David E. Coit, Jr., DBA, CVA, CVGA, CMAA
Director of Valuation + Financial Advisory Services
Ask any healthcare CEO or CFO about value creation, and you’ll hear a litany of ideas with buzzwords such as scalability, allocation of resources, network orchestration, platform optimization, and market exploitation. Moreover, ask 10 different healthcare executives about the best way to create value, and you’ll get 10 different answers. At this point, you might be asking yourself “why does value creation have to be so complicated?” The answer is – value creation isn’t complicated for today’s healthcare companies.
The big picture of value creation is quite simple. There are four basic ways to increase value in your company regardless of the healthcare vertical: size, growth, risk, and cash flow.
- Size – Size matters in building healthcare market value. All things being equal, the larger the company, the higher the value. Why? Because the larger the company, the greater the number of potential buyers. Potential buyers like larger companies (e.g. substance abuse disorder treatment organizations) because those companies have greater access to capital, are less volatile, have lower customer concentration, less key employee reliant, have greater market awareness, better access to new markets, are better able to attract top talent, than smaller companies. Size often leads to greater diversity which creates more opportunity (e.g. a treatment organization that has a full continuum of inpatient and outpatient services).
- Growth – Growing companies attract more buyers than stagnant or no growth companies. Why? Because buyers desire to increase their return on investment. Revenue growth increases company value more quickly than cash flow growth or margin expansion. Increasing revenue growth from 2% to 3% can increase value by as much as 10%, whereas a 1% increase in cash flow increases value by about 1%. For example, the owner of a regional DME focusing on mobility can significantly increase a market valuation by incremental organic growth in nearby communities or small-scale acquisitions in that service line.
- Risk – Healthcare companies with reduced perceived risk attract more buyers that riskier companies. Why? There are simply more buyers willing to invest in lower risk companies than higher risk companies. Moreover, the higher the risk, the higher the buyer’s required rate of return. As such, the higher the risk, the lower the value given that the buyer needs to get more cash flow to justify the riskier investment. Business risk comes in many forms, such as regulatory risk, customer concentration, technology obsolescence, location, quality of management, and competition. As an example, a physician-owned urgent care center can reduce risk and increase opportunity by marketing to customers who are willing to pay out-of-pocket for services and positioning some services in more affluent suburban areas.
- Cash Flow – The greater the future cash flow to the buyer the greater the market value. Why? Because high cash flow generating companies attract more potential buyers than low cash flow companies. And, many companies are valued using market multiples of cash flow. For buyers, high cash flow companies increase ROI, reduce risk by returning the purchase price more quickly (payback period), and increase buyer perception of a well-run company. Your Medicaid-funded I/DD company may not be taking advantage of the opportunity to bill more frequently at present. However, once you do you can immediately reduce some of your financing expense and increase desired growth options.
My advice? Keep it simple and tackle each key value driver one at a time. You may create and implement a growth strategy for your healthcare company, yet only move on to the next key value driver once you are convinced the growth strategy is working well.
If you want to find out what your healthcare company is worth and what you can do to increase its value going forward, please contact me at firstname.lastname@example.org or 480.256.0978.