Home Health Cuts to Drive Senior Living Acquisitions

Proposed reimbursement cuts to the home health industry are offering senior living providers a ripe consolidation opportunity to acquire new assets at depressed values.

Last month, the Center for Medicare & Medicaid Services (CMS) proposed a rule for the Home Health Prospective Payment System (HH-PPS) that would reduce the national, standardized 60-day episode reimbursement rate of 3.5% annually from 2014 to 2017. The cuts, which amount to an aggregate rate cut of 14%, will save the government an estimated $290 million, according to CMS.

Arriving on top of an approximately 10% reimbursement reduction CMS has already implemented since 2010, these newly proposed cuts stand to create a massive consolidation opportunity for well-capitalized and payer-aligned providers, analysts say.

“We’ve already been seeing acceleration in post-acute care providers aggressively moving into the home care and hospice markets,” says Eugene Goldenberg, associate at Cain Brothers and former senior equity research analyst at BB&T Capital Markets. “Over the last several years, a number of publicly traded operators have expressed their desire to pursue diversification strategies to include ancillary business segments.”

Post-acute care providers have already added home health assets into their existing business lines in recent months, including Emeritus Corporation’s (NYSE: ESC) $102 million acquisition of Florida-based home health provider Nurse on Call in November 2012, and Kindred Healthcare’s (NYSE: KND) unique cluster market strategy that integrates the company’s various care continuums within a centralized area.

“From a post-acute care perspective, providers are looking to leverage their current business lines and infrastructure, and bolster those with assets that add to their care continuums,” says Goldenberg.

Publicly traded home health operators have already witnessed the negative impacts of rebasing cuts, according to Goldenberg, several of which have seen their consolidated EBITDA margins cut in half from 15.6%, on average, in 2010 to 7.7%, on average, in the first quarter of 2013.

For senior living providers, there will be a number of opportunities to acquire home health assets, especially smaller, standalone “mom-and-pop” agencies, many of which don’t have the critical mass to survive in what will be a low-margin environment, according to Cory Mertz, a partner at Stoneridge Partners.

“[The rule] appears fairly draconian and many of the smaller agencies will have to make a decision—either sell or close their doors,” says Mertz. “The supply of smaller agencies on the market is going to continue to grow, which will depress valuations for those agencies.”

Even the largest home health operators, which account for roughly 16% of market share, according to Goldenberg, will have to undergo a period of margin compression, as three of the largest publicly traded home health companies have seen their stocks tumble on the heels of the CMS announcement on the proposed cuts.

Amedisys (NASDAQ: AMED), one of the largest home health and hospice care providers, fell 13% to $11.60 following the CMS announcement, signaling the biggest-single day decline in more than 13 months for the company.

Other heavy hitters in home health such as Gentiva (NASDAQ: GTIV) and LHC Group Inc. (NASDAQ: LHCG) also recorded reported stock declines of 13%, falling to $9.94 and $19.58, respectively.

While there is an “early mover” advantage for providers to get involved with home health, notes Goldenberg, looking forward, providers will have to factor in the reduced profitability model for these businesses relative to historical margins.

“There’s still money in home care,” says Goldenberg. “For any provider, acquiring home health assets will be cheaper, but they will need to identify operating cost and revenue synergies to see if purchasing these assets will make it worthwhile.”

The cheaper price paid for home health assets will be more a function of reduced EBITDA or cash flow as opposed to the multiple paid, added Goldenberg, although we could see some multiple compression as well so it’s a “double-whammy.”

Written by Jason Oliva