Ready for a resurgence

In 2009, for the second straight year, there were slim pickings in hospital mergers and acquisitions. 2010, however, looks likely to produce a bumper crop, hospital executives and deal advisers say.

Grappling with the recession, providers spent the first half of 2009 looking to survive, rather than make deals, say Thomas Barry and Carsten Beith, who are both managing directors at the investment banking firm Cain Bros. Most of the deals that were pursued had a compelling strategic rationale, such as in-market consolidation, Beith says.

Some of those deals prompted antitrust concerns, with federal regulators emboldened by their success in the Evanston (Ill.) Northwestern Healthcare case, a legal expert says (ENH is now known as NorthShore University HealthSystem). A deal in Maine unraveled as a result of the Federal Trade Commission's second request for information, while a Texas deal eventually made it through after much scrutiny.

View list of M&A activity for 2009

Another limit on dealmaking is the substantial increase in financial and legal due diligence that occurred in 2009, Barry says.

Modern Healthcare's 16th annual mergers and acquisitions report reflects those factors. The report found 85 deals that were announced or completed within 2009, down by six from 2008 and by 22 deals from the decade's peak year, 2006. That year also was the peak for the number of hospitals involved in the deals—331. The deals in 2009 included 131 hospitals, down eight from 2008. The total for 2006 was inflated by HCA's leveraged buyout, which accounted for more than half of the total hospitals involved in deals that year. In 2007, the total was boosted by Community Health Systems' acquisition of Triad Hospitals.

The report covers deals involving acute-care, behavioral-health, long-term acute-care and rehabilitation hospitals that were sold or leased. Management agreements and affiliations that do not involve a change in control are not included.

One factor that hindered dealmaking in 2009—tighter availability of capital—is poised to have the opposite effect in 2010, Beith and Barry say. Bond markets began thawing for financially strong hospital companies and systems last summer, providing them the means and the confidence to pursue acquisitions, they say. Those with weaker credit ratings, on the other hand, continue to find little credit available to them, pushing them toward a sale.

Add in the challenges of healthcare reform, says Ed Kazemek, chairman and CEO of consulting firm Accord Limited, and there will be a wave of not-for-profit deals in the next several years. Kazemek says these financial challenges are finally starting to overcome some of the historical reluctance among many not-for-profit hospitals to merge. “There's a lot of pride to being a stand-alone community hospital dedicated to helping the local community. And governing bodies have a fierce protection of that independence,” Kazemek says.

Kazemek, Barry and Beith all agree that it's not just the desperate who are considering mergers. Recession and reform are causing governing boards at stable, medium-size not-for-profits to ask whether they have a fiduciary duty to examine ways to grow the scale of their operations, Kazemek says—whether that means finding new partners, acquiring more hospitals or joining a larger system. “Even very sophisticated organizations that are doing well now are looking at this in their strategic planning,” he says.

Another alternative might be conversions of not-for-profits into for-profits, modeled on the conversions of state Blue Cross and Blue Shield plans, Beith says. Cain Bros. has been retained by two not-for-profit systems to study this, as they question the value of remaining not-for-profit, Beith says. Systems that are doing well on operations but have a weak balance sheet and don't rely heavily on philanthropy would be good candidates, Barry says.

Investor-owned hospital companies have been signaling since the summer that they will be aggressive acquirers. Besides their public comments (Aug. 3, 2009, p. 14), companies such as HCA and Vanguard Health Systems have made personnel changes that reflect a bullish outlook for acquisitions (Nov. 23, 2009, p. 14). LifePoint Hospitals made its own personnel move in this area late last year, altering Jone Koford's title to president of strategic growth and development.

Koford says LifePoint is expecting to acquire one to three hospitals in 2010. The company would like to do more deals like its acquisition of 154-bed Rockdale Medical Center in Conyers, Ga., last year—a facility that is bigger and offers more services than most of the company's hospitals, albeit in a more competitive market, Koford says. LifePoint is willing to consider moving into new states, she adds.

LifePoint also is looking to find tertiary hospitals to partner with its nonurban facilities as a way of boosting clinical quality and outcomes reporting, Koford says. These deals might be loose affiliations or they could involve LifePoint becoming a joint-venture partner in an outlying hospital owned by a tertiary provider, she says. The company also is looking at deals to tighten its relationships with physicians, such as buying or partnering on ambulatory centers, she says.

More interest LifePoint might find more investor-owned competitors on the acquisition trail. Besides the established companies, several large private-equity firms that aren't invested in the hospital sector are eager to jump in now, Cain's Barry and Beith say. RegionalCare Hospital Partners, a Brentwood, Tenn.-based company founded last year by former Province Healthcare Co. executives, is perhaps the leading edge of this interest, they say. Also, if privately held HCA were to make a public stock offering, it would be a catalyst for private-equity investment in hospitals, Beith says.

Deals between not-for-profits are expected to continue, despite the possible impediment of antitrust concerns. MaineHealth, Portland, decided to scuttle its deal with 53-bed Goodall Hospital, Sanford, Maine, after the FTC made a second request for information in the case, but the system has a new plan for getting local deals done, according to President and CEO Bill Caron.

Maine has a certificate of public advantage law, or COPA, and MaineHealth plans to use that state process to do a couple of deals that the system is contemplating, Caron says. In at least one of the potential deals, a federal regulatory filing would still be required, he says.

Douglas Ross, a partner at the law firm Davis Wright Tremaine in Seattle, says using COPA laws to do deals has been out of favor for about 15 years because the FTC wasn't intervening in very many deals. “If you could do the deal without it you would,” Ross says, referring to COPA.

COPA approval could be just the state-government blessing that mergers need to pass muster with a more confident FTC, Ross says. Richard Feinstein, director of the FTC's Bureau of Competition, has said several times in public that the FTC is reluctant to pursue hospital antitrust cases without support from that state's attorney general, Ross says. The restrictions on a merged organization's behavior that are codified in a COPA might be what a deal needs to win over a state attorney general, he says.

Thanks to the recession, another tack will be the failing-company exception to the antitrust laws, but that is a tough one to navigate, Ross says. The difficulty is that an acquirer not only has to prove that the hospital was failing and has no reasonable prospect of turning around but also that there are no other feasible buyers, he says.

“I do expect that we'll see more of this in healthcare, but it isn't the panacea that people think it is,” Ross says. “And obviously, it's no panacea for the hospital that failed.”