Ivan Colon has been eyeing opportunities to buy a few hospitals from the Puerto Rican government.
Colon, administrator of Hospital Auxilio Mutuo, the commonwealth's largest hospital, also has been loath to ask his board of trustees for the funds to make such a deal.
But last summer he came across an opportunity: A major dialysis provider wanted to buy Auxilio Mutuo's thriving renal-care business.
The results: The hospital sold the operation, the dialysis company continues to care for the hospital's patients, and Auxilio Mutuo has enough cash socked away to finance those coveted acquisitions.
Everything came together at the same time, Colon says. "Maybe we were lucky. I don't know."
What Colon did on the island of Puerto Rico, a small but growing number of hospital executives are doing on the mainland. They are taking a hard look at their holdings, pruning assets where needed and reinvesting the capital elsewhere.
It's not a widespread tactic yet. But Houlihan Lokey Howard & Zukin, a Los Angeles-based specialty investment banking firm that tracks healthcare divestitures, has seen evidence of it. Hospitals are spinning off radiology services, outpatient diagnostic businesses, home healthcare agencies and physician practices.
"It seems to be on a market-specific basis and a case-by-case basis," says Evan Moore, a senior vice president in the healthcare group.
The strategy contradicts in some ways the business imperatives of hospitals in the 1980s and 1990s: vertical integration and massive system-building. Buy more, build more, get bigger, let go of nothing.
Strategic divestitures in healthcare are partly a consequence of unfettered industry consolidation.
"I think many organizations have recognized that they may not have enough capital to pursue all the businesses that they have acquired or gotten into over the years. So they have tried to rationalize their ownership in these businesses," says Michael Hammond, a partner with New York-based Shattuck Hammond Partners, an investment banking and advisory firm.
Adds Moore of Houlihan Lokey: "My perception is that they're seeking new synergies." Capital reaped from one business line is being plowed into core businesses, he says.
Avoiding waste.The same strategy is being applied by Gary Puma, the 45-year-old president of Presbyterian Homes and Services, Princeton, N.J. He's faced with two rundown nursing homes and thinks rebuilding them would be a waste of capital.
One building had been a motel for senior citizens visiting the Jersey Shore. Now it serves Medicaid and private-pay residents. Puma would like to attract Medicare patients who require rehabilitative services after a hospitalization. But the building's narrow corridors and other structural deficiencies prevent it from qualifying for Medicare reimbursement.
The other facility sports about $1 million in physical plant improvements done in recent years. But it still needs a top-to-bottom overhaul.
When Puma began to consider financing options, he didn't see a future for his not-for-profit system in the freestanding nursing home business. A statewide boom in assisted-living projects threatens to skim away private-paying patients over time. In the near term, governmental payers' ever-tightening reimbursement spigot poses further financial challenges.
"I think the bottom lines on both (nursing homes) will be squeezed," Puma says. Currently, the facilities generate combined net income of $700,000 for the system, which has total annual revenues of $80 million. The New Jersey system also includes another freestanding nursing home as well as 15 low- and moderate-income housing communities, three continuing-care retirement communities and a licensed residential healthcare facility.
"Obviously, the impact of managed care on payer sources is driving our strategy to take a look at what we currently have and to consider other options in the future," he says.
Seeing an opportunity to stretch the system's capital, Puma recommended putting the two nursing homes up for sale.
Bidders apparently don't mind the buildings' timeworn condition. They're after the operating licenses. The New Jersey Association of Health Care Facilities says state regulators have not issued a call for skilled-nursing projects since 1993. That moratorium is fueling strong demand for existing licenses.
"We're in the process of meeting with interested buyers at this time," Puma says.
Presbyterian Homes' divestiture is expected to rake in $7.5 million to $8.5 million, easily covering $4.6 million of outstanding debt on the facilities. It leaves the system with a handsome equity contribution toward development of two new $10 million campuses, which integrate assisted-living and skilled-nursing services. And depending on how much the system puts down, it may walk away with a small nest egg for future capital requirements.
New expertise.In the long-term-care field, systems like Presbyterian Homes are ahead of the curve, says Jeffrey Blumengold, partner in charge of healthcare services at M.R. Weiser & Co., a New York-based accounting and consulting firm that's advising the system. He thinks many long-term-care providers lack the depth of management expertise to focus on such strategic financing issues. "I find that in many respects they are still very singularly focused," he says.
By contrast, in the acute-care field, competition "has weeded out the pure reimbursement specialists pretending to be CFOs," says Jim Scibetta, a director in the healthcare mergers and acquisitions group of Coopers & Lybrand Securities, New York. In the quest for capital to integrate and expand services, hospital and health system chief financial officers are essentially taking their business units public, he says.
Scibetta now is advising a $1 billion integrated delivery network on how to maximize the value of its nonacute business units. "We're exploring all reasonable possibilities, from roll-up strategies to outright sales."
He expects the wave of activity to continue as more systems take advantage of opportunities to outsource various lines of patient-care business. "What we've seen recently is not-for-profit systems looking to tap the equity markets (by selling) all or portions of their healthcare business units while still preserving the tax-exempt status of their core, acute-care hospital activities," he says.
Seizing an opportunity.In the case of Puerto Rico's Auxilio Mutuo, executives weren't trolling for a buyer. But they couldn't resist when outside companies began making inquiries about the facility's booming renal-care business. Between inpatient and home dialysis, the hospital served more than 500 patients at a time.
Leading the pack was Total Renal Care, which runs the third-largest kidney dialysis business in the U.S., including 20 dialysis centers in southern Florida. The publicly traded company, headquartered in Torrance, Calif., heard about Auxilio Mutuo's dialysis business from its Puerto Rico-based physicians, says John King, Total Renal Care's vice president and CFO.
King declines to say how much the company paid to acquire the business, and Total Renal Care's quarterly reports to the Securities and Exchange Commission do not provide terms of individual deals. But Colon says it's enough to buy two to three of the half-dozen hospitals the Puerto Rican government is selling off as part of a healthcare reform initiative.
There has been a big run-up in dialysis company stocks, so it's likely that Auxilio Mutuo made a nice profit on the transaction. "The multiples on (dialysis firms) are just astronomical right now," says Houlihan Lokey's Moore.
Auxilio Mutuo, unlike most mainland hospitals, consistently runs at full occupancy. The 402-bed hospital is involved in a major expansion program funded through a $92 million bond issue. It's adding 100 inpatient beds, 43 skilled-nursing beds and a medical office tower.
And since the government announced plans last year to sell its hospitals to private-sector operators, Colon has kept his eye on a 180-bed facility in Fajardo, Puerto Rico. Although Auxilio Mutuo recently lost the bid on that hospital, Colon is on the lookout for other attractive government hospitals as they go up for sale.
That's why Total Renal Care's offer could not have come at a better time. The cash from the sale will allow Auxilio Mutuo to pursue transactions without incurring further debt, Colon says.
Hospital board members supported the deal, and the transfer was completed in August. Because patients continue to receive dialysis services through the hospital's contract with Total Renal Care, Colon doesn't see any drawbacks to the deal, only positive cash flow.
Divesting assets for capital is serious business. Presbyterian Homes' Puma says his board of trustees raised lots of questions about what a sale would mean for the organization. But he didn't have to do a Kabuki dance to sell the idea. After weighing future capital requirements and mission, board members gave management the green light.
"It's simply a matter of repositioning ourselves in this marketplace today," Puma explains.
The system will retain 120 of the old nursing homes' 280 beds and move them to the new campuses it is planning to develop. That made the deal more palatable to the board. "It was not as difficult as it would have been if it were a straight sale," he says.
Risky business. Selling assets for capital can be risky. "The most obvious drawback is the potential loss of control of a part of the continuum of care," says Scibetta of Coopers & Lybrand. But that hazard, he says, can be mitigated by a long-term contractual agreement with the buyer, like the one Auxilio Mutuo negotiated.
There also is the danger of derailment when a for-profit buyer is involved. The sisters of Holy Cross Health System in South Bend, Ind., learned that lesson several years ago when they decided to sell their three Utah hospitals to Healthtrust, now part of Columbia/HCA Healthcare Corp. Bishop William Weigand of the Catholic Diocese of Salt Lake City initially resisted the deal, even traveling to Rome to have it suspended.
Weigand eventually backed off and the deal closed Aug. 15, 1994, but not before 13 of 20 Holy Cross Utah division trustees resigned from the board. The Federal Trade Commission also challenged the deal, forcing Healthtrust to agree to sell one of the three hospitals.
"The decision to divest was financial," says a consultant familiar with the deal, who spoke on the condition of anonymity. The system faced enormous competition from Intermountain Health Care, Healthtrust and Columbia. System officials, he says, could see that the capital could be better spent elsewhere.
Holy Cross officials, through Senior Vice President and CFO Amy Smessaert, declined to be interviewed, saying they would not have enough time to adequately prepare for an in-depth interview.
Sharp HealthCare, a San Diego-based healthcare delivery system, also faced controversy in trying to divest one of its holdings. But it looks like the story will have a happy ending.
Facing nearly prohibitive rebuilding costs in the range of $60 million to $70 million, the seven-hospital system placed its 50-bed Sharp HealthCare Murrieta (Calif.) hospital-formerly a 99-bed skilled-nursing facility-on the block.
In September Sharp entered a letter of intent with Santa Barbara, Calif.-based Tenet Healthcare Corp., whose bid was valued at $29 million. But the state attorney general directed Sharp to consider a sweetened offer by rival bidder Universal Health Services, King of Prussia, Pa. After doing so, Sharp recommitted to Tenet, citing Tenet's commitment to retaining acute-care services on the campus.
"It's been a long time coming," says Sharp executive Ann Pumpian of the deal. Financing for its Murrieta hospital was what launched Sharp's discussions with Columbia some three years ago, recalls Pumpian, Sharp's senior vice president of finance and CFO.
As part of a letter of intent with Columbia, Sharp expected to rebuild the Murrieta facility to meet the state's rigorous building code. The system agreed to replace the former nursing home under a waiver it received from the state when it acquired the building in 1989. But when the Columbia deal collapsed in February, the boards of Sharp and Murrieta sought a new investor.
Proceeds from the sale will offset $42 million of Murrieta debt, including $14 million of outstanding bonds. Sharp won't make a profit off the deal, but it will avoid hefty rebuilding costs. "It would have been a definite financial strain" to build a new facility, acknowledges Pumpian, who oversees the system's $57 million capital budget.
"As you manage an integrated delivery system, there is a constant balance of how you meet the needs of all your operating entities," she adds. "We are constantly balancing what is the next priority, not for the operating entity but for the system as a whole."