Uncovering the Gem: Hidden Elements in ASC
Valuation
Presented by
Lorin E. Patterson, JD, Partner, Reed Smith LLP
Todd J. Mello, ASA, AVA, MBA, Principal, HealthCare Appraisers
Presentation Outline
• Regulatory Considerations
• Practical Considerations
• Valuation Framework & Issues Specific to ASCs
• Factors Affecting Value
• Selection and Application of Appropriate Valuation Methodologies
• Other Relevant Issues (Partnership Life Cycle; Impact of Changes in
Reimbursement; Minority Interest and related discounts; Industry
Multiples)
• Managing the Valuation Process
Regulatory Considerations
• Cardinal Rule: In healthcare ventures, ALL relationships MUST be
conducted on FAIR MARKET VALUE terms.
– Adherence provides participants the best protection against possible
liability under Federal and State anti-kickback statutes and other
applicable laws.
– “Kickbacks” can include any form of remuneration, including
overpayments or underpayments for interests in physician-owned
ASCs.
Regulatory Considerations
• Risk Scenarios: Surgery Center grappling with the “Price of Success.”
– Years of successful operations result in prohibitively high unit prices
making recruiting additional investors difficult.
• Unreasonably low price or easy terms offered to “heavy hitter”
physician investors.
– The “spread” between FMV value and price offered could be a
kickback.
Regulatory Considerations
• Risk Scenarios
– Hospital anxious to maintain market share and appease groups of
specialists overpays for share in existing ASC or offers to provide
services or benefits (e.g., below FMV rent) to the venture on non-FMV
terms.
• Again, “spread” between FMV and actual terms could be deemed a
kickback to procure referrals.
• Real world example: Advisory Opinion 07-05 (6/19/2007). OIG
issues unfavorable opinion where Hospital buys units in ASC
directly from orthopedic surgeon at possibly inflated prices.
Practical Considerations
• When validating FMV, a third-party appraisal by an experienced third-party
appraiser will be the best means of procuring protection.
– Not necessarily required.
– Keep in mind that businesses are being valued – not referrals.
Practical Considerations
• Occasions where third-party valuations may be appropriate or necessary:
– Combination between two existing healthcare ventures.
– “Out of the ordinary course” sale of interests in existing ASC to group
practice, corporate partner or hospital.
– Commencement of service or other relationships between referral
sources.
Practical Considerations
– “Out of the ordinary course” buyouts of participants in existing
healthcare ventures.
– The commencement of a re-syndication by an existing ASC to a number
of physician investors.
Practical Considerations
• Occasions when obtaining an appraisal may not be necessary:
– In connection with the raising of capital by a newly formed healthcare
venture (value of interests will be speculative).
– True arms-length negotiations between participants of a healthcare
venture.
– Buyouts of existing participants where means of valuation is set forth
within the governing documents (e.g., through the use of a formula).
Valuation Framework
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What is the ownership interest being valued?
What is the purpose of the valuation?
 Pending transaction (e.g., a physician buy in/out or a transaction with an
ASC company)
 Compliance with federal ASC safe harbors and IRS private inurement
issues
 Shareholder disputes/litigation
What is the standard of value?
 Fair Market Value (“FMV”)
 Fair Value
 Investment Value
What is the premise of value?
 Going concern
 Liquidation
Definition of FMV
IRS Definition: In Revenue Ruling 59-60 the Internal Revenue Service
defines fair market value as “the amount at which property would
change hands between a willing seller and a willing buyer when the
former is not under any compulsion to buy and the latter is not under
any compulsion to sell and when both have reasonable knowledge of
the relevant facts.”
– CMS Definition: “the value in arm's-length transactions, consistent
with the general market value. “General market value” means the
price that an asset would bring, as the result of bona fide bargaining
between well-informed buyers and sellers who are not otherwise in a
position to generate business for the other party, on the date of
acquisition of the asset.” Usually, the fair market price is the price at
which bona fide sales have been consummated for assets of like type,
quality, and quantity in a particular market at the time of acquisition.”
Valuation Issues Specific to ASCs
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Physician ownership makeup or lack thereof is critical
Physician risk is the most important risk factor in ASC valuation
Value related to distributions (i.e., dividends) as compared to capital
appreciation – much higher liquidity built into investment
Divestiture typically required upon retirement, relocation, and inactivity –
buyout typically formulaic or fair market value
Importance of restrictive covenants
Numerous regulatory hurdles – anti kickback statutes and potentially
private inurement regulations
Publicly traded corporations are generally not relevant comparisons
Sales of similarly sized blocks of stock often not comparable
In valuing entity, important to understand uniqueness of industry
Primary Factors Affecting Value
TWO PRIMARY DRIVERS OF ASC SHAREHOLDER VALUE

Future Cash Flow available to shareholders (Distributions)

Volatility or Risk associated with future cash flow
There are a multitude of variables that impact the assessment of risk and the
projection of future cash flow.
The value of a business is not based upon historical earnings but rather future
earnings!
Historical earnings are only relevant to the extent they help predict future earnings.
Future earnings in a surgery center partnership can be very volatile!
Proper partnership management can reduce volatility.
Factors Affecting Risk of Future Cash
Flow
Cash Flow Projection Factors
 Case volume, mix, and reimbursement
 Expected changes in volume and reimbursement
 Opportunities for expansion (rooms, surgeons)
 Stability of operating expenses
Risk Assessment Factors
 Diversification (e.g., # of surgeons, number & type of specialties, payors)
 Size and demographics of physician ownership, appropriate non-competes
and ability to attract new investors
 Financial leverage, working capital, and on-going capital expenditures
 Nature of payor contracts; is there a substantial portion of “out of network?”
 Quality and age of facility and equipment
 Competent management
 Barriers to entry (e.g. CON)
Valuation Methodology
Selecting the Valuation Approach
Asset-Based Approaches
PURPOSE: Measures the value of an ASC by identifying and individually
valuing the ASC’s tangible and intangible assets and liabilities. Based upon the
Principle of Substitution; i.e., the premise that a prudent individual will pay no
more for a property than he/she would pay to acquire a substitute property
with the same utility.
Asset-based approaches are useful when:
 The ASC has no expected earnings or other attributes of value whereby an
“orderly liquidation value” yields the highest valuation; or
 To establish a “floor” of value when using other valuation methods
Valuation Methodology
Selecting the Valuation Approach
Market Approach
PURPOSE: Measures the value of an ASC by evaluating comparable companies
and/or transactions in the marketplace.
Market Valuation Methodologies include:
 Guideline Publicly Traded Company Method – generally not applicable
 Comparative Transaction Method – depends
Market Approach may be useful if:
 Valuing a controlling (as opposed to a minority) interest
 Truly comparable entities are available
Valuation Methodology
Selecting the Valuation Approach
Income Approach
PURPOSE: Measures the value of an ASC by determining the present value of
its expected future cash flow stream.
Income Methodologies include:
 Capitalization of Earnings
 Discounted Cash Flow
Income Approach is useful when:
 The ASC is generating significant, normalized cash flow from operations to
fund ongoing distributions
 When valuing minority interest in cash flowing centers
 When the ASC has significant intangible value and when reasonable market
comparables are not available
Valuation Methodology
Decision Tree
ASC
Unprofitable
Profitable
Profitable
Attributes
Going Concern Risk
Stable Earnings
Trending Earnings
Income approach
Income approach
Capitalization of earnings
Discounted Cash Flow
Asset approach
Compare value to market transactions
Adjust for atypical working capital
Use asset approach to establish floor of value
Depending upon standard of value and size of interest,
apply discounts
Other Relevant Valuation Issues
• ASC Partnership Life Cycle
• Minority vs. Controlling Interest Valuation
• Pending Changes in Medicare Reimbursement; potential impact to nonMedicare payors
• Industry Consolidation, Valuation, and Competition
ASC Partnership Life Cycle
ASC Life Cycle
START UP
GROWTH
MATURE
DECLINE
10.0
$ (in millions)
8.0
6.0
4.0
2.0
(2.0)
1
2
3
4
5
6
7
8
9
10
(4.0)
Years
REVENUE
EBITDA
11
12
13
14
15
ASC Partnership Life Cycle
Consequences of Decline Stage
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High Staff Turnover
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High Volume Physicians Slowing Down
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Non-Owner Physicians Disgruntled/ Exiting Facility
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Lack of Sufficient Capital to Reinvest in Business
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Capital Calls
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Deferred Maintenance on Equipment and Building
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ASC becomes less attractive to outside physicians
ASC Partnership Life Cycle
Relationship to Value
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Unmanaged Partnerships will Eventually Enter into Decline Stage
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Profits Decline Faster than Revenues
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ASC Partnerships are difficult to turn around
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Quality Governing Documents Assist in Extending the Life Cycle (e.g.
divestiture guidelines, restrictive covenants, safe harbor requirements)
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Accurate Valuations are Crucial to Sustaining ASC Partnerships
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Future Cash Flow and risk are related to life cycle
Valuing Minority Interests
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Simply stated: Interests providing absolute control (i.e., greater than a 50%
interest whereby key aspects of control are not diminished by governing
documents or otherwise) are worth more than interests which do not have the
same control rights
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Control granted by the governing documents (examples on next slide)
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Concept of “effective” control – physicians control with their feet
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Valuation Guidance: absence of control adjustments in financial projection
(preferable approach) or application of minority interest discount (reliance on
published studies or other; more difficult to quantify and support)
Valuing Minority Interests
Matters Subject to Control
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Capital Calls
Admission of new investors
Borrowings greater than a certain amount
Acquisition of equipment greater than a certain amount
Selling, assigning or otherwise disposing or encumbering assets
Entering into material contracts
Selling, liquidating, or merging the entity
Changing the core governing documents
Typical ASC ownership agreements are very friendly to the minority
shareholder
Note: Physicians display a certain level of control regardless of ownership
interest level
Additional Valuation
Considerations
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Medicare reimbursement reasonably “certain” through 2011; additional uncertainty and
hence risk related to non-Medicare payors
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Despite declining public EBITDA multiples between 2004 and 2006 (see next slide),
market multiples for controlling interests remain strong; a 12/06 survey performed by
HealthCare Appraisers indicates that 92% of ASC respondents are observing multiples
of 6X EBITDA or higher
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Multiples paid also driven by private equity transactions (e.g. USPI and Symbion)
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Despite continued consolidation within industry, per an August 2007 Market Letter
published by Verispan the top 5 outpatient surgery center chains still account only for
10.5% of the market share
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Minority interest multiples are based upon the individual center’s facts and
circumstances and are more difficult to determine
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Market multiples are interesting “rules of thumb” and are easy to calculate; however, do
not generally constitute an appropriate method for calculating fair market value
Additional Valuation
Considerations
Ticker
AMSG
NOVA
SMBI
USPI
Company Name
AmSurg Corp.
NovaMed, Inc.
Symbion, Inc.
United Surgical Partners
MVIC / EBITDA Multiples
2003
2004
2005
2006
6.98
6.91
5.00
4.52
7.87
11.01
8.71
10.51
9.31
7.85
6.42
8.96
12.29
10.65
8.29
Managing the Valuation Process
• Opposing parties will have inherently conflicting interests during the
valuation process.
– Adding “structure” will streamline the process significantly.
• Avoid “dueling valuations” unless a means of reconciling differences is
agreed upon.
– Consider joint engagement of a single appraiser selected from a list of
qualified appraisers.
Managing the Valuation Process
• Determine the degree of involvement of both parties in the valuation
process.
– Both parties may have the right to individually meet with the appraiser
and submit factors which they feel are most pertinent.
– Both parties may have the right to receive drafts of the appraisal report
and comment upon it.
– Agreement may be reached as to what price within the range of fair
market value in the final report value (e.g., mid-point) will be used in
the purchase agreement.
Todd J. Mello, ASA, AVA, MBA Principal
HealthCare Appraisers, Inc.
858 Happy Canyon Road, Suite 240
Castle Rock, CO 80108
(303) 688-0700
tmello@hcfmv.com
Lorin E. Patterson, JD, Partner
Reed Smith LLP
3110 Fairview Park Drive, Suite 1400
Falls Church, VA 22042
(703) 641-4368
lpatterson@reedsmith.com