When board Chairman Earl Jones describes the physical state of Good Hope Hospital, there is little doubt what prompted the board to seek state approval to build a replacement for its Erwin, N.C., facility.
The oldest building on the campus dates to 1921. The slate-roofed structure, which houses a critical-care unit, lacks fire-suppression sprinklers and even the space to turn a gurney around--its halls are only 7 feet wide, Jones says.
State regulators wanted the hospital to find a partner with deeper pockets, Jones says. After merger talks with a local competitor failed, Jones says the board hired advisers to seek bidders, including for-profit chains.
When Good Hope officials approached several buyers, it turned out the one that was willing to pay the most was right under its nose. Since July 1993, the hospital has been managed by Quorum Health Resources, a subsidiary of Triad Hospitals. In August 2002, Good Hope's trustees chose Triad's proposed joint venture--Triad would own 90% of the venture and contribute the cash to build the replacement hospital, while Good Hope would own 10% and contribute its facility to be operated while the new hospital is built.
The board judged Triad's offer to be the most lucrative, Jones says, and the trustees liked what they heard from other joint venture partners of the company. "Everywhere we went, and everyone we talked to, we got the same response," Jones says. " `If we had to do it over again, we'd do it with Triad again,' they all said."
But the question was different for Good Hope than for those other hospitals. Good Hope was dealing with a buyer who knew the hospital's operations intimately--far better than any other potential buyer would know the hospital, and possibly even better than the board itself. Jones says Good Hope guarded against the potential conflicts by hiring outside advisers and keeping their Quorum-employed administrator in the dark about his employer's offer to buy the hospital.
To date, hospitals like Good Hope--that sell to their management company--are rare. Only two of the major investor-owned chains--Triad, based in Plano, Texas, and Province Healthcare Co., Brentwood, Tenn.--run large hospital management subsidiaries. Both units were obtained during acquisitions--Triad's when it bought Quorum Health Group in 2001 and Province's when it bought Brim Healthcare in 1996. These management units say they have done barely a handful of acquisitions of their own managed hospitals over the past decade.
But the potential for such deals is there. Triad's Quorum Health Resources has relationships with about 200 hospitals, including full-service management contracts at 160, Quorum President John Stinson says. Brim, meanwhile, manages about 37 hospitals.
More important than the numbers, perhaps, is the type of hospital the two companies primarily manage--the independent, small-town hospital that struggles the most in obtaining capital and complying with complex regulations, and that is likely to be sold. For Quorum, 37 hospitals that used to be under contract management have been sold in recent years.
"The number of independent hospitals is declining, and that's our core business," says Dan Moen, Triad's executive vice president of development and management services and also chief executive officer of Quorum.
Dave Woodland, Brim's president, says regulatory changes and the competitive pressures on management are the usual reasons a board chooses his company to manage a hospital, but it's the need for capital that leads a board to sell. Woodland says Brim has purchased just three hospitals that were under its management since he went to work for the company in the early 1990s.
Both companies say they aren't targeting their managed hospitals for acquisitions.
"Part of the reason we wouldn't do that is because of the potential conflicts between the operations--growing services, increasing revenue--versus developing a good sales price," Woodland says. "I'm just thankful that it's one thing that we don't have to deal with."
But both companies also say they will consider an acquisition if the managed hospital's board decides to seek a buyer or joint venture partner. That decision is usually made because the hospital has poor access to the capital needed to replace its facilities and equipment.
"It's clearly not our strategy," Moen says. "Triad will only get involved in making a purchase or joint venture offer when the owner has approached us. It's best to keep a Chinese wall between those two businesses."
What is more important to Triad to show with Quorum, Moen says, is that it is a good partner to not-for-profit hospitals since the company does see partnerships with established not-for-profits as a key part of its growth strategy.
Triad recently has been more active in this area than Province. Besides Good Hope, Triad signed an agreement last year to lease Fairmont (W.Va.) General Hospital with the promise to build a $75 million replacement (July 29, 2002, p. 30). Triad dropped out of the agreement earlier this month because West Virginia certificate-of-need regulators approved a competing replacement project from 369-bed United Hospital Center, Clarksburg, W.Va., and the regulators had made it clear they would approve only one of the two projects, Moen says. Triad also negotiated a 20-year lease of 68-bed Woodward (Okla.) Regional Hospital, which the local hospital board announced last month.
Province has completed just two acquisitions of Brim-managed hospitals since purchasing Brim in 1996, Woodland says. Before its sale to Province, Brim bought one hospital that it was managing, he says.
The case of Good Hope
Good Hope's effort to replace its aging, 47-bed facility bears all the elements of a classic CON battle between competing hospitals.
The hospital first tried to work out a deal with its larger local competitor, 73-bed Betsy Johnson Regional Hospital, Dunn, N.C. "We made it clear to them that we were not looking to merge and go to Dunn," Jones says. "We were looking to build a county hospital that serves all of Harnett County."
That desire explains why Good Hope proposed building a replacement hospital in Lillington, which is more centrally located in Harnett County and would be near a crossing of several major roads, Jones says.
With the talks faltering, Good Hope sought other bidders. The trustees were careful to exclude CEO Donald Annis, a Quorum employee, from discussions involving Triad, Jones says.
"We had our own separate folks that we hired to consult with. We had our own attorney. Don, as our CEO, was involved with gathering information on the proposals, but with Triad's (bid), Don was usually the last person to find out about things," Jones says. "We kept him out of the loop."
Alfred Taylor, president and CEO of Betsy Johnson, says Annis' presence couldn't have helped the negotiations between executives at his hospital and Good Hope. "It is difficult to talk to a Quorum (manager) about a merger when they would lose their contract and their parent wanted to buy them," Taylor says.
Taylor contends that the joint venture is a sweetheart deal for Triad, because under it Quorum would keep its management contract, entitling it to a percentage of the joint venture's revenue before any profits are split between the partners.
Betsy Johnson officials, including Taylor, took their concerns over the summer to North Carolina Attorney General Roy Cooper, whose approval is needed if Good Hope is to convey its assets to the for-profit joint venture. "I think the attorney general is interested," Taylor says, but with the project lacking CON approval, there's no urgency for Cooper's office to make a ruling. A Cooper spokesman confirmed that the office is studying the proposal but declined further comment because the matter is pending.
Taylor says he also is concerned that Triad will eventually squeeze Good Hope out of the joint venture and take over full ownership of the hospital. The agreement calls for the partners to split the cost of capital upgrades in proportion to their ownership stake. If one side can't come up with the money, its stake in the joint venture is diminished.
Triad's Moen says that won't be a problem because the joint venture won't shoulder any debt related to building a new hospital because Triad will fund the construction. Improvements and upkeep of the new hospital, Moen says, will be financed by operating profits.
Jones says he's not concerned if Good Hope's share of the venture falls as a result of investment by Triad. That would boost the value of the whole enterprise, Jones says, and Good Hope will not have lost any value on the investment it made in the venture. A smaller stake also would mean a smaller share of the profits, but Jones says growth in profits generated by the investments could make up for that dwindling share.
As for the CON dispute, Taylor says a local medical society first suggested a merger in late 2001 and the North Carolina Medical Care Commission did the same when it turned down Good Hope's original, not-for-profit proposal in spring 2002. The commission's approval is needed for North Carolina not-for-profits to issue tax-exempt bonds. The state health plan also points to a merger as the best solution, according to Taylor's interpretation of it.
Of course, Betsy Johnson is in the midst of its own $31 million building project to add a 65-bed patient tower.
There's no doubt Harnett County is growing. To its north is the booming Raleigh-Durham-Chapel Hill area known as the "Research Triangle," which includes the state capital and three major universities. To its south is an enormous military base, Fort Bragg. Residents of these two areas are starting to spill into Harnett County, which has the eighth-fastest growth rate among North Carolina's 100 counties, Taylor says.
Taylor says he is amazed by the joint venture's ability to rally local politicians in favor of the project and against Betsy Johnson. "We're a relatively small community hospital and Triad is the big giant, and we have been portrayed in this community as the Goliath," Taylor says. "I think we're the David, not the Goliath."
Still, Taylor says he is keeping open the possibility that the two hospitals will merge.
Good Hope's Annis says the replacement-hospital project has garnered local support because of the clear need to replace the Erwin hospital and the economic benefits that would be derived from the 64-acre development in Lillington. The project calls for the hospital tract to include medical office buildings and other healthcare-related businesses, while a separate tract would include nonhealthcare commercial properties, Annis says.
What the dealmakers say
Two consultants who work with not-for-profit boards looking at their strategic alternatives say that neither Triad nor Province should be excluded from bidding on a hospital just because they're the manager. But they both agree that such a situation must be handled carefully by the local board. They suggest that the situation is one of the most obvious arguments for hiring independent advisers such as themselves.
Joshua Nemzoff, a transactions consultant, says the key, no matter who the potential buyers are, is to force them to engage in a competitive-bidding process. "Our theory has always been that you never, ever sell a hospital without competitive bidding," Nemzoff says of his firm, Nemzoff & Co.
"From Triad's point of view, if they're going to buy a hospital, there's no question that they should buy one that they've been managing, because they know everything about it," Nemzoff says. "But if you're on the hospital side, you have to raise a number of questions, including, `Do we have to sell?' Then, `Who is going to negotiate with us?' Don't give me the Chinese wall speech. There's no such thing as a Chinese wall. These two guys work for Quorum, and (its parent) is one of the bidders."
Moreover, Nemzoff says, trustees have to ask themselves, "If we need to sell because we're in trouble and you've been managing us, how do we know you've been doing the best job you can in managing us?"
Nemzoff also was skeptical that hospital trustees are the ones approaching their management companies to ask them to consider an acquisition. "I don't believe it for one second," he says. "I've been doing this for 25 years. Boards don't wake up some morning and decide it would be a good idea to sell. They get that idea from their management."
Even if there is an open bidding process, some buyers may think the playing field isn't level when the management company's parent is bidding on the hospital, too, Nemzoff says, so trustees have to go the extra mile to show that the process is completely above board.
Nemzoff says he's not accusing either company of unfair behavior in a bidding process for a managed hospital, but he says that can be the perception among those competing to acquire a hospital. He says he was not involved with the bidding process for Good Hope or Triad's scrapped deal in Fairmont, but he is familiar with both deals and says the bidding appeared open and fair in both cases.
The fairness of the process also will be important when the buyer and seller seek the state attorney general's approval and, eventually, apprise the Internal Revenue Service of the deal, he says.
Carsten Beith, a healthcare investment banker at Cain Bros., says he and his firm also strongly recommend competitive bidding. "When there's multiple bidders, then generally the proceeds are higher," Beith says, adding that for many attorneys general, the process itself is paramount.
For instance, a local competitor may, for strategic reasons, be willing to pay more for a hospital than for-profits entering a market, Beith says.
Multiple bidders "certainly assure a board that it has fulfilled its fiduciary duties," he says. "You don't have to take the highest bidder, but you do have to get fair market value, and one way to demonstrate fair market value is getting bids through an auction.
"As investment bankers, we're often asked to look at proposed transactions that don't come through an auction. It's not the optimal process from our perspective."
And given the management company's intimate knowledge of the hospital, its interest in acquiring it is pretty clear evidence that other companies would have interest, too, he says.
"My experience has not been that they are sort of aggressively trying to buy the hospitals they are managing," Beith says. "If the hospital is doing well under independent management and ownership, that typically doesn't trigger a call to Quorum or Province for a management contract. Usually, there's already some trouble by the time these management companies are brought in."
Beith points out that management companies can have just as strong a conflict in trying to persuade a board not to sell. "Some of these management contracts are pretty lucrative, and there isn't a high degree of motivation for a sale if they don't want to acquire and they won't keep the contract" after a sale, he says.
The academic view
Frank Sloan is director of the Center for Health Policy, Law and Management at Duke University's Terry Sanford Institute of Public Policy.
Like Nemzoff and Beith, he says hospital trustees don't have to eliminate their management company from consideration if they put the hospital on the block.
"It's really necessary to get outside help and get some outside options," Sloan says. "You might settle with that company, but you want to know what you're getting into."
Trustees should ask whether the parent company gives management employees any incentives if the hospital they manage is acquired by the parent.
Besides price, the competitive-bidding process can illuminate the differences between the interested companies regarding the quality and scope of services, the structure and governance of a joint venture, policies toward indigent patients and underserved populations and the amount of investment the company is willing to commit, Sloan says.
Of course, the trustees have to be realistic about the hospital's overall situation, he says: "If you're starting from a position of weakness, then your options are little bit more limited. There may not be a lot of buyers."
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