What the loss of a major acquisition means for Advocate Aurora's expansion plan

The failed acquisition of a Michigan hospital chain deals a blow to Advocate Aurora Health's aggressive growth agenda.

Acquiring Southfield, Mich.-based Beaumont Health would have advanced the 26-hospital chain's goal of more than doubling revenue within five years. But the deal collapsed Oct. 2 amid opposition from Beaumont doctors and other staffers, as well as Michigan lawmakers.

Their apparent success in blocking Advocate could encourage similar resistance to future acquisitions from doctors, communities and elected officials unwilling to see their local hospitals absorbed into a large, out-of-state chain. The setback also raises new questions about how—and where—the $12 billion-revenue hospital system based in Downers Grove can find the growth it seeks.

The pool of potential acquisition targets in the Upper Midwest is shrinking. Chains in Advocate's Chicago and Milwaukee strongholds likely are off-limits due to antitrust concerns, and many others are getting snapped up by large academic medical centers.

A deal with eight-hospital Beaumont would have given Advocate an additional $5 billion in revenue, bringing the system closer to its goal of boosting revenue to $27 billion by 2025. Advocate also would have picked up nearly 5,000 Michigan doctors, enabling it to quickly expand its value-based contracting strategy to another state. Such arrangements are attractive to health insurers and employers looking to cut costs by curbing superfluous care.

Without Beaumont, Advocate may look to execute a series of smaller deals, but a few physicians here and there—or even a few stand-alone hospitals—aren't likely to provide the jolt of growth CEO Jim Skogsbergh wants.

"It's got to be a big system or two," says Tim Classen, an associate professor of economics at Loyola University Chicago's Quinlan School of Business.

A system like Indiana University Health would be a logical next target, substantially increasing Advocate's revenue, Classen says. The 16-hospital system has four physician networks, a health insurance company and $6.7 billion in revenue. Its partnership with Indiana University School of Medicine also would be attractive to Advocate, which competes with academic medical centers like Northwestern Medicine and University of Chicago Medicine here. "IU Health has a long-standing commitment and mission to serve the health care needs of Indiana as an independent nonprofit health system and we have no plans to change that," says a spokesman for IU Health.

Skogsbergh unveiled his vision of Advocate as a "multimarket consolidator" at an industry conference in January, more than two months before the COVID-19 pandemic attacked hospital revenues. Patient volumes plummeted across the country as lucrative nonemergency surgeries were postponed, and operating costs soared as hospitals bid for desperately needed personal protective equipment and shelled out for additional staff and overtime pay to handle the influx of COVID patients.

Advocate reported a $302.7 million operating loss in the first half of the year, compared with operating income of $245.1 million during the same period a year earlier. Meanwhile, revenue decreased 3 percent to $6 billion.

'THE VALUE OF SCALE'

Despite the financial challenges, Skogsbergh has said Advocate's size helps it withstand the pandemic better than some other hospital chains.

"We are big proponents on the value of scale," Skogsbergh told Modern Healthcare in August. "It's not big for bigness' sake, it's really to get stronger. And that strength then can be translated in what we say is better health outcomes and less costs."

Even as patient volumes rebound, the pandemic continues to strain hospital finances and is expected to spur more dealmaking. The average size of sellers by annual revenue remains high at just under $400 million in the third quarter, when 19 transactions were announced, according to Kaufman Hall's latest M&A activity report.

Skogsbergh has said Advocate may expand in other parts of the country as it seeks to leap from 10th place to second among the nation's largest nonprofit health systems by revenue.

"Given today's virtual landscape, geographic location and size of a prospective partner are far less important than" shared values like a commitment to safety, health outcomes and making health care more affordable through value-based care, Advocate Aurora spokeswoman Brigid Sweeney says in an email.

There's little evidence that consolidation improves quality of care. In fact, a recent study by Harvard University scientists found that hospital mergers were associated with a modest decline in patient experience scores and no change in readmission or mortality rates.

But big multistate mergers offer hospital chains much-needed diversification, such as a mix of urban and rural hospitals or a broader network that funnels patients to large specialty facilities, says Jennifer Perry, managing principal at advisory firm FMG Leading.

"Particularly, having gone through COVID, many systems are seeing that when you've got a larger size and some diversification, you can weather some of those storms more effectively," Perry says.

Advocate likely will work to continue expanding its physician network and gain more bargaining power with insurers. In the Midwest, 55 percent of doctors already work for hospitals, according to a report from consulting firm Avalere Health and the Physicians Advocacy Institute.

"The slow and steady route" of gobbling up physician practices—gaining more pricing power in the process—will help increase revenues, says Anthony LoSasso, a professor at DePaul University who specializes in health care economics.

Size also presents an opportunity to cut insurers out of the mix, establishing more lucrative direct contracts with employers. But Advocate's focus on riskier value-based arrangements, in which physicians are compensated for keeping patients healthy, likely turned off some Beaumont doctors.

"Not all physicians are going to like that kind of model," Classen says. "Finding more physicians or a big group who would be tolerant of those kinds of risk-based contracts in the employed model, that would be an essential feature of their next target for expansion."