Key Factors Driving The Trajectory of the M&A Market
This week Paul welcomes back Larry Benz, CEO of Confluent Health to talk about the direction our market is going, especially leading into 2024. Larry gives his veteran perspective on where things are heading, and what business owners can do to prepare for the future.
Full transcript
Generated from the episode audio and lightly edited for readability.
Good afternoon and welcome to another episode of Paul Martin's Crucial Conversations. [clears throat] Today we are so excited to have with us Larry Brens and Larry is currently the full-time executive chairman at Confluent Health and Larry has done many of these shows and I can tell all of you are in for a treat to hear Larry's perspective as we continue in our Delphi series. Just a brief description of Confluent Health. Currently, they have over 620 clinics nationwide. 90 education partners and 1,900 plus workplace injury prevention sites.
That's a mouthful, Larry. Welcome. Well, thank you, Paul. It's always a pleasure to be with you and engage in some fun conversations. So, looking forward to this. Yeah. Now, you know, those who are calling me don't think these conversations are going to be fun. So I'm glad you're perceiving that this way. But you know the first of our three major deli questions here is you know the current trajectory that we're seeing for rehab M&A. What do you think are some of the key factors that are driving this current trajectory?
Yeah, it's a very fair question and you know I've been in the industry you know 37 years and so I've seen sort of these eb and flows these business cycles these economic cycles and one consistency that I've said over the years is you cannot look at physical therapy apart from health care you can't look at health care apart from the general climate on merger acquisition frenzy and you can't look at that apart from you know what are the interest rates and inflationary and other features. There's a lot less transactions and there are number of reasons.
In 20122 frankly a lot of physical therapy clinics had hiccups. Many went out of business. And why did they have hiccups? You had unprecedented inflation. We've lived in if you've been around just for few years, you've lived through some of the lowest inflation of your lives and some of the highest inflations of your lives. And the labor part of it was a big part of it. And so inflation hit labor, which means it doubly hit us in physical therapy. You have our front desk positions and our technician and other kind of support positions.
And then you also have physical therapy escalation in their labor and wages as well. On top of that, you had shortages. You know, predictable shortages. However, our industry did not do a good job of agreeing on either the shortage or communicating it appropriately. And then on top of that, you also had reimbursement cuts particularly by Medicare and what I call the hidden Medicare, which is Medicare advantage. And all of those resulted in 2022 underperformance. And when you have underperformance, you have by design less valuation because your earnings are less.
And so a lot of sellers are reticent to even think about it when all of a sudden they saw their cash flow and their business operation at one level go down quite a bit to another level. And so they're reluctant sellers. They don't need to sell regardless. And so they can live through these business cycles. But the interest rates are a direct correlate. Debt by transactors is more than doubled. Which means that by nature your valuations have to go down because you have a hurdle rate and part of that hurdle rate is the factor of what you're paying for the cost of capital.
Keep in mind most transactions have been primarily by private equity, some in the public market, but they all of them are leveraged and that leverage means that you're paying more. It'd be not any different than if you bought a house right now and your interest rates are at 8% when they were at, you know, 2% a few years ago. And so, you know, that's all sort of the environmental, you know, sort of issues, externalities, if you will. But then 2023 hit and things are a lot better.
We haven't had a full year yet. And when you value companies, you're looking at typically last 12 months. And so we haven't had a full year in many of the companies to even look back at that. There are buyers in PT and we could talk about that under some of your other thoughts. But I'm certainly convinced that you know the stagnation will be you know around for a while. But things are definitely better as we sit here today than they were, you know, nine months ago.
Yeah, that's great to hear and I think you know the folks in our shop here are sensing that. Larry, staying with kind of this first, you know, factors that are driving this, if there's a balance, which is weighing heavier in, interest rates being higher, debt being much more expensive on the buyer side, or is it more on the seller side of simply, you know, their performance and difficulty hiring physical therapists as well as EBITDA margins coming slightly down due to inflation of staff etc. Which on that balance scale do you think is driving what we saw in 22 and what you see that we're possibly coming out of in 23 here?
Yeah, it's a it's a fair question. I don't know that there's consistency in the answer. So let's talk about buyers. Generally they fall within two major categories. One is private equity or strategic buyers and the other is buyers that are new to the industry. You know, they like physical therapy and they want to be investors in the business. Well, the strategics all had hiccups themselves in 2022 and so their cash flow was less, their interest rates are higher. That has put undue pressure on them operationally.
It also forces them strategically to think, do I even want to use M&A as a strategy or do I want to try to get my same store sales back? You know, why should I buy something if my same store sales because the number of therapists that I have is 60% of what I once had. And so that is a major portion of it. It's that interplay, if you will, of performance, interest rates, strategy, and then on top of that, we still have these labor shortages. And everybody, there's a frenzy around recruitment.
There always is the correlation of interest rates. And even if interest rates haved tomorrow, which there's not going to, but even if they did, it's not going to drive the activity that we had the last few years. We also have to be a little bit measured here. Just because things are down doesn't mean they're bad. And, you know, we go from unprecedented levels of transactions to what might be normalized. You know, there's a concept called reverting to the mean. Maybe we are just getting into this normalization period and balancing these things out over a several year period.
The good news is that there is still a pretty good appetite for M&A as a growth strategy for strategics. There's a number of strategics. Some of them have cash on hand. Others have capacity within their credit facilities. And just because there there's not as many you know inbounds into your email box or texts doesn't mean there's not a good sophisticated group of partners and buyers out there for you. But it is inconsistent from one to another in terms of you know all these different factors. But don't discount the fact that many of the potential buyers a few years ago also had significant operating hiccups themselves in 2022.
Yeah. So, you know what I kind of hear you saying and is that the acquirers are getting a double hit because they're suffering from the same factors that are hitting small private companies. But on top of that, when they go to acquire, you know, with interest rates higher, debt being more expensive, equity being more expensive, it gives them that double whammy. Would you agree with that? Yeah. And I would even add other factors. Reimbursement cuts are very real. Medicare advantage is now over 50% of Medicare and pays what 70 80% of Medicare.
So you have operating model and pricing. You know, we can't match inflationary pricing with inflationary reimbursement. Those two are at odds, unfortunately, with one another. And so, I think it's multiffactoral, but I think you you've made the major classifications there, but there there's other there's other fingers to point here. Yeah. Yeah. So, I'm going to put you on the spot. You know, I heard you say that, 2023, you know, from Confluent Health's perspective and what you're hearing, seems to be much better. You know, we certainly had a downturn.
What's the what's the timing that you see that this downturn will start coming back significantly? Yeah, I think you're going to see a lot more transactions in 2024 because performances will be better in 2023. Will valuations come back? That's going to be a function of interest rate and the appetite of buyers relative to how much cash they have on hand, how their performance went in 2023. But the general feedback [clears throat] from the industry right now has been very good. It's definitely been what you might call a bounceback.
You know, phys physical therapy owners are very sophisticated. You know, they'll learn to adapt to a shortages to labor inflation. They'll create better business models and they'll have, you know, scale and you know, economies of scale to be able to deal with it. The external factors, by the way, are very good for us. Consumers love health care and health care within health care consumers love PT and the opportunities and the demand for PT is continuing to grow. Now, this is the challenge. It's growing during a time where we have labor shortages.
PT pathway or PT first is much more gaining in acceptability. You know, keep in mind we're only 10% of all patients that hit MSK issues are physical therapy patients, but the opportunity is so fantastic. I mean, look at the look at us as not physical therapy providers, but look us look at us as major players in the world of MSK, muscularkeeletal medicine. Now, pause for a minute and think about the primary care world. Oh my goodness, what a frenzy. You know, you have the attention of Walgreens and CVS and Walmart and Amazon.
Wow. It's just amazing. And the valuebased care is been the sort of inflection point. Now the next focus in my opinion has to be on muscularkeeletal because employers it's become the largest portion of their spend. We kind of got cancer under control. We kind of got cardiac under control. We kind of got diabetes under control. We're getting primary care addressed with a little bit, but a dollar of every six dollars is spent on aches, pain, sprains, and strains, and we have to be the players in it.
And and while there are challenges around staffing and all of these, you know, reimbursement things, the opportunities are going the other way for us. They're increasing. The question is how do we see this increasing demand within a business model that has a lot of pressure points on it and I have strong faith that physical therapy owners in general whether they be private equity-backed public companies or strong mom and pop players will be able to adapt and we'll be able to thrive. You know, I'm really curious with all this demand and as you just said, you know, a lot of difficulties hiring, retaining staff in order to obviously you know, provide the supply to this demand.
What strategies if right now you know certainly staffing has to be one of those strategies. But in addition to that, what strategies do you see if I'm right now a business owner and I'm looking to go into this market right now? How do I strengthen my market position? So, it's so the question is how do I how do I get better at getting better? H, you know, what will make me a more sophisticated player in the long run? And I tend to look at these things from the lenses of call it systems sophistication and scalability.
So on your system side of it, what is your system for hiring and retention and talent management and human capital? I see a lot of knee-jerk reactions to everybody rushing into a retention, you know, strategy. Well, maybe your strategy ought to be a hiring strategy first and how to hire therapists who yes, who are getting more money and frankly, they deserve more money at the entry level because of the cost of education. But money isn't all they're looking for. They're looking for a great place to work.
They're looking for a place that they could be proud of. They're looking for a place where they could learn and develop and become a master clinician and become a better leader and a better manager. So I use that as an example by saying you better be systematic in your thinking. What is my system for revenue cycle management? What is my customer service? What is my clinical delivery system? You know what is my operating tools and my business intelligent and my data and my KPIs? And you know then you start getting wrapped up into you know some level of u sophistication.
And then you know you go to this sort of third lens is you know how scalable am I you know we give a you know we have a horrible regulatory environment and our reimbursement continues to go down you know relative to the cost of inflation. And so how do I make it more scalable? Do I outsource my revenue cycle management if I'm a real small player because then I don't have to deal with the variable costs of hiring and retaining and those kinds of things. What how do I use artificial intelligence or data analytics in revenue cycle management or documentation or virtualization of my front office worker who if you really think about it there were you know and you really look where the major labor inflation don't look at your PTS look at how it's impacted your support system it's just been oppressive and then on top of that making sure you have a sound business strategy that fits you, that is well thought out.
You know, that you can recite, that is again systematic, define it, teach it, refine it, reward it, re-engineer it, and, you know, that's what I'd be focused on at all levels, whether you're a provider with, one therapist or a multi-site with 600 plus. Want to come back to you on one thing. You you talked about you know clinical opportunities leadership opportunities opportunities for continued education all big pieces of you know that staffing and that hiring challenge. We have a lot of folks and maybe some of them are out there right now and they want me to ask you this.
What percentage of physical therapists out there are really drawn by that versus we're going to pay you $100,000 to be a staff physical therapist and you know across the street they're only going to pay you 85. Where do you see that balance? And how do you guys kind of work through those challenges? Yeah. Well, there's the there's the enigma, right? So, you know, what are the tradeoffs you know, between hiring a therapist and just paying them more and therefore I can offer them less in development.
And people tend to see this thing as very binary. We never have, at least in our practice, and I think your better providers have it as well. We have this sort of temporary period where you had therapists graduating that were in sort of what I call TV school during COVID. Lots of physical therapy programs. There's about 300 of them and about 290 of them were all traditional brickandmortar programs. Okay? And those brickandmortar programs all of a sudden all the ones they badmouththed all of you know the folks who used a blended or a hybrid approach now found themselves having to deliver part of their content like you and I are talking over a you know over a Zoom or a web you know meeting of sorts.
And there's no question the outcomes were worse. Why do I know that? U because a failure rate on entrance exams is the highest failure rates we've had. That doesn't mean they're bad people. It just means they haven't been prepared accordingly. That's going to normalize. I already it is getting to the end of that sort of TV school time period. These are all great kids, students, therapists. They're passing it a second time. Maybe maybe you know remediating a bit. But let's call it what it is. The worst prepared, most stressed therapy entrance we've ever had.
They had behavioral health issues. They had this, you know, isolation issues. And we have to be sensitive to this. You hear a lot of talk about burnout. You know, I think burnout is more of, you know, experienced therapists, but there's no question that our graduates are coming in more stressed and the last thing they want is more school. The last thing they want to do is sit behind a computer. So we have to deal with that and we have to deal with that effectively. But that doesn't mean we pay them more and think that they're not interested in development.
It just means the development that you have to deliver might be a little bit delayed, might take a few more months. You know, we have two options in our residency program. We have a certification program which is a lot less intense and a little bit more volunteer optin and we have the very formal APQRF or whatever the initials are approved residency program. Well, less and less are wanting to go in. You know, is it interesting as a profession that we have the least enrollies in residencies in the history right now or not in the history but in the last several years.
But it's somewhat understandable when you look at it from I think the perspective that I've just outlined. And what you have to do is you have to be sensitized to the current crop of therapists that you're hiring, but not be overwhelmed by it and stick to your guns. Therapists do want learning and development opportunities. They just might want it in a little bit different format. But we see so much of the opposite going on. And you know, if a therapist is going to come into our organization, all they want is money.
They're going to leave to go to another organization where all they want is money. So, put your filters up a bit and don't and so many people are talking about retention strategies. Great. But you better put in place a very good hiring strategy and you better filter and interview correctly because if therapists are coming in and all they want is more money, they're going to leave for more money. And if they don't want to participate in development programs, you know, and don't commit to it, don't hire them.
You know, I think the other the other aspect of it is that is you know, it's okay to have more nos when you interview than more yeses. You know, sometimes we get offended that you know, yeah, we we're so in need of therapists. But stay away from the warm body approach. Stay in a human capital talent management mode because the downstream effects of it are so much better. You're going to get better quality. You're going to get better energy and passion. And frankly, you're going to get you're gonna get much better pts.
Yeah. And and you know, you talked before about these es and flows and I think you know a lot of good staffing discussion here and I think this is going to be really valuable for our audience. Anything that you guys are looking for specifically now in an acquisition target that in one of the other you know let let's go back to 2021 you know kind of right after COVID and the high we saw in the industry then anything different that you're looking for now that you weren't looking for then or even in prior es and flows yeah my answer might surprise you a little bit and I would say fundamentally No.
However, you know, the times are different. You know, it's kind of like when there's b been buying opportunities for homes and there's been times where there's been seller opportunities for homes. And so, the same phenomenon happens. And so when there's a market frenzy and there's more buyers and less number of sellers, you see all kinds of, you know, adjustments denovo adjustments, not to get too far in the woods, and other adjustments, and other, you know, indemnifications and walk away deals and these kind of things that you're just not going to see for a little while again, at least, hopefully never from my perspective, where it was just sort of one-sided.
Now you're going to get more measured and real cash flow that is understandable and a lot more straightforward. So the fundamentals haven't changed. You know, if you look at valuation, it really hasn't changed in my entire career. It's typically a function of growth rate, how much cash are you producing, your sort of EBITDA, if you will, and your margin. So margin, growth rate, and your total number of EBA, how big that you are. So, you know, there it's not formulaic, but it is a reflection of that.
Well, if you can now demonstrate that you've had a pretty good bounceback in 2023 and you historically have been at certain levels, that's going to really bode well for you. Your margin is probably tighter than it's ever been. We get, you know, certainly get that and understand it. But the good practices are still doing the right things. They're still doing the right approach to, you know, development of their therapists. They have a they've migrated to a much more sophisticated operating model. They know their units per visit.
They know the productivity of the therapist. They're saying, you know, if therapists want to get paid more, we're going to measure you more. You know, I hear a lot less complaints about u productivity standards generally right now because, you know, the reality is there's shortages and therapists have been, you know, their economics have been driven up, which I think is a good thing. So, you will see I do believe in 2024 in particular, you're going to see a frothier market for sure because 220 2023 for so many of these bounceback providers are good and you still have buyers, you know, so you still got that interplay going on.
Yeah, interest rates are higher and suggests that valuations won't be as high as they were when they were at their record highs. But, you know, Paul, you and I could go back a long period of time and talk about sort of multiples and what was the normalization at different time periods of our career and it has just the range is incredible. Yeah. Yeah. Has really changed has really changed. You know, a breakout of practices, business owners that are coming to you that you're seeing a real improvement of their operational awareness versus companies that were able to just operate, you know, kind of at moderate levels still get pretty good valuations.
Are you seeing a shift to, you know, as I heard you talking there, are you guys sensing a shift towards improved operations with companies that you're talking to? The better companies. Absolutely. Yeah. The the better companies, you know, dealt with high inflation, staffing, or were already pretty good at it. But even if you were pretty good at it in 2022, you were impacted. You know, you're going to be impacted when your front office worker goes from 10 bucks to $22. You're going to be impacted when your therapists have other opportunities or don't want to work 40 hours a week.
So, I have not seen you know, with few exceptions, I should say, I have seen a few that perform better in 2022 than they did in 2021. There were definitely some, just not a lot. And the industry trends you know, demonstrate that by the larger companies as well. I mean, you know, we didn't do as well in 2022 as we did in 2021. Fortunately, in 2023, we're back ahead of 2021. And let's not forget, we had a global pandemic we were all dealing with masks and with other things.
It's an easy thing to forget about, but it definitely also had an impact as well. Hopefully we'll stay away from, you know, sort of these global pandemics for a while. But that had an impact in the after impact ironically enough hit us harder than the impact probably itself visav inflation and shortages. Yeah. And that's I think really impactful for our audience because you know again strong operators will follow the trajectory of many of these large companies which in most cases are really strong operators. So you know, if the 2021 was, you know, the big year, 2022 down, but now starting to respond, we should all be responding out there.
I think that's saying, Larry. Yeah. No, that's absolutely right. Yeah. And we are seeing very good we're seeing really positives you know, very much so. It's a gonna be a lot more fun walking around national conferences and stuff in 2023 than it was in 2022. Yeah. Yeah. Are you seeing technological advancements and does that impacting your M&A decisions right now? In you know at any level technology advancements have always helped us going back from the times we used to do paper notes to electronic notes. So, again, I caution folks on overreacting.
You know, those extremely early adopters of EMRs overpaid, had hiccups and had problems. We used to submit paper claims, now we submit them electronic, then they went to clearing houses. So, be a little bit thoughtful in your approach on technology. You know how does it help you deliver those three lenses again system sophistication and scalability? You certainly wouldn't want to be doing your accounting by longhand anymore, right? You want to have a very nice operating financial system. But yes, these things will always help and you have to embrace them but also be measured.
Don't jump into the frying pan a little bit too early here. Virtual reception in the right in the right areas can help. I do think AI will help us in ways that we haven't thought of. Revenue cycle management, pre-certification, compliance. We use AI in our compliance program and it's saved us a ton and it helps us produce better, faster, and more compliant notes. So yes, I there's no doubt that those things are there to help us. The difficulty of course is this is an evolving area and there are a lot more things to sell than we than our providers and people have money to use to spend and take risk on.
And what I usually tell folks is don't take risk on technology. Narrow your know what you're buying. Not don't take a testimonial as the answer. Take a test drive. Take a demo. It's tough. It's you got to be patient. You have to be, you know, willing to get through that. But but now is a time to embrace technology, but either don't invest too early and make sure you're not taking a lot of risk that it truly will help you bring scale, sophistication, and system to you and preferably savings and better operations.
And I don't want to put you on the spot here, but I heard you say AI and AI, you know, aligned with compliance. Do you see AI in the near future playing a larger role in what we do as physical therapists? Maybe shaping our clinical decisions or are we a long way off from that? Yeah. So boy that's a good question. I hadn't had anybody ask me about clinical decision- making relative to AI. U but it's a very fair question. We have we have embraced AI and compliance because and we've looked at AI as a compliance disintermediator for one very critical reason there's more and more regulations every year and you know it is get harder to keep up with you have to have more and more people and to the extent that you can use it to your benefit documentation I see good long form documentation into AI evolving There are lots and lots of test sites of that going on more in the general healthcare than there are in PT but I see that as a help very much embracing it on revenue cycle management collections preser very helpful here's how I see it evolving on clinical decision making you know our patients you know in the old days would come in you know it's like the I'll give you the example outside of PT a patient would come in and tell the primary care doc this is the this is the antibiotic I want for my kid's ear nose a throat infection, the doc would say, "Where'd you hear that from?" "Well, I saw it on a commercial." Right?
And so, you know, the doc's no longer the doc. The patients are coming in telling the doc what to do. Well, we went from commercials to Google. And so, our patients then start coming in having done lots of searches on Google where of course we have lots of information. You know, the trade-offs of a free and open and transparent society. That's a good thing. But, as you all know, you know, lots and lots of noise on and relative sourcing. Are they credible or not? But there are better databases and our patients in muscular scalar are coming in and they're asking about dry needling that or they're asking about cupping that they see on the Olympics.
And those are all very positive. If you think about it, that's kind of a use of short form and what I think will eventually be long form, which is that, you know, I'm a 61 year old low back patient, love to play golf, I've got a little shoulder injury, and see what chat GPT or Bard or one of these other things say. So you're going to start to see that for sure if you're not already seeing it. Yeah. And the question is on the PT side, can I put in factors and that have that drive clinical decision making and I do see that evolving over time.
You know, it's not any different than when we didn't have treatment protocols and best clinical, you know, evidence and update. One of the technologies I recently looked at that I was invited to actually participate in is an ability for you know if I was the patient or even another therapist because what I saw this was more for the peer-to-peer side of it and I say you know I'm a physical therapist I just had a patient who's got diabetes is 50ome years old has these coorbidities and I can access this real time person telling me giving me advice.
Well, the reality is that real-time person is not is a real person, but that's all sophisticated databases talking to you. It's it's quite fascinating and that's where I do see so I think peer-to-peer education and our ability to help us is just a more sophisticated use of treatment algorithms and thing. So, I think it'll be better and I think it'll be faster and that'll be fine. But I will also caution our listeners and I hope you appreciate this in particular. Paul, you've been around forever and your group is very sophisticated experts.
You have a consulting side. You know, we love dealing with you know, on transaction companies that have ever used you or that use you even for transactions because we know it's going to be a very sophisticated, very credible and if they're not and if they've got major compliance faults, you're not probably taking them out as a CL, you know, a client unless they agree to change. So, that's a good thing. But what I see more and more of is a bad thing. They listen to these so-called experts on Twitter, now called X, who've never done anything in the profession.
In terms of what I would call testimonial, you know, they've never bought known practices. They've never run a successful practices. That's why they're on Twitter all day. And I unfortunately see our own therapists take the worst advice that they wouldn't, you know, if a patient came in and said, "Yeah, I read on Twitter, this is what I should be doing for my low back." You say, "Well, that's ridiculous." But out of the other side of my mouth, I shouldn't be going on Twitter and tell me some business expert is given advice that's never even owned a clinic.
Or if he did, they went bankrupt, you know, and now, you know, they're making a living y of giving advice. And and it even includes not just clinical, it includes business advice. And pronouncing it on transaction advice and I don't personally pay any attention to it. A lot of this comes to me through other you know other channels but it just you know my encouragement is for your sophisticated group is to stay sophisticated. Don't buy into the noise challenge the credibility and if AI helps us in that long form AI helps us in it great.
Yeah. Yeah. Well, Larry, you just opened yourself up for another interview because our conversation is leading me to [clears throat] a series on, you know, how, you know, big companies are considering and utilizing AI and where this will take physical therapy in the future. So why don't we get off and then we'll jump right back on and we'll do that interview today as well. Let's do it. Larry, any final words of wisdom for a business owner out there who may be hesitant right now about entering this space because of what they're hearing on Twitter or on Google or wherever it may be to kind of ease their concerns.
What final words of advice would you have there? Yeah, that's you know, I think I've addressed it in part, but learn as much as you can. Nothing eases hesitancy like information and information that is from credible, you know, sources. Don't listen to rumors. I've been doing this for a long time. You've been doing this for a long time. And when you hear that so and so is doing this and made so much money and their multiples were this and did you hear about so and so?
I can tell you 90% of it is not true. Be aware of those who everybody's got muscles on social media. And really challenge yourself to thinking, has this source ever really done anything that they're now teaching you what to do. So, I think that's part of it. And stay the course. You know, I I could tell you and you know, I I've probably said this to you in prior interviews, but I genuinely authentically feel it that our best days ahead. I think PT is you know, we get from 20 10% on MSK to 20% on MSK and we can we can do it.
And so I'm very long, very optimistic and very engaged. I've never been more energetic about this profession than I am today. Yeah. Well, Larry, as always, you have given our audience today and myself a lot of phenomenal information, and I want to thank you for your time and your input into this series. Well, thank you. I love to chat with PTS through all various types of mediums and this is certainly an important piece and a great network that you've built and developed. Thank you. Thank you.
And for all of you out there today who have a question or may have a question for Larry or myself, click below. Let's talk. And I appreciate you joining us today. Thank you.
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