“2010 from our perspective was a transformative year,” says David Cyganowski, a managing director of Citigroup and co-head of its healthcare investment banking team. “You've got M&A activity everywhere. It is activity that we feel is going to continue.”
Cyganowski believes that reform is making a lot of mid-sized hospital systems question whether they have enough scale to lower costs, fund healthcare IT investments and align with physicians. The largest systems, he says, are focused almost solely on physician alignment, but even they may start to question whether they have sufficient scale. The current corporate takeover drama, which started in December when Community Health Systems publicized its offer to buy Tenet Healthcare Corp., is probably stirring a lot of thought among investor-owned and tax-exempt systems as to how large is large enough, Cyganowski says.
Future deals will take a variety of shapes, Cyganowski says, including investor-owned companies buying tax-exempt facilities, bigger regional systems buying weaker local competitors, joint ventures between investor-owned and tax-exempt systems and deals between relative equals, such as Universal's acquisition of Psychiatric Solutions. Health Management Associates and LHP Hospital Group have been pursuing the joint-venture strategy, he adds.
Another factor that fueled deals in 2010 should continue in 2011—the abundance of capital that investor-owned hospital companies have, Cyganowski says. All of the for-profit operators are well-funded through some combination of public or private equity and public debt, he says.
Enrique Brito, senior managing director at McLean Group, an investment bank based in McLean, Va., says private-equity firms in particular could provide a strong engine for deals in 2011. These firms, Brito says, are sitting on $500 billion in funds that they need to invest on behalf of their clients, and healthcare is near or at the top of the priority list for many of the firms.
The prototype is 2010's deal by Cerberus Capital Management to acquire Boston-based Caritas Christi Health Care, he says. “Very large private-equity players will come in and buy entire hospital systems to capitalize those systems and then go out and do more acquisitions,” Brito says. “It will be equal to if not more than activity among hospital themselves.”
Brito, too, points to the capital needed to keep up with IT spending as another driver of deals. “IT is a train that nobody will be able to stop,” he says. “That is just the direction of the industry. The hospitals that are weak will have to partner up with strong hospitals just to survive.” This is especially true of hospitals and systems that already are highly leveraged and can't secure additional financing, he adds.
Another factor for more deals could be an action last fall by the Federal Trade Commission, according to Brito and David Burik, managing director for healthcare with Navigant Consulting. The FTC reclassified 11 hospital markets from “moderately concentrated” to “unconcentrated” under its merger guidelines, Burik says. The change makes it much less likely that the FTC would seek a second review of deals in those markets. “A second review can be expensive, time consuming and unpredictable,” Burik says. “It's a deterrent to a board agreeing to do a deal.”
Burik sees the same drive for scale that Cyganowski does. “Anecdotally, many institutions are seeing lower volume and less net revenue per case,” Burik says. “That only heightens people's interest in seeing solutions beyond their own organization. You have to be looking at cost and looking at scale and ways to achieve that.” Lower volume and lower revenue per case also could weaken financial results enough to put a hospital or system at risk of default on its loan or bond covenants, and that could push a board to pursue a deal, he adds.
Burik also sees more joint venture and other types of partnerships. Besides the investor-owned/tax-exempt deals that Cyganowski forecasts, Burik expects groups of community hospitals to pursue some partnerships short of true consolidation. Community hospitals are finding it harder to get physician coverage for many subspecialties, so a few of them might team up in an area to lure, for example, a colorectal surgeon who serves all of the hospitals, Burik says.