These are not easy times for healthcare executives, particularly considering the demand and speed of mergers and acquisition and strategic partnership activity. As the number of facilities has declined, as accountable care organizations have begun to proliferate, as more services are being performed on an outpatient basis, and as financial pressures have increased, M&A activity, and in particular strategic partnerships, have become the de-facto route to solve many of these issues.
As an outcome of the Patient Protection and Affordable Care Act, hospitals must now consider a number of critical issues not in their control including but not limited to: a radically changed reimbursement arena where value-based/capitation rates may become the norm, access to capital to upgrade aging infrastructure to keep up with the competition, and finally, diversification to meet all of its patients' needs. In order to address these issues, the most expedient avenue has been through M&A and strategic partnerships. The question then becomes "how do you find the right partner to align your facility’s strategic initiatives while meeting your financial objectives?" Well, by "running the numbers." 
Key issues to consider
Based upon the recent nationwide M&A activity, there are a number of key issues which need to be considered prior to completing a transaction:
- Run the numbers. Understand the financial implications of all potential transactions before you sign-on the bottom-line. For example; perform a three-to-five year financial projection integrating where you stand today, changes you anticipate after the deal and any other variable that might be a factor going forward (i.e., rate changes, new hires, new programmatic development, additional borrowings, etc.).
- Understand your community and the community of your M&A partner. Remember, it needs to be a good fit (don't try to force a round peg into a square hole).
- Know what you want to get out of a transaction before you get involved. This will save you significant time, and grief, on both front-end and back-end work.
- Anticipate what the changed environment will look like. Many times M&A activities are performed to reduce costs, gain access to capital and/or to share risk; this could mean cost reductions, layoffs, re-organizing, etc. Does your organization have the stomach for this, and who will be the winner/loser?
- Know what you are going to do and why you are going to do it before entering into an agreement, even an exploratory one. Many times hospitals (or other organizations) merge and then ask the question "what do we do now?" Once again, knowing this upfront will save time, money and heartache. This is a major reason why many mergers have destroyed rather than created capital.
- Know your partner – do your due diligence. No matter who your partner might be, you need to understand where the pitfalls may lie (i.e., legal issues, accounts receivable issues, what their plans are for you, why they are looking to merge/purchase, medical staff issues, etc.). You need to understand who you are going to the "dance with" to ensure that the M&A/strategic partnerships in both parties' best interest.
- Do what's best for your organization. Even if you are negotiating from a position of relative weakness, you still have control. In the end, you need to do what's best for your organization.
As is evident from the above there are numerous complexities to this issue. This article, the first in a series, will address address the first element at depth: "running the numbers."
Running the numbers
Getting started
It is crucial for the parties to understand why they are doing it and what the key financial implications for the future are. It is critical for each organization to assemble the right team and create an environment that will foster input from all parties during the process. Typically, the CEO, CFO, planners, the community and key medical staff members are Included in the process. However, the one overlooked party is the "non-partisan" facilitator who could be critical in ensuring that the M&A/strategic partnership is taking place for the right reason. This individual should be skilled in planning and financial assessments with the ability to develop a five-year financial projection model to allow everyone to see the "why" in the M&A. By building a financial model, both parties will have a tool to help them better understand where the combined institutions will be in the future and to allow for "what-if" scenarios so that issues can be addressed both prior to and after the M&A takes place.
Similar to other industries, hospitals must develop a clear sense of their market and financial position and understand how the future relationship will affect it. A carefully constructed financial model can do just that. Models can be developed in a number of different formats from formal, purchased mainframe solutions to customized PC/Excel-based systems. Various inputs need to be gathered during the process so as to allow for the model to be interactive and to address the unique issues raised for the merger or acquisition. The development of the model should include, at a minimum, the following key areas:
- Identification of service area
- Market share data (historic, current, and projected)
- Projection of utilization (both inpatient and outpatient)
- Population demographics, including socio-economics
- Use-rates (historic, current and projected)
- Proposed and anticipated regulatory changes (PPACA, etc.)
- Reimbursement trends
- Physician growth/contraction
- Competition
- Capital investment
- Historic financial data
Each of the above should then be integrated into a five-year volume-sensitive projection model, which will provide management with a better understanding of how each item interrelates and their effect on the bottom line. Management and the board will then be able to better understand how the transaction will work; which facility gets what services, renovate or build new, what are the needs of the patient population (services required, where are they currently receiving care) and what is the impact on the hospital's bottom line.
Making the 'Go' or 'No-Go' Decision
After gaining an understanding of an institution's market position both with and without the merger, acquisition or strategic partnership, providers need to begin to gauge which existing services are financially profitable (winners/losers), where they should be located and if these services improve with the new relationship. The potential effects of the new relationship can then be tested within the model by reviewing its impact on market share, utilization, patient origin and the associated impact on revenues and expenses. The facilities will be in a better position to determine which and where any new service should be offered, which services should be centralized and where FTE consolidation should occur. With the model in hand, a "go/no'go" decision can be made quickly and with the knowledge that it is not being made by "the seat of your pants." Many times hospitals fail to understand the total impact that a merger or acquisition may have on the organization and community, and post-transaction issues will need to be addressed which should have been addressed in advance.
Due to tight bottom lines and uncertainty with healthcare reform, access to capital is at the forefront of all institutions' strategic plans. Institutions therefore need to understand their borrowing capacity with and without a merger or strategic partnership. A properly developed model will assist management in its efforts to both determine not only what their borrowing limits are, but also where to invest their money allowing for an appropriately located and sized project. Hospitals can easily waste time and effort in developing projects that are significantly beyond their financial means, are not sized correctly and/or are not appropriately located. It is imperative that institutions build and use a model which can assist them in this decision making process.
Once financial health is assessed as a stand-alone, as a merged entity or with a strategic partner, it then becomes possible to start mapping out the various options for an institution's service expansion (or contraction), FTE additions or deletions and borrowing limits. With an appropriate model, hard data can be presented to the various constituencies, both internal and external to the institution(s), helping to show how the changed entity will work. It is at this point in the process where financial forecasting becomes most crucial and where data is critical.
Moving forward
Once a decision has been made regarding M&A/strategic partnership activities, a plan of progression can be developed along with an appropriate timeframe (usually three-five years). The model can assist in helping management and the board to decide: who do we partner with; what new initiatives do we want to move forward with; and what are the bottom line impacts of each relative to the status quo? With a model in hand, there is now a formal and subjective basis for decision making including how much when capital improvements should be made so as provide optimal financial results. The facility will now be able to build an M&A scorecard comparing itself to the benchmarked model on a go-forward basis.
The model can't answer all potential questions, but being able to assess the likely financial outcomes of the potential integration will aid in improved decision making, provide a roadmap for integration and ensure better overall organizational performance.
Steve Bilsky is a director with Causey, Demgen & Moore P.C., a CPA firm out of Denver, Colo. Mr. Bilsky manages the firm's healthcare consulting practice. He can be reached at sbilsky@causeycpas.com.