10 Key Healthcare Transaction Trendsbeckershospitalreview.com/hospital-transactions-and-valuation/10-key-healthcare-transaction-trends.html
Hospital Transactions & Valuation Issues
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 ofthe highest volumes recorded in a decade, according to a report from strategic advisory andinvestment banking firm Hammond Hanlon Camp LLC.
Reimbursement reductions alongside the shift to value-based payments, among otherfactors, have financially strained smaller hospitals, which have joined forces with largerhealthcare organizations in order to survive and thrive. The Patient Protection andAffordable 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 motivatingfactors: “In past years my speeches began with the premise that hospitals seek partners tocontrol 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 andthe need for proactive care beyond the walls of our hospitals. These two factors demandlarger and more diverse population portfolios and a better coordination of the care wedeliver to our people.”
In the past year, numerous hospital and health system deals were announced, includingseveral “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 healthsystems will continue to consolidate. Industry experts predict non-ownershipcollaborations will rise in popularity, while healthcare leaders become more strategic and
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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 tokeep in mind.
1. Hospital and health system transaction activity will likely slow slightly in2014. Although 2013 was a busy year in the healthcare M&A world, hospital transactionactivity will probably decelerate slightly this year as providers concentrate on refining theirexisting operations to cut costs and increase quality.
M&A activity already dropped in the fourth quarter of 2013, according to a report fromIrving 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 lastyear. 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 madein the first 11 months of 2012.
Joseph Cerreta, assistant vice president of Juniper Advisory, says the perceived level ofactivity in the market has also been “somewhat inflated by the fact that hospital and healthsystems are being more transparent about exploring their strategic options than they werewilling 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 CainBrothers & Company, says he and his colleagues are seeing higher hospital and healthsystem transaction volumes.
“I expect that over the next five years significant consolidation will continue atunprecedented levels,” he says.
2. Mega-merger activity characterized 2013 but may not be as prominent in2014. Last year, several health systems announced their intentions to combine and createlarge, multihospital networks in “mega-mergers.” These deals included the CHS-HealthManagement merger, a transaction valued at $7.6 billion — $3.9 billion in cash and stockand the assumption of $3.7 billion of Health Management's debt. The merger makes CHSone 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 VanguardHealth Systems — valued at $4.3 billion — was another high-profile deal. Tenet now ownsand operates 77 acute-care hospitals, 173 ambulatory surgery centers and outpatientfacilities, five health plans and six accountable care organizations.
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Last May, Mich.-based Trinity Health and Newtown Square, Pa.-based Catholic HealthEast 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 stayafloat and ensure market relevance, an Irving Levin Associates report issued in October2013 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 knowsof a number of organizations engaged in discussions that would lead to mega-mergers andexpects 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 combinedstill only account for between 15 percent and 20 percent of the total industry revenue,” hesays.
3. Nonprofit hospitals and health systems in particular will continue toconsolidate. Various factors such as the transition to value-based payments, more risk-based contracting and Medicare payment cuts are straining the finances of nonprofithospitals and health systems in particular. Standard & Poor's Ratings Services, FitchRatings and Moody's Investors Service have issued negative forecasts for nonprofits in2014.
As nonprofits seek to stay strong and strategically position themselves in their markets,strategic advisory and investment banking firm Hammond Hanlon Camp has predictedthey will continue to seek out mergers, acquisitions and other types of transactions. Theyhave already been responsible for a considerable chunk of healthcare M&A activity; of the94 hospital and health system transactions in 2012, 60 percent of them took place amongnonprofits. However, according to Mr. Beith of Cain Brothers, it's important to keep inmind that 80 percent of hospitals are nonprofits, meaning they are less activeproportionately.
All five hospital sector deals announced in November 2013 involved nonprofit acquirersand targets, reflecting a trend of nonprofit health systems and standalone hospitals joininglarger organizations to stay afloat, according to Irving Levin Associates. However,Newpoint's Mr. Lupica is skeptical of trend-spotting in the nonprofit arena. “When dealingwith 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 fiduciarydecisions a 'trend' comments on history more it really predicts the future.”
4. “Troubled sales” transactions are declining as healthcare organizations3/8
become more selective. Transactions driven primarily by one organization's financialdistress and inability to remain independent seems to be drawing to a close, although thosetypes of deals continue to take place, according to Hammond Hanlon Camp. Instead,hospitals and health systems are approaching transactions with the main goal ofproactively positioning themselves in their markets.
Mr. Cerreta of Juniper Advisory affirms this observation: “We are seeing more hospitalsand 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 toexecute 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. Ashospitals and health systems take a more strategic approach to transactions, they canchoose to structure deals in a variety of ways depending on their objectives and the internaland external constraints that exist, according to Holly Carnell, JD, an associate at the lawfirm McGuireWoods, McGuireWoods Partner Bart Walker, JDand Jordan Shields, vicepresident of Juniper Advisory, an investment bank that works exclusively with hospitalsand health systems.
A transaction can take the form of an asset purchase, which generally involves a for-profitbuyer and nonprofit seller. This model limits the buyer's legal obligations as far as historicoperations are concerned and typically includes a purchase price and, when acquired by aninvestor-owned operator, debt being retired or defeased.
“One of the main benefits of the asset purchase model is that you can attempt to partitionliabilities as between the buyer and the seller,” Mr. Walker says. “The one big potentialexception to this is Medicare-related liabilities. These can be more difficult to shed and bydefault follow the Medicare number, if it is assigned to the buyer. In transactions where atax-exempt hospital or health system is selling its assets, it is fairly common to establish acharitable trust with all or a portion of the proceeds for the purpose of furtheringcommunity health needs.”
Increasingly, the healthcare organizations involved in a transaction will adopt a jointventure model, under which a larger hospital and a smaller hospital both hold ownershipin a new entity. Although the larger hospital takes a bigger ownership stake, both partieshave equal board representation within the new entity.
Finally, hospitals and health systems can also pursue various “alternative” transactionmodels that fall short of a full merger or sale. One of those structures is a managementservices agreement, under which a health system usually provides management services to
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a hospital for a fee. This model has various advantages such as better contracting servicesfor the hospital, but it also has potential downsides such as less success in realizing scaleefficiencies.
“There are also quite a few health systems that utilize a joint operating model, where theparties to the combination contractually agree to allocate governance and economicconcerns in a specific way without actually moving assets or ownership from one legalentity to another,” Mr. Walker says. “The parties are almost fully integrated from anoperational, financial and governance perspective, but retain some vestiges of theirseparate 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-ownershipcollaborations. Rather than executing full-on mergers or acquisitions, some prominenthealthcare organizations such as the Rochester, Minn.-based Mayo Clinic and theCleveland Clinic have decided to pursue non-ownership collaborations and affiliations,allowing smaller hospitals and health systems to retain local control while giving themaccess to a larger organization's resources and expertise.
According to Hammond Hanlon Camp, healthcare providers are pursuing non-ownershippartnerships more and more in order to reap the benefits of joining forces without goingthrough an actual merger and relinquishing ownership. This trend goes hand-in-hand withorganizations becoming more strategic in their transaction decisions; it's also particularlyapplicable 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 moretraction 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 sectordeals involving physician medical groups increased 5 percent year-over-year to 20 deals inthe fourth quarter of 2013. That's also a 33 percent increase from 15 deals announced in thethird quarter of 2013.
However, reports from Deloitte and Jackson Healthcare have stated medical groupacquisitions 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 70reported medical group acquisition deals. However, Jackson Healthcare reportedphysicians who identified as hospital-employed rose from 20 percent in 2012 to 26 percentin 2013.
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8. Consolidation will give hospitals and health systems more bargainingpower with payers. As hospitals continue to join forces, they will gain more bargainingpower with health insurers, according to a report from Moody's Investors Service. Sincecommercial health insurers have already merged to form large entities capable of puttingsignificant pressure on providers, this development will make the balance of power moreequal, according to Moody's.
However, a recent report from consulting firm Alvarez & Marsal stated consolidation willgive hospitals unprecedented pricing power and lead to massive inflation. Hospital andhealth system acquisition of physician practices and other outpatient facilities is ofparticular concern, since profit margins are higher for outpatient services for commerciallyinsured patients, according to the report. According to the Medicare Payment AdvisoryCommission, Medicare payments rates for surgeries are 74 percent higher in HOPDs thanin ambulatory surgery centers.
Overall, the report concluded consolidation could lead to a few providers gaining astranglehold on hospital inpatient, outpatient diagnostic imaging and laboratory services.
9. Antitrust enforcement will continue to be a significant issue. Hospitals andhealth systems executing transactions continue to face antitrust scrutiny from the FederalTrade 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 groupwas decided recently: U.S. District Judge B. Lynn Winmill ruled St. Luke's violatedantitrust law when it acquired Saltzer Medical Group in Nampa, Idaho. St. Luke's wasordered 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 thehealth 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 ManagementConsultants, a leading strategic healthcare consulting firm.
“We have so many different agencies at the federal level and then there are the stateagencies,” he says. “The boundaries for antitrust enforcement have always been a tiny bitvague. 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 marketconsolidation where “there is a compelling case to increase efficiencies (reduce costs),improve quality and access and where payors are supportive.” He cited the CHS acquisitionof two hospitals in the Scranton, Pa., market as an example.
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10. Hospitals and health systems need to consider several factors to ensure atransaction is successful. In order to minimize the odds of running into antitrustissues and other problems, healthcare organizations preparing to execute transactionsneed to consider several factors. For instance, before initiating a transaction, they shouldensure their board members are aware of their fiduciary duties under state law.. Amongother things, board members must carry out a full investigation of relevant details, ensurefair market value and evaluate alternatives and any competing offers. They must alsodetect and avoid all conflicts of interests, keep discussions about the transactionconfidential 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-statebasis,” says Mr. Walker of McGuireWoods. “Different states have taken different positionson the level and requirements for approval of these transactions.”
Hospitals and health systems must also conduct pre-transaction diligence, which includesensuring its relationships with referring physicians and those physicians' family membersdon't violate the Stark and Anti-Kickback laws.
“Our recommendation is hospitals as a good business practice and regardless of whetherthey are contemplating a transaction or not, should carefully review all their physicianrelationships to ensure they are compliant,” says Mr. Beith. “In addition, what may havebeen perceived to compliant at one point, may no longer by compliant under increasinglystringent regulations.”
Finally, healthcare organizations looking to carry out transactions should identify andquantify other key liabilities and concerns such as pension plan obligations, collectivebargaining arrangements and real estate leases, which could have provisions that cansignificantly impact potential deals .
Mr. Lupica of Newpoint says hospitals and health systems need to keep in mind what'struly important in executing a transaction.
“So many of our clients begin by asking, 'How many seats do we get on the new board?'” hesays. “Not the right question. Reserved powers trump the number of seats because theydefine what power resides in those seats. More importantly, post-closing contractualcommitments 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 theRFP, the entire negotiation, and the exact wording of the definitive transactionagreement,” he says.
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