Since the unveiling of President Clinton's healthcare reform initiatives almost a year ago, an interesting dichotomy has emerged between investor-owned and voluntary hospitals. The equity price of publicly owned hospitals has skyrocketed while credit ratings of voluntary hospitals continue to plummet.
Is the difference simply capital structure or have the economic underpinnings of health services permanently shifted?
Wall Street investors reward growth-oriented companies through high price/earnings valuations, thus the low cost of capital. A P/E multiple of 25 roughly translates into a 4% cost of capital, substantially below prevailing tax-exempt bond rates. To sustain such lofty P/E multiples, however, public companies need sustained earnings growth. Acquisitions, because of enhanced economies of scale and marketplace leverage, provide the best road to those higher earnings.
Capitation payments, regional integrated networking and physician partnering define our new healthcare delivery landscape. Cash acquisitions funded through depletion of investment reserves or added debt weaken credit profiles and provide a poor substitute for ongoing ownership incentives. The financial glue that seems to bind diverse interests is common enterprise equity. But private inurement concerns and fraud-and-abuse issues complicate transactions between for-profit and not-for-profit providers.
For trustees of freestanding hospitals, the challenge of preserving local autonomy and governance while retaining the economic value of community assets may appear incompatible. Not all hospitals will survive the necessary reduction in systemwide capacity. In this consolidation process, the needs of all stakeholders-including employees, physicians, patients and creditors-must be considered.
Consolidation options.The alternative to the status quo is a merger into a regional health system or a cash sale to an investor-owned chain. The first option may provide ongoing board representation, while the latter would produce sale proceeds to create and maintain a locally controlled charitable foundation. In both cases, the decisionmaking process moves to a regional or national corporate office, much the same way banking has consolidated in the nation's financial centers.
Trustees might look for strategic alternatives to conventional "sell or merge" options by examining other sectors of the nation's economy. Mutual savings banks, like not-for-profit hospitals, were owned by depositors within a community. Confronted by similar capital constraints and deregulation pressures in the 1980s, bank trustees faced the same problems many hospital boards now must address. What most often happened was the "demutualization" of ownership and the creation of locally controlled-but publicly traded-companies.
Banking, like hospitals, is a local business with both advantages and disadvantages of regional or national affiliations. Some banks do best by focusing exclusively on local opportunities and market dynamics.
For these new stock-ownership banks, like many hospitals, a crucial advantage is retention of local governance, management and reinvestment of earnings within the community. Shareholders provide capital in exchange for dividend income and stock price appreciation, but they don't dictate corporate policies, strategic direction or other governance mandates. Property taxes and income taxes will have to be paid. Most analysts, however, do not believe voluntary hospitals will be able to hold on to exemptions from these taxes.
Staying local.Few industry experts believe healthcare services will become a truly national enterprise. Health services will continue to be most effectively managed and organized in communities.
The next generation of healthcare cost efficiencies may reside in locally oriented networks where vertical integration and ownership interests are combined. To effectively fulfill their responsibilities, hospital boards must start with a national perspective of changing industry economics. State laws and regulations enacted for yesterday's medical industry undoubtedly will give way to cost-driven market forces. Our healthcare system will remain pluralistic, with ownership models complementing local community economies and cultures.
New variations of investor ownership will emerge, such as local and regional integrated providers combining physician stockholders as well as employee investors.
At a time when interest rates appear to be headed higher, local governments' appetite for tax dollars seems insatiable and equity markets are infatuated with hospital ownership, voluntary trustees must look objectively at how best to finance the health needs of their communities.
Can we really expect the conventional funding sources that capitalized a regulated health industry in the 1980s to remain receptive to a managed-competition model of healthcare forecast for the 1990s? If not, new forms of ownership need to evolve to better serve community needs. By separating the tax benefits of 501(c)(3) status already in question under health reform, trustees might instead retain a more prized objective-control and governance of a financially integrated, local healthcare delivery system.