Five Key Takeaways From the Public Healthcare Operators in 2021
February 9, 2022
While the valuation of a public company is dependent on macroeconomic, industry, and company-specific factors, VMG Health has attempted to isolate key drivers of the recent market pullback of public healthcare operators. Specifically, VMG Health has isolated two variables:
VMG Health reviewed the change in enterprise value, EBITDA, and the implied forward multiple, as defined below, of 17 publicly traded healthcare operators from December 31, 2021, to June 10, 2022. We then quantified the impact on enterprise value for each of the identified companies in Exhibit A resulting from fluctuations in EBITDA as compared to the implied forward multiple over the observed period.
Based on a review of 17 publicly traded healthcare operators, aggregate total enterprise value declined by approximately $46.1 billion, or 15.0%, from December 31, 2021, to June 10, 2022. While 10 of the 17 companies now have lower consensus EBITDA estimates, this appears to account for only 10.9% of the enterprise value decline. The overwhelming reduction in the total enterprise value is due to multiple contraction with 13 of the 17 companies currently trading at a lower implied multiple.
Furthermore, 14 of the 17 public operators experienced a decline in enterprise value over the last six months, whereas Acadia Healthcare Company, Inc., LHC Group, Inc., and U.S. Physical Therapy, Inc. were the only three companies that saw an enterprise value increase over the same period . Unsurprisingly, these companies also did not experience multiple contraction.
The two publicly traded diagnostic laboratory businesses, Laboratory Corporation of America Holdings and Quest Diagnostics Incorporated, experienced the most significant enterprise value decline because of multiple contraction. On average, the implied forward EBITDA multiples decreased by approximately 4.0 turns of EBITDA, from around a 13.0x to approximately a 9.0x.
Select Medical Holdings Corporation (“Select”) saw the most significant enterprise value decline due to a decrease in consensus EBITDA estimates. Select’s EBITDA has declined by almost $150.0 million over the last 6 months, which has resulted in a 15.6%, or $1.2 billion, reduction in enterprise value. Overall, the trading multiples for public operators within the post-acute care sector have remained relatively flat, but consensus EBITDA estimates have declined by approximately 6.7% with an approximately $2.6 billion impact on enterprise value.
Among the publicly traded acute-care hospital operators, HCA Healthcare, Inc. experienced the most significant dollar reduction in enterprise value, decreasing $19.6 billion, or 17.0%, from $115.3 billion to $95.8 billion. Of this change, approximately 62.6% was due to multiple contraction and 37.4% was due to consensus EBITDA decline. Collectively, enterprise value for the acute care hospital sector decreased by approximately 14.2%, or $24.0 billion, driven primarily by a contraction in trading multiples of nearly 1.0 turn of EBITDA.
Of the other publicly traded healthcare operators observed, Surgery Partners Inc. experienced the most significant impact on enterprise value, on a percentage basis, due to the contraction in implied multiple. The company’s multiple declined by almost 5.0 turns of EBITDA from December 31, 2021, to June 10, 2022, resulting in a $1.9 billion, or 21.8%, reduction in enterprise value. Overall, declines in consensus EBITDA estimates did not have as significant of an impact on enterprise value as implied multiple contraction for the other companies with two of the five operators experiencing growth in their consensus EBITDA estimates over the observed period.
The equity markets continue to react to macroeconomic factors, such as interest rate fluctuations, as well as industry-specific information, including rising labor costs. While many of the public companies currently have lower consensus EBITDA estimates for FY 2022, the market seems to have also pulled back on valuations, as evidenced by the decline in the implied forward multiples. It is yet to be determined if this reduction is short-term in nature, and VMG Health will continue to monitor the public markets.
 VMG Health relied on S&P Capital IQ for the FY 2022 consensus EBITDA estimates as of December 31, 2021, and June 17, 2022. The consensus EBITDA as of December 31 is primarily based on analyst estimates following companies’ Q3 2021 earnings calls through December 2021. Similarly, the consensus EBITDA as of June 17 is largely comprised of analyst estimates following the Q1 2022 earnings calls through June 2022.
 While VMG Health’s analysis focuses on the effect of two variables on enterprise value, we understand there are additional factors impacting public company valuations. For example, following the March 29, 2022 announcement of UnitedHealth’s plan to acquire LHC Group, LHC’s price and forward multiple increased and have remained elevated based on the market expectations of this transaction.
As we enter 2022, we look back to reflect on the major trends that shaped the healthcare sector over the past year. COVID-19 continued to be a major player throughout 2021, forcing healthcare systems to adapt to new variants, rising labor pressures, financial activity, and new regulations. Despite these challenges, the sector remains optimistic and ready to adapt.
Here are five key takeaways we believe defined the healthcare sector over the past year:
After the Q2 earnings season, VMG Health released an article analyzing post-COVID healthcare operator guidance. Generally, we found that healthcare operators were optimistic about the recovery of their revenue and adjusted EBITDA metrics over pre-pandemic levels, with most operators increasing their FY 2021 guidance with each subsequent reporting period.
While optimism for recovery to pre-pandemic levels remains, it appears that the post-acute operators have tempered some of their recent growth expectations. Based on disclosures of the public operators, the recent resurgence of COVID-19 through the Omicron variant has caused additional strain on the post-acute sector. During the J.P. Morgan Healthcare Conference, Universal Health Services (“UHS”) CFO, Steve Filton noted that the company was struggling to find providers who can accept COVID patients once they are ready to be discharged from the hospital.
Post-acute providers appear to have been hit especially hard by the recent labor shortages in the healthcare industry (discussed further below). As compared to the hospital operators, the financial performance of these post-acute providers has been affected disproportionally by the labor shortages. While hospital operators have been receiving additional reimbursement for COVID patients, helping to offset a portion of the increased staffing costs, the post-acute care providers have not received a similar subsidy.
Due to these recent pressures, Select Medical Holdings Corporation (“SEM”) released an expected earnings announcement in advance of the actual results, in which it noted “the unpredictable effects of the COVID-19 pandemic, including the duration and extent of disruption on Select Medical’s operations and increases to our labor costs, creates uncertainties about Select Medical’s future operating results and financial condition.”
While we have seen increasing optimism by healthcare providers over the past few quarters, the recent disclosures from the post-acute sector illustrate that the effects of COVID continue to ripple through the healthcare sector. With the fourth quarter results being released over the coming weeks (HCA and Encompass recently released), it will be interesting to hear if other sectors report similar headwinds.
Healthcare labor expenses continued to exceed historical levels with a 12.6% year-over-year increase based on a recent analysis of over 900 hospitals. Labor expenses grew at a faster rate than the number of clinical hours worked, which supports the notion that rising labor costs were not due to increased staffing levels but rather due to labor shortages driving higher pay to improve employee retention. Part of the labor shortage can be credited to the surge of Delta and Omicron variants in the second half of 2021 that resulted in high volumes of quarantined staff and a reliance on costly contract labor and travel nurses. At the Bank of America December 2021 Home Care Conference, LHC Group announced a decrease in quarantined staff throughout Q4 from a high of 4% down to 1% in December. This indicates that the labor market issues will see some improvement as health systems’ dependence on pandemic-related contract labor declines as COVID-19 surges dissipate going into 2022.
A more concerning challenge faced by all sectors was the shrinking workforce, coined the “Great Resignation.” The Bureau of Labor Statistics reported healthcare and social assistance workers had the second highest quit rate in November 2021 at 6.4% due to increasingly high levels of professional burnout. The waning labor force has prompted companies to offer additional incentives such as shift and retention bonuses. For example, HCA reported during Q3 a 10-12% annual increase in FTEs being in the premium pay categories. Many large public players have voiced an anticipation of continued high levels of premium pay, competitive bases, and higher annual wage inflation to attract and maintain adequate staffing levels in 2022.
Leaders in the industry have announced initiatives to decrease labor pressure primarily by focusing on recruiting and retention to bounce back to pre-pandemic levels of employment. With a heightened focus on attracting and maintaining adequate levels of hired staff as opposed to contract labor, it appears the overall industry expectation for 2022 is that labor costs will likely decrease compared to 2021 although not to pre-pandemic levels. The chart below shows the percentage change in employment across the healthcare sector from the Bureau of Labor Statistics Job Openings & Labor Turnover Survey from February 2020 to November 2021. This highlights the steady recovery toward pre-pandemic staffing levels for outpatient care and physician offices, the continued employment challenges in home health and hospital settings, and the notable struggle for community and nursing care facilities to return to a state of normalcy.
Deal activity within the healthcare sector was strong in 2021 with industry-specific multiples that reached or in many cases exceeded 2019 levels. Experiencing a noticeable rebound from 2020, volume and value of deals grew by substantial margins on a year-over-year basis. Deal volume in the health services industry rose by 56% while value rose 227% in the TTM 11/15/21 period. Long-term care led all sectors with the highest volume of deals, as seen historically, and continues to remain a hot spot in the transaction space. Similarly, physician medical groups and the rehabilitation sector experienced the largest growth transaction volumes year-over-year.
Physician medical groups have received vast interest in physician employment from private equity firms, new-age value-based care organizations, services arms of managed care giants (Optum, Neue Health), and health systems. This, coupled with independent physician group operating challenges from COVID-19 related volume impact and looming Centers for Medicare and Medicaid Services (CMS) cuts, is creating a robust transaction environment that is expected to continue during 2022. For the rehabilitation sector, strong demographic tailwind, along with the lifted CON moratorium in Florida and continued joint venture interest between health systems and strong rehabilitation operators (Select, Kindred, Encompass), has resulted in material deal volume in the space.
Hospitals and health systems were the only sector to see a decline in volume of deals, down 26% from the previous year. Despite the decline, the total transaction size of deals only dropped slightly year over year, indicating larger deal-size on a per-transaction basis. The acceleration of megadeals taking place, the shifted focus on scale, and the diversification of their business models all drove average total size per deal higher than seen before in 2021.
Effective January 1, 2021, the Centers for Medicare and Medicaid Services (CMS) implemented a price transparency rule requiring hospitals in the United States to provide accessible pricing information to patients about the cost of the care they may receive. Hospitals must display negotiated rates for all items and services, in a machine-readable format, so that patients can compare prices before arriving at the hospital.
Though, in July 2021, a study was published by PatientsRightsAdvocate.org detailing that a vast majority of hospitals were not compliant with the new rule. At the release of the study, the penalty for non-compliant hospitals was $300 per hospital, per day. While many patients advocate for CMS to stiffen penalties for non-compliant hospitals, healthcare professionals argue against the rule, stating CMS did not provide enough clarity on what the rule should entail.
A vice president of a large U.S. health system discussed the ambiguities around the rule with Fierce Healthcare. “One interpretation is you simply publish your rate schedule – whatever your rate exhibits are in your contracts, publish that and that’s compliant. Another one is to summarize these [CMS] packages [and] what your negotiated charges are.” For many health systems, the resources required to implement their rates in a machine-readable format far outweigh the penalty of remaining non-compliant. The VP stated that he believes many hospitals already provide their rates in a clear, understandable way, but the rule’s lack of clarity and the requirement for a machine-readable format make compliance difficult and costly.
In November 2021, CMS released the 2022 Outpatient Prospective Payment System (OPPS)/Ambulatory Surgery Center (ASC) Payment System final rule (OPPS Final Rule). Within this rule, CMS increased penalties for hospitals that are not compliant with the price transparency rules and removed barriers for patients accessing online pricing information.
While the Final Rule may be beneficial for patients, Stacey Hughes, Executive Vice President for the American Hospital Association (AHA), states that they “are very concerned about the significant increase in penalties for non-compliance with the hospital price transparency rule, particularly in light of the many demands place on hospitals over the past 18 months, including both responding to COVID-19, as well as preparing to implement additional, overlapping price transparency policies.”
The new penalties, visible in the chart above, went into effect on January 1, 2022.
A record number of health and health services companies went public during 2021 by way of SPAC or IPO. Rebecca Springer, a private equity analyst with PitchBook noted, “The multiples in public markets are very, very strong right now, so you can get, all else equal, a better return on your investment if you go public with your company rather than selling it to a strategic investor.”
Unfortunately, while the stock market might be performing well, the recently public healthcare operators have not faired as well since their initial offerings. The Healthy Muse Health Tech Index (“HTI”) generally underperformed the overall performance of the stock market, with the majority of the players finishing in red; the HTI declined 35% as opposed to the 27% gain for the S&P 500 during 2021. The public markets seemed like a perfect place for an exit strategy given the multiples observed in the public markets. All recent entrants finished the year below the original IPO price and while the reasons for the price declines varied it is clear the public markets are less forgiving with valuations if an organization does not achieve expectations.
Overall, the healthcare sector experienced highs and lows during 2021 as it continued to navigate a post-COVID world. As pandemic pressures continue into 2022, healthcare institutions will have to keep a close eye on staffing costs and abide by new regulations. Despite these challenges, the appetite for M&A transactions and market participation in the sector remains strong. We look forward to a new year of challenges, wins, and continued changes in this interesting industry.