Black Box Analysis Offers Transparency in Healthcare M&A Transactions

black box analysis

Contracted reimbursement rates are often a blind spot in M&A deals. A black box analysis can provide clarity for both buyers and sellers.

There are many moving parts to examine before a merger or acquisition transaction in the healthcare sector takes place, especially when it comes to financial considerations. Both the buyer and seller involved with a potential M&A transaction need to assess the prospective value for the deal and having as much information as possible can make this process smoother and lead to better outcomes for both sides.

However, when preparing to enter a transaction, information is not always easy to come by. For example, for many reasons – including payer contractual clauses as well as confidentiality agreements – payer reimbursement rates and terms are often proprietary. Not being able to see other healthcare providers’ contracted reimbursement rates with payers limits the ability to fully assess the true value of a potential deal. Fortunately, there is a solution that can help both parties take some of the guesswork out of a transaction.

Black box analysis projects managed care revenue

Black box analysis for healthcare is a process that can provide clarity into these insurance rates by projecting managed care revenue through a model that uses historical frequency utilization data. This type of analysis can be helpful for all parties as it compares managed care revenue levels under both the buyer and seller’s payer contractual rates. Utilizing a black box analysis helps supplement the lack of information in an area where there isn’t much transparency.

For a buyer, this analysis can help validate if the current economic deal terms are appropriate or require renegotiations, as well as which party’s payer rates are higher. A seller can benefit from this analysis when their post-merger or acquisition employment contracts and/or earn-out agreements are directly impacted by potential changes in managed care rates (whether good or bad) and they currently have no transparency into how revenues will be affected by the transaction.

For many healthcare organizations about to engage in a merger or acquisition transaction, engaging a third-party advisor to conduct a black box analysis can go a long way in providing that transparency. In addition to potentially not having access to the necessary information, healthcare organizations, especially smaller to midsize physician practices, may not have the internal resources to make these critical evaluations. A black box analysis can indicate that further earnings potential may exist in a merger or acquisition than which was previously expected.

For a sense of how this process would apply, imagine that a large physician group is looking to acquire a smaller practice that only has five physicians. Prior to the deal, the buying party engages a healthcare M&A consultant to perform a black-box analysis to gain insight into how their contracted rates with their payers compare to the contracted rates of the practice they are targeting for acquisition.

During this process, the buyer learns that their contracted reimbursement rates are higher than the seller’s contracted rates when applying them to the top revenue-driving services. Overall, these rate differences could lead to a potential managed care upside of 20%-30% that could be achieved after the close of the acquisition. After learning this, the buyer may then feel much more comfortable increasing their bid in order to win the acquisition. Additionally, they would have a significantly improved overall deal multiple (the ratio of the purchase price to annual earnings) as compared with their prior expectations.

Black box analysis is customized based on specific buyer and seller circumstances

A black box analysis can be tailored to the needs of an organization based on their size and how they operate.

For instance, a large practice that has multiple payer relationships may require a highly detailed level of analysis in order to gain a more useful projection. In this case, the model may need to consider multiple products and reimbursement rates for any one given payer. Furthermore, future negotiated reimbursement rate escalators and/or historical collection rates for buyers and sellers may need to be assessed during the managed care calculation in order to understand the full picture.

Other organizations may need a less intricate process. If the black box analysis is being performed for a smaller business that does not have many services or payer relationships, it may be more useful to only examine a select amount of billing codes or payer relationships. This analysis would provide a higher-level look at the potential financial impact of a prospective deal. 

Other considerations for healthcare black box analysis

It is also important to note that there are other considerations that need to be taken into account when going through the black box analysis process. Healthcare organizations considering an M&A transaction should also examine issues related to timing, which can have a number of impacts on the financial side. For example, a party needs to account both for when the prospective contract goes into effect and when a contract can be terminated, which can each have a significant financial impact. Additionally, based on certain terms of the merger or acquisition, the parties may be required to notify the payer of a change of ownership control after the close of the transaction which could delay the timing of anticipated reimbursement changes.  These aforementioned items can create a sizable change in the ultimate revenue received from a deal.

Though there may be times where a black box analysis may not make sense for a potential transaction, such as a smaller merger or acquisition or a situation where rates may be shared amongst parties, in many cases, the information that it provides can significantly enhance a buyer or seller’s ability to effectively negotiate an optimal deal.

Ultimately, a black box analysis can have a crucial impact for all parties involved. Buyers can gain insight into how to structure a more cost-efficient purchase (for example, how much cash to pay up-front versus including certain earn-out provisions), while sellers can evaluate if they are getting sufficient value for the business they worked so hard to grow. By helping an organization to fill in informational gaps related to the other party’s contracted reimbursement rates with payers, a black box analysis can lead to significant savings and benefits in the M&A transaction process – both in the short term and the long run.

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