Lease agreements are becoming a more desirable acquisition strategy for investor-owned healthcare companies as they strive to bring not-for-profit hospitals into their fold.
Although most investor-owned hospital companies' deals involve outright acquisitions, they aren't always possible. Many communities cherish their not-for-profit hospitals like a local church or the town hall and don't want to give up control.
"Lease agreements are politically more acceptable," said William Schoen, chairman, president and chief executive officer of Health Management Associates of Naples, Fla., which recently has stepped up its leasing activity.
The lease allows the hospital chain to control operations and capture profits but doesn't involve control of assets. The lease essentially keeps the assets in the control of the not-for-profit board, or the local government if it is a public hospital. But once the lease agreement is finalized, the hospital becomes a for-profit entity and is no longer tax-exempt.
Of the 26 hospitals HMA operates, eight, or 31%, are held through leases. The chain's last three hospital acquisitions came via lease agreements.
Other companies, like Quorum Health Group and Community Health Systems, both of Brentwood, Tenn., which have far fewer leased hospitals, are following HMA's lead.
Of the 63 not-for-profit hospitals that announced or finalized agreements last year to be acquired by investor-owned chains, 18%, or 11, were lease agreements, according to MODERN HEALTHCARE's third annual list of mergers and acquisitions (Dec. 23-30, 1996, p. 37).
Principal Hospital Co., which last month acquired Portland, Ore.-based Brim's healthcare group, also is pursuing the lease strategy.
"Some of the communities out there just don't want to give up control, and that's really what's driving these lease agreements," said Richard Gore, Principal's chief financial officer.
As a result of the Principal-Brim merger, Principal holds seven hospitals and manages 53 in 23 states. Six-including the five acquired from Brim-of the seven hospitals Principal holds are leased.
Principal wants to become more attractive to Brim's managed hospitals, which may be looking to be owned or leased.
"Our intent is to purchase (outright), but we'll negotiate the lease if that looks better for the seller," Gore said.
While executives at most investor-owned companies will say their first preference is to acquire a facility outright, a lease is better than no deal at all, which has been Brim's recent record with hospital acquisitions. By the start of this year, Brim hadn't acquired a hospital in three years but was negotiating lease agreements with two of the hospitals it manages at the close of its merger (Jan. 6, p. 13).
"It's a way to control operations and capture profits and gives (the not-for-profit hospital's board) a large capital pot it didn't have to play with before," said Steve Taylor, the longtime president of Brim's healthcare division who's now Principal's senior vice president of acquisitions and development.
Leasing doesn't appear to have harmed HMA's growth. In the past five years, HMA's revenues have grown an average of 21% per year, while its earnings have climbed an average of 29%.
"We like the lease agreements and have never hesitated in doing them," HMA's Schoen said.
Typically, HMA's lease agreements involve a "prepaid lease" that gives the owner of the hospital most of the money upfront. The leases are usually for terms of 30 or 40 years and may include annual rent payments.
"The board or county can take the money and form a foundation or use it for other purposes," Schoen said.
Although hospital sales vary from county to county and state to state, proceeds can be used for everything from the general fund to building roads and bridges.
In Clarksdale, Miss., HMA finalized a 30-year lease with Coahoma County in December 1995 for 195-bed Northwest Mississippi Regional Medical Center.
"Our first priority in the lease was that we wanted to try to protect the taxpayers," said Hugh Jack Stubbs, administrator for the Coahoma County Board of Supervisors.
HMA paid $30 million upfront, retired about $2 million in hospital debt and committed to annual rental payments .
"We'll at least have some input in the way they operate in the community, which we wouldn't have had with a sale," Stubbs said.
The county plans to use an estimated
$2 million in interest generated annually by investment of the upfront money to build a general reserve fund, Stubbs said. State law allows the county to spend as much as half the interest each year on a variety of health-related projects and needs.
"We're sitting tight on the $30 million for now, but we can use the interest for health programs and relieve expenditures from the county health department," Stubbs said.
HMA also agreed to provide $15 million in capital improvements in the next five years.
Since Principal started business last February, the company has completed only one lease, but it's working on others.
"If they aren't inclined to a sale and not inclined to lease for a long period of time, then most likely nothing will happen," Gore said.