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March 16, 2012 11:44:45 am

Hospital mergers and acquisitions are on the rise

In health care today, many forces and factors are creating an environment for hospitals that might be called "consolidation friendly." Stresses within the financial industry have reduced access to capital, while funding requirements for new and updated facilities, physician employment, IT, and service-line expansion are soaring.

And all of this is occurring while many hospitals' profit margins are being squeezed by deteriorating payor mixes and declining volumes of profitable lines of business. As a result, mergers and acquisitions (M&A) are on the rise.

Numbers don't lie
In fact, there were never more than 60 M&A transactions among U.S. hospitals in any single year between 2006 through 2009, according to business intelligence firm Irving Levin Associates. Then, in 2010, M&A activity jumped to 76. As of June 2011, 56 M&A transactions had been completed, accounting for 21% of total health care services transaction activity.

For hospitals, there are good reasons for considering an M&A deal. The right one can allow you to:

  • Spread fixed costs for technology and administration over a larger revenue base,
  • Fill the gaps in penetration of local markets,
  • Avoid deterioration of full-cost reimbursement in your payor mix,
  • Add capital for new or updated facilities, physician employment and practice acquisition, IT systems, and service-line growth,
  • Be in a stronger position for contracting with payors,
  • Relieve pressured operating margins and bolster declining liquidity, and
  • Transition from a volume-based to a value-based business model.

Freestanding hospitals and small hospital systems can partner with stronger organizations that have the capital needed to meet these challenges. Larger systems also have the opportunity to acquire undervalued hospitals and achieve the benefits that result from increased size and scale. Moreover, merging with or acquiring another hospital falls right in line with demands under the new reform law.

Getting started
When seeking an M&A partner, it's critical to develop clear business objectives. They'll provide the basis for selecting and evaluating partners, as well as the benefits to be achieved from the new entity.

The objectives should be not only specific, but also realistic. All parties should understand what's expected of them, including what each party will give up — such as decision-making autonomy, unique brand identification, and certain features of organizational culture. They may also face potential department closures and workforce layoffs.

The language should be unequivocal, allowing no room for misinterpretation or failure to follow through.

How the process works
The M&A process will be conducted by two groups:
  1. Senior management, with its financial and legal advisors, will perform the practical tasks and activities of negotiating the deal, and
  2. A subset of the governing board will oversee the implementation of the deal once it's been agreed on.

One of the early steps is to define the criteria for desirable candidates. They may include, for example, the hospital's prior experience with a candidate, its financial strengths and ability to access capital, physical facilities and location, strength and consumer perception in the market, physician group composition and relationships, and operational infrastructure.

One particularly important prerequisite for a merger candidate is cultural compatibility. To determine whether a good match exists, interact with key constituents of the prospective partner, such as the hospital's advisory board, senior executives, midlevel managers, supervisors, staff, physicians and community leaders.

Eventually, all parties will need to decide on the appropriate partnership structure. The options range from looser integration, through a simple "affiliation," joint operating agreement or joint venture, to the tighter integration possible from a merger of equals or the acquisition of assets or the entire hospital business.

When a strategic partnership has been negotiated, stakeholders from both organizations must fully support the agreement. In addition, all physicians (employed and independent), staff of all ranks, the patients being served, and the surrounding communities should be onboard.

Balancing pros and cons

Executing an M&A is a substantial, high-risk undertaking. If your hospital's leaders can't find good reasons for partnering with another hospital, or they can't find any good candidates for partnership, consolidation may not be right for you. Keep in mind that, in some situations, nearly as much can be accomplished through strategic partnerships based on artfully drawn legal contracts as through a full-blown M&A deal.


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