Last year, we outlined reasons on why having an appraisal review completed may be a prudent step in the transaction process.  Healthcare transaction activity during the last year has continued at a rapid pace, with buyers and sellers becoming increasingly aware of the resources available to them in ensuring a fair and equitable transaction is consummated.  As a result, we have experienced an increased demand from our clients for appraisal review services.  An appraisal review may be a wise choice in a variety of circumstances, such as when a seller is unable to fully interpret an appraisal the purchaser completed, or when negotiations have stalled as a result of a purchaser and seller having completed separate appraisals with widely different results.  We have also been engaged to complete appraisal reviews when both the buy-side and sell-side of a transaction agree to jointly engage an appraiser, whose resulting work product was skeptically viewed by one or both of the engaging parties.  As a follow-up to our article from last year, we have outlined some recent outcomes that have resulted from our appraisal reviews over the last year.

We completed an appraisal review of a diagnostic imaging center that was completed by an internationally renowned accounting and consulting firm.  In their application of the Market Approach, three of the five comparable public companies that were selected by the firm were Fresenius, LabCorp, and Quest Diagnostics.  Fresenius, an international firm that is headquartered in Germany, is focused on the provision of dialysis services and associated equipment and consumables, while LabCorp and Quest Diagnostics are focused on providing outsourced clinical diagnostic testing through the use of blood samples and urinalysis (among others).  These entities are not comparable to a diagnostic imaging center, which not only provides very different services, but has also been facing a much different trend in payor reimbursement in recent years.

The Income Approach prepared by this firm modeled several expenses that were applicable to that of the post-transaction hospital purchaser.  Included was a hospital corporate overhead allocation, which substantially reduced the resulting cash flows that were utilized in the discounted cash flow analysis.  As the imaging center was performing on a standalone basis without the need for these expenses, including these expenses resulted in a standard of value that was not applicable to the scope of work – investment value instead of fair market value (“FMV”).  The FMV standard requires an appraiser to model the cash flows of a hypothetical purchaser – not a specific purchaser (i.e., a hospital).

Lastly, this firm did not take the time to understand the entity they were appraising.  The imaging center expense structure had been sharing staff with a related radiology professional practice that had common ownership.  The imaging center expense structure had also been reporting certain physician-related benefit expenses.  Adjustments were necessary to move expenses related to the physician practice off the expense structure of the diagnostic imaging center, which resulted in a sizeable increase to the imaging center’s operating margin.

We completed an appraisal review of a medical group that was completed by a national healthcare valuation firm.  While the appraisal did not include a report narrative, the valuation exhibits were very detailed, containing 70 pages of data analysis and valuation modeling.  Despite this level of detail, some basic addition and subtraction math errors resulted in EBITDA being understated by nearly 100 percent.  This materially affected the value of an entity which was already valued at tens of millions of dollars, before consideration of this adjustment.

We conducted a separate appraisal review of a medical group that was completed by a national healthcare valuation firm, in which the firm misapplied the excess earnings method in determining normalized physician compensation.  The firm utilized benchmark data in their analysis which had such a small sample size of respondents and great variance in the data year-over-year, that generating a statistically significant conclusion from this data was impossible.

FMV Pitfall: Most healthcare appraisals are complex valuation assignments.  Mistakes that seem small may have large repercussions on the conclusion of fair market value.  The extra cost and time associated with completing an appraisal review should be viewed as a smart investment in ensuring that multimillion-dollar transactions are being completed at the correct value.