The urge to merge

Central Connecticut Health Alliance is choosing to walk into the arms of a nearby system—before low margins, lack of capital and healthcare reform make it run.

The 330-bed hospital, with campuses in New Britain and Southington, has signed a memorandum of understanding with Hartford (Conn.) Healthcare to become the system's fourth hospital. The deal could take up to 18 months to complete, as Central Connecticut and Hartford Healthcare seek approvals from certificate-of-need regulators, the state attorney general and the Federal Trade Commission.

Central Connecticut has been planning this move for two years, said Laurence Tanner, president and CEO of the alliance and its New Britain campus. “We don't have margins that I believe are sustainable over time. They certainly aren't adequate to replacing plant and technology and the other needs for growth and maintaining the status quo,” Tanner said. “We started looking for a relationship before the market collapsed and before the aura of national health reform.”

Central Connecticut could be part of the leading edge of what some observers think will turn out to be an eruption of deals. Like the movement of tectonic plates, the pressures have been building up slowly for stand-alone hospitals. Plenty of them have felt the initial tremors and have chosen to join larger systems in years past. The rumbling has only intensified, starting with the tightening of credit that began two years ago and accelerated greatly in September 2008. Followed by the recession and the uncertainty of healthcare reform, stand-alone hospitals may feel that the earth is about to split beneath them, and perhaps more than ever, they are choosing which side of the fault line is best for them.

“This notion that we had two years ago, that we need to do it for the right reasons, has now, I would say, increased by tenfold for both the need and the expediency,” Tanner said. “It doesn't matter what part of the country you're in. You're seeing the same things happen. You're seeing an explosion in free-standing hospitals looking for solutions that go beyond their capabilities.”

Hospital deal announcements were steady in the first half of the year compared with the first half of 2008—28 deals were announced in each six-month period, according to Irving Levin Associates, Norwalk, Conn.—but a spate of announcements have come since July 1 (See chart, p. 16). Besides the Central Connecticut tie-up with Hartford Healthcare, two other of these deals involve a stand-alone hospital joining forces with a larger system, along with two such deals announced or completed on or just before July 1. In the others, boosting economies of scale is still a motivating factor, such as for the planned combination of Sanford Health, Sioux Falls, S.D., and MeritCare Health System, Fargo, N.D.

Anu Singh, a vice president at advisory firm Kaufman Hall, Skokie, Ill., said stand-alone hospitals are facing a lack of capital along with healthcare reform, physician alignment strategies and the continuing need to invest in facilities and information technology. “Individually, each one of these factors could have pushed the trend for more transactions taking place,” Singh said. “What's interesting is all of them happening at once. Community hospitals are looking for the size and scale that systems can provide.”

That combination is making the hospitals that are seeking partners more diverse in their financial results, Singh said. “It's not just the small, struggling community hospitals—that's part of it—but there are ones that are doing OK that are saying, ‘This is as good as it's going to get for us.' To survive is one thing, but to thrive, they need a partner.”

At the same time, there are more not-for-profit systems that are interested in acquisitions or other partnerships than in recent years, Singh added. These systems are seeking both in-market consolidation and geographically complementary acquisitions, and their interest extends beyond hospitals to include physician practices and ambulatory surgery and diagnostic imaging centers, he said.

Trey Crabb, a managing principal in the Nashville office of Stroudwater Associates, said the number of calls to his clients from tax-exempt hospitals seeking to affiliate with larger systems, whether tax-exempt or investor-owned, has picked up significantly. The activity could accelerate in the second half of this year, as Stroudwater is predicting an increase in debt covenant defaults by smaller not-for-profits, Crabb said. Well-capitalized systems, whether for-profit or not-for-profit, will have a “special opportunity” to make deals over the next two years, he said.

The hospitals looking for partners will examine a spectrum of options starting with just joining a system's group purchasing process all the way up to full acquisitions, Crabb said. Affiliations that fall in the middle of that spectrum, such as the recent “affiliation services agreement” that three-hospital AnMed Health, Anderson, S.C., signed with Charlotte, N.C.-based Carolinas HealthCare System, could lead to more extensive tie-ups down the road, Crabb said. “If they're already in an arrangement like this, they're in the best position to judge the value of those hospitals in the future,” he said.

The deals announced recently offer varied examples of what Singh and Crabb described.

In the Northeast, Goodall Hospital, Sanford, Maine, has agreed to join integrated delivery network MaineHealth, Portland, which has seven member hospitals and four affiliates. Frank McGinty, executive vice president and treasurer of MaineHealth, noted that his system and its medical staff have had a good working relationship with Goodall for years before this more formal connection was announced.

Goodall's region had been the fastest-growing part of the state throughout the 1990s and into the first half of this decade, but now the region has been hit harder by the recession than any other, McGinty said. On top of that, he said, “Certainly, the discussion of healthcare reform at the national level has heightened people's concern about the future and what it might hold. Most hospital officials here believe that we need to fundamentally change the way that the Medicare program pays for services.” Whether that's through bundling or paying for episodes for care, McGinty said, the change has to somehow make providers more responsible for treating a patient population on a given budget.

Adding Goodall to MaineHealth will spread the system's fixed costs over a larger patient base and make care more efficient in York County, the southernmost county in Maine, where the system has a hospital in Biddeford, McGinty said. Purchasing, legal, audit, compliance, employee benefits and IT can all be done less expensively in a system, and physician recruitment and clinical initiatives can be done more efficiently and at a higher level with the combination, he said.

Northern Virginia offers two more examples of complementary geography driving acquisitions, although these deals were announced before July 1. Novant Health, Winston-Salem, N.C., made its first foray for a hospital outside the Carolinas in its acquisition of Prince William Health System, Manassas; Sentara Healthcare, Norfolk, Va., has agreed to acquire Potomac Hospital, Woodbridge. Consolidation in Sentara's southeast Virginia base also is occurring, with Shore Health Services, Nassawadox, agreeing in late June to affiliate with Riverside Health System, Newport News, Va.

Both Novant and Sentara said that their strategic growth plans had envisioned moving farther afield for hospitals. “Health system growth is a way to position all of our hospitals better in an environment where reimbursement will not improve,” said Jim Tobalski, a senior vice president with Novant. “A larger health system can cut supply costs and provide expertise and resources much less expensively as we spread those costs over a larger system: from alcohol wipes and saline syringes to MRI scanners and a very expensive IT system.”

In Houston, the public Harris County Hospital District is looking to expand its footprint with the potential purchase of a hospital from Memorial Hermann Healthcare System, also based in Houston—a case of expanding economies of scale for one provider while diminishing them for another.

Memorial Hermann Southwest Hospital would solve the district's urgent need to expand capacity in order to compete in the Houston market for private-pay patients, said George Masi, the district's executive vice president and chief operating officer. That need has become even more pressing, as the district has seen its uninsured patient mix climb from 60% to 61.9% in just the past couple of months, Masi said. About 60% of its revenue comes from a property tax levy, he said.

Southwest Hospital has been using about 300 beds, but the facility is large enough to staff 600 beds, Masi said. It also would provide a huge expansion of the district's capacity for surgeries: The district's three campuses contain only 26 operating rooms between them, Masi said. Boosting the district's inpatient, surgery, imaging and emergency capacities are behind an expansion plan that includes a new emergency department at the district's Lyndon B. Johnson General Hospital campus, two new primary-care clinics and a multitower diagnostic imaging center, Masi said. Plans for an ambulatory center with offices for specialist physicians were put off at the district's Ben Taub General Hospital campus pending the exploration of a deal with Memorial Hermann, he added.

Healthcare reform and the aging of the population onto Medicare could combine to cover more of Harris County's estimated 1.2 million uninsured residents, putting even more pressure on the district to meet community standards on the timeliness of care, Masi said.

“If my Medicare benefit allows me to get my CAT scan within 24 hours, I clearly will take that option rather than waiting several days or even a week,” Masi said. “All public hospitals are competing on those principles.”

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