Lab company Rennova is an unlikely buyer of CHS hospital

The planned purchase of an 85-bed hospital in Tennessee by lab testing company Rennova Health raises a lot of questions. Chief among them: What does a lab company that's losing tens of millions want with an underperforming rural hospital that Community Health Systems is trying to sell?

West Palm Beach, Fla.-based Rennova recently reported in a Securities and Exchange Commission filing a $51 million net loss from continuing operations in 2017 and a $16 million operating loss on less than $5 million in revenue. The company ended the year with no cash on hand from continuing operations, and has been sued by landlords and contractors alleging unpaid bills, according to the SEC filings. Three former employees have sued the company in Palm Beach County court alleging unpaid wages.

CHS agreed to sell the hospital, Tennova Healthcare-Jamestown, for $1 plus the amount of net working capital as of the effective closing time, minus its capitalized leases, according to the asset purchase agreement contained in the SEC filing between CHS and Rennova. The deal includes an associated physician practice, medical office building, outpatient facilities and ancillary services. The agreement lists the closing date as April 1, but that has since been pushed to June 1.

There's been a trend in recent years of lab companies buying or partnering with rural hospitals to gain greater reimbursement for lab services using the hospitals' favorable payer contracts. The difference in price could be $2,000 per test.

Related: 'Desperate' rural hospitals team with lab companies

Scott Phillips, managing director of the firm Healthcare Management Partners, which specializes in turnaround management for distressed hospitals and is in a joint data venture with Modern Healthcare, said while he does not know Rennova's intent, the key players in this proposed deal—a struggling rural hospital and an out-of-state lab company—fit the profile of between eight and 10 such lab test billing arrangements he's aware of elsewhere, including cases he's personally worked on.

Rennova CEO Seamus Lagan told Modern Healthcare in an interview that acquiring the hospital to alter lab reimbursements is "absolutely" not his intention in purchasing Tennova Healthcare-Jamestown. He added that he's aware of the such arrangements, but said this is not one of them.

"That is not an area we have any interest in pursuing or looking at," he said. "We see these hospitals as a good little business on their own with increasing the services that are required by the local community and absolutely without the need to get into any complicated or convoluted agreements with far-away companies."

CHS included Tennova Healthcare-Jamestown in its $25 million in goodwill impairments related to hospitals up for sale in its first-quarter earnings report released May 1, but a CHS spokeswoman said the company does not comment on pending divestitures beyond its official filings.

Typically when companies sell hospitals, the buyer is the one asking a lot of questions, such as what capital expenditures will be necessary and whether the price is fair, among other things, said Steve Valentine, vice president of strategy and advisory consulting for the healthcare consultancy Premier.

"I know it sounds harsh, but a seller, it's not their responsibility to sell it to someone who necessarily will keep operations going, who will have the financial wherewithal to invest," he said.

Rennova's main revenue source over the past five years had been urine toxicology testing, but commercial insurers have dramatically cut back on reimbursements for such tests amid overtesting by some providers, Lagan said. He said Rennova was not one of those unscrupulous companies, but nonetheless saw a nearly 80% drop in its insured lab test volume last year compared with 2016. Rennova used to operate five labs, but now has only two, Lagan said.

Lagan described rural hospitals as "much more predictable" than drug testing. "We see hospitals as a more reliable revenue source, more consistent," he said.

Data show rural hospitals are anything but predictable, having faced declining occupancy rates relative to their urban peers and dire financial situations in recent years. More than 80 rural hospitals have closed since 2010 and more than 670 are at risk of closing, according to the National Rural Health Association.

Tennova Healthcare-Jamestown saw a net loss from operations and in total each year from 2013 through 2016, the most recent year for which data is available. The hospital reported a loss of $2.5 million in 2016 on total patient revenue of $15.6 million, or a negative profit margin of 16.2%, according to Modern Healthcare Metrics, the joint venture with Healthcare Management Partners.

Tennova Healthcare-Jamestown ran an average daily census of 13 patients in its 85 beds last year, a roughly 15% occupancy rate, according to Phillips of Healthcare Management Partners. Phillips said he doesn't know how a hospital like Tennova Healthcare-Jamestown, which does not have a critical-access hospital designation, can survive with such a low occupancy rate.

Another rural health expert, Brock Slabach, senior vice president of the National Rural Health Association, said, "I don't know what the advantage would be—let's put it that way—in this company wanting to take over this hospital."

Lagan said he believes Rennova can turn around the hospital's financial performance, and even "make a little profit," by giving the hospital the changes and investments it needs to thrive, including potentially upgrading equipment and providing additional services. CHS focuses more attention on their larger hospitals, not the ones they're divesting, he said. "The focus that's required, the management that's required to make these smaller hospitals run efficiently and work well, they can get a much better return from that same effort being expended on a larger facility," Lagan said.

CHS spokeswoman Tomi Galin wrote in an email that the hospital chain made a strategic decision to focus future investments in its Knoxville market, about 90 miles from Jamestown.

"We've announced significant plans and investments in Knoxville that we believe will best serve that community and help generate long-term success for our Tennova healthcare system," she wrote.

Meanwhile, Rennova has had its own problems. Nasdaq delisted the struggling company in October because its equity balance fell below the $2.5 million minimum requirement for listing. The company currently trades on the OTCQB, a market designed for early-stage and developing companies.

In Rennova's 2017 financial report, an independent auditor questioned whether the company can stay in operation.

"As shown in the accompanying consolidated financial statements, the company has significant net losses, cash flow deficiencies, negative working capital and accumulated deficit," Green & Co wrote. "Those conditions raise substantial doubt about the company's ability to continue as a going concern."

In 2017, Rennova paid $21.4 million in interest expenses, while its current assets as of year-end were $3.4 million and its current liabilities totaled $24.9 million.

Rennova admitted in the same report that its weak accounting procedures may not have documented all cash disbursements. "Based on these material weaknesses in internal control over financial reporting, management concluded the company did not maintain effective internal control over financial reporting as of December 31, 2017," the company wrote.

Elsewhere in the filing, Rennova wrote that management, "does not expect that the company's disclosure controls and internal controls will prevent all error and fraud."

Last August, Rennova opened its first hospital, Big South Fork Medical Center in Oneida, Tenn., which the company bought out of bankruptcy for $1 million. The company reported generating $1.8 million in net revenue last year from the hospital, which Lagan said does not perform toxicology testing in its lab. The company announced in January it signed an agreement with CHS to buy its hospital in Jamestown, less than 40 miles away.

Lagan said buying a second hospital nearby will create synergies. Rennova plans to refer patients from the smaller Oneida hospital to the larger one in Jamestown, Lagan said.

Lagan said Rennova's stockholders voted Wednesday in favor of giving the company the ability to issue up to 3 billion shares, up from 500 million. But he said the company does not currently plan to issue the shares, as Rennova has a number of other financing options it can use to buy the hospital, including cash, debt or debt financing.

There's not a robust market of buyers for small, rural hospitals, so hospitals are eager to seek alternatives, including lab companies, said Michael Lane, managing director with the healthcare strategic advisory firm Hammond Hanlon Camp in Chicago.

"There is just no value in those rural hospitals," he said.

An edited version of this story can also be found in Modern Healthcare's May 21 print edition.