Valuations Part Three – When to Invest in Investment Value
Part three of our series on valuations finds us on the topic of investment value.
Investment Value is described in the International Glossary of Business Valuation Terms as, “The value to a particular investor based on individual investment requirements and expectations.” However, when it comes to a particular type of healthcare business such as an urgent care center business or an ASC business it also can be a value to a particular set of buyers, as we will point out.
The definition as stated above is one that is not specifically tailored to an ASC scenario. Rather, it is a definition that is applicable to all types of businesses. Thus, it’s important for owner operators of ASCs or other outpatient surgery centers to look at investment value from a different perspective.
“Within healthcare, the fair market value standard must be followed when one of the parties is either a non-profit entity or is a referral source to the purchaser or seller of the interest,” said Curtis Bernstein, Managing Director at Altegra Health. “Accordingly, the compensation paid within a transaction must be fair market value for the interest purchased in approximately 80% of all healthcare related transactions. The other 20% of transactions involve private parties not in a position to refer.”
There are several different scenarios wherein investment value can be invoked as opposed to fair market value (FMV) in an ASC transaction, according to.
“Some of the health systems/hospital transactions have involved premiums for potentially increased market share, an example of investment value at play in situations not requiring Stark/AKB compliance or private inurement rules,” they said. “Another example – if a facility has purchase economies relating to medical supplies, thereby allowing it to operate at a relatively lower cost structure, any transaction involving the facility should give consideration to such cost savings.”
When it comes to how often investment value can be used, it depends on whether the circumstances render the use of investment value appropriate or not. The catch is that investment value can only come into play when there are no FMV requirements. This is because investment value is tailored to one particular investor.
In terms of the range of multiples that a center might trade at under the investment value standard, there can be variances from transaction to transaction. These will depend on the incremental benefits/synergies associated with a specific transaction.
In breaking things down further, a distinction between strategic value and investment value must be made. Although at times these terms are used interchangeably, there is a slight difference. This difference relates back to fair market value, according to Blayne Rush, President of Ambulatory Alliances, LLC.
“If FMV comes into play you cannot pay for investment value because that is the value to one particular investor and the FMV tenet is ‘any willing buyer,’ thus it is looked at as all of a group or sector,” he said. “A business owner that wants to achieve the highest marketplace value needs to focus on the highest and best use of the business. This is typically found by selling to a strategic buyer (not always, i.e. if you are a potential platform, the financial sponsors could very well be the best buyer universe for your business because of their willingness to lower their internal rate of return).”
Strategic or synergistic is similar to investment value. However, the distinction revolves around the fact that investment value places the focus on one particular investor, while strategic value relates to a pool or group of buyers.
“Synergies can be cost savings and or revenue enhancements that are achieved with business combinations,” Rush said. “This value is not presented on the financial statements but you accomplish this by recasting and negotiating the allowed synergies. This is not prohibited by the Stark definition or the case law. The hurdle is that synergies fall outside of the valuation professionals’ FMV definition. Many sellers do not understand this and leave money on the table.”
It is important here to recall that the 66 Fed. Reg. 945 states in part:
“There is no requirement that parties use an independent valuation consultant for any given arrangement when other appropriate valuation methods are available…”
An owner must negotiate the synergies with the general market first, then FMV is established in accordance with governmental regulations, as long as he or she is not paying for prohibited synergies through referrals, etc.
Because strategic value is structured to a specific group of buyers, an owner operator might wish to make adjustments to earnings to account for those buyers. According to the ladies at CBIZ, there are some things that must be taken into account for these adjustments to be made.
“With regard to a specific transaction, reasonable assumptions pertaining to the facility’s growth profile, market share, cost structure and beneficial business relationships (contracts, other agreements) will have to be quantified and included as part of the valuation analysis,” they said. “If a transaction allows for synergies tied to a lowered cost of capital, elimination of duplicative overhead, ability to growth market share, among others, such factors will be considered in making the necessary adjustments. Again, all these adjustments relate to strategic value aspects that are separate from referral generation.”
In Menon’s opinion, strategic or synergistic value can be the more reliable option because of its nature as a valuation tailored to a specific transaction.
“An owner operator can have a more reliable indication of what the transaction means in terms of the value,” she said. “For specific buyers and specific targets there can be cost savings or the ability to increase market share or to optimize their cost of capital. All of those have an impact on the underlying economics and cash flows, thereby actually supporting a higher valuation. That is something that can be analyzed under investment market standards.”
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