How hospital M&A has been driven by investors and industry evolution in 2017

Uncertainty surrounding the Affordable Care Act and how President Donald Trump will enforce the law has been a major story line in the healthcare industry in 2017. However, one trend has largely flown under the radar of mainstream news: consolidation among providers.

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Major provider M&A activity was largely concentrated in the eastern half of the U.S. in 2017

Mergers and acquisitions don't appear to be slowing down despite the uncertainty surrounding the industry. In fact, experts expect the number of hospital and health system transactions in 2017 to exceed 2016's volume. The activity reflects industry transformation as well as speaks to the trend of sophisticated investors entering the space. While it will be important for providers to assess their own local markets when considering a deal, a strategic rationale for taking on a collaboration will be absolutely critical as deal makers look to the future health of their businesses in a changing industry.

The pace and scope of deal-making in 2017

The volume of hospital mergers picked up steam in 2010. Nearly 40% of the 1,412 hospital mergers that occurred from 1998 to 2015 were concentrated from 2010 to 2015.

While the volume has ebbed and flowed since 2012, its activity is pacing steadily. This year's volume is on pace to exceed last year's activity, Kaufman Hall stated. Large systems have been especially active; there were eight transactions of health systems with nearly $1 billion or more in revenue announced this year.

The world of healthcare M&A can get murky with the myriad variety of deals whether they be mergers, joint ventures, affiliations or another mutation. The above map shows the major health system deals announced in 2017, though it is not meant to be comprehensive of every deal or closure.

Deals were concentrated in the eastern half of the U.S. but the West Coast is by no means quiet on this front. For example, San Francisco-based Dignity Health and Englewood, Colorado,-headquartered Catholic Health Initiatives have been in merger discussions while Washington state-based Trios Health is exploring options with Tennessee-based RCCH HealthCare Partners and UW Medicine.

Still, time remains to strike a deal before Q4 closes.

Jeff Byers / Healthcare Dive. Data: Irving Levin Associates

Why industry transformation is contributing to the trend

Anu Singh, managing director at Kaufman Hall, recently told Healthcare Dive the activity is the consequence of a transforming industry. "Health systems are under pressure to ensure they have the right assets in the right place to optimize care," Singh said.

Despite uncertainty coming out of Washington, there remains an industry focus on outpatient settings to guide patients to lower cost settings in hopes of curbing healthcare spending costs. Health systems have gotten on board with the idea and seek to build out their access points to lower acuity settings such as urgent care centers and freestanding emergency departments. This helps providers on many fronts: the strategy utilizes lower care settings, builds brand recognition and allows for referrals across a distributed care network, thus retaining patients.

Other continued focal points are industry transparency, which ease patient decision-making regarding care services, and new reimbursement models such as bundled payments and paying for value. Taken as a whole, these transformations trickle down to business model changes, according to Singh. However, that also means what made providers successful 10 to 15 years ago may not be the tools needed going forward.

The industry's evolution is forcing companies to rethink traditional barriers and M&A opportunities as new entrants seek to take market share from incumbents. For example, the news that CVS Health is reportedly in talks to acquire Aetna points to the transformation of healthcare M&A activity.

"If you don't embrace these new ways to address competition and new business models, you risk falling behind where the industry is going," Singh said.

Hospitals and health systems have a couple of options to compete across the new landscape they see before them. They can choose to enter into business arrangements with others or build out capabilities or facilities themselves. For many with limited resources, M&A activity is an easier route to scale out.

Thinking nationally, acting locally

Thad Kresho, U.S. Health Services Deals Leader at PwC, expects the hospital market to continue to experience M&A activity, in part because private equity investors continue to invest in the industry. Activist investors have lit a fire under for-profit health systems this year as health systems' stocks trend downward. Both Tenet and CHS have been divesting assets to reduce their debt load while HCA has been active in purchasing properties to push its strategy on long-term growth in select markets forward.

In the current hospital industry, M&A benefits both parties. For sellers, the proceeds of sales from facilities with low-performing margins can help reduce debt load, improve margins and allow management to focus on better performing assets. On the other side, it's clear that to succeed in a market, a health system has to negotiate scale in a market, Jessica Gladstone, SVP at Moody's, recently told Healthcare Dive.

"If you don't embrace these new ways to address competition and new business models, you risk falling behind where the industry is going."

Anu Singh

Managing director, Kaufman Hall

Hospitals want a strong market presence and multiple access points to get patients in their network, Gladstone said. From there, a hospital or health system is better able to negotiate insurer rates as well as grow their referral bases.

For a health system looking to compete on a national scale, they are thinking locally. A lot of M&A activity for providers will vary market to market based on local provider needs, population bases and available acquisitions, Kresho stated. However, an observer can already see some patterns taking hold as hospital operators make their stakes in or retreat from markets.

Tenet, with the sale of Chicago-area MacNeal Hospital to Loyola Medicine, is signaling an exit in the area where the company did not have enough market share. While outpatient ambulatory settings has been a big part of Tenet's strategy, looking forward "they probably want to maximize the inpatient facilities they have so that those facilities are focusing on high acuity and trauma, areas that aren't going to go to outpatient settings," Gladstone said. "In markets where they may not have enough demand or too much competition around the high acuity patients or lower margins, it may be better divesting those and focusing on the core group of high acuity facilities," she said.

HCA is looking to build out its market share in Houston and the Gulf Coast of Florida and enter the Savannah, Georgia market. "[O]ur approach is built around volume growth," President and COO Samuel Hazen said on the company's Q3 earnings call. "We have to have volume growth I think to be successful." The company is continuing to look for growth opportunities through acquisitions. William Rutherford, CFO and EVP, said the acquisition pipeline is the best the company has seen in 15 to 20 years.

Though it will depend on local market opportunities, as healthcare companies look at decentralization, investors act bullish on market opportunities and health systems rethink their market strategies, expect hospital deals to continue.

"I'll retire before it stops," Kresho joked.

Singh reminds that the strategic rationale for taking on some sort of collaboration or transaction is absolutely critical. "There has to be a strategy behind what organizations are aiming to achieve or trying to benefit for their communities, employees or stakeholders," Singh said. "Make sure that strategy is true as to what you're experiencing in your market as you look into the future and not what it was historically."

Unintended consequences

Though M&A is trending, experts debate its merit for the industry.

For example, Brent Fulton, assistant adjunct professor at Petris Center in the School of Public Health, University of California, Berkeley, in a recent Health Affairs article noted "reviews of studies of hospital markets have found that concentrated markets are associated with higher hospital prices, with price increases often exceeding 20% when mergers occur in such markets."

However, Singh believes it can be a premature to determine the impact of competition and consolidation in the space as the industry is still in transformation. He states the industry is evolving to pay more attention to the value of care that's delivered and not just cost. "If we have cost increases year-on-year but the quality is significantly better, it seems to me you'd want to capture that in the assessment of determining whether this industry transformation is a net positive or net negative," Singh said. "I think that remains an open area for the industry to figure out and what's the right way to capture that."

While the impact maybe filed under TBD for patients, there are certain unintended consequences that may be under consideration for facilities in the face of mergers and acquisitions. For one, consolidation can lead to workforce reductions. Jefferson Health, following a spate of merger activity, will reportedly reduce its workforce by less than 1%, or about 300 positions. "Our growth, along with the changes in technology, healthcare and education, present Jefferson with the opportunity and the responsibility to effectively manage limited resources," Dr. Stephen K. Klasko, president and CEO of Jefferson Health, was quoted in Philadelphia Business Journal. Lahey Health is laying off about 75 employees (less than 1% of its workforce) following the BIDMC merger disclosure though the system says the merger is not behind the reasoning.

While these moves may be coincidental, health systems will take stock of their workforce following a merger and act accordingly. For example, a population in an area could be shrinking and/or a hospital may have overcommitted beds or resources to a service line that made sense 10 years ago but is no longer needed at its current size.

While the market may dictate heavier decisions such as hospital closures, M&A activity is reflecting the changing nature of access to care. "As things generally more toward to lower cost settings, you're probably not going to need as many high acuity inpatient facilities across the country," Gladstone said.