CHI faces financial strains in building national network

In the ongoing rush of healthcare deals, perhaps no other health system has been as aggressive as Catholic Health Initiatives, which has executed a dozen transactions in the past three years that have expanded its operations into health insurance and established a $1 billion foothold in Texas.

But the not-for-profit Catholic system's latest financial results show its growth comes with costs beyond the price of buying hospitals and insurers and paying off debt. The system's recent weak financial results underscore the financial risks that can accompany the potential promise of healthcare consolidation.

In recent deals, CHI has expanded its reach in Kentucky, acquired Nebraska's largest health system, added hospitals in Arkansas, Ohio and Washington state, and entered Texas with the $1.2 billion acquisition of six-hospital St. Luke's Health System. Subsequent deals have swelled its Texas operations to include 13 hospitals. The system became majority owner of a Medicare Advantage plan in early 2013 and acquired a commercial insurer last summer.

The deals have put financial strain on the system. While revenue has surged with the expansion, growing from $9.8 billion in 2012 to $13.9 billion last year, expenses also have soared. Last week, the system reported a large, unexpected operating loss for its fiscal first quarter, which ended Sept. 30, and officials said they would cut the system's workforce by 2%. Acquisitions largely drove the 11% increase in expenses during the first quarter compared with the same period a year ago, according to financial statements. Revenues grew roughly 8% during the same period.

CHI's debt soared from $6.1 billion in 2012 to $8.4 billion in 2014. Operating losses in the past two years have replaced profit margins that averaged 3% in the five prior years. The system lost $134.7 million on revenue of $3.2 billion in the first quarter after losing $14 million on revenue of $13.9 billion all of last year. The system's first-quarter loss prompted Standard & Poor's to drop CHI's rating by a notch.

Fitch Ratings left Catholic Health Initiatives' rating unchanged at A+, but lowered its outlook to negative. Fitch described the growth strategy as “appropriate,” but said the system's weak operating performance could drag down its credit unless executives correct it.

“It's a big hole to dig out of,” said Liz Sweeney, a director with rating agency Standard & Poor's.

CHI has invested $1.7 billion to install electronic health records across its growing operations and is expected to spend at least another $800 million on EHRs. Buying and expanding health plans to operate in six states has drained cash from the balance sheet and added new operating expenses. Hiring doctors, other providers and IT professionals has added to labor costs as the system seeks to build networks that reach beyond hospitals to clinics, nursing homes and other settings.

CHI officials contend the investments and growth are necessary as healthcare reform and continued pressure to slow healthcare spending reshape the marketplace. The investments will create broad regional networks of providers that can be marketed to employers and consumers under the system's own health plans. CHI's health plans have expanded their operations into four more states, with intentions to enter all of the system's major markets.

CHI's geographic reach and investment in clinically integrated networks will allow the system to better manage cost and quality of care, officials said in recent statements.

Reaping the return on those investments will take time, said Dean Swindle, one of the system's presidents and its chief financial officer. “There is a disconnect from the strong value of our enterprise and the short-term operational performance.”

CHI was formed in the 1996 merger of four Catholic health systems, and it now operates 105 hospitals in 18 states. Roughly one-quarter of those hospitals were added through deals in the past two years, a period that also saw the system rapidly expand its physician hiring. CHI employed 3,400 doctors and other providers at the end of last year, up from 1,400 doctors in 2012. Its home-care arm, boosted by the 2010 acquisition of Consolidated Health Services, has expanded to 89 locations in nine states.

One drag on CHI's financial performance has been its expansion in Kentucky. Swindle said uncertainty in the market set back integration plans there for roughly a year. In January 2012, CHI's St. Joseph Health System and Jewish Hospital & St. Mary's HealthCare formed KentuckyOne Health. But Tennessee's governor blocked plans to include the University of Louisville Hospital over concerns that an out-of-state company would control a state asset and that the Catholic bishops' Ethical and Religious Directives governing CHI facilities would limit access to certain healthcare services.

Ultimately, KentuckyOne negotiated a March 2013 deal to operate the University of Louisville Hospital under a joint operating agreement, preserving access to certain reproductive services for women. The system's health IT expansion also added to the Kentucky market's poor performance.

Elsewhere, health IT expenses contributed to CHI's first-quarter losses. In Washington state, operating performance declined by $60 million because of CHI's investment in new EHR systems and disruption caused by their installation. Poor investment returns also dragged down first-quarter results by $40 million, Swindle said.

CHI's turnaround plans are not expected to produce a profit for 2015, and Standard & Poor's analysts are not convinced they will succeed with those plans. But Swindle said his system will cut its expenses this fiscal year, including cutting 1,500 jobs through January. The cost-reduction plan, he said, will improve performance by $200 million through the end of the year and, ultimately, will boost operations by $400 million.

Analysts and consultants agree that CHI's growth strategy could better position the system to compete as payers increasingly turn to value-based contracts tied to meeting cost and quality targets.

“Today, the goal is not market share, but the number of covered lives that you're responsible for in a given market or region and how integrated your system is,” said David Cyganowski, a managing director at Kaufman Hall, a healthcare advisory firm. “It's no longer sufficient to be a hospital company. You have to be a healthcare company.”

But Bruce Henderson, leader of the national healthcare practice at consulting firm Navigant, said there's always “execution risk,” meaning there's no guarantee CHI executives can capitalize on consolidation and the associated economies of scale. “It's not just the size, it's what you do with the size when you've gained that scale,” he said.

Follow Melanie Evans on Twitter: @MHmevans