaterhouseCoopers (PwC). Hospice or home health assets accounted for 95 of these deals, up 16% from last year, according to the report. All told, the collective price tag on these transactions was in excess of $11.8 billion, reflecting record-high enterprise hospice and home health multiples of 26.2x compared to 16.1x for the overall health care sector.

Despite soaring valuations, hospice providers will have to tread lightly as they enter deals, particularly when it comes to regulatory issues and compliance, and as value-based care makes its way into hospice this year. Evolving payment models have posed challenges for hospices in a crowded market, according to Kris Novak, vice president of mergers and acquisitions for Amedisys, Inc. (NASDAQ: AMED).

“There’s a lot of competing priorities around what hospices are trying to accomplish in a transaction,”With all the regulatory changes and developments such as the [Patient-Driven Groupings Model (PDGM)] and value-based purchasing, said Novak. “And with a large population shifting into managed care, all these models can give the ability to continue to operate and have a competitive advantage over others.”

The U.S. Centers for Medicare & Medicaid Services (CMS) implemented the PDGM home health payment model in 2020, with waves reverberating into hospice as providers gained a stronger foothold into the personal care business. The model classifies patients into payment categories based on clinical characteristics and other information.

PDGM and population demographics were tailwinds for Amedisys’ recent acquisition of Contessa Health, Amedisys CEO Paul Kusserow said last quarter during the company’s Q1 earnings call. The deal’s total consideration amounted to $250 million for the Tennessee-based provider of hospital-at-home and skilled nursing-at-home services.

Value-based models have been a primary driver of value for the hospice segment, pushing forward deals such as the acquisition of Kindred at Home by Humana Inc. (NYSE: HUM) last month. In collaboration with private equity firms Welsh, Carson, Anderson & Stowe and TPG Capital, Humana recently acquired the remaining 60% ownership of the business to the tune of $8.1 billion, building upon its existing 40% equity value for $2.4 billion in 2018. The insurance giant said the transaction would bolster its financial outlook for 2021 and 2022, attributing leverage in value-based arrangements gained by the acquisition of 100% interest in Kindred at Home.

Outside of regulatory compliance in evolving payment models, a hospice’s future cash flows and existing revenue can be minefields during transactions, with transparency key to avoiding explosions, according to Berman.

“The biggest risk buyers see is when receivables are not collectable,” said Berman. “Revenue is one thing, but they also care about cash flows. If they can’t collect on their receivables, then that buyer can get rid of that deal. A hospice’s own capitation is its high-risk area.”

Additionally, risks can exist unbeknownst to hospices. As such, having an objective third-party financial expert dig deeper into a provider’s bottom line is key to avoiding misrepresentation, according to Michael Prost, partner at Wipfli LLP.

“The important thing that I want to impress upon is don’t assume anything. Your valuations and calculations, people look into those and assess the risk factors,” said Prost. “That’s how we build our value as we build up risk. Value fluxes as risk goes up or down. Hospices need to identify those risks in advance, and it can be very hard for anyone to locate that within yourself and identify those factors.”