The volume of hospital M&A deals has doubled over the past six years, with fewer and fewer community hospitals still going it alone. For the remaining holdouts, they are at an important juncture: Should they continue fighting for independence or join a larger system?
This heavily-debated question is at the core of many board meetings. While the answer is unique to each institution, in either scenario, the community hospital that proactively controls its own destiny — instead of losing that control to market forces — can come out ahead.
Whether the future holds independence or acquisition, here is what leadership needs to know to position their hospitals for future growth.
What does it take to stay independent?
For efficient facilities with ample cash on hand, there's an understandable allure to remaining independent. After all, the board of directors at a community hospital is typically made up of individuals from the local area who can continue to focus exclusively on addressing the needs of the local community rather than answer to a distant corporate team.
But a lean and high-volume operation today just isn't a strong enough indicator to choose independence for the long term. Leadership must consider broader questions that take into account a host of internal and external factors:
• Where is the local market heading? Competitive activity in the region can point to whether the hospital can continue to dominate market share, or whether competition is likely to disrupt the status quo in a damaging way.
• Are forecasted volumes sustainable within key services? For core offerings, the hospital must determine whether volume trends and future projections are positive, or if they signal declines in the business areas that contribute most to positive margins.
• What is the rate of turnover among senior leadership? Confidence levels among the executive team can point to trouble, such as if senior leaders have been trickling out of the hospital in order to join larger systems, maybe even direct competitors.
• What are the trends in provider retention and recruitment? Medical staff trends can show whether the organization is perceived as a provider of long-term stability and whether highly qualified candidates can be attracted to practice in the local setting without access to the resources larger systems provide.
Even if the hospital currently dominates the market or has innovative programs in the pipeline, considering the above factors is crucial to examining the sustainability of independence in the future. And if performance or market trends suggest trouble, leadership should start to explore partnership opportunities if they've exhausted internal efforts.
Ensuring a favorable acquisition
Independence is enviable if you can make it work. But if a community hospital can anticipate when it is time to initiate a merger process and position itself as an attractive acquisition target, then M&A doesn't have to be unfavorable or adversarial. That's because a standalone hospital will need a partner (and quickly) if there is a sudden turn of events.
One 300-bed facility in the northeast, renowned for delivering comprehensive medical and surgical services in its region, wanted to remain independent despite some worrying trends — including a string of operating losses. A hospital in that scenario should start getting its house in order so that if acquisition is the best option, then there's at least a favorable outcome for the facility.
Unfortunately this hospital didn't take early steps to set itself up as an attractive buy, which ended up costing them $20 million in the acquisition deal. A few years later, they are now in a much better place — financially and clinically — as a result of merging with a strong partner who is invested in the community and the hospital's success. But it was a bumpy road getting to where they are today and leadership didn't have much control over the way it all happened.
So what might they have done? While there are external market attributes that are difficult or perhaps impossible to reposition (population served, level of competition, physician landscape), there are internal factors that can significantly impact the equation. In our experience, the most important are a positive operating margin trending for at least two years, a manageable debt load in relation to total operating revenue, and a compelling market position—measured by both market share and referral patterns.
With the house in order, a hospital's board of directors can then have control in the acquisition process—by conducting an RFP process and choosing its system partner based on the most compelling offer. Here are some of the most common factors our recent clients tend to value and prioritize:
• Capital Commitment: It's critical to examine all capital offers and negotiate accordingly. We've seen health systems commit the same amount as a hospital is getting in routine capital, which is a very weak offer.
• Board Representation: The hospital will inevitably lose board control but they should seek a partner that guarantees at least some local representation. Despite the system-level control, the hospital can benefit greatly from its membership in a more diverse network of partners.
• Clinical Program Investment: The health system's strategic vision — programs they will keep, resources they will add — should align with local needs. Overall, the board must protect local interest by protecting key clinical programs in the deal.
For community hospitals that aren't yet sure what the future holds, they should understand the attributes that make a hospital attractive to potential partners and keep a close eye on how they perform against these attributes. Doing so both strengthens the ability to remain independent and positions the organization well if a merger becomes the better long-term option — without putting the community's fate into someone else's hands.
John Johnston, CPA, MHA is senior vice president of consulting at Advisory Board, Washington, D.C.
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