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Masters of their Domains

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Fred Norton felt like he was playing an unpleasant version of Let’s Make a Deal. A tax attorney in Texarkana, Texas, Norton is chairman of the board for Wadley Health System, the parent organization of Wadley Regional Medical Center, a standalone 404-licensed-bed hospital near the state’s eastern border. Eight straight years of significant losses had left the hospital vulnerable, in default on its bond covenants and with negative debt service coverage. Its competitor, Christus St. Michael’s Health System, had moved out of downtown into a new facility near a major interchange and was eating Wadley’s lunch. Wadley was losing money on its trauma center to the tune of $4 million a year, and the hospital as a whole lost between $5 million and $10 million a year between 1999 and 2002.

Then-Chief Financial Officer Mike Potter, now president and chief executive officer, was trying to help the board decide between two scenarios that would provide an injection of cash, new management expertise and economies of scale—infusions that would help Wadley compete with its flashy neighbor. Behind door No. 1 was Plano, Texas-based Triad Hospitals Corp., a Fortune 500 investor-owned hospital company that actively seeks out troubled standalones like Wadley for acquisitions or joint-venture opportunities. Behind door No. 2 was the idea of shopping Wadley to a nonprofit hospital corporation similar to Christus Health, which owns the neighboring St. Michael’s. But given the board’s reluctance to relinquish control to a corporate overlord, neither possibility seemed attractive.

“We needed to find a partner, but it was a difficult dance to maintain our autonomy,” says Norton.

Fortunately, Norton and the rest of the board uncovered a third option: an affiliation with a nonprofit hospital operator called Community Hospital Corp. that provides management expertise in return for a yearly fee—$500,000 in Wadley’s case. The arrangement allows many hospitals to retain local control as well as their nonprofit status. CHC, also in Plano, was created in 1996 by the hospital members of a VHA Inc. arm called VHA Southwest, a nonprofit healthcare provider alliance based in Irving, Texas.

CHC is a 509(a) tax-exempt nonprofit support organization that helps local hospitals maintain community control in a “less-obtrusive fashion,” says Michael Williams, the organization’s president and CEO. If Wadley had sold to a traditional acquirer, says Williams, “there’s diminished input from local board. We have an advisory board, but the key decisions are truly in the hands of the local organization.”

Williams makes no secret of the fact that CHC targets fiscally challenged hospitals whose boards are convinced their only option is to sell to a private company—the same hospitals companies like Triad or other nonprofit corporate parents target. CHC currently leases or owns 11 organizations and provides management oversight and consultation to several others.

But CHC does not function as an “owner” in the traditional sense. If a local board decides to take on CHC as a “corporate member,” as Wadley did in February 2005, they cede certain controls to CHC but retain others that would be lost in a traditional acquisition, such as decision-making power over the hospital’s services. That was a big selling point for Wadley, which operates money-losing clinics that offer prenatal and pediatric care. The hospital delivers about 90 percent of the Medicaid births in the area; those services lose about $1 million a year, but Wadley didn’t want to lose them.

“That subsidy—more than $1 million a year—would be one of the first things that would go away under a for-profit owner,” Williams says.

Painful cuts

Under CHC, Wadley’s board retains total authority for medical staff, decides what services the hospital will offer, and retains significant say in all economic decisions, Williams says. With other acquisitions, even those by nonprofit corporate owners, the local board may be eliminated or reduced to an advisory role with little real power. But depending on the deals it strikes, CHC sometimes is allowed to appoint some local board members and retains reserve powers over the hospital’s decisions about debt. They also hold the all-important responsibility of appointing senior management to operate the organization.

So despite the reprieve they got from taking on CHC as a corporate member, Wadley’s board members weren’t absolved from difficult economic decisions. Wadley didn’t receive an immediate infusion of cash, as it might with a more traditional acquisition. For-profit or nonprofit acquirers “will build you a new hospital, but they expect a return on their investment of 20 percent a year,” Williams says.

In such cases, the local hospital won’t have much input on how that return is yielded, Williams argues. “You might have to wait two to three years to realize your dreams of a new hospital if you go with us, but the quick-fix over the long term is going to be detrimental to the community.”

CHC does not sweep earnings to the corporate level. One of the drawbacks to a traditional nonprofit acquisition, to say nothing of an investor-owned sale, says Potter, is that after its problems are rectified, the hospital loses control of any margin it makes to its corporate parent. Further, with CHC, there is no consolidation of debt on the corporate level, so a large degree of risk remains for the hospital that is “acquired” by CHC.

Because CHC does not bail out a board’s financial missteps—one of the major attractions in an outright acquisition—Wadley’s board still had some tough calls to make to return to profitability.

The toughest was closing its Level II trauma program, the only one of its kind between Dallas and Little Rock, Ark.—a distance of 290 miles. “It was successful in that people are alive today who otherwise wouldn’t be,” says Norton. “But that came at great cost.

The most difficult decision I’ve ever made was to vote to close that trauma program, but we were upside down by $4 million.”

Painful changes can yield long-term benefits, however. “Through CHC’s own internal resources and through their connections, they’ve put us in touch with folks who’ve helped us with our goals of improving operational performance of the hospital,” Potter says. That dispassionate third-party look at the hospital’s financial issues helped Wadley take in $2 million in 2006—the facility’s first positive net income fiscal year since 1998. Wadley also was able to obtain supply-chain savings of $1.8 million from 2003 to 2006. The dramatic turnaround will allow Wadley to issue bonds to make a move of its own out of downtown and closer to the interstate, making for better patient access and a more attractive facade.

Williams stresses that CHC’s role is not that of a corporate master, but to work to bring operational accountability to organizations so they can maintain their community control. “Each of our organizations stands on their own financial footing,” Williams says, “so if one fails it doesn’t affect the rest of the company.”

Philip Betbeze is finance editor with HealthLeaders. He can be reached at pbetbeze@healthleadersmedia.com.