The ambulatory surgical center (ASC) industry experienced a substantial amount of transactional activity in 2007. There is every reason to believe that the industry will continue to show signs of a “bull” market well into 2008. In this market, certain trends have emerged in connection with ASC transactions and business operations.

The first trend is developing an ASC with a corporate investor but still allowing the physicians an opportunity for a significant liquidity event in the future. Second, ASCs are bringing in new physician utilizers and a corporate investor through a simultaneous syndication and sale. Third, ASCs and their physician investors are buying back the ownership interests of under-utilizing physicians through a squeeze-out merger. Fourth, ASCs are considering ways to joint venture with health systems to bill under the higher hospital outpatient department (HOPD) rates. Fifth, physician investors in ASCs are interested in business models that allow them to profit from the anesthesia services performed in the ASC.

Indicators of an ASC “Bull” Market

There are a number of reasons why 2008 is shaping up to be an active year for ASC equity transactions. First, purchase price multiples remain high in virtually all geographic markets and have even increased in certain markets. This is likely driven by the ASC investment community’s insatiable appetite for the development of new ASCs and the acquisition of existing ASCs.

Indeed, both United Surgical Partners International (USPI) and Symbion — two leading national ASC management companies — announced that they would be acquired by private equity funds. These transactions will likely fuel both companies with additional resources to continue to fund a pipeline of ASC development and acquisition opportunities well into 2008.

Add into the mix existing national players such as NovaMed and AmSurg as well as Surgical Care Affiliates (corporate spin-off of the HealthSouth ASC division), and there are a number of national ASC management companies focused on developing and acquiring ASCs to fuel their future revenue growth. Health systems and smaller regional management companies are also competing for the same transactions as the national companies, which is helping to facilitate the high purchase price multiples.

Second, with the exception of certain specialties, the ASC reimbursement changes will likely have a modest impact on the total revenue of many ASCs. While single specialty endoscopy centers or multi-specialty ASCs with a high case mix of endoscopic or pain management procedures will likely feel the pinch on their bottom line, the reimbursement impact on most other ASCs may not be too significant.

Third, physician owned hospitals continue to remain under Congressional scrutiny. If, in fact, a new law is passed that outlaws physician ownership of hospitals, there will likely be a flurry of surgical hospital management companies, ASC management companies with surgical hospitals as part of their portfolio and physicians who will be looking for opportunities to invest in ASCs around the country. Finally, an ever broadening range of procedures are reimbursable in an ASC setting, as the Centers for Medicare & Medicaid Services (CMS) and commercial payors continue to view the ASC as a safe and less expensive alternative to a hospital for same day surgery.

Developing an ASC With a Corporate Partner but Still Enjoying a Liquidity Event

Many ASCs are developed by physicians in partnership with a health system or ASC management company. There are clearly some advantages to having a company experienced in the development of an ASC handling many of the common issues that arise in developing an ASC, including issues with lenders, architects, contractors, city permits, suppliers and managed care companies. Also, a corporate partner can often add credibility to the ASC venture.

For those physicians who historically utilized a regional ASC developer, the developer is often interested in “flipping” its ownership to a national management company for a significant purchase price within 18 to 36 months after the ASC has commenced operations. The physician investors are often permitted to participate in such sale and put some money away.

By contrast, when a health system or corporate investor has participated in the initial development of the ASC, the physician investors have historically not enjoyed any sort of liquidity event. A recent trend has emerged where the national ASC management companies and health systems initially own a minority interest in the ASC with the option to increase their ownership interest at some point in the future.

This allows the physician investors to benefit from the management company’s or health system’s expertise in developing the ASC and still allow the physicians to participate in the sale of a meaningful interest to the corporate investor after the ASC’s profits have ramped up.

Simultaneous Syndication and Sale

In this seller’s market, ASCs continue to be valued by ASC management companies and health systems at a high multiple of profits. A physician syndication (i.e., selling equity interests to a large number of the utilizing physicians), however, is often a prerequisite to the more lucrative sale to a corporate investor. That often translates into time delays and additional expenses, as the founding physician owner(s) have to first negotiate a transaction to sell a portion of their ownership interests to other utilizing physicians.

A recent and cutting edge trend that has emerged involves the consolidation of the physician syndication and the sale to a corporate investor into a single closing. One driving force to these transactions relates to the difference in multiples paid by a physician to acquire a minority interest in an ASC vs. the multiple that a corporate investor is willing to pay.

For example, suppose an ASC that is owned by three founding physicians has $1 million in EBITDA. The founding physicians would like to sell a meaningful interest to a corporate investor but the buyer desires at least two new physicians to invest in the ASC prior to closing the deal. The founding physicians then identify two utilizing physicians who desire to purchase a 10 percent interest each based on a fair market value multiple of three. This translates to a purchase price of $300,000 per new physician (i.e., $1,000,000 x 3 = $3,000,000 or $30,000 per 1 percent). The corporate buyer then pays a 7-plus multiple to the founding physicians in exchange for a meaningful interest which translates into $70,000 per ownership percentage point ($1 million x 7 multiple = $7 million; $7 million divided by 100 = $70,000 per 1 percent). The new physician investors also participate in the sale to the corporate investor by selling 5 percent each as well for $350,000 each.

The result — a win for the ASC and its founding physicians who have sold their interests to a corporate investor in an expedited manner, a win for the new physician investor who pockets some cash and maintains a 5 percent equity interest and a win for the corporate investor who has successfully syndicated the ASC to other physicians while acquiring a significant equity interest.

Redemption of Physician Equity Interests and Squeeze-Out Mergers

Animosity among physician owners of an ASC often results when a physician partner does not use the ASC as an extension of his or her practice, yet profits from the procedures performed by the other surgeons. Often, such inactive physicians also serve as an impediment to consummating the more lucrative transaction of selling a meaningful interest to an ASC management company or health system.

A recent and successful trend has been developing that allows the ASC to eliminate (or squeeze out) these physicians through a properly approved transaction. These transactions could prove to be of even greater utilization in connection with cleaning up physician ownership of a distressed ASC with such inactive physicians simultaneously with the sale of a substantial interest to an ASC management company or health system.

A squeeze-out merger is a concept that has been implemented in other corporate, but non-healthcare settings, for sometime and basically involves two steps. First, the physicians who intend to continue to utilize the ASC (and perhaps the ASC management company or health system) form a new entity. Second, the new entity and the existing ASC are merged together. In order to minimize any disruptions in operation from both a cash flow and licensure perspective, the existing ASC should be named as the surviving entity in connection with the merger.

As a result, the physicians being “squeezed out” are entitled to receive the fair market value in cash for their equity interests. The remaining physicians (and the ASC management company or health system if one has participated) receive equity in the surviving entity, and thus become the sole owners of the ASC on a going-forward basis. In practice, the mere intention of a squeeze-out merger can also serve as a successful negotiation tool to consummating the buy-back of equity interests from such physicians who may have otherwise not been willing to cooperate in such purchase.

There are two important caveats. First, a squeeze-out merger can only be performed if the owners of the existing ASC who desire to effectuate the transaction can obtain the requisite vote to authorize the merger. If, for example, the governing document of the existing ASC requires that the approval of a merger be subject to a higher voting threshold (which is often the case) and the squeezed-out physicians have enough of such vote to block the merger, then a squeeze-out will be more difficult to effectuate. Absent a provision in the governing document providing for the contrary, state laws generally require that a merger be approved by the holders of a majority of the equity interest in the existing ASC.

Second, most states’ laws provide for a dissenter’s rights claim, which is the right of an owner who objected to a merger to bring a claim to make sure that he or she is paid a fair price. As a result, it is highly advisable for the ASC to obtain an independent fair market value appraisal as the basis of the amount paid to the squeezed-out physicians.

ASC Management Arrangements and HOPD Reimbursement

The ASC management model has been receiving increasing attention from hospitals and physicians due to the greater differential in reimbursement rates between ASCs and hospitals that have resulted from the ASC reimbursement changes. Gastroenterologists and certain other specialties that are more greatly impacted by the reimbursement changes have been particularly interested in this model. Often referred to as an “under arrangement” model, it typically involves the ASC and its physician investors providing the hospital with turnkey management of the hospital’s outpatient surgical department. In exchange, the hospital pays a management fee or otherwise purchases the facility component of the surgical procedure from the ASC. The ASC does not bill Medicare or any payor, but rather bills the hospital for the hospital’s use of the ASC’s facility and other services that it renders. The hospital then bills Medicare or the other applicable third party payor for the services rendered under the HOPD rate.

Such a model, however, should not be implemented without careful legal guidance. While the Stark law generally does not apply to ASCs, hospital outpatient services are covered by the Stark law. If properly structured, the arrangement could meet the Stark law indirect compensation exception. Additionally, it is critical to analyze the transaction structure under the federal anti-kickback law and other federal and state healthcare laws to such an arrangement.

CMS also recently announced that it will be taking a closer look a these types of arrangements.

Parties desiring to enter into a surgery center under arrangement transaction with referring physicians may want to consider the fact that CMS could very well implement changes in the near future that prohibit such arrangements. That is particularly true if it relates to an existing hospital service. If, perhaps, the project involves a new replacement facility or an additional site, then the associated regulatory risk may be somewhat less. In all instances, however, it is critical to have a comprehensive legal analysis of the arrangement and plan a solid exit strategy.

Anesthesia Arrangements with ASC Physician Investors

Many ASCs are considering ways to profit from collaborating in the delivery of anesthesia services. Two common models involve requiring an anesthesia group to pay to be the exclusive anesthesia provider or requiring the anesthesia group to reimburse the ASC for certain supplies and drugs. Both of these models, however, implicate material regulatory risk under the anti-kickback law.

There are a number of models that would allow the physician investors of an ASC to profit from the anesthesia service without material regulatory risk. For example, in the “in-house” provider model, the ASC might consider employing or contracting with the anesthesia providers and have the ASC bill for such services. The company that owns and operates the ASC would obtain a second Medicare provider number to operate a group practice and bill for the anesthesia services under the group practice number.

Alternatively, in the closed group model, the ASC’s physician investors could employ or otherwise contract with the anesthesia providers through the surgeons’ existing group practices. This model is often used where an ASC is owned by one or two group practices. Finally, in the anesthesia partner model, the ASC’s physician investors and the anesthesia providers could form a new company to provide anesthesia services to the surgery center. The new company enrolls in Medicare as a group practice and the anesthesia services are billed and collected for through the new company. Each of these models has associated advantages and disadvantages and different regulatory risk profiles, all of which should be considered prior to implementation.

Conclusion

There are a number of reasons why the ASC transactional market should remain hot in 2008. As newly developed ASCs mature and physician investors of existing ASCs become more business savvy, new trends have emerged which could present an ASC with just the right transactional and business operation opportunities to continue to succeed in the future. 

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