Anticipating the Purchase or Sale
After a period of hypergrowth from 1994 to 1996, hospital mergers and acquisitions declined from a height of more than 450 transactions in 1996 to a mere 50 in 2009. John Reiboldt, managing director of Coker Capital Advisors (Alpharetta, Georgia), says that the merger/acquisition market is heating up once again with the return of many of the factors that drove the action in the early 1990s: pressure from payors, the threat of managed care, greater regulatory burdens and government intervention, physician employment, physician integration, and economic uncertainty. In Orlando, Florida, on February 22, 2011, Reiboldt presented “Mergers and Acquisitions in the Hospital Market” at the annual meeting of the Health Information and Management Systems Society. He says that he did not expect to see the number of deals experienced in 1996, but that hospitals will increasingly engage in merger/acquisition activity as a strategic alternative. The total number of hospital transactions in 2010 was 77, with a total value of $12.7 billion—a dramatic increase over the total values of $2.6 billion for 2008 and $1.7 billion for 2009. Reiboldt refers to these as the lost years. Deal Characteristics An interesting wrinkle in the latest go-round is the widely dispersed types of transactions (see table) that occurred in 2010, with not-for-profit entities buying for-profit organizations (and vice versa), and with new participants and deal structures. “What really surprised us was the acquisition of Caritas Christi Health Care System (Boston, Massachusetts), an $830 million acquisition by a private-equity company, Cerberus Capital Management LP (New York, New York),” Reiboldt says, noting the 2006 investment that the company made in the GMAC division of General Motors.
Table. Selected 2010 Hospital TransactionsReiboldt believes that, based on demographics, the for-profit providers are gearing up for volume-based medicine—rather than the accountable-care organization (ACO) concept—with dispersion of costs, economies of scale, and economies of scope as the strategic objectives. On the other hand, in-market consolidation has been an earmark of not-for-profit acquisitions, supporting the ACO concept of delivery of care on multiple levels. Both for-profit and not-for-profit providers, however, are thinking about the impending demographic surge as more of the baby-boom generation reaches retirement age; the percentage of people in the United States who are over 65 years old is set to soar from 13% in 2009 to 19% in 2030. “The number of people who are entering our health-care system, who are asserted to be high utilizers, is absolutely staggering,” Reiboldt states. “Right now, hospitals are not prepared for that.” Care for most of these patients will be paid for under Medicare rates, which is why Reiboldt believes that the ACO concept is not coming into play in a big way in the current round of acquisitions. “What you see is people preparing for volume-based medicine instead of value-based medicine,” he says. Reiboldt also notes a good balance between buyers and sellers, which has sent valuation multiples slightly higher. Sellers are selling because the financial crisis has sent many community and government owners running for the exit. Preparing and paying for stages 1, 2, and 3 of meaningful use under the Health Information Technology for Economic and Clinical Health Act have been factors, Reiboldt believes. “You go to some of these hospitals, and you have unfunded pension liabilities and significant financial risk, so they are going to people with deeper pockets, both on the for-profit and nonprofit sides,” he says. “I’m a big believer that the days of the single hospital are over.” All of this has made executives and boards more amenable to these transactions. “They are finding that it is a good way to maintain quality health care in their communities,” Reiboldt says. “Merger and acquisition are no longer dirty words.” In addition, many hospitals have no choice but to consider selling. Reiboldt recommends that you avoid finding yourself backed into a corner with no options. Buyers, on the other hand, are acquiring entities to build economies of scale, to enter new geographic markets, to add new services, to attract and retain physicians (probably among the biggest drivers), and to diversify patient and payor mixes, as well as because they have the financial backing to do so. Preparing for a Transaction Whether you are planning to buy or to sell, the merger/acquisition process should be part of your strategic plan. “Going out and selling your hospital doesn’t have to be your strategy,” Reiboldt says. “Going out and buying other hospitals doesn’t have to be your strategy. All it has to be is a component of your long-term strategy.” Reiboldt recommends taking four steps. First, outline and adhere to your transaction goals before and during the process. Second, recognize what drives value, and don’t be afraid to drive value—which doesn’t always mean monetary value. It could be as simple as investing in the physical plant, in the IT infrastructure, or in building the physician network. Third, think ahead, plan for an auction, and create a market. Fourth, consider other methods of affiliation, such as joint ventures, that might be more appropriate. There are seven key components of a successful transaction process, beginning with confidentiality, which must be maintained internally and externally. The other six are the development of a strategy (your play book), thorough due diligence (the most money does not translate into the highest stability), the identification of prospective partners, buyer due diligence, maintaining competition among multiple potential partners, and a negotiation process that optimizes economic and noneconomic terms. Sellers can use one of three transaction-process alternatives: a negotiated process with one to two buyers, a targeted auction marketed to a select group of targeted buyers, or a broad auction marketed to a wide range of potential buyers. The first alternative ensures speed and confidentiality, but is unlikely to achieve maximum value. A targeted auction is both expedient and likely to achieve full value, while a broad auction maximizes competition. Reiboldt advises hospital buyers to be clear about their long-term strategies, to understand their financial capabilities, to know their competitive environments, to know why they want other hospitals, and to identify opportunistic targets (those with reasonable valuations that are viable acquisition targets). Be prepared to invest the time and money that it takes to conclude the deal properly. One of Reiboldt’s clients spent $5 million on IT integration alone for a large hospital acquisition. It’s not about the deal; it’s about the integration, which doesn’t begin the day you sign definitive agreements, but at least 120 days earlier. “The day you start thinking about buying a hospital is the day you should start thinking about integration,” Reiboldt concludes.
Table. Selected 2010 Hospital Transactions