This article is sponsored by The Braff Group. In this Voices article, Hospice News sits down with Mark Kulik, Senior Managing Director, The Braff Group, to talk about how the M&A landscape panned out in 2022 compared to prior years. He explains how the M&A strategies of larger hospice players evolved as of late, and he discusses some of the major macroeconomic forces affecting hospice M&A over the next 12-24 months. He also explains how owners can best prepare to sell in today’s hospice landscape, whether they are ready or not. (This interview took place prior to the recent bank crisis omitting any comments thereof.)
Hospice News: How did the M&A landscape pan out in 2022 compared to prior years?
Mark Kulik: After two back-to-back record years in ’20 and ’21, there was a noticeable fall-off in 2022. Overall, if you look at the bigger picture of home health, hospice and home care, we went from a record level of 221 transactions to 144 transactions going from ’21 to ’22. That was about a 34% fall-off and approximately 77 fewer transactions.
It has been a very noticeable change. If you dig deeper into the hospice sector alone, a similar pattern occurs. We had record years in ’20 and ’21, and if you compare ’21 to ’22, there were 67 versus 39 deals respectively. That was about a 42% drop off. Hospice mirrored the bigger picture, and it definitely fell off.
How have the M&A strategies of larger hospice players evolved as of late?
For the most part, larger hospices have done many smaller deals. Our best information indicates that Agape Hospice Care did four, and St. Croix Group did three. Then after that, there were activities spread across a dozen or so of the major hospice providers. Last year, I would characterize the larger players as using a rifle versus a shotgun for their M&A strategy. They were much more selective and purposeful in their approach to acquiring hospice agencies.
Talk about some of the major macroeconomic forces that will affect hospice M&A over the next 12 to 24 months.
The tailwind conditions that existed in ’19, ’20 and ’21 became headwinds in ’22. At the top of the list, of course, was increasing interest rates. That has been the most profound and impactful change to the M&A business for hospice. In March of last year, the fed rate was 0.25%. Today it’s approximately 4.75%, so there was a dramatic increase in 12 months.
As per Powell’s testimony, the market’s now expecting another increase — probably half of a point. More importantly, he’s signaling continued increases, which the marketplace previously assumed would be leveling off around now. We’re faced with indications that he’s going to continue to raise interest rates until he sees inflation come down — a major change from ’22 to ‘23. Secondly, that interest rate, of course, indirectly increases the borrowing cost or the cost of capital for buyers. It’s now much more expensive for them to buy an agency because of higher interest rates.
The double whammy is that it also limits buyers’ leverage because they’ve got to spend more on servicing interest payments to the lender. That downward pressure on leverage also exerts downward pressure on valuation with the greatest amount being felt at the top end of the market where the premiums were the highest.
Lenders have also become a bit more conservative in their assessment of risk. Naturally, if market conditions are such that there’s a higher risk for default, lenders will tighten their criteria and become more conservative and risk-averse.
Another macroeconomic effect is increasing inflation rates; labor rates have soared across the board. Agencies are now dealing with a very fluid labor pool, competing with other types of providers like hospitals, home health agencies and long-term care providers. We are seeing elevated levels of labor costs simply to retain valuable clinical staff members, whether it be increasing pay and/or special bonuses. Certainly, on the recruiting side, that’s evident. You’ve got to pay more to attract a new hire. Almost every provider is offering some sort of bonus out there.
All of this is making it very challenging for hospices to grow as they’re limiting new admissions due to labor issues. They could grow faster and service many more in need if they had more clinical staff to handle the new admissions into their program.
How can owners best prepare to sell in today’s hospice landscape, and what should all owners keep in mind regardless of whether they plan to sell?
I have a framework for this that I call the “Fab Five.” First, owners absolutely should keep accurate financial records. Whether they decide to keep the business for 50 years or sell in five days, having accurate financial records for any buyer to review is essential — but it’s also critical to run the business. You need accurate numbers to monitor and measure your business and to help your organization thrive going forward. You can’t make sound business decisions with sloppy or erroneous books.
No.2 is similar — agencies need to keep comprehensive and accurate clinical records. Every agency needs to ensure the integrity of its patient files. The overall focus on clinical due diligence has skyrocketed in the last 12 months. The amount of increased UPICs and TPEs of late has been very noticeable. Buyers are much more in tune, and some are placing a higher emphasis on the clinical side of due diligence versus the financial side. They’re weary of any adverse risk that they’re taking on relative to a future investigation or audit by CMS.
No.3 is leadership. Owners need to continue to develop their managers, directors and team leaders. I believe that at least 50% of the value of any agency is dependent upon the key acquisition criteria of experienced leadership. Buyers are looking not just at how the business is run today, but also how it will run when the owners leave.
Typically, owners retire. What happens to the company after that? Who’s in place to take over and continue the growth of the company, its quality services, and its ability to retain and recruit new talent? This is a critical component that most operators don’t give enough thought to as they plan their exit.
No.4 is referral source diversity. For an extreme example, if 80% of an organization’s referrals are coming from one referral source, that poses a huge risk to a buyer if that referral source changes his or her mind after the owner(s) depart. A wide, diversified group of referral sources is key. At Braff, we like to see no more than 10% in any one referral source’s hands. It definitely helps to elevate the value, but also protects the buyer from something adverse happening that they didn’t expect.
Certainly, now with large insurance companies like Humana and United buying major home health and hospice providers, a lack of referral source diversity may pose a risk in the local marketplace. If those large national payers have a local agency that provides hospice service, one would assume they would turn in-house for a referral versus outside of the company that they own. Owners should keep that in mind.
No.5 is people. People are the most obvious and critical need for every agency owner. Owners need to stay as close as they can to their employees and try and stay in constant touch with them. From my perspective, it should be the first thing they think about when they come to work and the last thing they think about when they leave. People are the heart and the soul of any hospice agency. Without their staff, the other four points pale in comparison relative to importance.
How has the process of an acquisition changed in your time with the Braff Group?
The acquisition process has become exponentially more difficult than it was even five years ago. In fairness, owners have demanded higher purchase prices, and they’ve been pressing the market for the highest valuation. It’s resulted in changes on both sides of the table.
In exchange for those owners seeking the highest valuations, buyers are looking for the most pristine businesses to buy. I think they’re saying, “I don’t mind paying a bit more money, but what do I get for it? If it’s not in pristine condition, then I’m not inclined to pay this superlative price.” As a result of that equilibrium, due diligence has become elongated and there is a much more granular investigation.
Again, financial documentation is essential because buyers have to prove the revenues, the cash and the profits. It’s not just simply presenting a piece of paper. They want to validate that the company is really the size it claims to be. Further, on the compliance scale, the human resources department has spiked in its visibility. Five, ten years ago, it was assumed that everyone was in compliance. Today, buyers are looking at any entity they acquire as being fully compliant with all state and federal employment requirements.
Buyers are conducting extensive investigations into active and past patients. They want to make certain that there is absolutely no shadow of a doubt that each patient qualified for hospice care and that the service was needed. Most owners assume that if they get through a state survey, they’re in great shape, but that is not true relative to passing a buyer’s audit. A buyer’s audit goes well beyond state assessments and looks more deeply into not just conditions of participation, but conditions of payment.
The investigation on the clinical side of the business has gone far deeper and far longer than I’ve ever seen before. Most owners assume if they’re below their cap, then everything is in good shape. Buyers are looking at long lengths of stay, and even looking more closely at live discharges. That has been a new phenomenon in the past couple of years.
In summary, I would say that the whole due diligence process has practically become a full-time job. I tell all my clients, for two to three months, you’re going to have to devote substantial time and resources to get through due diligence, which is significantly different than it was ten years ago.
Barrett Kulik recently joined the team as an Associate for Home Health, Hospice, and Home Care. Talk about his addition to the Braff team, as well as how that ties into The Braff Group’s plans for future growth.
Thankfully, our hospice and home health business has grown dramatically over the past five years. We expect our new client engagements to continue to grow for at least the next five years. It’s been a welcomed period of time for us. Accordingly, we have noticed the need to address two critical areas from our perspective.
First is business development. We’ve gotten to the point where we need more resources in the client services area to continue to provide exemplary representation to our clients. Barrett joining the team has allowed us to help increase the levels of communication and elevated levels of interaction with our clients, not just adding a matter of additional capacity.
The second major need is client support. Given the current elongation and granularity of the buyer’s due diligence process sellers are faced with a new challenge. With the elevated burden of due diligence, we also brought Barrett on board to do everything possible to “lighten the load” for our clients and all related requests that come in from buyers. We’re trying to be a part of the solution versus part of the problem from our client’s perspective.
Barrett came from a national, public investment bank that is also in the health care industry. As a result, he’s got great technical and client management skills and brings an enormous amount of energy to the process. You’ll see him join me at upcoming conferences and client meetings as well.
Finish this sentence: “In the hospice industry, 2023 will be the year of…”
… smaller-sized, bolt-on transactions.
Editor’s note: This interview has been edited for length and clarity.
The Braff Group is a mergers and acquisitions advisory firm specializing exclusively in health care services including behavioral health, home health, home care and hospice, health care staffing services, home medical equipment, pharmacy services and ancillary health care services. To learn more, visit https://thebraffgroup.com/market-sectors/home-health-hospice/.
The Voices Series is a sponsored content program featuring leading executives discussing trends, topics and more shaping their industry in a question-and-answer format. For more information on Voices, please contact [email protected].