With Coronavirus Disease (“COVID-19”) surfacing in China at the end of 2019 and ultimately arriving in the United States in January 2020, federal and local governments have been forced to react quickly to battle both the health and economic impact of this pandemic. Following the realization that the worldwide spread of COVID-19 was imminent, the public markets have experienced a historic downturn in response to expected short-term and long-term economic interruptions. Both the disease itself, as well as the response required to combat it, have impacted every sub-sector within the healthcare industry. As market leaders in Ambulatory Surgery Center (“ASC”) valuations, VMG Health is receiving increased inbound client inquiries into the impact of COVID-19 to the current operations and resulting value indications for surgery centers. Therefore, we explore these issues briefly and outline our initial thoughts. It should be noted that this is a very fluid crisis and facts and circumstances can quickly change. As the environment changes, VMG Health will react and communicate accordingly.
On March 18th, the Centers for Medicare & Medicaid Services (“CMS”) announced at the White House Task Force Press Briefing, “all elective surgeries, non-essential medical, surgical, and dental procedures be delayed during the 2020 Novel Coronavirus (COVID-19) outbreak.” Subsequently, on March 19th, the Ambulatory Surgery Center Association (“ASCA”) published guidance related to COVID-19. Per the guidance, “if a procedure can be safely postponed without additional significant risk to the patient, it should be delayed until after the pandemic.” On March 20th, ASCA published additional guidance stating, “Traditional hospital services may soon lead to federal and state government decisions to use ambulatory surgery centers to support the healthcare system in expanded surgical use and new ways during the pandemic. You must be prepared for your ASC operations to work in coordination with local hospitals to manage care and patients not currently contemplated…”. We have seen this guidance play-out real-time with our ASC clients as many had already begun rescheduling truly elective procedures and performing medically necessary/urgent procedures only.
When approaching a valuation of an ASC in uncertain times, it is important to return to the roots of valuation theory – the driver for all business valuations is an investor’s expectations of future returns for that business coupled with the risk of achieving those expected returns. Valuation opinions are based on the expectation of long-term earnings, long-term cash flows and risk. Conversely, the public markets can produce volatility on an hour-by-hour basis. Some of the volatility being observed in the public markets can be attributed to factors that don’t exist or impact the private ASC equity market. Historically, ASCs have been desirable for physicians, corporate and other third-party investors because of their proclivity for generating consistent, distributable cash flows and their attractive value proposition in lowering the cost of care. Despite the impact and disruptions caused by this current crisis, these positive attributes remain attractive over a long-term investment horizon.
During times such as these, it is paramount for a valuation firm to work closely with ASC leadership to secure a clear understanding of center specific near-term and expected long-term impact. While undertaking a valuation during this pandemic can present challenges, an appraiser can work with local management to develop reasonable cash flow projections and assess short and long-term risk that is reflective of these challenging times.
As it relates to expected cash flow generation and associated risk, COVID-19 will likely have an impact to both. Although they are related (expected cash flow and projection risk), we’ll address them discretely with the cash flow impact first:
In addition to discrete cash flow impact to projections, the cost of capital may also be impacted. Cost of capital refers to the expected return required by a specific class of investor. As perceived risk increases so does expected or required return. Risk factors that may impact the cost of capital include:
Such risk factors cannot be discretely forecasted in the cash flows however they may be reflected in the discount rate.
Some centers may choose to delay equity transactions for a period of time hoping for private markets to stabilize and for increased clarity on the magnitude and duration of impact, however other transactions will move forward and will require thoughtful assessment of risk, short-term and long-term cash flow impacts. The effective date of a transaction will play a critical role in valuations. During uncertain times, business operations and overall risk are more fluid and can change rapidly. In these uncertain times it is critical that a valuation analysis consider all the facts and circumstances that may impact short and long-term cash flow and overall business risk. Lastly, it is important to note that our fundamental valuation approach remains unchanged in this crisis as during less turbulent times. As stated earlier, VMG Health will continue to keep the ASC industry informed on these evolving topics. Please contact our thought leaders if you have any questions about the current state of the industry.