Question & Answer

Wednesday, April 30, 2003

Supply and demand drives market

PITTSBURGH, Pa. — Of 109 transactions in the home care industry in 2001, 63 or 41% involved home medical equipment dealers, according to The Braff Group’s report M&Annual 2002. That’s a significant jump over 2001, when the HME market saw 44 deals completed. To see if the bull market on HME companies can or will continue, HME News talked to Dexter Braff to get his take on where things may be headed.

HME: In your report, you stated that market multiples for HME companies held firm in 2002 at four to six times EBITDA and will likely stay the same in 2003. But with Washington lawmakers seriously discussing competitive bidding and other Medicare reimbursement cuts, doesn’t that make the market more risky and in turn decrease valuations?

Braff: There is no question that the HME risk profile has ticked up. It hasn’t soared. It’s not that any of the issue our there are new, it’s that they have moved a step closer to reality and the risk profile has moved upward. Generally speaking, the greater the risk, the lower the value. But the demand for quality acquisitions is greater than the supply. As a result, market competition is keeping the downward pull on valuation in check.

HME: Do you see that continuing?

Braff: Certainly over the next year there is no question. If you look at the industry, it has been an industry in which this type of relationship has been a consistent one. The risk profile of HME has continued to ratchet upward with every change in reimbursement. It has a storied history of challenges regarding reimbursement. But at the same time, new buyers come in when old buyers exit. That has done a lot to keep valuations not only in check, but, we would argue, that valuations have increased over the past five years or so.

HME: Any sense of how much they have gone up?

Braff: Since the mid 90s, relative values have increased 20% to 25%. When people think of valuation, they tend not to think about supply and demand. But part of your company’s worth depends on how many people are interested in buying it. And on the HME side, the industry has been fortunate to keep on having active buyers.

HME: In terms of acquisition activity, how does the current market rank?

Braff: I think the volume of deals was significantly higher in the mid 90s. There was a tremendous number of transactions at that time. There was slow down in the aftermath of BBA ‘97, as buyers and sellers were trying to figure out what they were going to do. But once the market understood that, it’s been an aggressive opportunity to sell business for three or four years.

HME: How should the likelihood that reimbursement will change, either through inherent reasonableness, competitive bidding or some other methodology, influence a company’s decision to sell or not?

Braff: You have to look at where you are in terms of your growth profile. If you are growing rapidly, you can outgrow reimbursement cuts. Companies that are more mature and growing at the demographic growth rate — somewhere in the 8%-10% range —are not grabbing share. They are growing with the market. That’s the time you start to say, ‘Could the reimbursement risks out there cut my profitability substantially enough to say, now’s the time to make my exit.’ It depends on where a company is it s growth cycle.

HME: How is the market for home medical equipment companies that avoid or only dabble in home respiratory therapy?

Braff: There is limited activity for companies that do not derive the bulk of their revenue from respiratory products and services. Essentially, the activity we are reporting on is predominately respiratory companies because the other ones don’t exist. HME