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CFO Alert: Hospital Mergers and Acquisitions Just Ahead

 |  By kminich-pourshadi@healthleadersmedia.com  
   May 10, 2010

Several months back I spoke to Steve Filton, the CFO at for-profit hospital company Universal Health Services in King of Prussia, PA, about the likelihood of seeing more mergers and acquisitions (M&As) of hospitals in the coming year. At the time, he said that since summer 2008 UHS speculated that there would be a shakeout among the nonprofit providers and that many of them may look to merge or sell.

At the same time I was doing research for an article in the May edition of HealthLeaders magazine, there was some discussion around the halls at HealthLeaders Media about the speed with which these M&As would take place and whether, until the recession lifted more, there would be much activity at all.

I'm no prognosticator, but I do spend a lot of time speaking to CFOs and the impression I was getting was one of openness toward the idea of consolidation. Thus, I made the case with my colleagues that there would be a lot of consolidation in the next two years—and the for-profits would be the ones to watch as they would use this financial maelstrom as an opportunity to expand. Not everyone agreed with me, which is to be expected in a room filled with educated healthcare writers, but it looks like Moody's Investors Service may be siding with me on this one.

Last week Moody's released a special comment, "For-profit investment in not-for-profit hospitals signals more consolidation ahead". In it they note, "The for-profits represent potential new partners capable of injecting much-needed capital for modernization and expansion. However, only those capable of attracting for-profit partners will benefit—the remaining independent not-for-profits may face operating challenges and increased competition from their newly capitalized competitors. The net effect is likely to be an increased rate of mergers of not-for-profits with both other not-for-profits as well as for-profit firms."

The comment goes on to say that the possible purchases by for-profit entities of two sizable nonprofit healthcare systems in separate deals may signal a significant shift in the hospital industry toward increased competition and consolidation, placing downward credit pressure on less-competitive systems.

"If finalized, the sale of Detroit Medical Center and Boston's Caritas Christi may be the start of a new wave of acquisitions by for-profits," said Moody's Vice President and Senior Analyst Brad E. Spielman in the release. "They would also place additional stress on the remaining not-for-profits, creating an even greater need for sound management and capital strategies to compete in markets favoring larger hospital systems and chains."

Why merge?
What I find fascinating is the rationale for why hospitals want to consolidate. In the past, the main reason was generally to gain market share or to expand their offering. Now the main reason is just as likely to be economies of scale and better access to capital or out-and-out survival.

Moody's says that two of the reasons for consolidation stem from the reduced access to capital markets and deferral of needed investment. Over the last couple of years, few facilities ventured into construction projects to grow their facilities, and the cost of medical devices and mandated, costly information technology systems continues to increase the hospitals' demand for new capital investment within the industry.

"Hospitals with a strong balance sheet may consider consolidating with other facilities. There are plenty of benefits to doing so," says Mark Reiboldt, vice president of Coker Capital Advisors in Alpharetta, GA. Coker Capital is affiliated with Coker Group, a national healthcare consulting firm—and they felt so strongly that the M&A situation was about to expand that they launched a division in the midst of a recession to address the potential.

Reiboldt says if a facility was able to make it through the roughest part of this recession and they came out looking "relatively good" to investors—after all nearly every hospital took a hit to their credit rating, lost some money in the bond market, and had a few scary days where days cash on hand got a bit too low—they look pretty good from a financial standpoint.

"A lot of not-for-profits have emerged stronger," he says. "That's made these health systems even more attractive to investors."

Who's investing?
That brings me to another interesting point in Moody's comment and one that Reiboldt echoed in his discussion with me. While the most likely scenario is for for-profits and not-for-profits to participate in these mergers, other outside investors are salivating over the chance to invest in healthcare facilities—after all healthcare is still a growth industry, albeit a slow one.

"There's a new group of people who are becoming more interested in investing in hospitals, including private equity firms and large institutional firms," Reiboldt notes. "Financial advisors realize they can't expect the same kind of returns as other investments and they look at this in terms of a long term investment."

Which is why the proposed acquisition of Detroit Medical Center by Cerberus Capital Management, may be viewed as a harbinger of mergers to come. Moody's goes so far as to say that these deals could "signal an increased appetite for challenged credits by for-profit investors," as the facility is Ba3 rated.

What did they forget?
When it comes to M&A there are a host of influences that go into the decision to consolidate. One factor that Moody's doesn't touch on in its report is the role that physicians play. These deals sound great but they'll take far more than an investor and C-suite buy-in to happen.

"You have to factor in the relationship the physician has with the hospital and in the community," he says. "They can't do anything without the physicians onboard because if the hospital loses those doctors—if they aren't happy with the deal—then the investor is losing the revenue stream which made the hospital attractive in the first place."

So, to round out the Moody's analysis, investors would need to gauge how their potential hospital investment might be viewed by the folks that make profit in healthcare possible everyday—the doctors. It's highly likely that this factor is something most outside investors would never have had to consider with their previous investment adventures. Nevertheless, if they are going to dabble in healthcare they need to realize that this industry doesn't operate like other industries—though it's still a great investment.

Now that we are five months into 2010, I have a little more time to see if my prognostication that there will be a slew of these M&As taking place will come true. I'll be keeping a watchful eye to see how things progress; I suspect most CFOs will be watching to see how they and their competitors fare during that time as well.


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Karen Minich-Pourshadi is a Senior Editor with HealthLeaders Media.
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