Pharmacy Location Rules - How the changes affect you

Published Tue, January 31 2012 11:51am by

FRANK SIRIANNI, Management Consultant, MEDICI CAPITAL (www.medici.com.au)

Substantial amendments to the "Pharmacy Location Rules" were announced on Tuesday 27 September 2011. These changes took effect from 18 October 2011. The first applications that can be submitted to Medicare will be heard at the Australian Community Pharmacy Authority (ACPA) meeting on 25 November 2011.

The National Health (Australian Community Pharmacy Authority Rules) Determination 2006, which outlines the current "Pharmacy Location Rules", will be replaced by The National Health (Australian Community Pharmacy Authority Rules) Determination 2011. The Department of Health & Ageing has also issued an updated Applications Handbook which is available on the Department's website.

Links to these websites and further information are available at:
www.medici.com.au/pharmacy-approval-number-location-rule-changes

The changes and the relevant impacts are complex but expected to have a substantial impact. They will affect all Pharmacy Owners in some way or another and I strongly recommend you speak to an expert to fully understand your individual circumstances.

As there have been numerous articles and commentaries summarising the changes, I will not outline the changes per se but rather discuss some of the impacts and how the will affect you as a Pharmacy Owner. These are discussed in this month's column.

Rumours of the death of pharmacy values are premature

While many in the market have, often because of vested interests, suggested a significant and detrimental impact to pharmacy values, these views appear short sighted.

Clearly, the changes are far reaching and will have a dramatic impact in some locations. However, generally speaking, pharmacy values are likely to improve rather than decline.

In summary, the impacts are as follows:

Area: Impact: Comment:
Value of operating pharmacies - going concerns Unlikely to change - may improve in some locations Value for going concern is driven by profitability, growth and associated risks.
New pharmacies More pharmacies some of which will be not financially viable. Experience suggests that a greater propensity to open new sites which may be of marginal viability may arise from the new rules.

Act with caution.
Location rules still in place Check - vigilance The new rules may open the door for competitors to establish in your area. Owners will need to be vigilant and may need to establish defensive strategies.
Pharmacy Approval Numbers (PAN) Generally will no longer have an implied value Ultimately the value of a PAN was "in use". That is, the price paid was always reflective of the opportunity value not indicative of any intrinsic value in the number.
Backfills Backfills, except for a short window, no longer available New rules do not allow for long-distance relocation of numbers. New pharmacy numbers available in specific cases.
Increase in competition in some locations New pharmacies will establish in some locations and centres While this may be restricted to a number of specific locations which meet the new criteria, it will result in increased financial pressure for some pharmacies.

Further details

1. Valuation of Going Concern Pharmacies

As a pharmacy valuation specialist we are receiving calls from pharmacists inquiring about the changes and impact on valuations. First and foremost, we believe the valuation of going concern pharmacies is not expected to change.

Pharmacies will still be valued according to commonly accepted industry standards using the Capitalisation of Future Maintainable Earnings approach. The key issue remains with all valuations, what are the expected returns for the pharmacy? Value is driven by profitability, growth and associated risks. These remain the key drivers of value (as they always have been).

Changes in the location rules, to the extent that they do not change business performance and related risks, will not change values. However, in some areas, where the new rules provide greater security (and therefore reduced risks), values may increase.

The new location rules will limit the ability for pharmacies to move into some locations for five years or more. This may increase the value of pharmacies located in some areas.

2. New Pharmacies

As the amended rules allow for the application for new pharmacy approval numbers ("PAN"), pharmacists will have the ability to open new pharmacies without the existing barrier of having to purchase a PAN. In turn we are likely to see more pharmacists open new pharmacies.

This can be great for pharmacists and will open opportunities not otherwise available but be advised that, while the cost of setting up the pharmacy will be substantially less, do not fall into the trap of simply setting up a pharmacy for the sake of it. An unviable pharmacy is still an unviable pharmacy even if it is cheaper to open!

Note, new pharmacies will be restricted from moving again (i.e. in some cases five to ten years and in others indefinitely). So it is important you get your location right the first time!

While we believe numerous applications will be made under the new rules we are not expecting a "free for all" with new pharmacies flooding the market to unsustainable levels. The requirements of the rules ensure this to a certain extent.

3. Locations are still protected

The new rules have not changed all the location rules. The new location rules still protect locations. These rules retain many of the requirements of the old rules, whilst adding a few other requirements. They still go a very long way to protecting your business that you have worked hard to grow.

I strongly recommend you have analysis completed outlining any specific impacts to your pharmacy. Each individual case will need to be assessed.

In some locations, you may need to consider a defensive strategy to protect your territory and centre. While, in some ways, we are seeing "back to the future" (Pre the Community Pharmacy Agreements (and therefore prior to the micro-economic reform introduced by the Guild / Government negotiations on behalf of the sector), pharmacy owners would establish another pharmacy as a defensive strategy to protect market territories.) type strategies, these may be necessary to protect your patch. In other locations, you may be protected - get advice.

4. Sale of stand alone PAN's will diminish

The sale of stand alone PAN's will be affected. Long distance relocations of PAN's will cease albeit transitional arrangements are provided for. What this means is that after the transitional arrangements end there will be effectively no relocations except for short, less than 1 kilometre, relocations and within same town or facility.

This means the value of a PAN as a stand alone asset (key being stand alone) will be diminished and are expected to vanish in most circumstances (not all). Location specific numbers will still potentially have value (i.e. CBD location) as you can relocate within 1 kilometre without distance restrictions (note those in a "facility" have distance requirements).

Given PAN's will have limited stand alone value what are the implications?

Common industry practice is to value a pharmacy at the higher of asset break up value or capitalisation of future maintainable earnings. In circumstances when asset break up value is used (poorer performing pharmacies) the value will be much lower.

The asset break up value of a pharmacy will be substantially reduced as it previously included a value ascribed to the PAN (i.e. $500,000 was about the average sale value). It is expected stand alone PAN's will cease to be a saleable asset (post transitional arrangements) unless they have desirable location characteristics.

As was the case previously, profitability will be the key to maintaining value. Strong performing pharmacies are not expected to be affected. That being said the valuation floor that existed due to the realisable value of assets of poor performing pharmacies will be much lower.

Banks may have a reduced security position for some pharmacies. While the changes were rumoured, they were a surprise and will apply relatively immediately. Medici Capital is working with Banks to ensure the rules are understood in context of their client's current financing arrangements. If your bank has questions or concerns I suggest you refer them to Medici Capital for expert advice.

5. Backfill of pharmacies effectively ceased

The practice of what is commonly referred to backfilling of pharmacies is effectively ceased due to new rules by the addition of a new general requirement for all PAN's.

This loophole has always been a strange quirk in the location rules and we can all agree its removal is better for the industry as a whole.

6. Pharmacies at risk of increased competition due to new number approvals

As there are numerous rules giving pharmacists the ability to obtain a new approval number, current Pharmacies could be at risk of increased competition. This will be given further impetus by the fact that these numbers appear to be "free" and will not require the purchase of an existing number (i.e. recent market sales of $500,000).

Each individual case will need to be considered individually and thoroughly in the context of the new rules. I recommend you speak to experts such as Medici Capital to ensure you are not at risk. Given applications can begin 18 October I strongly advise doing this immediately.

Examples include:

  • Second and third pharmacies may be introduced into large shopping centres. Lower entry barriers may see pharmacists more likely to enter shopping centres. I reiterate, an unviable pharmacy is still an unviable pharmacy, so be careful what lease arrangements are entered into without completing proper investment analysis.
  • Larger one town pharmacies may be at risk of increased competition whereas they were previously protected.
  • Medical Centre Pharmacies may be able to apply under the new rules (whereas they could not before) and will need to be investigated.

7. Transitional arrangements

Transitional arrangements will require certain pharmacists to act fast to secure numbers that could be obtained under old rules but not under new ones. Therefore the market will still exist for relocatable numbers until the transitional arrangements have ceased. You will need to act fast if you are in this category.

Conclusions - A good or bad thing for Pharmacy?

A number of positives will come out of the changes and all in all I expect the rules to positively impact community pharmacy. Key points to note:

  • The value of profitable pharmacies is not expected to change. Unprofitable pharmacies, previously sold on an asset break-up basis or opportunity value, may decrease in value.
  • The community will enjoy greater access to pharmacy and the rules are expected to "improve the health outcomes of all Australians through access to, and quality use of Medicines" (National Medicines Policy).
  • Certain anomalies in the old rules have been rectified. These anomalies / loopholes were in a large part unfair and won't be missed.
  • Pharmacists will now have opportunities for new PBS numbers where they did not previously exist and at a lower cost.
  • In most cases the rules still provide protection to pharmacy owners from pharmacies being introduced in close proximity albeit you will need to check your individual circumstances. For these businesses, value may increase.

Medici Capital has expert consultants who are experienced in ACPA applications and fully understand the impact of these changes. We can give assistance in the following ways:

  • Assess the impacts in your individual circumstances
  • Complete ACPA applications on your behalf (under old or new rules)
  • Make objections to exiting applications (under old or new rules)
  • Give you valuable insight into how you can benefit from the rule changes and the interim transitional arrangements.

What are your ideas?

Tell us your story. What are your ideas? How will the new rules impact you and your pharmacy?



Please call Medici Capital on (03) 9853 7933 for further information or to discuss the results.

Frank Sirianni can be contacted at Medici Capital on 03 9853 7933. Medici Capital, industry leaders in pharmacy valuation, finance & management consulting. Helping pharmacists achieve their goals. www.medici.com.au

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