Hospital M&A Boom's Top 3 Drivers

It's getting to the point where hospital mergers and acquisitions aren't really news anymore beyond the healthcare trade publications and the local service areas that are affected by the deals.

According to Irving Levin Associates Inc. there has been a fairly steady increase in the number of hospital mergers and acquisitions over the past several years: up from 38 M&A  deals involving 56 hospitals in 2003 to 90 involving 156 hospitals in 2011. That's almost two deals a week.

We've seen this cycle before. Hospital M&A accelerated in the late 1990s along with the advent of managed care. Levin notes that M&A fever peaked in 1998 with 139 deals involving 287 hospitals and steadily declined until 2003.

While it is entirely possibly that we could be at the top of an M&A cycle once more, this time it feels different. We are seeing the broad consolidation of the hospital industry in all parts of the nation and it's difficult to see any market forces out there that will reverse this trend.

A report from the Healthcare Financial Management Association succinctly explains the three primary drivers behind the rising numbers of hospital M&A:

1. Lower payment rates from all payers will invite consolidation as hospitals look to reduce costs and improve economies of scale and market leverage with payers and vendors.     
2. Physician-employees, technology, and regulatory compliance are driving up the cost of doing business. 
3. Accountable care organizations reward integrated healthcare delivery that improves quality at reduced cost.

In the face of these headwinds, scores of otherwise stable and well-managed not-for-profit hospitals have joined with larger health systems in any number of partnership models. The strategy for many of them is to negotiate now from a position of strength rather than waiting for market pressures to force a move.
Last week, for example, Marquette General Health System in Michigan's Upper Peninsula finalized a $483 million deal that will make it the fourth hospital, and the first in Michigan, for investor-owned Duke LifePoint Healthcare, which itself was created two years ago in anticipation of the consolidation trend.
Marquette General CEO/President Gary Muller told me that the Duke LifePoint was one of 16 entities that showed an interest in acquiring the 315-bed specialty care hospital.

"The 16 proposals are pretty unusual because we were in a strong position," Muller said.

"Financially bottom line operating income was building up. All of our quality marks were good," he explained. "We didn't need to do anything but our board was looking ahead and saw that storm clouds are coming in healthcare and they acted preemptively. The analogy is selling your house when the roof is fine and the foundation is good and everything is painted and that is the way Marquette is."

Muller told me that Duke LifePoint was not the highest bidder, but that the Marquette General board picked it because of its mix of business and clinical expertise. Duke LifePoint will invest $300 million in capital improvement projects that will include an outpatient surgery center, cancer center, private patient rooms, new technology and new IT infrastructure. Duke LifePoint will also invest $50 million for physician recruiting over the next 10 years.

In addition, the deal allows Marquette General to retire about $100 million in long-term debts and unfunded pension liabilities, and provides another $23 million for the hospital foundation.

For Duke LifePoint the toehold in northern Michigan provides an opportunity to compete with blue chip providers that include Cleveland Clinic, Mayo Clinic, University of Michigan Health System, and Henry Ford Health System. Muller says Duke LifePoint also sees an opportunity to expand its orthopedic sports medicine program in Marquette, which is the home of a U.S. Olympic Education Center.

The biggest knock on hospital M&As is the loss of local autonomy. Hospitals are often the biggest employers and economic engines in the regions they serve and a source of local pride. No matter what guarantees are put in place the boards at most acquired hospitals are usually reduced to advisory status and their control is greatly diminished.

Muller says the Marquette board will still have a role in strategic planning and credentialing. It is satisfied that any concerns it has will be heard by the new owners. "The board is an advisory board now but it is 12 members and they are all local except for one from Duke and we wanted that," he says. "They don't feel like the community governing role is something they need to hold on to the detriment of the hospital."

And that's just it.

Marquette General and scores of other hospitals across the nation have seen which way the winds are blowing. Increasingly they are willing to forfeit a certain amount of autonomy in exchange for access to the capital and clinical and business expertise that will improve their position in a highly competitive market.

This all makes perfect sense in the nearly $3 trillion healthcare economy that is otherwise huge, bafflingly complex, and in the midst of historic change. There is no reason to think that this trend toward consolidation will reverse itself anytime soon.