Tips on choosing the best valuation approach when valuing home healthcare businesses
Home health and hospice care is a subset of all healthcare providers with the same goal: to provide a continuum of services to allow disabled or older individuals to stay in their homes for support and treatment. The five major service lines of home healthcare include:
- Home health—skilled nursing, physical therapy, occupational therapy, speech therapy, aid service, and medical social work provided to patients in their home;
- Home hospice—care provided for terminally ill patients (those with a life expectancy of six months or less) and their families in their homes (can also be provided at other care sites);
- Private duty and staffing services—personal care and supportive services that a home care aid primarily provides;
- Home medical and respiratory equipment—durable medical equipment such as walkers, beds, wheelchairs, and oxygen concentrators; and
- Home infusion—intravenous therapies such as parenteral nutrition, antibiotics, and chemotherapy.
Proponents of home healthcare believe it is a less expensive and better care alternative for most people. These services, when combined, would represent a very comprehensive home healthcare business. But, more often than not, an appraiser will be valuing businesses with fewer service lines, and often the business may be comprised of only one service line, such as home infusion.
As with other industries, a unique set of variables drive the profitability and risks associated with each of these service lines, making it difficult to make global assumptions. Appraisers need to develop an understanding of each home healthcare service line and how they interact if the subject business operates in two service lines or more. Appraisers will also need to choose the best valuation approach for the unique service line they are valuing. Here are a few tips on each of the approaches.
Income approach
The income approach, and, more specifically, the discounted cash flow method, is the valuation approach and method most appraisers prefer when valuing profitable operating businesses. This method can be difficult to use for marginally profitable or unprofitable businesses if there is inadequate cash flow to provide a reasonable return on the business’s assets. In that case, methods under the market or asset approach may be more appropriate.
Under an income approach, it is important to determine whether the forecasted cash flows are reasonable and achievable. If the appraiser thoroughly understands the business and the industry (as previously discussed), he or she should be able to reasonably make this determination and factor it into the development of a discount rate applicable to the cash flows forecasted for the subject company.
Market approach
Methods under the market approach can be useful but difficult to use correctly when valuing home healthcare businesses because it is always hard to find publicly traded companies and sales transactions for companies that are truly comparable to the subject company. Unless the comparable company is publicly traded, it is almost impossible to adequately evaluate a comparable company’s operating characteristics.
Some comparable sales transactions may predate current reimbursement levels, economic changes, or not have anticipated proposed legislation, which might result in an erroneous conclusion about a current transaction. Furthermore, a significant number of comparable sales transactions represent acquisitions by existing healthcare companies that may recognize economic synergies resulting in an investment or synergistic standard of value (not fair market value if that is the standard desired).
Despite these limitations, a thorough analysis of publicly traded companies and comparable sales transactions is extremely useful in developing an understanding of the marketplace, value drivers, who the most likely buyers are, and in determining a reasonable range (low to high) to test values indicated under other approaches.
Asset approach
Methods under the asset approach are rarely used as the primary method to value operating companies such as home healthcare unless the business is unprofitable or marginally profitable whereby cash flows do not produce an adequate return on assets. However, methods under the asset approach should still be considered to ensure that values under other approaches (primarily the income approach) exceed values that would be developed under an asset approach, which is usually viewed as the lowest or floor value.
Under an income or market approach, the premise of value is almost always a going concern. When using an asset approach, the premise of value is sometimes more difficult to determine, but the valuation methods used must be applied consistent with the premise chosen.
Conclusion
Valuing home healthcare businesses is not unlike valuing other businesses—it is imperative that appraisers have a significant understanding of their operating characteristics and the industry. To learn more about these approaches when valuing home healthcare businesses, download an excerpt from Alan B. Simons in BVR’s publication Guide to Ancillary Healthcare Services Valuation.
