EXPERT OPINION: A Conversation with David Friend

July 24, 2015

In this Expert Opinion, David Friend, Managing Director and CTOBDO Center for Healthcare Excellence & Innovation, discusses due diligence in the skilled nursing market...

Read the Transcript

David FriendDavid Friend is a Managing Director and CTO at BDO Center for Healthcare Excellence & Innovation. He has more than 35 years of global healthcare experience and provides advice on mergers and acquisitions, strategy, clinical integration, physician engagement, and enhancing shareholder value. He received his BA from Brandeis University, his MBA from The Wharton School of The University of Pennsylvania and his PhD from The University of Connecticut.




Read the Interview Transcript:


Steve Monroe

I’m pleased to have with me Dr. David Friend.  He’s the Managing Director at BDO Center for Healthcare Excellence & Innovation. 


He actually has an interesting background, for the long term care junkies out there who are listening.  The formerly Beverly Enterprises, which was taken private and became Golden Living, he was one of the senior executives there, and actually the head of all the entire clinical area for Golden Living for several years.  So he’s got a lot of experience in the due diligence, both on the financial side and the clinical side.  


So let’s get right to it.  Let’s talk about due diligence.  You know, the skilled nursing industry has changed a lot in the last 20 years.  A lot of people would say it’s changed a lot in the last 10 years.  When I got in the business 30 years ago, the big new thing in due diligence was environmental issues.  So what’s the biggest thing that’s changed for buyers today when doing their financial due diligence?


David Friend

Well, I think the biggest thing that’s changed is that the reimbursement world is being completely rethought, and that’s being largely driven by the new legislation, the ACA, the IMPACT Act.  And the big driver is that reimbursement increasingly is going to be driven by clinical outcomes.


So really, for the first time ever, what you get paid is going to be increasingly dependent on the quality of the care in the building.  And that’s a complete sea change from anything that you’ve ever seen before.


Steve Monroe

So that’s obviously the biggest thing.  Is part of that also going to be with managed Medicaid, where they’re going to be looking at providers, taking the lump sum of money, and basically telling the provider, this is what we’re going to pay you, and this is how long this person is going to stay there?


David Friend

Oh, absolutely.  The ramifications are as you describe, and they’re all over the place.  So you’re going to see a proliferation of managed care, which is going to put new demands on the skilled nursing facilities to provide certain quality and levels of care in return for payments.  You’re seeing a move about bundled payments, where the skilled nursing facilities are going to have to work with hospitals, physicians, to provide a comprehensive service. 


So for example, with a hip replacement, in a bundled payment situation, you will literally have the consumer pay one price and receive the implant, receive the hospital services, the surgical services, the skilled nursing services, the rehabilitation services, the home services. 


So the skilled nursing provider is going to be one of those players, and they’re going to have to really know what their costs are.  They’re really going to have to provide high quality, and they’re going to have to work well with those other suppliers to successfully, for example, get that hip replaced and get that patient out walking again.


That’s a completely new way of doing business in terms of pricing their services; frankly, having the financial capacity to absorb the risk of delivering a service for a certain cost.  You’re seeing accountable care organizations asking the skilled nursing facilities to do more.  In many cases, the last day of hospitalization is increasingly becoming the first day at the skilled nursing facility.  And finally, the whole emphasis on outcomes and five star ratings is just going to increase. 


So what you’re really seeing is the skilled nursing industry is now truly being incorporated into the medical industry.  Really, up until now, it was kind of a stepchild to traditional hospital and medical care, and that, I believe, is really coming to an end.  I believe the skilled nursing facility is going to be integrated into traditional medicine, and that’s a sea change for every one of them. 


Steve Monroe

But how do you, from a due diligence perspective, if you’re consulting with a client, how, from a due diligence perspective, do you look at those changes and advise that client on basically, one, whether they should buy the nursing home or not; and two, how that’s going to impact the cash flow?  Because he’s looking at the cash flow today is $800,000.  Two years from now, when all these things start moving along, that could be $1.2 million, or that could be $200,000.  How do you advise them on that, or educate them?


David Friend

You’re absolutely right.  The big sea change is that traditionally, the EBITDA was fairly stable.  You could project some kind of growth rate out there.  So the multiples that folks were paying was a fairly stable concept.  That is completely being thrown out the window.  And the people who are still valuing that way, which is largely many, we believe are making fundamental mistakes, and there is tremendous mispricing going on in this industry. 


We believe the way you do this going forward is you’ve got to have a four part multidisciplinary approach.  Clearly, you’ve got to look at the finance.  But you also have to then integrate the clinical perspective.  You’ve got to use data analytics to understand your market.  And you have to have a good understanding of the legal and regulatory environment that you’re working in.


So it’s really creating a 360 degree analysis using financial, clinical, data analytics and legal and regulatory.  And I’m happy to expound on that on any of the above.  But that is the approach we’re taking, and that’s in fact why we created a center for healthcare excellence and innovation.  We, in fact, believe if you’re not looking at all four, you’re basically doing an incomplete analysis.  The old way of just looking at finance, just looking at quality of earnings, we think does not tell you what you need to know going forward.


Steve Monroe

All right, we’ll talk about the clinical side in a second.  But we’re looking at the market.  It’s getting complicated.  So from a buyer’s perspective, is skilled nursing, with a higher acuity, different payers, you’ve got Medicare Advantage, you’re going to have managed care for Medicaid.  Is it getting too complex for the small owners; or a newcomer who’s thinking, hey, the elderly market demographics, let me buy a skilled nursing facility.  Are they crazy?


David Friend

No, I don’t think they’re crazy.  I don’t think it’s size so much as brains.  I think the smart buyers who understand these concepts, who are willing to develop skill sets in the finance and clinical and data and legal, can do extremely well.  Large buyers who are not particularly sophisticated are going to have as much trouble. 


So I don’t think it’s going to be so much size as frankly bandwidth and ability to really integrate these concepts.  And there are folks out there who know how to do it.  They’ve been very successful investing for many years.  But it’s a new breed, a new way of thinking, and some people are able to adapt more easily than others.  o I think a lot of it is, how flexible are you in your ability to adapt to a changing environment? 


Steve Monroe

Yeah, except size can result in experience and dealing with these issues.  And if you’re new or only have one or two facilities, you may not have that experience which can educate you on what’s going on.


David Friend

Oh, I think you’re clearly right.  There are certain advantages of scale, and we can talk about that.  But I think clearly, as you look at investing in IT, if you look at trying to have a market dominating position, which we believe is the approach except that scale is important. 


But there are a lot of big organizations that we think are over-levered, that are not particularly innovative, and are very vulnerable to the market place.  So it’s not just the function of size.


Steve Monroe

Let’s switch to the operational side of the business on due diligence.  Obviously you’ve got the issues of staffing.  But what’s the biggest operational issue that one should look at from a due diligence perspective?


David Friend

Well, on the clinical side, we think, for example, outcomes is just imperative.  So increasingly, we are looking at re-hospitalization rates, rates of opioid usage, rates of antipsychotic usage.  These are going to be very important for the survival, and frankly for these institutions to thrive, that they demonstrate that they are producing good outcomes.


And they need to be verifiable.  We will go in and often we’ll find institutions claim that their re-hospitalization rate is X.  And we’ve often gone in and done, in essence, a verification process and have found that those rates are not as reported.  So this is a very significant issue in doing diligence.  That what people are claiming to be true clinically is not necessarily the case. 


Steve Monroe

How do they get away with claiming that when it’s not the case?  It’s something that’s so relatively easily identifiable. 


David Friend

Well, I’ll give you a perfect example.  Look at the Veteran’s Administration.  They were claiming that the waiting time for veterans was a certain number of days, and they collected hundreds of millions of dollars of bonuses based on very simple, verifiable data.  People went in and said, hey, guess what?  They’re lying about the numbers because they want to get paid lots of bonuses. 


As you know, the FBI is crawling all over the VA right now.  This is a huge problem at the VA.  And it isn’t just the VA, Steve.  We believe this is a potential problem throughout the system.  And if you’re not doing diligence, you could end up just like the Veteran’s Administration.  So this is a very significant problem that is really not being discussed.


Steve Monroe

How about with staffing when you’re doing due diligence and a target facility is very deep into agency staffing?  How do you go in and really determine whether they can really cut it?  Because so many buyers, when they talk about their deals, they say, well, there’s 800,000 of agency staffing and we’re going to cut it to zero.  How do you determine how realistic that really is on a due diligence perspective, or whether the seller is basically stuck and has to because that’s just the market?


David Friend

Well, I think again, you can look at things like, we look at turnover.  We look at retention.  So how many people have been in the place for five years?  That’s very important to us.  What is the retention rate?


It’s clear to us if you look at five star ratings, if you look at any quality of care measure, the more stable your workforce, the better the quality of care.  Because providers have to work together for periods of time to get better.  If you look at operating rooms, all the studies show that experienced teams that have been doing something together for a long time are a lot better in terms of their performance than surgical teams where there’s temporary nurses and agency nurses and continual change.


So in general, if you have a high agency level workforce, you’re already behind the eight ball in terms of quality, because it’s just hard to have people who have not worked together for a long time.  As you see skilled nursing facilities increasingly create specialty programs, in heart or lung or diabetes or other chronic conditions, once again, you’re going to want to have an experienced team.  Remember, this is a team sport, so you need people who work together a long time. 


We believe that one of the great assets is going to be a stable, a well-trained, loyal workforce.  And for those people who are unable to provide that, we think they’re significantly disadvantaged.


Steve Monroe

Let’s talk about that.  When you’re doing a due diligence, let’s just say there’s some quality care problems, and there’s a lot of agency staffing.  How can you determine, is the quality issue because of the agency use?  Or is the quality problem something that’s just more inherent in management there?  How do you figure that out?


David Friend

I think what we do is, often we’ll take an initial look at data.  So we’ll look at traditional metrics.  We’ll look at the turnover rates.  We’ll look at the loyalty rates and the fact of how many people have stayed on retention.  But then more importantly, we actually walk the buildings.  I mean, I’m a physician.  We have a team of physicians, nurses, so we’d care for these patients.


So we will actually walk in there.  And there’s no substitute for a hands-on look at what’s really happening, and why are there problems.  I chair the clinical affairs at the University of Connecticut School of Medicine, a teaching hospital, so I used to do this work all the time in the hospital setting to understand when we had a problem.  Was it ill-trained people?  Was it poor systems?  Poor management?  We wanted to get to the heart of the matter so we could fix it.


And I think those same analytical skills that we brought, again, to organized medicine in the hospital world, is now coming to skilled nursing.  And again, for folks who are comfortable with hospital and skilled nursing, it would make sense.  But many of the people in skilled nursing have no hospital experience, and I think are at a huge disadvantage of going forward in this market place, which is increasingly going to ask the skilled nursing facility to become, in essence, a step-down unit of the hospital.  That’s just the way the world is moving. 


Steve Monroe

And one of the other things we see all the time is, as people are buying skilled nursing facilities, is they’re constantly saying, well, I’m going to double that five percent Medicare sentence to 10 or 12 percent.  And when you’re going in and doing the due diligence and advising your client, how easy is it to really figure out, is that viable?


David Friend

Well, there’s only a certain number of Medicare patients.  So everyone just wants to wave a magic wand and say, we’ll get the quality mix up.  We’ve seen very good operators do it.  We’ve had transactions where you had very low penetration, one, two, three, four, five percent Medicare.  A year later it’s 30 percent. 


So a very skilled operator can do it, but they focus on some of the things we’ve discussed, and many others.  Which is having that stable workforce, really committing to the programs, really committing to be all in for the patients.  And really provide the high quality clinical care even if their EBITDA margins are not all that attractive the first year.  That they’re going to invest in getting the care to where it needs to be.


But again, that requires a sensitivity to the care.  Some of the buyers are simply financial players.  They don’t really understand the clinical component.  They tend to ignore it because they don’t understand it.  And for them, they’ll just do a spreadsheet model and say, well, this is just simple.  We’ll increase the Medicare percentage.  And they have real difficulty, because you’ve got to provide good quality care.


The other things that we look at, we use data analytics to ask, what does the market place look like?  If there are Medicare patients that are classically being underserved, then clearly there’s a greater opportunity to grow your share than if there are not.  Or if you do a competitive analysis, and you can understand where some of the weaknesses in the market, and where you have an opportunity to take patients away from competition.  Or if you understand your hospital referral network, and understand where you have opportunities to attract patients from those hospitals.


So it can be done, but you have to be thoughtful about it and really have a plan.  Simply saying that you’re going to do it is not a plan.


Steve Monroe

So your scenario where your client took them from two percent to 25 percent plus in Medicare census, were they basically taking from other providers, or was that an underserved Medicare market that was just screaming for, we need more help on the skilled nursing side on Medicare?


David Friend

No, in many ways they were taking.  They were taking from others.  They were able to go to the hospital referral networks and say, what are you not getting from our competition?  We’ll get it for you.  So we advised them to place one of their own staff in the hospital ER.  They were available to help look at patients.  They were available to help direct patients in the discharge planning process to their facility. 


We’re also seeing a movement, because of the pressure on managed care, to take that last day at that hospital, that $3,000 day, and instead, relocate it to the SNF.  And we have SNF clients that can command $1,200, $1,300, $1,400 a day if they can provide that high quality hospital level care, because the insurance says, well, instead of spending $3,000 I’d spend $1,200, so I’ve done well.  The SNF operator is very happy because instead of getting $200 for Medicaid he’s getting $1,200 for Medicare plus SNF rates from that hospital.


So it’s really the ability to substitute the more expensive hospital for the less expensive but same high quality SNF.  We call that four R’s—right care, right place, right time, right cost.  And the good SNF operators really start to understand what their role is in getting the right care at the right place, which is their place, at a better cost than the hospital during that last length of stay day of the admission.

So that’s a big trend going on in the industry right now. 


Steve Monroe

The other thing we hear all the time is a small operator is buying, whether it’s skilled nursing or assisted living, but we’re talking about skilled nursing right now, buying a facility from a large chain.  They come in and they basically say, well, we’re going to double or triple the EBITDA because it’s been mismanaged, there’s no attention from headquarters and all that. 


I know it’s true, but when you in and advise on due diligence, what are you seeing as what the big company is not doing in terms of why they’re not operating it very profitably, but the smaller guy comes in and can double, triple EBITDA? 


David Friend

Well, each has advantages.  So the big company should have advantage of scale.  So whether they’re doing purchasing in their areas of contracting, they should have advantages.  And they should have geographic concentration, because these are all local businesses.  So no matter how large you are, you’re still small.  The largest managed care company in the United States, United Healthcare, is still only at 14 percent of the addressable market.


So no one is that large in reality, from a national perspective.  So we always look at the local market.  How strong are you in the local market?  And I think what the small providers often can offer, frankly, is just more management bandwidth.  A lot of the referral process is kind of one-on-one.  If you have good relations with that hospital, good relations with those local providers, and if you have local people, local employees who are really committed to your business and will give the additional satisfaction. 


And not only to the patients.  Remember, the skilled nursing has two customers.  Not only do they have customers as the patients, but the physicians and the people who refer to their facilities are also customers.  And often the larger chains don’t see that.  They don’t take the time to build the relationships to provide that service on a Friday night, or a time when it’s difficult to place a patient. 


So the smaller operators can often give better customer service to their referral providers.  And that can make an enormous difference in their ability to attract the kinds of patients that they want. 


That doesn’t scale as well.  That’s more a, how much attention, how important am I to you, interaction. 


Steve Monroe

Got you.  Okay.  Well, this is all interesting.  Is there something I missed?  I know we could talk about this for an hour or so, but any particular thing you want to add?


David Friend

I would just say it again, that we are suggesting to people who want to buy or sell that in a financial area, not only do you look at the quality, but they recognize there’s a real linkage to clinical outcomes.  That they’re really going to have to understand their cost of care.  That they’ve got to understand their ability to absorb risks.  Those are things we would look for diligence financially. 


In the clinical area we would say, outcomes are critical.  Five star ratings are critical.  And you’ve got to verify.  As we talked about the VA, make sure you’re verifying that what you’re being told is true. 


On the data side, really understand your demographics.  Where do the patients and the families live?  What’s the travel time to your skilled nursing facility.  What are the referral patterns like? 


And finally, on the legal and regulatory, it’s really important to understand where the federal legislation is going to go.  Whether it’s the Affordable Care Act, the IMPACT Act, recognize that there’s a Center for Medicare & Medicaid Innovation that’s looking to change things all the time.


And then you also have to understand the state that you’re in.  DSRIP is coming to New York, Texas, California.  That will change Medicaid.  Opt in programs where patients are going to be automatically enrolled in Medicaid unless they do something bad; it’s going to change the world. 


So I think those four areas.  It is the combination of the clinic, the finance, the data and the regulatory and legal we think will give you an advantage in doing your diligence and buying or selling smart.


Steve Monroe

Okay.  Dr. David Friend, thank you very much for sharing your thoughts on this issue.  I think due diligence, as it gets more complicated, is going to get even more important.  Thanks for spending time with me.


David Friend

Well, thank you very much.  I appreciate it.


Steve Monroe




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