Under pressure to contain costs while simultaneously delivering higher-quality care, hospitals and health systems have been consolidating at a feverish pace in recent years.
In 2012, more than $143.3 billion in healthcare mergers and acquisitions took place, one of the highest volumes recorded in a decade, according to a report from strategic advisory and investment banking firm Hammond Hanlon Camp LLC.
Reimbursement reductions alongside the shift to value-based payments, among other factors, have financially strained smaller hospitals, which have joined forces with larger healthcare organizations in order to survive and thrive. The Patient Protection and Affordable Care Act's call to coordinate care has also motivated providers to come together.
Joe Lupica, chairman of Newpoint Healthcare Advisors, sees a change in the motivating factors: "In past years my speeches began with the premise that hospitals seek partners to control costs and build fee-for-service volume," he says. "But that premise is already old-school; it’s a cliché. Now our core thesis recognizes the reality of risk-based payment and the need for proactive care beyond the walls of our hospitals. These two factors demand larger and more diverse population portfolios and a better coordination of the care we deliver to our people."
In the past year, numerous hospital and health system deals were announced, including several "mega-mergers" such as Franklin, Tenn.-based Community Health Systems' acquisition of Health Management Associates in Naples, Fla.
This year, as many of the PPACA's major provisions take effect, hospitals and health systems will continue to consolidate. Industry experts predict non-ownership collaborations will rise in popularity, while healthcare leaders become more strategic and selective in deciding who they choose to partner with or acquire, among other trends. Looking forward to the rest of 2014, here are 10 healthcare transaction trends and facts to keep in mind.
1. Hospital and health system transaction activity will likely slow slightly in 2014. Although 2013 was a busy year in the healthcare M&A world, hospital transaction activity will probably decelerate slightly this year as providers concentrate on refining their existing operations to cut costs and increase quality.
M&A activity already dropped in the fourth quarter of 2013, according to a report from Irving Levin Associates. The hospital sector saw a 35 percent decline in transaction volume, from 34 deals announced in the fourth quarter of 2012 to 22 in the fourth quarter of last year. Deal volume also declined 8.3 percent from 24 deals in the third quarter of 2013. Eighty deals were announced during the first 11 months of 2013, compared with 96 made in the first 11 months of 2012.
Joseph Cerreta, assistant vice president of Juniper Advisory, says the perceived level of activity in the market has also been "somewhat inflated by the fact that hospital and health systems are being more transparent about exploring their strategic options than they were willing to admit publicly in the past."
"While transaction volumes have still yet to reach the levels that were seen in the late '90s, more and more organizations are proactively assessing their ability to remain independent, which creates the illusion that more consolidation is actually taking place," he says.
Still, Carsten Beith, managing director of the healthcare investment banking firm Cain Brothers & Company, says he and his colleagues are seeing higher hospital and health system transaction volumes.
"I expect that over the next five years significant consolidation will continue at unprecedented levels," he says.
2. Mega-merger activity characterized 2013 but may not be as prominent in 2014. Last year, several health systems announced their intentions to combine and create large, multihospital networks in "mega-mergers." These deals included the CHS-Health Management merger, a transaction valued at $7.6 billion — $3.9 billion in cash and stock and the assumption of $3.7 billion of Health Management's debt. The merger makes CHS one of the biggest hospital systems in the country, with 206 hospitals in 29 states.
Dallas-based Tenet Healthcare Corp.'s acquisition of Nashville, Tenn.-based Vanguard Health Systems — valued at $4.3 billion — was another high-profile deal. Tenet now owns and operates 77 acute-care hospitals, 173 ambulatory surgery centers and outpatient facilities, five health plans and six accountable care organizations.
Last May, Mich.-based Trinity Health and Newtown Square, Pa.-based Catholic Health East merged, creating an organization that encompasses 82 hospitals across 21 states, assets of more than $19 billion and annual operating revenue of $13.3 billion.
Although standalone hospitals will continue to join larger healthcare organizations to stay afloat and ensure market relevance, an Irving Levin Associates report issued in October 2013 stated there likely wouldn't be any more mega-mergers in the near future.
However, not everyone agrees with that forecast. Mr. Beith of Cain Brothers says he knows of a number of organizations engaged in discussions that would lead to mega-mergers and expects to see several more deals of this type during the next few years.
Mr. Cerreta says despite the recent large-scale transactions, the hospital industry remains "extremely fragmented."
"Even with the several 'mega-mergers' in 2013, the ten largest hospital systems combined still only account for between 15 percent and 20 percent of the total industry revenue," he says.
3. Nonprofit hospitals and health systems in particular will continue to consolidate. Various factors such as the transition to value-based payments, more risk-based contracting and Medicare payment cuts are straining the finances of nonprofit hospitals and health systems in particular. Standard & Poor's Ratings Services, Fitch Ratings and Moody's Investors Service have issued negative forecasts for nonprofits in 2014.
As nonprofits seek to stay strong and strategically position themselves in their markets, strategic advisory and investment banking firm Hammond Hanlon Camp has predicted they will continue to seek out mergers, acquisitions and other types of transactions. They have already been responsible for a considerable chunk of healthcare M&A activity; of the 94 hospital and health system transactions in 2012, 60 percent of them took place among nonprofits. However, according to Mr. Beith of Cain Brothers, it's important to keep in mind that 80 percent of hospitals are nonprofits, meaning they are less active proportionately.
All five hospital sector deals announced in November 2013 involved nonprofit acquirers and targets, reflecting a trend of nonprofit health systems and standalone hospitals joining larger organizations to stay afloat, according to Irving Levin Associates. However, Newpoint's Mr. Lupica is skeptical of trend-spotting in the nonprofit arena. "When dealing with a vital element in the social fabric of their communities, fiduciaries decide to affiliate – or stay independent – for a variety of reasons," he says. "Calling a group of fiduciary decisions a 'trend' comments on history more it really predicts the future."
4. "Troubled sales" transactions are declining as healthcare organizations become more selective. Transactions driven primarily by one organization's financial distress and inability to remain independent seems to be drawing to a close, although those types of deals continue to take place, according to Hammond Hanlon Camp. Instead, hospitals and health systems are approaching transactions with the main goal of proactively positioning themselves in their markets.
Mr. Cerreta of Juniper Advisory affirms this observation: "We are seeing more hospitals and health systems acting from a position of strength while searching for a partner. Without a burning platform, these organizations are able to leverage their strength to execute on a broader range of transaction models."
Furthermore, Mr. Beith of Cain Brothers says strategically driven transactions are "substantially more appealing" to buyers.
5. Hospitals and health systems employ a variety of transaction models. As hospitals and health systems take a more strategic approach to transactions, they can choose to structure deals in a variety of ways depending on their objectives and the internal and external constraints that exist, according to Holly Carnell, JD, an associate at the law firm McGuireWoods, McGuireWoods Partner Bart Walker, JDand Jordan Shields, vice president of Juniper Advisory, an investment bank that works exclusively with hospitals and health systems.
A transaction can take the form of an asset purchase, which generally involves a for-profit buyer and nonprofit seller. This model limits the buyer's legal obligations as far as historic operations are concerned and typically includes a purchase price and, when acquired by an investor-owned operator, debt being retired or defeased.
"One of the main benefits of the asset purchase model is that you can attempt to partition liabilities as between the buyer and the seller," Mr. Walker says. "The one big potential exception to this is Medicare-related liabilities. These can be more difficult to shed and by default follow the Medicare number, if it is assigned to the buyer. In transactions where a tax-exempt hospital or health system is selling its assets, it is fairly common to establish a charitable trust with all or a portion of the proceeds for the purpose of furthering community health needs."
Increasingly, the healthcare organizations involved in a transaction will adopt a joint venture model, under which a larger hospital and a smaller hospital both hold ownership in a new entity. Although the larger hospital takes a bigger ownership stake, both parties have equal board representation within the new entity.
Finally, hospitals and health systems can also pursue various "alternative" transaction models that fall short of a full merger or sale. One of those structures is a management services agreement, under which a health system usually provides management services to a hospital for a fee. This model has various advantages such as better contracting services for the hospital, but it also has potential downsides such as less success in realizing scale efficiencies.
"There are also quite a few health systems that utilize a joint operating model, where the parties to the combination contractually agree to allocate governance and economic concerns in a specific way without actually moving assets or ownership from one legal entity to another," Mr. Walker says. "The parties are almost fully integrated from an operational, financial and governance perspective, but retain some vestiges of their separate legal existence. This is a flexible structure with lots of potential for customization, but is certainly not uncomplicated from a legal perspective."
6. Hospitals and health systems are increasingly choosing non-ownership collaborations. Rather than executing full-on mergers or acquisitions, some prominent healthcare organizations such as the Rochester, Minn.-based Mayo Clinic and the Cleveland Clinic have decided to pursue non-ownership collaborations and affiliations, allowing smaller hospitals and health systems to retain local control while giving them access to a larger organization's resources and expertise.
According to Hammond Hanlon Camp, healthcare providers are pursuing non-ownership partnerships more and more in order to reap the benefits of joining forces without going through an actual merger and relinquishing ownership. This trend goes hand-in-hand with organizations becoming more strategic in their transaction decisions; it's also particularly applicable where antitrust concerns exist, according to Mr. Beith.
"Systems affiliating with local hospitals are learning that ownership is overrated," says Mr. Lupica of Newpoint. "Knowing and achieving mutual objectives gets both parties more traction than squabbling over who holds the keys."
7. Physician medical groups remain "hot commodities" for health systems, hospitals and public companies, according to Irving Levin and Associates. Hospital acquisition of medical groups continues to grow, and overall healthcare sector deals involving physician medical groups increased 5 percent year-over-year to 20 deals in the fourth quarter of 2013. That's also a 33 percent increase from 15 deals announced in the third quarter of 2013.
However, reports from Deloitte and Jackson Healthcare have stated medical group acquisitions declined after reaching a peak in 2011, which saw 108 deals between hospitals, independent delivery systems and other acquires. By contrast, in 2012, there were only 70 reported medical group acquisition deals. However, Jackson Healthcare reported physicians who identified as hospital-employed rose from 20 percent in 2012 to 26 percent in 2013.
8. Consolidation will give hospitals and health systems more bargaining power with payers. As hospitals continue to join forces, they will gain more bargaining power with health insurers, according to a report from Moody's Investors Service. Since commercial health insurers have already merged to form large entities capable of putting significant pressure on providers, this development will make the balance of power more equal, according to Moody's.
However, a recent report from consulting firm Alvarez & Marsal stated consolidation will give hospitals unprecedented pricing power and lead to massive inflation. Hospital and health system acquisition of physician practices and other outpatient facilities is of particular concern, since profit margins are higher for outpatient services for commercially insured patients, according to the report. According to the Medicare Payment Advisory Commission, Medicare payments rates for surgeries are 74 percent higher in HOPDs than in ambulatory surgery centers.
Overall, the report concluded consolidation could lead to a few providers gaining a stranglehold on hospital inpatient, outpatient diagnostic imaging and laboratory services.
9. Antitrust enforcement will continue to be a significant issue. Hospitals and health systems executing transactions continue to face antitrust scrutiny from the Federal Trade Commission and state agencies. One high-profile healthcare case involving Boise, Idaho-based St. Luke's Health System's 2012 acquisition of a 40-physician medical group was decided recently: U.S. District Judge B. Lynn Winmill ruled St. Luke's violated antitrust law when it acquired Saltzer Medical Group in Nampa, Idaho. St. Luke's was ordered to fully divest itself of the medical group's physicians and assets.
Healthcare organizations lack clear guidance on how to pursue the triple aim (improve the health of populations, enhance the patient experience of care and reduce the costs of care) along with the necessary structural models to achieve it without violating antitrust law, says Steve Messinger, managing partner and board member of ECG Management Consultants, a leading strategic healthcare consulting firm.
"We have so many different agencies at the federal level and then there are the state agencies," he says. "The boundaries for antitrust enforcement have always been a tiny bit vague. The margins on the vagueness now are huge. Organizations are flying blind."
However, Mr. Beith of Cain Brothers says the FTC has expressed more openness to market consolidation where "there is a compelling case to increase efficiencies (reduce costs), improve quality and access and where payors are supportive." He cited the CHS acquisition of two hospitals in the Scranton, Pa., market as an example.
10. Hospitals and health systems need to consider several factors to ensure a transaction is successful. In order to minimize the odds of running into antitrust issues and other problems, healthcare organizations preparing to execute transactions need to consider several factors. For instance, before initiating a transaction, they should ensure their board members are aware of their fiduciary duties under state law.. Among other things, board members must carry out a full investigation of relevant details, ensure fair market value and evaluate alternatives and any competing offers. They must also detect and avoid all conflicts of interests, keep discussions about the transaction confidential and consider the implications the deal will have for the organization's mission.
"Although the basic principles are similar, many of these issues vary on a state-by-state basis," says Mr. Walker of McGuireWoods. "Different states have taken different positions on the level and requirements for approval of these transactions."
Hospitals and health systems must also conduct pre-transaction diligence, which includes ensuring its relationships with referring physicians and those physicians' family members don't violate the Stark and Anti-Kickback laws.
"Our recommendation is hospitals as a good business practice and regardless of whether they are contemplating a transaction or not, should carefully review all their physician relationships to ensure they are compliant," says Mr. Beith. "In addition, what may have been perceived to compliant at one point, may no longer by compliant under increasingly stringent regulations."
Finally, healthcare organizations looking to carry out transactions should identify and quantify other key liabilities and concerns such as pension plan obligations, collective bargaining arrangements and real estate leases, which could have provisions that can significantly impact potential deals .
Mr. Lupica of Newpoint says hospitals and health systems need to keep in mind what's truly important in executing a transaction.
“So many of our clients begin by asking, 'How many seats do we get on the new board?'" he says. "Not the right question. Reserved powers trump the number of seats because they define what power resides in those seats. More importantly, post-closing contractual commitments trump all."
He advises that "success begins at your first meeting to consider affiliation."
"Set firm objectives with input from your stakeholders, and then carry them through the RFP, the entire negotiation, and the exact wording of the definitive transaction agreement," he says.
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