Compared to all other home care sectors—Medicare and non-Medicare home health, home infusion therapy, specialty pharmacy, and hospice—the HME sector (by far) has enjoyed the longest uninterrupted string of consolidation activity; a period that began in the early 1980s and continues to set transaction volume records 20 years later. Such a record of consistency, however, is not a function of an unchanging environment (between rent-purchase, O2 guidelines, the Omnibus Budget Reconciliation Act of 1990, and the Balanced Budget Act of 1997, nothing can be further from the truth). Rather, the long run is a testament to the industry’s ability to reimagine and reconfigure merger and acquisition strategies to adapt to, and prosper under, ever-changing market conditions.

Such is the case over the past 12 months, where we have seen substantial shifts in M&A strategies, largely in response to reimbursement and health care policy initiatives spawned by the Medicare Modernization Act (MMA).

Beyond Medicare Oxygen
Don’t get us wrong. Buyers still love Medicare oxygen revenues—Medicare for its quick cash turnover and oxygen for its uncapped, sustained profitability. It is just that after contending with a near unending string of price cuts—the latest being MMA-inspired FEHBP reductions announced earlier this year—buyers are finally beginning to like non-Medicare and nonoxygen services as much as they have in the past.

We have even heard buyers mention the “D” word of late. That is, the value of diversifying their portfolio—at least to some degree—away from a strict reliance on Medicare and/or oxygen. While far from a stirring endorsement, this shift in attitude has had a remarkable impact on merger and acquisition activity in recent months.

No longer does a firm have to generate 60% to 70% of its revenues from respiratory products and services to attract acquisition attention (a mix of 40% to 50% will now often suffice). As long as reimbursement is at least plus or minus $150 per month (uncapped), buyers are increasingly less likely to substantially discount the M&A value of oxygen revenues and profits derived from managed care and/or private insurance. Moreover, we have even seen buyers acquire firms that focus on providing oxygen to skilled nursing facilities, a specialty that, in the past, has been actively avoided.

Infusion Moves up the List
While it would be an overstatement to suggest that home infusion therapy is the “new oxygen,” it is the product line that has seen the most dramatic increase in acquisition interest and activity over the past year. There are several reasons for this. First, infusion therapy offers HME providers substantial diversification away from Medicare and oxygen in a product environment they are: A) already in; and/or B) comfortable with.

Second, as buyers become larger and the pool of oxygen-focused acquisition candidates gets smaller, it is increasingly difficult for firms to rely solely on HME providers to achieve increasingly ambitious growth targets. Having largely been relegated to the M&A sidelines since the market peaked in the mid 1990s, the IV sector offers a wealth of acquisition opportunity. Third, and perhaps most important, Medicare will begin to cover home infusion therapy drugs in 2006 as part of the MMA prescription drug package. If the infusion industry convinces regulators to pattern the benefits after those in many Medicare Advantage programs (Medicare Part C) or have the benefit shifted to Part B (either of which many believe possible), infusion therapy could prove to be an extraordinary growth engine for providers over the near term.

Dexter W. Braff

Managed Care Comeback
In the Medicare Modernization Act, one of the most important economic policies embodied and advanced by the legislation is the reallocation of dollars away from government-run Medicare fee for service (FFS) to privately administered managed care organizations (MCOs). To facilitate such a shift under the MMA, MCOs received substantial increases in payments, enough so that according to Urban Institute senior fellow Robert Berenson, MD, payments to Medicare managed care plans on average are 16% greater than FFS (compared to traditional FFS plans under the MMA). It should also be noted that immediately after the MMA was passed, one of the most active health care M&A sectors was in the HMO/managed care arena as companies sought to acquire more capacity—and more lives—to take advantage of such favorable reimbursement.

Many observers believe that unlike the last incarnation of managed care—where overly restrictive access for patients and excessively low and slow payments for providers ensured its demise—this time the lucrative kick-start, combined with lessons learned, will lead to success. Subsequently, revenues attributable to managed care are no longer being shunned by buyers in the M&A market. Moreover, in select situations, buyers are beginning to target firms with managed care contracts, both for the opportunity to capture more revenues as more beneficiaries move into these plans, and to gain the experience and expertise necessary to develop profitable programs of their own in other markets.

Nebulizer Medications Value Reemerges
In the immediate aftermath of the MMA (2003) when it was unclear whether anything could (or would) be done to mitigate the average sales price (ASP) plus 6% pricing methodology, the M&A value of this product line plummeted to near zero. By the end of 2004, however, the industry won a crucial battle to obtain dispensing fees in addition to the ASP plus 6% reimbursement. Not surprisingly, while values have not (and likely never will) reach pre-MMA heights, buyers are once again ascribing value to nebulizer medications—a development that has enabled sellers that derive substantial revenues and profits from these products to once again reenter the M&A market.

Leveraging Nebulizer Platforms
While the profitability (or potential lack thereof) hung in the legislative balance for much of 2004, buyers with large, established nebulizer medication programs did not sit idly by. Rather, they recognized that the nebulizer customer management, product procurement, billing, and delivery infrastructure could be leveraged to support other product lines with similar market characteristics. Accordingly, over the past 12 months we have seen buyers selectively target diabetics suppliers and other specialty product providers that serve patients with chronic conditions.

Impact of Competitive Bidding
From an M&A standpoint, competitive bidding has had limited impact to date. Absent the identification (at this writing) of the first 10 metropolitan statistical areas (MSAs) to be included and without a fully developed basis upon which winners will be selected (paramount of which is service coverage requirements), there is simply not enough information for providers to significantly factor competitive bidding into their M&A planning. On the periphery, however, we have seen certain buyers favoring—though not necessarily aggressively targeting—markets in which they A) anticipate competitive bidding may be implemented and B) have coverage gaps. Similarly, from the seller’s perspective, for companies located in large potential first-round MSAs that have seriously contemplated a sale for other business, financial, and/or personal reasons, competitive bidding likely has tipped the scale for some in favor of a sale.

Once the competitive bidding MSAs and guidelines are announced, however, we anticipate a surge of activity in these markets as committed firms seek to round out their capacity, as necessary, to position themselves to bid successfully.

The larger question, the one that will have a dramatic impact on valuations in these bid areas, is how the delicate balance of supply and demand—one that arguably favors sellers today—will play out. With an expected increase in acquisition demand, it is also reasonable to expect an increase in potential sellers that are ill-suited or unwilling to participate in competitive bidding. If the increase in demand is equal to or greater than the increase in supply, valuations will hold, or tick upwards respectively. If, however, a wave of sellers floods the market, valuations could suffer. But that is a big “if,” one that will depend, in part, on the role (or lack thereof) apportioned for smaller providers in the competitive bidding programs.

If ever there was an industry capable of adapting to seemingly unadaptable initiatives, it is the HME industry. Accordingly, counter to predictions of mass exodus, we suspect that providers that have the energy and enthusiasm to persevere will find opportunities to do just that. DP

Dexter W. Braff is president of The Braff Group, Pittsburgh, a middle market merger and acquisition firm that specializes in the HME, home health care, hospice, staffing, specialty pharmacy, infusion therapy, and eHealthcare market sectors. The firm provides merger and acquisition representation, strategic planning, and valuation services. Braff can be reached via e-mail: dbraff@thebraffgroup.com.