EBITDA Recent Market Trends
With several areas of healthcare in dispute for 2017 it is time for The Ambulatory M&A Advisor to present to its readers a Healthcare Sector Update and tips for examining EBITDA during transactions in the current year.
When examining EBITDA, it is best to ultimately understand what the method of measurement of value is and how the industry works with it.
Douglas Smith, FRBMA and managing partner at Integrated Medical Partners, says that the ‘E’ in EBITDA, is the most important part of the acronym.
“EBITDA really communicates: what kind of cash is this business going to generate for the owner? What are the earnings?” Smith asks. “What’s the profit forecast without all of these other things like interest, taxes, depreciation and amortization in the income statement and balance sheet?”
Business owners can look at their EBITDA over past years to help determine future cash flow, therefore, regular examination of where a business stands can be crucial since in a transaction, the value of a company is cash flow expectation.
During a healthcare M&A transactions, a potential buyer is going to examine what they think the potential cash flow, or EBITDA, is going to be in the future, and how likely it is that, as a new buyer, they will be able to achieve that number.
According to Mark Dietrich, CPA, EBITDA is generally calculated on a 12-month basis. If a company has recently completed their fiscal year, it can just take a look at the most recent annual financial statement to determine its EBITDA. If a valuation is done in the middle of a fiscal year, Dietrich says that it’s common for companies and valuators to use what’s called the trailing 12-months.
The trailing 12 months takes a look at the EBITDA of the four most recent quarters, and then adding them together to reach a consensus. Dietrich says the trailing 12-months is great for urgent care centers because they tend to be seasonal.
Studies and past market examples have shown that different sectors in healthcare rise and fall throughout the various quarters. Dietrich says some of the reasons for these shifts include the season in general, location during a particular season, or the location of the sector as well as its patient demographic.
According to Duff & Phelps, a valuation and corporate finance advisory firm the latest February 2017 update presents some increases in numerous healthcare areas, and some significant decreases in others.
These reports are based on a closely monitored timeline of the various healthcare sectors and markets, and The Ambulatory M&A Advisor is dedicated to keeping its readers up to date on any financial changes in the healthcare field that could impact investment decisions during the remainder of the year.
Based on the most recent report presented by Duff & Phelps, as of February 2017, the S&P Healthcare Services Index has seen a recent increase of 6.0% since January.
This increase also displays that the Healthcare Services Index outperformed the S&P 500 despite the S&P’s increase during the same time period. The S&P 500 saw an increase of 3.7 % over the same studied period.
Best and Worst Performances in the Healthcare Sector
Over the recorded months of the sector study, results show that the best performances in healthcare were Acute Care Hospitals, Distribution/Supply, and Psychiatric Hospitals.
According to the report, Acute Care Hospitals is up by 10.6 %, with Distribution/Supply up 9.7 %, and Psychiatric Hospitals up 9.2%.
As usual in the market, not all numbers proved to be positive in the report. The worst performing sectors during the time of the report were Assisted/Independent Living, which was down by 2.7 %, Consumer Directed Health and Wellness, down 1.7 %, and Diagnostic Imaging with a slight increase of 0.4 %.
Current LTM Revenue and LTM EBITDA
Based on the reports, the current median LTM (Last Twelve Months) revenue and LTM EBITDA show multiples of 2.39X and 13.5X for the overall Healthcare Services Industry. These multiples show a slight increase and decrease from the November 2016 report where the multiples were respectively 2.18 X and 14.2X.
Sectors with the highest valuation multiples include “Other Services,” Consumer Directed Health and Wellness, HCIT, and Care Management/TPA.
Other Services lands on this section of the report for the fourth time in a row with LTM revenue of 2.09X and a LTM EBITDA of 18.1X. Although Other Services has landed on the highest valuation multiples list again, these numbers represent a large decrease from the November report that had an LTM EBITDA at 45.1X.
Another second contender for highest multiples is Consumer Directed Health and Wellness. Currently, this sector shows 3.85X LTM revenue and 25.1X LTM EBITDA. This sector has also raised its LTM EBITDA from its November report of 3.80X EBITDA.
HCIT came in with high multiples with 5.30 LTM revenue, and 23.3X LTM EBITDA. These current multiples also reflect an increases since the November report of 5.23X LTM Revenue.
As far as Care Management/TPA, the sector experienced 1.16X LTM Revenue, and 22.3X LTM EBITDA.
For a complete list of the results of the most recent Healthcare Sector Update, including detailed charts and graphs emphasizing changes in the market, view the full report here.
John Hakanson, Senior Associate with HealthCare Appraisers Inc. says that when examining such reports on the market it is important for potential sellers to understand how multiples and EBITDA impact a sale.
Hakanson says that one way to understand this is through research. He says many business in the business of buying and selling other healthcare businesses research for surveys and market trends every year where they collect private transaction data in order to get a sense of what multiples in the ASC and Urgent Care industries are being bought and sold in the current marketplace.
“The market data is a good benchmark to start off with, but obviously, every surgery center is different. At the valuations date, two surgery centers could have the same EBITDA but be trending in opposite directions. As such, these two centers would not be valued the same. There are many factors involved in valuation, and EBITDA multiples never tell the whole story,” Hakanson says.
Daniel Michaels, partner with the law firm Jones Day says the multiple values really depend on the industry and not only the historical performance but also the future growth prospects of that industry.
“The multiples people are willing to pay obviously vary not only from industry to industry generally, but also, based upon current opportunities in the industry at the time. Those are adjusted based on what people see as the past of future growth of the industry or company, the number of “best in class” assets that are or may become available at any given time, what recent exits have been and/or where recent regulations or developments may provide specific growth opportunities or enhance certain businesses,” Michaels says.
“You also see multiples that buyers are willing or have to pay affected based on the identities of the potential suitors, specifically strategic versus financial bidders. Typically, the involvement of strategics in any process will drive up multiples. There are a variety of factors and it is not always specific to the underlying company actually being sold, sometimes the ultimate valuation a seller receives is outside the control of management and the company and more a product of the deal environment at the time.”
It should be understood that when discussing multiples and what their different values mean, multiples in their ever changing fluxes can be a dangerous situation if not examined and tracked closely enough.
Dietrich does not deny that EBITDA is a popular method for determining a healthcare business’ value, but he does add that EBITDA is not necessarily the best method, especially when attempting to predict the future success of a business.
Dietrich adds that because EBITDA adds back depreciation, it does not take into account the need, or lack of need, in the business for future capital expense outlay.
“You can’t have a depreciation expense unless you’ve previously acquired property, plant and equipment. If you add back all of the depreciation, it ignores the fact that you are required to purchase property and equipment to sustain the business.”
Dietrich says that capital outlay reduces cash flow and offsets depreciation, which is a primary weakness of using EBITDA multiples.
According to Dietrich, one could have a business that is losing money if the EBIT piece of the equation is negative, but when they add back depreciation, it may become positive.
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com.