In 2010, ASCs and surgical hospitals can expect to encounter numerous trends and opportunities, including consolidation in the industry, increases in multiple purchases and a growing number of physician-hospital joint ventures.

Below is a brief discussion of trends and opportunities in the ambulatory surgery center (ASC) and surgical hospital industries during 2010.

Consolidation in the Industry

We expect to see significant consolidation in the ASC and surgical hospital industry during the coming year. For those who attended McDermott’s 2010 ASC Symposium in Miami, Florida, you will recall the general agreement among many industry leaders that several factors likely will lead to this trend. While there are several large companies in the ASC and surgical hospital space, the industry remains fragmented. Moreover, the struggling economy and the uncertainty created by the wrangling over health care reform held at bay many buyers during late 2008 and 2009. A number of stand-alone facilities and smaller ASC/surgical hospital companies have experienced drops in volume or reimbursement and are in search of capital and/or economies of scale. In addition, a number of companies backed by private equity sponsors may be anxious for some level of liquidity (if not complete exits) from their investments. All of these factors will likely create an environment robust with consolidation activity over the next 12 to 18 months.

Physician-Hospital Joint Ventures

As part and parcel of the consolidation trend, significant increases in physician-hospital joint ventures are likely during 2010. With health reform legislation still uncertain, congressional changes to the Stark Law whole hospital exception remain in limbo. Thus, a window of opportunity may exist for physicians and hospitals to enter into joint venture arrangements involving specialty hospitals, including surgical hospitals. Many such arrangements may be structured as hospitals within hospitals or utilizing existing facilities in order to expedite the licensure and accreditation processes. Ambulatory surgery centers should avoid any moratoria on physician ownership and remain a strong vehicle for alignment of hospitals and their physicians. However, we expect that hospitals will demand, and often receive, majority equity positions in these deals so as to allow the venture to take advantage of their managed care contracts. In addition to these ventures, we have seen some outright acquisitions of physician-owned ASCs by hospitals. Often, these facilities are converted to hospital outpatient surgery departments, in order to take advantage of higher hospital outpatient department (HOPD) rates, and accompanied by a management contract allowing the former physician owners to manage the facility.

Increases in Purchase Multiples

Concomitant with the consolidation trend should be an increase in purchase multiples. The last several years have seen a general downward trend in purchase prices. However, several recent transactions indicate an upward trajectory in acquisition price multiples. Recent indications are that control transactions may command implied EBITDA multiples as high as 6 to 7, net of funded debt. It is unclear, however, whether these levels trend even higher and reach those seen in 2007 and 2008. Market multiples of the few publicly traded entities in the space will limit, somewhat, these prices.

Health Care Reform and Physician Ownership of Hospitals

The continuing saga of health care reform has infused the marketplace with uncertainty; as such the future of physician ownership of surgical hospitals remains in question. There is little doubt that opponents of these facilities will continue their legislative assault on the model. Proposed changes to the Stark Law “whole hospital exception” have limited transaction volume and have put at risk millions of dollars of capital invested in facilities under development. Physicians and other investors in these facilities continue to scramble to gain licensure and Medicare certification, and in some cases to increase bed and surgical capacity, in anticipation of some form of permanent moratorium on development and expansion. This uncertainty may provide opportunities for investors with the financial resources to bring certain of these deals to closure. In addition, physician investors may want to consider the “soft landing” of a hospital partner, or a large industry consolidator of these facilities, in the event legislation is passed.

Reimbursement Trends

Ambulatory surgery centers are not immune from downward reimbursement pressure. The various changes to the ASC reimbursement structure proposed by Medicare in 2006 will take full effect by 2011. Under this new scheme, most procedures will be reimbursed at, approximately, 65 percent of HOPD rates (unless capped at physician office rates). It appears that certain specialties, such as orthopedics, ENT and general surgery, will fare well, while others, such as gastroenterology and pain management, will continue to be pressured. Moreover, there will be winners and losers, on a procedure-by-procedure basis, even within specialties. In addition to the above, insurers and certain state enforcement agencies are putting increasing pressure on ASCs and hospitals that provide out of network services to patients. For example, a major insurer in New Jersey has brought suit against several ASCs and hospitals alleging deceptive billing practices, violation of state laws related to waivers of co-pays and deductibles, etc., in connection with their out-of-network billing strategies. This leverage is not likely to let up. Thus, developers of de novo facilities and buyers or others considering transactions with existing facilities are well advised to do their homework and understand specialty-specific reimbursement trends as well as the economics and risks attendant to a facility’s out of network strategy.