The Future of VACs: Valuation and Strategic Considerations

Vascular access centers operating as extensions of physician practices saw declines in payment rates in 2017 that could threaten their viability. These organizations have the option of converting to ambulatory surgery centers, however, thereby realizing increases in payment. It is critical for healthcare finance leaders to understand these risks and opportunities as part of organizational strategic planning.

Vascular access centers (VACs) are outpatient facilities that specialize in treatment of patients with end-stage renal disease (ESRD) who have problems with vascular access (for example, where efforts to access a vein or artery result in prolonged bleeding, inadequate blood flow, or increased venous pressure). Dialysis is a primary cause of such problems and the associated need for treatment in a VAC.

About 80.3 percent of patients with ESRD undergoing dialysis are treated via catheter, which means that VACs also play a critical role in reducing the hospitalization of patients with ESRD by allowing nonemergency interventional procedures to be performed in an outpatient setting. For patients who do not have ESRD, VACs may offer an alternative setting for other interventional vascular procedures, including vascular access for reasons related to medical oncology, peripheral arterial disease (PAD), and enteral nutritional and medicine delivery. 

Many VACs operate under an extension-of-practice (EOP) model, whereby procedures are performed and billed as an in-office ancillary service of the physician practice and paid under the Medicare Physician Fee Schedule (MPFS). Beginning Jan. 1, 2017, changes in the MPFS resulted in significant payment cuts for several commonly performed vascular access procedures, and as a result, VACs operated under the EOP model are seeing significant declines in revenue and profits.

As the exhibit below shows, the bundling of certain CPT codes and reductions in the fee schedule has reduced payment for certain VAC procedures by as much as 47 percent.

Situational Analysis

With the decline in payment under the MPFS, VACs operating under the EOP model face the difficult reality that they may no longer be profitable or viable as ongoing business enterprises. Many VACs will have to significantly reduce operating costs to remain profitable, and some will be forced to shut down.

There is an attractive alternative available for some VACs, however: conversion from the EOP model to a freestanding ambulatory surgery center (ASC). Despite the reductions in vascular access payment under the MPFS, payment for vascular access actually increased under the 2017 Outpatient Prospective Payment System and ASC fee schedule. As a result, many of the VAC procedures that can no longer be performed profitably in the EOP setting are now economically viable in an ASC setting.

Billing for vascular access in the EOP setting is performed globally (i.e., both the professional and technical components of payment are included), whereas ASC billing includes only the ancillary technical component, and may be subject to multiple procedure discounting. As a result, a cross-walk of payment from an EOP to an ASC requires an in-depth CPT level billing analysis. Depending upon the underlying procedure mix, some VACs may experience a 40 percent or greater increase in payment for the technical component in the ASC setting (while still billing for the professional component through their medical practice).

The exhibit below shows a high-level summary of the rate changes from 2016 to 2017 under the ASC fee schedule.

Not surprisingly, many VACs that currently operate under the EOP model are evaluating whether a conversion to an ASC might be viable and legally permissible, and what types of costs might be associated with such a conversion. For investors in VACs, such considerations set the stage for an important cost-benefit analysis that may have a significant impact on the value of the VAC.

Based upon a preliminary review of the 2018 fee schedules, angioplasty and thrombectomy will have a 15 percent  reduction in payment in the ASC setting.  These two procedures account for a majority of the case volume and revenue in most VACs, and this change therefore will have a material impact on many centers. Unlike 2017, where EOPs received major cuts in payment, EOP payment will experience a slight increase of about 2.5 percent in 2018.  

Although we have not conducted a detailed analysis of the fee schedules, a high-level review suggests that although ASC conversion remains a viable economic alternative to the EOP setting, market participants will need to closely monitor future changes in payment and carefully evaluate the risk of further reductions in the ASC fee in their conversion cost-benefit analysis.

Comparative Case Example

The exhibit below offers a comparative example showing the impact on revenue, costs, and profits for three representative VACs.

Revenue and Expense Summary: Comparison of Vascular Access Centers (VACs) In Extension-of-Practice Settings With VACs In Ambulatory Surgery Center (ASC) Settings

For purposes of comparison, adjustments were made so that each of the VACs in the exhibit would have the same case volume, but variations in revenue per case are maintained to account for individual procedure mix and regional payment factors. Direct and indirect expenses are normalized and modified to exclude center-specific expenses.

It also should be noted that, whereas the revenue shown for the EOP-model VACs includes both the professional and technical components of payment, the revenue for the VACs in the ASC setting reflects only the technical component. Similarly, the EOP setting also includes physician compensation expenses for the interventional nephrologists, whereas the ASC setting does not. For procedures performed in the ASC setting, the professional component of revenue continues to be billed by the physician separately, and any associated compensation expense also remains with the physician’s professional medical group.

Valuation Considerations

As operators of VACs consider their options following the fee schedule change, many are considering divestitures or other transactions involving their VACs. Due to the regulatory environment, any transaction involving the VAC should be priced at fair market value (FMV) through an independent appraisal. The factors to be considered in the valuation will differ depending on whether the VAC is in an EOP setting or an ASC setting.

Valuation as an EOP-Model VAC

The valuation of a VAC structured as an in-office ancillary service line is highly nuanced, subject to significant regulatory risk, and it requires detailed analysis to properly identify and allocate revenue and expenses between the professional practice and the ancillary service being transacted.

The first step in such a valuation is to perform a coding analysis to isolate the ancillary technical component of revenue. As mentioned above, VACs operated as an EOP bill globally, but when valuing the service line as a carve-out, the professional component of revenue remains with the practice and should not be included in the valuation. In addition to isolating the technical component of VAC payment, it may be necessary to eliminate certain services not directly associated with vascular access. In a VAC operated as an EOP, the participating physicians may perform services in the VAC, such as office visits or consults, that are not typically associated with stand-alone ancillary businesses, and these services (and the related revenue and expenses) should be reallocated to the professional practice in the valuation of the VAC.

The second step is to clearly identify the direct and indirect costs associated with the VAC’s operations. Costs may be more easily identified for VACs that have separate financial reporting or that are located in separate and distinct physical spaces than for VACs that lack these characteristics, but in general, staff and other operating expenses tend not to be clearly delineated between the VAC and practice. Nonetheless, in any proper valuation, it is critically important to carefully identify the expenses necessary to support the VAC on a standalone basis.

The third step is to identify the equipment and other assets associated with the VAC, which may be comingled with the asset register for the practice. This step can be accomplished through a physical inventory and appraisal or with help from the practice to identify assets on the register that are associated with the VAC.

Once these steps are performed, a restated profit and loss statement and balance sheet can be created, and the VAC can be valued using traditional methods, such as the discounted-cash-flow (DCF) method. ^a Using the existing fee schedule and payer rates in this model will establish a baseline for evaluating existing value and the cost-benefit of conversion. 

Valuation as an ASC

FMV should account for the highest and best use of an asset (or business), considering all legally permissible and economically viable alternatives to the status quo. Thus, appraisers tasked with valuing a VAC during this point of inflection in the market should consider within their appraisals whether the VAC’s conversion to an ASC is legally permissible and economically viable. In some cases, the conversion will not meet these conditions, and even in those instances where conversion is feasible, the inherent uncertainties (risks) and incremental investment necessary to convert should be considered.

To determine the feasibility of conversion, and the associated value proposition of doing so, it is critical to understand the anticipated uptick in revenue, direct out-of-pocket costs, timing, risks, and other considerations that may affect the VAC. Key considerations include the following, among others.

Certificate of Need (CON) requirements, where applicable. Depending on the state in which the VAC operates, a CON may be required to operate as an ASC. For a VAC located in a CON state, the first step in considering the VAC’s value as an ASC should be to evaluate the likelihood of CON approval. CON laws vary from state to state, and the determination of need can vary dramatically from county to county. Depending on the process required for the specific market, this effort could add significant costs and timing delays, and it could prevent conversion altogether.

Based on our conversations with CON consultants and attorneys, it seems clear that the probability of obtaining a CON in a highly contentious state or county is very low. Moreover, some also suggest that, even if CON approval were obtained, costs could exceed $100,000 per operating room (OR) and could be even higher with litigation challenges and appeal costs. Moreover, the timeline of receiving CON approval could take anywhere from a few months to a few years depending on the amount of contention in the local marketplace.

If the state in which the VAC resides requires a CON for an ASC, it will be necessary to review the associated state’s published rulings and recent reports, which often provide insight into the timeline, costs associated with a CON, and state-specific nuances that may raise additional challenges. Special insight also is required to complete a comprehensive filing for the VAC’s CON.

If a CON application is denied or if analysis concludes significant time and resources will be needed to acquire the CON, the VAC’s best option might be to seek to purchase a CON from an existing business that has an unused or underused licensed OR. The cost of purchasing a CON can vary significantly depending on the demand in the state or county, in some cases exceeding $1 million per OR. And CON approval may still be required under such circumstances, although the approval process tends to be more streamlined.

Development and construction costs. Depending upon the location and layout of the current facility, physical relocation may be required to meet the requirements for an ASC. Even when relocation is not required, significant capital expenditures may be required to upgrade the facility to ASC standards. Depending upon the location, layout, and size of the VAC, construction costs for conversion could range from about $200,000 for a relatively simple upgrade to more than $1 million per OR if a complete buildout is required. Such costs may include architectural design and state plan review, construction management, permitting, HVAC and electrical upgrades, accessibility improvements, and equipment upgrades. In some instances, the VAC may need to cease operation for some time as these improvements are being made, adding opportunity cost and lost revenue to the development process.

The coding crosswalk. Once the CON analysis has been completed, the next step is to perform the coding crosswalk. As discussed previously, the fee schedules underwent significant changes in 2017, including bundling of codes and significant shifts in payment. In developing projections for a VAC through a transition from EOP to ASC, understanding the effects of these changes is one of the most critical considerations in evaluating the conversion. Therefore, access to detailed billing and coding and revenue cycle insight and information is of the upmost importance.

Payment during the transition phase. When an EOP-model VAC is converted to an ASC setting, the VAC will need to obtain a new Medicare payer ID and negotiate new contracts with commercial insurers. As a step in the process of obtaining Medicare approval, the VAC will be required to perform a certain number of cases that will not be eligible for Medicare payment for about 45 days. The VAC also may need to operate out of network with commercial insurers for some period until contracts are negotiated and in-place. Payment during this transition phase will be highly uncertain, and a phase-in period with no payment may need to be part of the DCF development. Beyond the phase-in period, there also will be uncertainty regarding the commercial rates that will ultimately be determined through contract negotiations. For valuation purposes, it may be most appropriate to use Medicare rates as a starting benchmark, given that the payer mix of ESRD patients will consist largely of Medicare patients. In some markets, however, commercial payment may actually be lower than Medicare for certain VAC procedures.

The need for Medicare approval. Gaining Medicare approval can be a time-intensive process. Understanding the Medicare approval process, requirements, and timeline is critical. As stated previously, a VAC should budget for the numbers of unpaid procedures it will need to perform in the ASC setting while awaiting approval and the likely timeline for this requirement. This process could take a couple months at a minimum, and possibly much longer, depending on inspector availability.

Differences in operating expenses. Operating a VAC as an ASC likely will require additional direct and indirect costs, and the magnitude of these incremental expenses varies based on specific circumstances. Examples of some of these additional costs may be increased occupancy expense (e.g., rent and utilities), additional administrative oversight, and different management fee structures. 

Risk. Each of the elements stated previously have a high degree of uncertainty, and a change in any one of the assumptions could have a material impact on the viability of conversion to an ASC and the value proposition. Therefore, the rate of return used in the valuation model should account for this additional risk. Thus, the rate of return should be greater than that used to value the VAC as an EOP, and the magnitude of the premium should reflect the degree of variability and potential magnitude of a deviation from expectations.

Defining Circumstances

Although conversion to an ASC can yield significantly higher profits for a VAC, it is still possible for a VAC to remain a going concern in the EOP setting depending on its case mix and expense controls. By incorporating the revised assumptions described here into an alternative DCF scenario, a VAC provider or operator can compare the VAC’s value under the EOP model with that in an ASC setting. Simply put, if the VAC’s value as an ASC on a risk-adjusted basis proves higher than its indicated value as an EOP, and conversion is viable, then FMV should be determined using the ASC conversion scenario.

If, however, conversion is not feasible (for example, because of CON restrictions or other challenges) and the VAC under the EOP setting also is not viable, the providers face the decision of liquidating the assets of the VAC and moving cases to an already existing ASC. 

Given the recent payment changes for vascular access, it is critical to understand all of the moving parts and value-drivers when valuing a VAC. When possible, healthcare finance leaders, operators, and providers contemplating a conversion of an EOP-model VAC to an ASC setting should seek guidance from informed market participants and operators, including those that have successfully undertaken such a conversion, to thoroughly understand all the pertinent risks, timing, and costs of a transition.

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Brad Brumbaugh, CFA, CBA, is manager, Business Valuation Services Division, VMG Health, Denver.

Jason Ruchaber, CFA, ASA, is managing director and office leader, VMG Health, Denver.

Silas Eldredge is a senior analyst, Business Valuation and Research Divisions, VMG Health, Denver.

Footnotes

a. It should be noted that the use of the market approach to valuation may not be appropriate for VACs until the market has assimilated and priced the risk associated with the fee schedule change. Multiples gleaned from historical transactions involving VACs may not properly account for these changes.