A decade ago, hospital consolidations typically were undertaken by facilities struggling for survival, following tried-and-true legal structures for change-of-ownership transactions. By contrast, today's overhauled healthcare market finds players with clout engaging in hospital-to-hospital mergers and acquisitions, and choosing among an expanding array of strategic alternatives—and hybrid structures—to make them happen.
Now industry M&A experts tell Healthcare Dive that the best approach for hospitals is to keep an open mind about their burgeoning array of options in change-of-ownership transactions.
According to attorney Kristian Werling, a Chicago-based partner in the law firm McDermott Will & Emery, “some of the stronger hospitals being in the market to do M&A deals are really driving this innovation. They have the power to talk to potential partners,” and define the deal's parameters.
Jordan Shields, a vice president at Juniper Advisory LLC, an investment banking firm that specializes in M&A activity for the nonprofit hospital industry, agreed. “Generally, we have seen in the last five years an increase in really well-positioned hospital systems looking at mergers to help support healthcare in the community: improve quality, improve access and improve efficiency,” he said.
“We're still seeing struggling hospitals pursuing mergers to keep their [doors] open, and their hospitals vibrant,” Shield said. “But we're seeing an uptick [since just prior to the Affordable Care Act's enactment in 2010] in activity among strong hospitals going to market because they want to, not because they have to. And that has led to some innovation.”
The opportunity for creative consolidation is vast: Nationwide, there are an estimated 4,500 acute-care hospitals, with care being delivered by more than 2,000 separate hospital companies. Amid such fragmented ownership, experts say it is no wonder that improving population health, controlling costs and delivering efficient and coordinated care are elusive goals. (By contrast, 80% of the managed care market is in the hands of fewer than 10 firms.)
Even though hospitals' M&A activity has picked up significantly, and has been steadily rising, under the ACA, Shields said the numbers are still catching up to the last big wave of transactions in the late 1990s. And despite all the recent activity, the hospital industry is “still incredibly fragmented,” and transaction volume is “still tiny drops in the bucket,” he said. (That may arise partly from conflicting federal signals, M&A experts said—even as the ACA is spurring consolidation as a way to lower costs and create efficient delivery systems, federal enforcers are getting more aggressive in pursuing M&A activities as potentially anti-competitive.)
Still, there is an expanding range of M&A alternatives. Shields and Werling are among the co-authors of McDermott Will & Emery's new briefing paper on hospitals' strategic alternatives in change-of-ownership transactions.
“We find that our clients have a vague, general understanding of what many, but not all, of these structures offer,” Shields said, “and they rule things out based on this general understanding.” Instead of deciding that only a seller joint venture, for example, makes sense, he said a hospital should go to market, get various proposals in real time, make comparisons—and only then make M&A decisions.
The June 24 paper focuses on several types of emerging “hybrid” structures.
Seller joint venture
This typically occurs between a community hospital and an investor-owned company. The latter acquires a majority interest (usually 60% to 80%) in the hospital, but the hospital retains control by keeping 50% governance on the joint board. To work, the selling hospital must be able to pay off its liabilities by selling a 60% to 80% share of its business. It also must have modest future capital needs, because it would have to pay its 20% to 40% share of future capital investments.
Buyer joint venture
This combines the respective expertise of a clinical partner (i.e., a prestigious academic medical center) and an investor-owned system. Under this structure, the clinical partner holds a minority interest (typically 3% to 20%) and is responsible for overseeing medical safety and quality. The investor-owned partner provides capital (typically 80% to 97%), along with operational and management capabilities to run the community hospital.
Shields cites a wave of about 20 buyer joint ventures around the U.S. over the past several years, including last year's joint venture between for-profit RegionalCare Hospital Partners, based in Tennessee, and nonprofit Billings Clinic in Montana. This year they are bringing in Community Medical Center in Missoula, Mont.
Multi-party joint venture
This complex transaction combines the characteristics of both seller and buyer joint ventures. Under this structure, community hospitals can use the financial proceeds to support research, education, training and other academic functions in a community hospital setting. A foundation is created through the deal, and the promise of access to a share of its annual earnings is used to attract an academic partner committed to research and clinical growth at the hospital.
In this, the two parties join to create a new parent company with a self-perpetuating board. MWE said this was a popular structure in the 1990s and has seen a revival under reform, creating many of the larger national 501(c)(3) systems, including Advocate in Chicago, Banner in Phoenix and Sentara in Virginia. Consolidation transactions are difficult to execute, the authors said, because the two health systems must share a common vision and be of similar size.
“What's new is the regionally prominent 501(c) (3)s, like Inova...or Advocate in Chicago or Sentara in Virginia feel the need to grow to be successful in the post-Affordable Care Act environment,” Shields told Healthcare Dive. “So they're developing a new level of acquisitiveness and starting to cross state lines.”
This is the most common structure between merging nonprofit hospital systems, and is analogous to a stock sale transaction: The seller transfers its ownership to the nonprofit acquirer who becomes the new “member.” The seller’s corporate structure typically stays intact, but ownership and control shift to the new parent, which also typically becomes liable for the seller’s debts.
Often, the nonprofit buyer agrees to continued investment in the facility and medical staff.
This is a common transaction between a nonprofit hospital and investor-owned system. But it also can occur between two nonprofit partners. Typically, there is a purchase price, and the seller uses its cash and the purchase price to retire its liabilities and transfer its assets to the new owner. If there are additional assets, after liabilities are paid, a community foundation is generally formed. Often, as in other structures, the buyer agrees to invest in the facility and medical staff for a specified time.