Trends In the Evolution of Healthcare Consolidation Transactions

As the medical provider community continues aligning toward clinical integration, and with the passing of healthcare reform—which is certain to change the industry forever—hospitals, health systems, and medical groups are looking to new alternative efforts to stay ahead of the curve, despite all of the changes happening around them. One of the results of these trends has been a boom of consolidation spurring mergers and other transactions, as many organizations consider these strategies that were in many cases not available previously.

In looking at recent transaction activity involving healthcare services companies, these deals represented more than 50% of total healthcare deals since January. Despite the ongoing burden of uncompensated care and looming threats of declining reimbursement, many entities are readily seeking transaction opportunities, including Community Health Systems (NYSE: CYH) and Health Management Associates (NYSE: HMA). These developments have attracted billions of dollars in new capital to the healthcare market, which we observed with the recent news of an HCA public offering, rumored to exceed $4 billion, according to Bloomberg and the Financial Times.

Healthcare sector leaders are under increased pressure to aggressively tackle alternative growth strategies in order to can gain an edge over emerging competitors, such as Catholic Healthcare Partners, which recently closed on a $180 million acquisition of a Cincinnati hospital and Ascension Health, which recently finalized a $1.35 billion bond financing that will capitalize the nation's largest not-for-profit health system's growth.

Throughout this evolution, many organizations have found themselves dealing with unfamiliar challenges. While a transaction may seem attractive on paper, it rarely takes long for executives to realize why more than 80% of mergers fail. For investment bankers, management consultants and other advisors, this wave of consolidation has turned into a bonanza of activity where leading organizations are seeking new solutions to propel future growth. There are three trends that have emerged through this evolution, which many executives are embracing in planning and executing their growth strategies.

Trend 1: Transaction Service Advisors. These advisors are becoming tremendous resources on healthcare deals. While many executives look at due diligence merely from a legal standpoint, today's most innovative companies are embracing the three-pronged approach to due diligence:

1. legal diligence (contracts, litigation, regulatory matters, etc.)
2. financial diligence (accounting, treasury, etc.)
3. operational diligence (products/services, personnel, technology, supply chain, etc.)

It is the third component that is too often ignored, yet that is the one that typically results in the issues that are most challenging and time-consuming to resolve, or impossible to fix altogether.

This is especially pertinent within healthcare services, where deals often revolve heavily around individual providers. The risks acquirers must consider go deeper than legal contracts and tax filings. For instance, what will an acquirer do when they realize their high-producing target depends on technology that the firm is not able to adequately support or scale? Or, what about the likelihood that some of the providers will not maintain the necessary productivity to make the economics of the deal work?

These types of scenarios often require additional investment to grow or even sustain the acquired business. This happens frequently, most of the time where the companies do not realize issues until the deal is closed, resulting in the failure of countless mergers.

Trend 2: Engaging Investment Bankers. The second area where companies can improve a deal's success is to engage investment bankers with industry expertise. Only within the last ten years have financial services companies developed specialized focus areas to work with healthcare companies, which unfortunately developed as the result of numerous failed transactions. Healthcare businesses are unique, as are their transactions, thus requiring knowledge, experience, and expertise unique to the industry, which healthcare executives are seeking, rather than depending on advice from generalists.

This is particularly prevalent in deals involving health systems, medical groups and other companies depending heavily on the third-party reimbursement system unique to healthcare. While there are still some financial advisors boasting cross-industry expertise, the days of an advisor going from a telecommunications deal one day to a healthcare transaction the next have faded almost entirely.

Trend 3: Embracing Post-Merger Integration. The third area where companies are taking action to implement successful deals is through embracing post-merger integration planning early in the process. Healthcare financial leaders must understand that the “post” in post-merger integration is a misnomer. More than 90% of the value in post-merger integration lies in the planning that occurs prior to the deal ever being structured. This often occurs in conjunction with due diligence, because that information can ultimately be used to form the combined entity's go-forward strategy.

While there is much more to implementing a successful transaction than the areas outlined above, these are some of the key components of today's healthcare deals that many executives are embracing to be successful. By the same token, these are also areas that when ignored are proving to be the most devastating for organizations. If modern healthcare executives are going to be effective in their growth strategies through consolidation, industry businesses will need to evolve, so they can grow more innovative and dynamic in their execution strategies. The good news is that they do not have to go at it alone. A good transaction advisor will exponentially prove their weight in gold.