Freestanding ED Valuation

Volume 8, Issue 18, November 23, 2021

by Alan Hymowitz, Managing Director, and David E. Coit, Jr., Director, Finance + Valuation

Freestanding emergency departments (FSED) have seen substantial growth over the past two decades. Research published in the Western Journal of Emergency Medicine states that the National Emergency Department Inventory determined in 2001 that about 1% of all emergency departments (ED) in the United States were FSEDs. Fast forward to 2016 and the Medicare Payment Advisory Commission reported that FSEDs had accounted for 11% of all EDs nationwide. Grand View Research is projecting that the U.S. FSED market size, which was valued at around $3 billion in 2019, is expected to expand at a compound annual growth rate (CAGR) of around 5% from 2020-2027.

This rapid growth has been welcomed by some and pushed back against by others. As such, the FSED market is experiencing a mix of headwinds and tailwinds. In this column, we'll begin by providing a general overview of FSEDs and the market and then dive into some of the key points owners of these organizations should consider if they are contemplating a sale in the short or long term.

Overview of Freestanding Emergency Departments

An FSED is a facility that is structurally separate and distinct from a hospital and provides emergency care. There are two types of FSEDs:

1. A hospital outpatient or off-site hospital not located on the hospital campus
2. A satellite ED not associated or located near a hospital

What's important to understand off the bat is that an FSED is not the same as an urgent care center. FSEDs, also referred to as standalone EDs, can provide services like basic imaging (e.g., X-ray, CT scans, EKGs, ultrasounds), laboratory services, and emergency and trauma care while generally serving lower acuity patients. FSEDs are currently concentrated in certain markets, notably in Texas and Colorado, and they tend to locate in areas where patients have above-average incomes.

Independent Freestanding Emergency Departments

Independent FSEDs not affiliated with a hospital cannot bill for Medicare reimbursement. In addition, private insurers tend not to contract with these organizations. As a result, these independent FSEDs bill as an out-of-network provider, meaning that patients are often left to pay the balance of the charges.

According to several news reports, out-of-network independent FSEDs often charge private insurers significantly higher rates and receive these increased payments. As word of this billing tactic has spread, communities have soured on independent FSEDs, which has motivated many such organizations to affiliate with hospitals so they can bill Medicare. The majority of independent FSEDs are in Texas, where the number increased from none in June 2010 — when state licensure of these facilities began — to 191 facilities in 2016. Colorado, Minnesota, and Rhode Island also have independent FSEDs. More than 50 unique entities own these facilities, most of which are for profit.

Off-Campus Emergency Departments

This brings us to a discussion about another type of FSED: hospital-based, off-campus emergency departments (OCED). In 2016, 363 OCEDs operated in 35 states. They were affiliated with about 300 hospitals. These facilities represented 64% of all standalone EDs. About 6% of hospitals reported having at least one OCED, with these hospitals tending to be urban, relatively large facilities affiliated with a health system. Most of these hospitals operate a single OCED, but about 30 hospitals operate multiple OCEDs. Between 2008 and 2016, the number of hospitals with an OCED nearly doubled.

State Regulations of Freestanding Emergency Departments

Thus far, 21 states have issued policies regulating FSEDs, with California implementing specific hospital regulations prohibiting these facilities, while 29 states lack regulations. The net effect of this variation is that most states (e.g., Florida, Ohio) allow OCEDs but not independent FSEDs and these states view OCEDs as an extension of the hospital. A few states — Colorado, Minnesota, Rhode Island, and Texas — permit OCEDs and IFECs.

Last year, the Centers for Medicare & Medicaid Services (CMS) issued guidance permitting licensed, independent FSEDs in Colorado, Delaware, Rhode Island, and Texas to temporarily provide care to Medicare and Medicaid patients to help address patient surges associated with the COVID-19 public health emergency. This action was intended to increase hospital capacity to help ensure the states could quickly and effectively care for their most vulnerable citizens.

At the time, CMS Administrator Seema Verma stated, "Expanding the number of providers available to Medicare and Medicaid beneficiaries eases some of the burden shouldered by traditional hospitals and allows the healthcare system to treat more patients at a time when capacity is often limited. We must leave no stone unturned as we seek to bolster the healthcare system during this unprecedented crisis."

Selling Your Freestanding Emergency Department: Key Things to Consider

If you're thinking of selling your FSED, understand the following:

• The market is strong now because of the vast amount of money/capital searching for well-performing organizations. It's unclear how long this will last and when it will inevitably slow down. The market can change quickly, and you may lose your opportunity to sell at a favorable price if you wait too long.
• As acquisitions and consolidations continue, you'll likely be competing against larger, better-capitalized companies. The competitive landscape is changing. Larger competitors are likely to offer a broad range of services, a strong marketing campaign built around an established brand, efficient business processes, and the ability to bid for value-based contracts with large payors.
• Owners of FSEDs are aging. One estimate is that 60% of owners are over the age of 60. As such, we expect an increasing number of FSEDs seeking buyers during the next few years.
• Many FSEDs have already found value in merging to create economies of scale and the resources to better compete with larger organizations.

How Much Buyers Will Pay for a FSED (Market Multiples)

Pricing rules of thumb are a quick but somewhat inaccurate way of estimating value. One of the rules of thumb is that FSEDs are priced by buyers at 1.0x to 2.0x annual revenue. The problem with this method is that some organizations are more profitable and have more growth opportunities than average. As such, those more profitable FSEDs should be priced higher than the average. Moreover, larger organizations sell for higher relative purchase prices than smaller organizations.

Accordingly, buyers most often determine an offering price based on a multiple of normalized or adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). Adjustments to EBITDA include nonrecurring expenses, such as one-time legal fees, and discretionary expenses, such as charitable contributions, owners’ compensation, and owner-related personal expenses.

For FSEDs, the industry average net profit margin is approximately 23.0%, and the average adjusted EBITDA margin is approximately 31.25% of revenue.

Market multiples refer to the estimated purchase price, or enterprise value, related to adjusted EBITDA. The typical range of market multiples for FSEDs is 3.0x to 6.0x of adjusted EBITDA. A particular provider falls within the range based on quantitative factors, such as historical and projected financial performance, and qualitative factors, such as location, the remaining term of property lease, employee turnover, type, technology, and age of equipment. Moreover, size matters, as larger revenue organizations typically attract more buyers than smaller organizations.

The following are estimated market multiples of adjusted EBITDA for FSEDs by revenue, assuming positive qualitative qualities:

• $1 million to $3 million in annual revenue: 3.0x to 4.5x adjusted EBITDA
• $3 million to $5 million in annual revenue: 4.5x to 5.0x adjusted EBITDA
• $5 million to $10 million in annual revenue: 5.0x to 5.5x adjusted EBITDA
• $10 million to $20 million in annual revenue: 5.5x to 6.0x adjusted EBITDA

For example, an FSED with $4.5 million in annual revenue and $1.4 million in adjusted EBITDA (31.25% adjusted EBITDA margin) would have a market value in the range of $6.3 million to $7.0 million, or a 1.41x to 1.56x multiple of revenue.

There are outlier market multiples in unique merger and acquisition (M&A) transactions where optimal buyer/seller synergies push valuations above the norm. Moreover, market multiples change over time depending on the overall economy, regulatory and reimbursement modifications, and industry trends.

Please note that using market multiples is an excellent way to estimate a company's value. It is most often accompanied by using a discounted cash flow approach. The discounted cash flow approach estimates a company's value by calculating the future cash flows expected from the company and putting the future cash flows into today's dollars. However, the market multiples approach provides a reasonable shortcut for estimating the value of a company.