Deal-making is back.
Has it reached the frenzied levels of the mid-1990s? No. But figures from the first six months of 2004 show that mergers and acquisitions are racing ahead of the very weak start they were off to in 2003. And a few factors suggest that the pace will keep up, at the very least, over the course of 2004.
The first half of 2003 was plagued by a sluggish economy, a weak flu season that held down patient volumes and the war in Iraq.
Hospitals also face more consolidation among health plans, a trend that could sap the market clout hospitals gained during the last merger boom. Mega-deals such as the proposed $16.4 billion merger of WellPoint Health Networks and Anthem-companies that built themselves by consolidating Blue Cross and Blue Shield plans-and acquisitions of smaller rivals by bigger companies are continuing a 10-year trend of health plan consolidation (April 12, p. 18).
The economy has picked up strength and patient volumes recovered in the second half of 2003 and into this year, leading to the improved performance that provides the cash to complete transactions.
Add to those factors the extra cash being brought into hospitals by the Medicare modernization act, and more deals should be the result, said Sandy Steever, editor of Health Care M&A Monthly, published by Irving Levin Associates.
"Last year was the bottom, and we're starting to trend up from that," Steever said, although he noted that the broader trend over the last eight years has been a decline in deals. "If you look at the second half of 2003, (deal-making) was going up, mostly because of the Tenet effect."
In March 2003, Tenet Healthcare Corp., Santa Barbara, Calif., announced plans to divest 14 hospitals. Twelve of those hospitals were sold in the last six months of 2003. In January, Tenet announced a divestiture plan nearly twice as big-27 hospitals. Coupled with unrelated decisions on four other hospitals, Tenet is in the process of divesting 31 hospitals this year, and deals have been announced for only two of those hospitals so far.
"The new Medicare law makes more hospitals into attractive acquisitions," Steever said. He acknowledged that some hospitals that were contemplating a sale or merger may be able to avoid it with the improved cash flow from Medicare payments. However, he said he expects those hospitals to be outnumbered by hospitals that will improve enough to be good acquisition targets.
Cities and counties that own hospitals are another source of deal-making, as many cash-strapped governments look to sell assets to raise cash and exit an area in which they aren't experts, Steever said.
There's also no shortage of buyers. Several established investor-owned hospital companies are in the market and are looking for acquisitions, said David Felsenthal, a principal with Wellspring Valuations. Felsenthal said he expected Community Health Systems, Essent Healthcare, Iasis Healthcare Corp. and Province Healthcare Co. all to be active acquirers.
Moreover, a whole slew of new investor-owned hospital companies have started up in the past year and are looking for acquisitions (March 1, p. 40). Their ranks grew again when Integrated Healthcare Holdings, Costa Mesa, Calif., recently joined the fray.
The merger wrinkle
The numbers are too small to say that they are statistically significant, but there is anecdotal evidence that local-market mergers are making a bit of a comeback, particularly in the eastern half of the country. Market consolidation is also a factor in the acquisition market, as hospitals buy out their local competitors.
In Springfield, Ohio, Catholic Health Partners and Community Health Services Foundation agreed to merge their two hospitals. With plans to build a single hospital within five years to replace both campuses, Springfield will become a one-hospital town for the first time since Mercy Medical Center opened in 1950. The deal, which formed a new system called Community Mercy Health Partners, was completed July 1.
In West Virginia, two hospitals in the eastern part of the state, 144-bed City Hospital in Martinsburg and 60-bed Jefferson Memorial Hospital in Ranson, have agreed in principle to a merger with 423-bed West Virginia University Hospitals in Morgantown, said Bill Case, a spokesman for the university system. The two smaller hospitals need access to the university system's physicians to boost services locally, while the university needs more spaces for medical students to complete their residency.
"What the hospital boards are working on now is the governance structure of the merged institution and what it will look like, getting that hammered out, so they can present that to the residents of that part of the state and the West Virginia Health Care Authority (which regulates certificate of need)," Case said.
In New York, 734-bed NYU Hospitals Center and 157-bed Hospital for Joint Diseases Orthopaedic Institute have agreed to a full-asset merger that they expect to complete in 2006. The merger would make more resources available to the smaller specialty hospital, positioning it for growth in a growing segment.
Keystone State of mergers
In Pennsylvania, three mergers are in the works or have been recently completed.
The two private acute-care hospitals in Altoona-172-bed Altoona Hospital and 167-bed Bon Secours-Holy Family Regional Health System-announced a nonbinding memorandum of understanding to merge the two hospitals under a single parent organization with the governance split 50-50 between the two parents. Cost savings were estimated at $32 million in a consultant's report.
Gnaden Huetten Memorial Hospital in Lehighton and Palmerton (Pa.) Hospital, long-time rivals located about nine miles apart, completed their merger on July 1 and are now known as Blue Mountain Health System.
A similar merger was completed the same day in western Pennsylvania, when two-hospital Westmoreland Health System in Greensburg and Latrobe (Pa.) Area Hospital finished their merger. Until a permanent name is chosen, the new system will be known as Westmoreland-Latrobe Health Partners.
Like Gnaden Huetten and Palmerton, Westmoreland and Latrobe had often discussed bridging the 11 miles between them with a merger over the past two decades, said David Gallatin, the former chief of Westmoreland and now chief executive officer of the merged organization. "We serve similar markets in close proximity, and it seems to be a natural outgrowth," Gallatin said.
Also like the new Blue Mountain Health System, Westmoreland and Latrobe will evenly split governance, with each side naming eight members to the new board. The two organizations saw that having half-control of a merged board provided a lot more local say over decisions than either would have if they sold to a larger system, said Douglas Clark, who led Latrobe Area Hospital into the merger and is now president of the new system.
The decision was spurred by a tough climate for reimbursements and malpractice insurance. Collaborating instead of competing makes it easier for the combined system to recruit physicians and ensure them that the patient volumes will be there to provide them with a robust practice, Clark said. Other factors in favor of a merger include the slow population growth of western Pennsylvania and the dominant position of Highmark Blue Cross and Blue Shield, Gallatin said.
Gallatin and Clark sorted out the thorny issue of leadership by focusing on their strengths. Clark's experience as a hospital operator made him more suited to the president's role and having day-to-day control of operations, while Gallatin focuses more on the strategic level and working with the board, they said in a joint interview. The deal received the approvals of both the state attorney general and the Westmoreland County Orphans' Court. "It's the merger that passes the common-sense test," Gallatin said. "Unlike some mergers, there wasn't significant community opposition."
Regulators on the lookout
As interest has grown in merging, so has the interest of regulators in investigating mergers. The Federal Trade Commission has been conducting a lookback review of several hospital mergers for nearly two years (Sept. 16, 2002, p. 12). The FTC and the U.S. Justice Department's antitrust division also conducted a series of hearings on competition in healthcare over the last two years that is expected to yield a report, perhaps this summer.
The American Hospital Association took notice last month with a 17-page letter to the FTC and the antitrust division seeking to expand healthcare antitrust protections (June 21, p. 8). In the letter, the AHA said regulators should pay more attention to the effects consolidation of health insurers is having on hospitals. The AHA argues that studies have shown that consolidation reduced overcapacity and had little effect on the prices paid for hospital services.
Researchers who published a study in the March/April edition of Health Affairs said they found evidence that consolidation has allowed hospitals to negotiate higher rates with preferred provider organizations. Another study published in Health Affairs' November/December 2003 edition said that consolidation has increased in many urban markets, but con-cluded that the effect on consumers was difficult to judge because higher prices might indicate improved quality rather than a better bargaining position for hospitals with insurers.
Another sign of regulators' interest in hospital antitrust enforcement came in West Virginia, where the Justice Department is investigating a collaborative agreement on cancer and heart services between Bluefield (W.Va.) Regional Medical Center and Princeton (W.Va.) Community Hospital (June 28, p. 8).
Another consolidation avenue
Acquisitions can also concentrate market power, sometimes for an entire town or part of a large urban area. Triad Hospitals sold its El Dorado Hospital on the east side of Tucson, Ariz., for $33 million to TMC HealthCare, which owns Tucson Medical Center on that side of town. Even as Triad was selling on the east side of Tucson, it was in the process of building a new hospital in a northwest suburb Oro Valley, Ariz., and it also operates another hospital on Tucson's northwest side.
Another Triad deal completed this year makes Alice, Texas, a one-hospital town again. Christus Health bought Triad's 138-bed Alice Regional Medical Center for $18 million. Christus Health was the second entrant to Alice when it built Christus Spohn Hospital Alice in the late 1990s, said Peter Maddox, senior vice president of business, strategy and corporate development at the Roman Catholic system.
"It's a small, rural south Texas community," Maddox said. "What we did, basically, is return it to its historical healthcare roots."
Acute-care services are being consolidated at the former Triad hospital, which was built as a replacement hospital about the same time the Christus hospital was built, Maddox said. The old Christus hospital is now home to an in-patient psychiatric unit, inpatient and outpatient rehabilitation, and other new services are planned, he said.
Maddox dismissed suggestions that Christus now had free rein to raise prices as the sole hospital in the market. The Texas attorney general had the same concerns before approving the deal, he said. The deal has little effect on managed-care negotiations because Christus typically handles those on a statewide basis, and Alice is a relatively small town.
"In today's world, it's not a retail world anymore," he said. "We don't set prices like that."
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