Where will the turbulent M&A Market go next?
An episode from the NEXTLEVEL Owner Podcast archive.
Full transcript
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Good afternoon and welcome to another episode of Paul Martin's Crucial Conversations. Today we are very excited to have with us Richard Leaver and Richard will kick off our deli series. Now, Richard is a physical therapist, but he is also the CEO of Alliance Physical Therapy Partners. And Richard has a long and decorated career in physical therapy, having spent time with phys physiootherapy associates, ATI, and Richard graduated from one of my favorite universities and one of the best universities in the world, the University of Michigan. Now, Alliance PT Partners is a private equity-backed company that's based out of Grand Rapids, Michigan.
And currently they have 15 unique brands, meaning companies across the United States that are a part of Alliance and over a 100 clinic and again in 15 states. Richard, great to have you with us today. Thank you so much. I'm very humbled to be here. Certainly my career has been long. And I don't know if it's been distinguished, but that's yet to be told. But thank you very much. No, it's always great to have you and I'm looking forward to hearing some of your thoughts because I think you know some of the questions that we're going to talk about today.
Everybody that calls us are answering these questions. So I am just so excited to get the wisdom of you know someone who's in this every single day and hear what you have to say about you know some of these things. So let's jump right in. First, let's talk about the trajectory of the M&A landscape in rehab. What are some of the key factors that are driving this current trajectory of the M&A landscape? Okay, I think in order to talk about the challenges, headwinds, tailwinds, I think first of all, we got to talk about, you know, what is exactly the trajectory at the current time.
Things have essentially slowed down. I think if you look at all M&A activity, it's slowed down. Health care is not immune to that. But when we talk about slowed down, from what I read and understand, it's really slowed down to what was the prior norm really. So, it's still significant activity going on. It's just not as frothy as it was for the last few years. And how that long that will last for, we can talk about a little bit later. There's definitely some headwinds though. Essentially, you know, the elephant in the room is really interest rates.
Wherever interest rates really go, I think deal valuation and number of deals probably follow. And then also there's cash has been a factor as well. So there's been a lot of purchasing of assets, a lot of buyers being act very active the last few years. And I think in some respects there's some digestion of what's being purchased at these companies. So I think that has perhaps in part impacted perhaps the amount of deals and also the size of the deals. And then also another headwind has really been the financial performance of the sellers entities.
You know since co there have been challenges in originally it's directly related to code and then more recently the economic challenges which has really impacted I think a lot of businesses regards to their ebiter and eer margin which has perhaps impacted the number of deals and but you know having said all that there's definitely still a lot of tailwinds and they're not going away there's still a very large pull pool of interested buyers. Every year there seems to be more private equity looking at the rehab space.
However, you know, even though the pool is increasing, I think there's as buyers they're becoming more disconcerning with regards to what they're looking at. And I also believe that there's you know definitely been work or definitely been improvements as it pertains to controlling inflation which will at some point have a knock-on effect with all being well reducing the interest rates and the ability to borrow and I think that will kind of free up the M&A market again going forwards at some point you may even see actually in the short term an improvement in the net interest margin.
What that essentially means is the difference between what the banks can obtain money at and then the interest rate charged to its customers. And that spread is quite large at the moment which is putting a lot of pressure on larger entities buyers and all being well you'll see a reduction in that spread which will essentially make money a little bit cheaper to borrow and hopefully that will translate into the ability like Alliance to actually be able to perhaps purchase more entities. You know, first of all, your word frothy in there just that that's such a good description.
But what I heard loud and clear is that it's down to where it was before the almost craziness in many ways. And that you know you're seeing potentially a narrowing there of the cost of money. You know got the banks obviously and what I also heard Richard was that it's not just on the buyers it's also on the seller side that performance is down. But here's kind of the million-dollar question. And I don't know when you look out at deals pitchbook, you know, maybe it's the billion dollar question, but considering, you know, these economic conditions, what's your projection on the longevity of this somewhat downturn in the rehab sector?
When's it going to end? When's it going to come back? Yes. I wish I had a crystal ball. It's it's really difficult to predict. And I'm sure there's much more intelligent people than me that can perhaps give you a better answer, but I don't think it's going to be anytime too soon. I think we might even see continued slowdown before it gets better. I think there's a kind of a lag between the macroeconomic factors and actually deals. So I think they might even see a slightly even a slower Q4 than perhaps we would anticipate and going into next year number of deals.
But I think definitely there seems to be some stabilization. What what markets don't like and what larger entities don't like is change and movement. As long as you know the environment you're operating, it doesn't necessarily matter what that level is as long as it's stable. So I think as we get inflation rates under control, interest rates tend to stabilize, I think the markets will tend to tend to positively react to that. But I don't see a quick turnaround either with that. You just look at what they're talking about with interest rates and interest rates still we mentioned already are the key factor.
It's a cost of debt. But I think there's also a couple of other factors really, not just interest rates, is really sellers need to adjust their business to be able to offset the increased inflationary pressures they've recently experienced and reimbursement challenges. Really got to try and work out how to return to what I would say is normal EBITDA or the appropriate margin to be able to really be attractive to buyers because essentially we're buying EBIT and you know sellers have to adapt to new conditions that have really occurred the last couple of years.
I think the other last thing is I don't think it I'm putting my neck on the line a little bit here. I don't necessarily think that I don't necessarily believe that we want it to return to how it was when it was really as we say frothy. I think everyone understands that was an anomaly when you look at the long term and it probably wasn't healthy as it pertains to really long-term stab stability of any market as well as obviously the rehab space. Yeah. Said from the from right from the side of a buyer.
Boy, we certainly hope it returns. But no, I can certainly understand and you're right. You know, you can only pay you know, X multiples for so many deals before something has to has to change. And I'm going to put you on the spot maybe a little bit, Richard, but are you thinking in terms of the timing, are we talking months or years? And I'm thinking like maybe is it two plus years or is it, you know, three, six, nine, 12, 18 months that we're looking at for this downturn to at least come back somewhat.
Yes. Again, I believe if you follow the news as it pertains to interest, it will mirror or be have probably have a six-month lag to interest rates. So in the short term, I don't necessarily think interest rates are going to change particularly. They may even go up another 40% later this year which again will put continued pressure on borrowing and debt servicing which will again inhibit the number of deals or the type of deals as well. I think next year you'll see a gradual easing of interest rates all being well obviously there's multitude of things could occur that would knock that off balance and change that very easily.
So I think you're probably looking at least 12 months before things perhaps tend to ease up. But even then I think there has to be a understanding from sellers that you're not going to see or unlikely to see the level of multiples because they really weren't sustainable you know a couple of years ago 18 months ago anyway. And I think buyers are becoming more sophisticated as well rather than just you know offering to pay large multiples for entities that perhaps weren't of sufficiently high quality to demand those multiples and valuations.
I think you'll find that there will be a kind of a more conservative pro approach perhaps. Yeah, great point. And you know I mean seller expectations is you know obviously for you and for us. One of the things that you know we just have to make sure we are on top of and you also you said something else Richard that came through loud and clear which is you know we're buying EBITDA now everybody out there knows that you know I mean you're a physical therapist and you know this too you're buying the relationships you're buying you know the physician relationships you're buying the brand etc but what pays for the business for you guys to be able to pay even not you know modest multiples is that ITA that's the only thing that can come into play there so that was very well said I think I think Paul if I may interject as well I think I think there's two other factors as well that perhaps you know the listeners might find helpful and I think certainly what I we're looking at and I know other entities are is you what we're trying to do is as cost of money goes up obviously we want to try and control risk and obviously sustained or anticipated predicted ebiture is one but there's two other factors.
One is compliance. You really that's a gating item. Entities, sellers have to make sure that their businesses are 100% compliant because otherwise they won't even get out of the gates. And then lastly, perhaps what's changed is the staffing component. Not only are entities buying EBIT, but they want to be confident and know that the staffing is there to be able to support future EBITER as well. So there's the kind of a dual focus, shall I say? Yeah. No, re really good point. Really really good point.
Staffing models. Yeah, we're finding that is a real challenge for business owners right now. So let's do the third big question here. If you're looking at business owners out there who were saying, you know what, this is my time. I'm ready. I'm ready to find a partner. What strategies would you advocate for them to strengthen their market position? I heard you just say compliance and EPIDA. What are some of the strategies you would advocate? Yeah. Essentially financially optimized businesses and business that are well-run, strong culture mature are still commanding high valuations.
I think there's almost the market is almost separated into two and those that aren't necessarily as strong from a business perspective are definitely finding it extremely difficult but those that are performing well are still finding multiple entities to as potential buyers but I think there's some other factors I think sellers can be aware of and focus on as well as eB But the things that often trip up deals are facility leases for instance, okay? The ability to transfer those leases and how clean those leases are.
Because that's a significant cost to the acquiring entity and risk. So they need to be clean. Any legacy staffing issues or legacy compliance issues need to have been resolved. A buyer doesn't want to have to come in and from day one have to make significant changes or to be the bad guy. So if there are any outstanding issues, they need to be resolved and not likely to occur going forwards. And as we said already, clean financials in a format that is easily digestible and to be evaluated by buyers and then stable staffing.
Yeah, you know, we typically will tell a seller that an acquirer should be able to go through one document, you know, a small book and pretty much arrive at a value, certainly conversations, etc. But yeah, no, I think what I hear you saying is preparation financial, operationally, compliance is key and yeah, I would I would a thousand% agree with you. Yes. The really there it's no different than before. It's just I think an increased focus. As we said the risk goes up. So in order to control that risk they're going to look deeper where in the past they might have a cursory look at certain facets of the business.
That's not going to happen now. They're going to dive deeper. Yeah. Yeah. No. And I think you know we see that it's the private equity behind companies like yours. They they don't want to get burned with a compliance issue because that literally can just bring a company to its knees. Absolutely. Richard, so if now we're kind of looking forward again, what do you think is you know one or two of the most significant challenges as well as opportunities looking out in the future here next three one three five years in the rehab industry.
Absolutely. So challenges that I see three main ones. First is the perception of sellers of the value the multiple that they can achieve. Okay. It's a bit like everyone believes that their car or house is worth more than it is. If you get it great, if you get a bidding war, fantastic. But I think the expectations have to be tempered. And I have many conversations with sellers more recently about this and providing them information about how the market is and the overall with regards to M&A and how valuations have come down.
You know the valuations of the larger entities have come down. So it's it makes it's obvious to me but perhaps not to small independent practices that the valuations that they are going to achieve are coming down as well. I think the cost of debt is going to remain relatively high compared to the last you know 5 10 years. So that's that I think is a thing of the past low interest rates or very low interest rates. And then I think the other challenge for really specific for these small practices the sellers is really how do they maintain as we said EBITDA and ETA margin with continued challenges to reimbursement and essentially wage inflation as well with regards to the supply and demand mismatch of licensed clinicians.
However, having said all that there are there is there is some opportunities. I don't want to don't want to be negative too much. So good assets will always shine through. Okay, a good asset will always find that there are a pool of interested parties. Perhaps that pool might not be quite so large, but certainly there will be choices and there will be opportunities and strong valuations going forwards. There's still considerable runway for consolidation as well within the rehab space. You know, I would imagine probably approximately about 30% of the outpatient rehab space is perhaps consolidated at this point.
Significantly more than it was 10 years ago. There was about 5% less than 5% even. But there's still huge amount of runway compared to when you look at other kind of health care type entities and businesses. So consolidation will continue. And then lastly, I think health care traditionally has been a safe space to invest, and I don't think that's necessarily changed. Usually, it's impacted less and it's not impacted for as long. So, I think we're in a great space in order to be able to consider as a as a seller you know being sold to a buyer at any time because we're buffered from perhaps some of the macroeconomic factors a lot more than other types of industries.
Yeah, absolutely. And I think you know when you talk about that fragmentation of the industry and you talk about you know good companies are still going to you know the cream rises to the top. I had a high school football coach who said that every but you know and I think good companies still seem to be getting really good looks from really good acquirers. So yeah, your point really well taken going to you the buyer. And as this, you know, kind of current M&A landscape continues to evolve, is there something that you're specifically seeking in a potential acquisition today that may have been different from that two years ago boom?
I don't think necessarily different. There's probably the importance of certain factors may have changed slightly or we're looking at additional things. So, from a diligence perspective, I think we're looking a little more closely at pay mix. There are insurances that don't reimburse anywhere near the cost of what it does to pro provide the care. So, if there's a high payer mix that really is providing low reimbursement rates, then that's obviously going to be a factor. Okay. And also that's really kind of patient population as well to a certain extent.
I think we're perhaps being a little more cognizant of what states we're looking at and making sure that it not only is states that have sustainable reimbursement levels but really also fit in within the strategic plan for the entity that is buying. So, you know, in the past perhaps buyers weren't quite so disconcerning as it as is as it pertains to you where they would purchase practices. But I think you're going to find that and what you're seeing in the space is larger entities are kind of more focused.
They are divesting of entities that don't fit within their long-term strategic plan. So, geography is a factor. And then you know they're looking at profit profitability more closely. Trailing 12 months. They're not necessarily going to give credit for future anticipated growth. It's really what was the last 12 months and that's really it. Yeah. Yeah. What have you done for me lately? Right. Yeah. Some really great points and you know this the state-to-state it's just amazing in this industry that even states that are aligned can be so different and I think it's a little bit of a misconception that smaller practices have that you can just migrate right over a state line into another state and continue to do things the way you have done it in your first state.
And just the way in which physical therapy businesses operate, how they communicate to physicians seems to change in addition obviously to reimbursement insurance companies, Medicaid laws, etc., etc. So, yeah, really interesting point. What about technology? How will technology impact M&A decisions, you know, in the rehab industry? Or maybe it doesn't. This is a really difficult question. And I that's why I gave it to you, Richard. That's right. A simple answer is I don't know. But I what I do know is it's going to impact it.
Technology, as they say, you always overestimate in the short term. You always underestimate sorry, you overestimate in the short term, underestimate in the long term. So definitely from a from a nuts andbolts perspective as it pertains to the diligence, I definitely think you're going to see the introduction of technology to actually assist with the financial analysis and possibly more than that going forwards. But but with regards to the sellers embracing technology to perhaps become more attractive or valuable, I'm not seeing that at the moment. Obviously, the multiples or the valuations of technology-led msk management are much higher.
But I'm not seeing myself any significant impact to perceived value associated with technology, but I'm sure that's going to change. Yeah. So you so AI is not going to be introduced to be making physical therapy related diagnoses and decisions. You think we're still safe as physical therapists that we'll still be making those decisions? Well, I for the minute having said that though, we are using AI already within our business and you're seeing also entities looking at bots to do a lot of non-clinical processes. And that's going to increase and that that's really a financial imperative based on the fact of trying to control labor cost.
So that is definitely impacting the business now but I don't know how much of that is being translated to the smaller entities. It will come and it will be expected or it will be the norm but I think it's going to take a little time. Yeah. Yeah. I kind of hope it takes a little time actually. What about regul regulations policy changes whether they're already in place or anticipated for the future does that shape how you guys are planning for you know your M&A run in the future. [sighs] Outpatient rehab has played defense for so long when it comes to regulation and policy at the macro level and I am seeing good signs of the profession improving its advocacy level and pushing back and from an M&A perspective all being well that advocacy will translate into perhaps higher reimbursement rates.
It's a move towards different reimbursement models all being well that reward you know good care quality care but in a in a sustainable financial manner. I think there's going to be some some people or some businesses that perhaps fall by the wayside as we transition as we continue to move forwards. In the short term, I think we are still struggling with being heard as it pertains to policy and regulations. But you know just the fact that payer recently backtracked as it pertained to administrative requirements or the burden of administrative requirements I think I think we're beginning to be heard but it's in the very early stages and I'm always a strong voice as it pertains to really communicating our value in an objective manner and pushing back where there are processes required that make no clinical sense.
It's purely to control reimbursement rates and total reimbursement and just saying enough is enough. Definitely seeing some practices certainly larger entities refusing to become in network with certain payers. We've done it ourselves. We've walked away from a couple of significant payers in a couple of states we're in because it just isn't economically viable. So, I think I think definitely in the medium to long term we're going to make some progress. Short term, I think it's you're going to have to shout pretty loud to have an impact.
You know, those I think that are on the outside looking into this industry, you know, there's so much talk on valuebased reimbursement. And to me, when you look at valuebased reimbursement, if truly if truly payers were reimbursing for the value that physical therapists give to patients, our reimbursement would go up. You just don't as you just talked about it's how these policies are brought in. Remember back gosh I think it was close to 20 years ago now when it was everything went decapitated you know you have so many lesson and there's still capitation out there but we thought the whole industry was going to and had the whole industry gone to capitation with the way it got brought on I'm not sure there'd be anybody in some of these some of these businesses so yeah really good point there and I ju I just hope that as these policies get brought to rehab that they're really thought through on the reimbursement side and as you said we're talking to companies that tell us that they've had some increases in their reimbursement.
Absolutely. I think I think the stronger the voice we have and that has to be a collective voice the more we will gain traction and yes there have been minor wins and we're certainly generating collateral material to support our case but we have to be vocal enough to be able to get a seat at the table as well. Sure. Sure. So lot of great conversation. Last point, if you're a physical therapy business out owner out there, okay, and you are a little hesitant about entering this M&A space because of what you've heard from your friends and your neighbors, what advice or some insights would you have on being able to maybe ease that concern for them?
Yeah, I think there's three things. First off is talk to people, ask questions, talk to as many people as you can. Very often it's the first time maybe the last time that one is looking to kind of sell potentially sell. So you know talk to as many people as one can both on the buy side and sell side to educate oneself. So that's the first thing I think the second thing I would say is don't feel a rush. Take your time. Take whatever time that you want to take.
If you want to move quickly then that's fine but take the time. There's nothing worse than buyer's remorse or sellers remorse. And I think if you take the time then that in part can address that. And then lastly is really un truly understand and articulate what you as a seller want. Okay. When things usually go wrong as you're I'm sure you're no doubt cognizant Paul is when there is a mismatch between the buyers and sellers and when that isn't communicated both communication from the seller to the buyer and vice versa.
So I think as sellers it's really understanding what do you truly want out of this obviously you know a nice payment but what else what are I call what are your non-negotiables because that really has to be the starting point for any conversation any relationship between the buyer and seller. Yeah such a great point. We we've turned that termed that as what is the criteria by which you will evaluate you know potential buyers and when you did that are you changing it now throughout the process just based on what you're hearing you know maybe tweaks to that but there is something there are things that you need and want away from the financial piece of this obviously that you know that's a big driver but so yeah Richard that was yeah I think really an important point for our listeners.
Richard, as always, you have brought an enormous amount of knowledge and forethought to our discussion today and I cannot tell you how much I appreciate your time today. Thank you very much. Always a pleasure speaking with you, Paul. And for all of you out there today who have listened to my conversation today with Richard Leaver from Alliance Physical Therapy, if you have any questions on what you heard today from myself and Richard and you'd like to talk to myself or Richard, click below and let's talk. Thanks for joining us today and have a great rest of your day.
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