NEWTOWN, PA – Last week, mergers and acquisitions (M&A) veteran Jonathan Sadock talked about the “unexpectedly strong” M&A activity that characterized much of 2021. “Based on the run-up of activities we saw in December 2021, there is tremendous momentum for 2022 in many areas of healthcare,” says Sadock, managing partner/CEO, Paragon Ventures LLC, Newtown, Pa. “While we anticipate continued growth of transactional volume, these transactions will continue to require overcoming key challenges to close successfully.”
On the heels of the recent Apria acquisition, Medtrade Monday asked Sadock for his assessment of the future and the challenges that everyone must confront. The following is part two of the conversation.
Medtrade Monday: What are your educated guesses about the M&A climate in 2022?
Sadock: I don’t have a crystal ball, but I do have direct involvement in transactions that are occurring. Some healthcare sectors are not quite as in favor. For example, there are challenges in home health nursing/skilled nursing services related to HR being able to find workers.
Medtrade Monday: Which areas are more promising?
Sadock: In the areas of respiratory, sleep, medical and diabetic supplies—the areas that Medtrade focuses on—there is tremendous momentum and we anticipate continued growth of transactional volume. The transactions will continue to require that you overcome some key challenges to close successfully.
Medtrade Monday: What are those challenges and considerations?
Sadock: There are many, but I have whittled it down to five. Number one is trajectory of the business. Specifically, how is the business doing? We use the term EBITDAC. A lot of people are familiar with the term EBITDA [earnings before interest, taxes, depreciation, and amortization] and we added the “c” at the end and that stands for coronavirus. The reason is that we are charting the trajectory of the business and want to see what is sustainable in relation to COVID—because there is going to come a day when COVID goes away. It’s really important that the trajectory is strong and continuing. A strong company is going to not only command a strong valuation, but greater surety to close in a transaction.
Number two is reimbursement risks/rewards. We’ve always had reimbursement challenges in this sector. At one point there were so many reimbursement cuts that you’d think we were paying the payors to provide service. There have been some positive things happening with reimbursement in the sector, but you need to be aware of them and how they might impact—positively or negatively—the valuation of your business and a buyer’s interest in that business.
Number three is profitability. There was a day and time when the average HME provider was generating 40% net income from operations. That has eroded, but what’s interesting is that while it has eroded, the size of the companies has increased. While competitive bidding reduced the number of companies, through it all the businesses that survived are stronger companies today. They are more profitable companies because they manage their business well.
Number four is quality of earnings (QofE). Basically, acquiring firms will perform an assessment of the quality (accuracy) of the income and profitability of the business. This assessment may include converting cash basis accounting to an accrual method.
Number five is realistic expectations of business owners regarding valuation. I have heard things all over the board. As recently as last week, one individual said that he read that some company had sold for 2.5 times their revenue and that’s what they want. However, he did not understand that the valuation of the business has nothing to do with a multiple of revenue. It had to do with a multiple of the EBITDA of the business and the fact that the multiple of the EBITDA was accelerated by the size of the company. In that case, the Company that sold was sizeable and generating more than $10 million in EBITDA.
When you start generating that kind of EBITDA, the multiples that a buyer is willing and able to pay may increase. Conversely, if you have a smaller company—still a good company—but generating $500,000 in EBITDA in a transaction, it is not going to demand double digit multiples in most cases.
Whatever the valuation of your business, you should know it in advance of going to market. That is one of the things we do with every prospective client. We start every client engagement with an assessment of the value of the business and what components of the business add or detract from the total economic value of the business. Once that is done, a business owner can have a realistic expectation of the value of the business.