Over the past year, interest from sophisticated investors in the hospital sector has increased significantly. Last year, private equity fund Cerberus Capital Management bought Caritas Christi Health Care System in Boston for $900 million, while Vanguard Health Systems, backed by the Blackstone Group and Morgan Stanley Capital Partners, bought ailing Detroit Medical Center for $1.5 billion as well as hospitals in Chicago and Phoenix areas. This year, both HCA and Vanguard have gone public, with initial public offerings of $3.79 billion and $450 million, respectively.
At a time when healthcare costs are under attack and many hospitals are struggling to survive, it seems curious such sophisticated investors would be entering or expanding their presence in the hospital market. However, Jeffrey Gruen, MD, director of healthcare services at PRTM, a global management consulting firm, says this market uncertainty is exactly why investors are pouncing on struggling hospitals.
"In general the opportunity for private investment in a sector increases when there is significant change in the market," says Dr. Gruen. "Our observation is that this is the time of some of the most significant and potentially disruptive change. This is creating the opportunity to rapidly innovate and change business models."
According to Dr. Gruen three forces have been driving the current uncertainty in the industry.
1. Significant declines in reimbursement from both government and commercial payors. Reimbursement growth rates are trending down. "Typical projections may have several percent growth in projections year over year in commercial payor reimbursements," says Dr Gruen. "Now, CFOs need to downgrade that to 1-2 percent or even flat." Additionally, Medicare and Medicaid rates are at best expected to remain relatively flat, and depending on what lawmakers agree to in terms of a budget reconciliation, reimbursements from both of those programs could potentially decrease dramatically, he says. With these changes in net reimbursement, Dr. Gruen expects hospital operating margins to fall in the 2-5 percent range.
2. At the same time, hospital costs are on the rise. Factors such as general cost inflation, the continued nursing shortage, electronic medical record implementation and the trend of hospitals acquiring physician practices has led to increase costs for hospitals at a time when reimbursements are strained, says Dr. Gruen.
3. Reimbursements are shifting away from the fee-for-service model. "On top of these changes in the traditional fee-for-service reimbursement categories, we're seeing payment reform and the potential for payment reform creating a new category of administrative costs that could lead to downgraded [revenue] projections," says Dr. Gruen. Whether a hospital participates in an ACO, episodic bundled payments or capitated risk, all of these models are new for most hospitals, making it difficult to project how such models will impact finances.
Many systems will be significantly challenged by these three forces, and will be in need of capital and expertise larger hospital operators can provide. While hospitals can consider joining a non-profit of for-profit system, Mr. Gruen expects for-profits to be much more aggressive with acquisitions. While non-profits' acquisition strategies are changing, many non-profit systems also have the impending expenses of EMR implementation, ICD-10 conversion and other capital-intensive initiatives vying for funds, which often rank before acquisitions, he says.
How investors will make money off of ailing hospitals
Given these challenges, it may be unclear what investors see in hospitals. However, Dr. Gruen points out that all of these new pay-for-performance models actually present hospitals the opportunity to fare better, and sophisticated investors believe ailing hospitals can be quickly turned around. "[These models] can be a windfall for hospitals that can get highly organized and take advantage of payment reform," says Dr. Gruen.
Plus, it's a great time to acquire hospitals; pricing is depressed compared to historic pricing. The current forces working against hospitals have severely hurt those that haven't been able to adapt. As such, finances falter and they are valued at lower prices. If turned around quickly, the potential for profits is considerable. "Investors are attracted because of devalued assets," says Dr. Gruen.
In the past, the hospital sector has been unable to meet private equity and investors' desired rate of return, but the current perfect storm of depressed assets and turnaround opportunities has drawn strong interest to the sector, says Dr. Gruen. But, what it will take to succeed in a turnaround will be markedly different than turnaround of the past. "In the past it was all about operation efficiencies. In future, it's still about operational efficiency but it's also as much about the ability to dynamically change the business model and reposition the organization," says Dr. Gruen. "There's a new opportunity to change the business model, which is very exciting — a whole new vision for how you can make revenue."
7 Points on How Hospital Acquisition Strategies Have Changed
At a time when healthcare costs are under attack and many hospitals are struggling to survive, it seems curious such sophisticated investors would be entering or expanding their presence in the hospital market. However, Jeffrey Gruen, MD, director of healthcare services at PRTM, a global management consulting firm, says this market uncertainty is exactly why investors are pouncing on struggling hospitals.
"In general the opportunity for private investment in a sector increases when there is significant change in the market," says Dr. Gruen. "Our observation is that this is the time of some of the most significant and potentially disruptive change. This is creating the opportunity to rapidly innovate and change business models."
According to Dr. Gruen three forces have been driving the current uncertainty in the industry.
1. Significant declines in reimbursement from both government and commercial payors. Reimbursement growth rates are trending down. "Typical projections may have several percent growth in projections year over year in commercial payor reimbursements," says Dr Gruen. "Now, CFOs need to downgrade that to 1-2 percent or even flat." Additionally, Medicare and Medicaid rates are at best expected to remain relatively flat, and depending on what lawmakers agree to in terms of a budget reconciliation, reimbursements from both of those programs could potentially decrease dramatically, he says. With these changes in net reimbursement, Dr. Gruen expects hospital operating margins to fall in the 2-5 percent range.
2. At the same time, hospital costs are on the rise. Factors such as general cost inflation, the continued nursing shortage, electronic medical record implementation and the trend of hospitals acquiring physician practices has led to increase costs for hospitals at a time when reimbursements are strained, says Dr. Gruen.
3. Reimbursements are shifting away from the fee-for-service model. "On top of these changes in the traditional fee-for-service reimbursement categories, we're seeing payment reform and the potential for payment reform creating a new category of administrative costs that could lead to downgraded [revenue] projections," says Dr. Gruen. Whether a hospital participates in an ACO, episodic bundled payments or capitated risk, all of these models are new for most hospitals, making it difficult to project how such models will impact finances.
Many systems will be significantly challenged by these three forces, and will be in need of capital and expertise larger hospital operators can provide. While hospitals can consider joining a non-profit of for-profit system, Mr. Gruen expects for-profits to be much more aggressive with acquisitions. While non-profits' acquisition strategies are changing, many non-profit systems also have the impending expenses of EMR implementation, ICD-10 conversion and other capital-intensive initiatives vying for funds, which often rank before acquisitions, he says.
How investors will make money off of ailing hospitals
Given these challenges, it may be unclear what investors see in hospitals. However, Dr. Gruen points out that all of these new pay-for-performance models actually present hospitals the opportunity to fare better, and sophisticated investors believe ailing hospitals can be quickly turned around. "[These models] can be a windfall for hospitals that can get highly organized and take advantage of payment reform," says Dr. Gruen.
Plus, it's a great time to acquire hospitals; pricing is depressed compared to historic pricing. The current forces working against hospitals have severely hurt those that haven't been able to adapt. As such, finances falter and they are valued at lower prices. If turned around quickly, the potential for profits is considerable. "Investors are attracted because of devalued assets," says Dr. Gruen.
In the past, the hospital sector has been unable to meet private equity and investors' desired rate of return, but the current perfect storm of depressed assets and turnaround opportunities has drawn strong interest to the sector, says Dr. Gruen. But, what it will take to succeed in a turnaround will be markedly different than turnaround of the past. "In the past it was all about operation efficiencies. In future, it's still about operational efficiency but it's also as much about the ability to dynamically change the business model and reposition the organization," says Dr. Gruen. "There's a new opportunity to change the business model, which is very exciting — a whole new vision for how you can make revenue."
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