The two-year slowdown in healthcare mergers and acquisitions has begun to reverse itself, though not because of a reappearance of the consolidation frenzy of the past decade. Instead, much of the activity involves physician management groups selling unprofitable practices back to the physicians themselves, a trend that is expected to continue into the new year.
"Some hospitals may buy practices (in 2001), but just as many are getting rid of them," says Sanford Steever, editor of Healthcare Merger and Acquisition Reports published by research firm Irving Levin Associates of New Canaan, Conn.
"Hospitals are still looking to merge where they can on a local level, but there are not going to be any national hospital brands" created in the near future, he says.
According to a recent Levin Associates report, mergers and acquisitions in the healthcare industry declined 27% during the third quarter of this year compared to the third quarter last year. Deals involving physician groups fell 29%, hospital mergers were down by 38% and activity in the managed care sector plummeted 41%.
Furthermore, Chicago-based investment banking firm Houlihan Lokey Howard and Zukin noted just three initial public offerings among healthcare providers for the 12 months preceding June 30, 2000. There were 36 nonprovider IPOs in the healthcare industry during the third quarter alone, says Mark Francis, senior vice president for healthcare at Houlihan Lokey.
But Levin Associates reported just a 5% drop in healthcare M&A activity in the third quarter of this year from the second quarter, suggesting that the downturn may be ending.
Francis subscribes to this theory. "For the next couple of quarters, we see
activity stabilizing at a low level. We don't think it will pick up until late next year."
Industry analysts generally agree that the majority of the deals consummated during 2001 will be on a much smaller scale than in years past.
Charles Lynch, a stock analyst with CIBC World Markets in New York, says that the proposed takeover of Quorum Health Group of Brentwood, Tenn., by rival Triad Hospitals, announced in October, may be the last of the megamergers in the healthcare facilities segment for a while. He also says federal antitrust regulators may require Dallas-based Triad Hospitals to shed assets before approving the acquisition.
Instead, according to Steever, the focus is shifting to smaller deals involving physicians with common specialties.
"The ones that are successful (in mergers and acquisitions) are the single-specialty groups," he says. "It's much easier to predict your patient revenue flow with a single specialty. Multispecialty practices work well within certain areas when they've grown organically over the years, but when you try to cobble them together, you start to have problems."
Indeed, hospitals have found that the many primary care practices they bought in the 1990s have been consistent money losers, says Davis Fansler, principal and co-founder of Minneapolis-based Partners Healthcare Consulting. "Their strategy was to be accumulation engines, but very little was done to deliver on value propositions" offered by acquiring physician groups, Fansler says.
"There needs to be more emphasis placed on what to do after the deal is done," Fansler advises. Otherwise, he says, "hospitals face the real threat of being carved up" into a series of specialty clinics.
Because performance of merged healthcare entities has lagged, the mid-1990s free flow of venture capital has slowed to a trickle. "Access to capital on both the equity and debt sides is extremely tight right now," says Francis.
Francis notes that lenders have become "very, very conservative" as healthcare investments have become riskier in the wake of some high-profile busts. A failed 1998 merger between former PPM giant PhyCor, which lately has been shedding assets to avoid insolvency, and MedPartners, now known as Caremark Rx, helped close the cash pipeline.
Smaller combinations have had their share of growing pains, too. "A lot of the marriages are beginning to unwind on the physician practice side," says Gregory Mertz, president of The Horizon Group, a healthcare consultancy in Virginia Beach, Va. In terms of merger combinations, "The physician side is peaking right now or maybe slightly on the downside," he says.
Mertz believes that medical groups by necessity will become smaller. "Medicine will be delivered in small units of two, three, four, five physicians, not 20 to 25," he says.
"That postmerger-sized organization is somewhat unstable," Mertz says. "Many physicians have no experience making business decisions jointly, for the good of the organization."
He adds: "You need a business manager. Most medical directors are not good business managers." The best of the best, which Mertz calls "visionary, business-minded physicians," typically command salaries upwards of $250,000, well out of reach for all but the largest physician groups.
Healthcare consultant Fansler concurs. "There is a real dearth of physician leadership in management," he says.
According to Mertz, growing larger "is not a valid goal for a merger, but a byproduct of it." Per-physician income can tumble sharply because merged practices often require an additional layer of overhead to manage the business.
As a result, lenders are demanding more equity, generally at least 21/2 times a company's annual pretax earnings, before issuing loans. "That's a tough target," Francis says.
Uncertainties on Wall Street and in Washington about the volatility of the stock market and the transition to a new Medicare reimbursement system also have put dealmaking on hold. Rising interest rates and tumbling bond ratings have not helped either.
Meanwhile, the bond market for healthcare issues remains weak. And, Steever says, ratings agencies are not done downgrading PPM debt securities.
At the moment, healthcare financiers see technology, life sciences, medical devices and pharmaceuticals as stronger investments than physician management groups or medical facilities. For medical group mergers and acquisitions to increase in 2001, "Healthcare providers are going to have to be more consistent with their revenues and earnings," Francis says. "Growth through acquisition only works for a short time until you start to have to prove your business model."