by Jason Ruchaber, CFA, ASA
In response to the global pandemic caused by the novel coronavirus, Federal and State governments took the unprecedented action of closing large portions of the U.S. economy and issuing stay-at-home orders in an attempt to stem the spread of the disease and “flatten the curve”. These actions led to immediate and widespread economic damage, business closures and high levels of unemployment. And despite several economic stimulus packages designed to support impacted businesses and employees, the coronavirus has created a watershed moment that will fundamentally alter businesses across all industries, including healthcare.
If you or your organization was contemplating an acquisition, merger, joint venture or sale transaction prior to the COVID-19 outbreak, here are some key factors to consider:
1) History may no longer be a predictor of the future
Business values are derived from expectations regarding the future economic benefit that will be derived through ownership. These expectations are often developed as an extrapolation of historical performance, with adjustments made to reflect those changes that are reasonably known or knowable (for example the recent addition of a new payor contract or provider). In the wake of COVID-19, however, the expectation that practice patterns will return to normal once this has all passed may not be the case. With widespread unemployment, many will lose their access to health insurance and due to the loss of income may forego elective and non-emergent visits. In addition, the fear and anxiety created by the pandemic may permanently alter how patients engage with the healthcare system, with many opting to limit their exposure to physician offices and medical facilities through reduced healthcare utilization or through a transition to virtual or home-based care. As a result, pricing models developed with proformas and DCF analysis will need to be revisited and modified.
2) Pricing of risk should be carefully analyzed
In valuation, the term “risk” refers to the likelihood and magnitude that future performance will vary from expectations. Risk is priced in the form of an interest rate, or rate of return, and the corresponding value of a given set of expected cash flows is inversely related to risk (i.e., higher risk = lower value). No one could have predicted the large-scale governmental intervention to shut down the economy, and now that we have seen that this is a reality, investors must account for the possibility that future contagions may result in similar interventions. There is no model that currently prices this risk, but as institutional investors and financial markets process and analyze these new possibilities, the risk and required rates of return on equity investments will most certainly be higher.
3) Valuation Multiples
Valuation multiples observed from transactions prior to COVID-19 are no longer appropriate in the immediate post-COVID environment. Observed valuation multiples from prior transactions reflect the expectations for future financial performance and risk that existed at the time the transaction occurred. For the reasons noted above, these expectations have changed in the wake of coronavirus, and the use of these valuation multiples is no longer a reasonable basis for establishing FMV.
4) Increased debt levels
Equity value is defined as the enterprise value minus debt. In response to the business interruptions caused by the coronavirus, many organizations are funding operating losses by drawing on existing lines of credit, opening new credit facilities, and/or accepting federal stimulus dollars. This additional debt burden has a dollar for dollar reduction on the value of shareholder equity even in the absence of changes to other valuation inputs. As a result, previously valued equity transactions will need to be repriced to account for higher levels of debt.
5) Opportunities and pitfalls
Like all sudden and unforeseen events, the economic impacts of the coronavirus outbreak will create both winners and losers. Whereas reduced expectations for growth in earnings and higher risks will reduce values for many sectors of the healthcare industry, we have already seen a massive increase in investor interest for telehealth technology and platforms, and this will spawn additional opportunities in related ancillary businesses. Beyond the immediate and obvious opportunities, organizations that are able to respond and reposition themselves for the changing care environment may also benefit from these changes. These include alternative care delivery platforms such as care on demand and home-health, retail and drive-through clinics, and concierge medicine. Finally, for organizations that did not have sufficient capital or technological infrastructure prior to the outbreak, or those unable to adapt to new modalities of care, there will be a wave of business failures that will allow well managed and dynamic practices to emerge stronger and enhance their competitive position.
At Root Valuation we are committed to helping clients navigate market and regulatory uncertainties through a consultative approach to valuation services. If your organization needs help navigating a business transaction or help understanding how these changes may have impacted your organization’s value, please give us a call at 720.390.6673 or email us at info@rootvaluation.com.