Hospital Consolidation Explained in One M&A Deal

Duke LifePoint has agreed to spend more than half a billion dollars on Conemaugh Health System over the next 10 years. The CEOs at both organizations detail what drove them to this deal and why we can expect to see more like it.

If you're trying to explain to someone outside of healthcare why hospitals are consolidating, allow me to direct your attention to Exhibit A: Last month, for-profit Duke LifePoint Healthcare signed an agreement to acquire Conemaugh Health System, a three-hospital not-for-profit system headquartered in Johnstown, PA.

Financial terms were not disclosed for the deal, which is expected to be finalized later this year. However, Duke LifePoint has agreed to spend more than half a billion dollars on Conemaugh over the next 10 years to upgrade inpatient and outpatient services, technology, and facilities.

I spoke with senior leaders at Duke LifePoint and Conemaugh after the deal was announced and I found myself nodding along in agreement as they explained why it all made sense. The rationale they used is why we can expect to see more of these consolidations.

Conemaugh CEO Scott A. Becker described "a great three-way partnership" where everybody wins. "We get the depth and breadth of the clinical strength of the Duke University Health System and we get the partnership and capital and operational skill set from LifePoint," Becker says.

"They are getting a strong player in our marketplace and they will make us stronger. We are coming into their organization as a strong organization and we want to – knock on wood – help them continue to grow strategically to make Duke LifePoint even stronger and more prevalent across the country."

Smaller hospitals that are about to be gobbled up by larger systems often talk about "negotiating from a position of strength." That begs the question: If Conemaugh is so strong, why sell?

"When we say we are dealing from a position of strength, we don't think our financial performance was ever going to be as good as it is right now," Becker says. "Our board has gone through a four-year strategic process where we are north of $1 billion in terms of gross revenues and north of $500 million net. That's not small. We are the third-largest system in Western Pennsylvania."

"The reality is we felt we needed to continue to grow and develop our marketplace with a clinical partner who will help us with evidence-based protocols and prepare for population health, and a financial partner who will bring us the strength to do the investments we need to do now and not in four or five years from now."

A Classic Acquisition
But why a full acquisition? Why not some sort of relationship that allows for more local control?

"From our standpoint, you minimize the overall potential capital commitment," Becker says. "We felt so comfortable and the trust was so strong that our local board feels that they are going to have an opportunity to continue to grow and develop with Duke LifePoint."

William F. Carpenter III, chairman and CEO of Brentwood, TN-based LifePoint Hospitals, calls the Conemaugh deal "indeed a classic acquisition."

"It's very consistent with our national strategy that we began a couple of years ago as we have focused on a hospital like Marquette General, which is a regional tertiary hospital," he says. "Duke can bring its focus on clinical quality and patient safety and advanced clinical programs and development of advanced clinical programs and programs like heart and cancer and neonatology. And LifePoint can add its operational experience and expertise and financial resources to add value in that way."

Duke LifePoint is itself a "flexible affiliation" business model formed in 2011 to take advantage of Duke University Health System Inc.'s clinical expertise and LifePoint Hospitals' management skills and access to capital. Carpenter says Duke LifePoint will continue to "seek opportunities in geographies that we think make sense and there are quite a number of them that we have identified."

"The geography and the service area that Conemaugh has the ability to reach are quite compelling. We do believe that there is the opportunity to expand the ability of Conemaugh to serve the region in a bigger way. It is one of those opportunities that came together and we do think that it presents a very compelling opportunity both for Duke LifePoint and for Conemaugh Health System."

Expanded Economies of Scale
It's clear to see what is driving Conemaugh and Duke LifePoint to push this deal. They have a lot to gain financially and organizationally, including an expanded economy of scale that improves leverage with competitors, vendors and payers.

But what about the patients, and the towns where these Conemaugh hospitals are located? What do they get out of it? Don't they lose a significant say in how healthcare is delivered in their communities when the local board if directors cedes control of the purse strings?

The answer is 'yes, but…"

First of all, Conemaugh will become for-profit, and Becker estimates that local government will collect about $4 million in taxes.

As for the loss of local control, local communities have legitimate concerns whenever an outside entity comes in and buys the hospital, which is often not just the center of care provision, but also the largest economic driver in communities. When boards cede budgetary authority and become mere advisory councils, there is a loss of control. It sounds frightening until we consider the riskier alternative, which in most cases is stay small, stay independent, and slowly drown.

One of the three hospitals in the Conemaugh deal, for example, is Meyersdale Medical Center, a critical-access hospital. The problems these small, isolated but vital providers face are well documented, to the point where it is hard to see how independent critical access hospitals can survive, even with enhanced Medicare reimbursements.

Becker says that under the Duke LifePoint deal there is a 10-year guarantee of clinical services at Meyersdale, provided that the hospital can maintain its critical access status and, thus, its favorable reimbursements.

"For us as long as that reimbursement window stays open, it is a very viable process," he says. "It is not going to be Conemaugh or Duke LifePoint that makes the decisions about the systems in play. It is going to be Washington. If they take the critical access designation away, that has the potential to decimate rural hospitals in this country."

Duke LifePoint has agreed to build a $3 million outpatient center in Meyersdale as part of more than $100 million in capital improvements to Conemaugh over the next two years in a Rust Belt region still groggy from the Great Recession.

"That is all in the outpatient arena," Becker says. "We are not going to not pay attention to inpatient capacity but where our growth is going to be is continuing to expand our footprint and grow and make this more accessible and easier to utilize for the patient."

The people of Meyersdale, PA would probably say they would prefer a for-profit, taxpaying, functioning critical access hospital and new outpatient services and access in their town to a shuttered building.

Sudden Hospital Closure Stuns MA Community; More Coming

So, when you look at what's happening at Conemaugh, when you see that they're talking about expanding services, building projects, hiring more people, generating tax revenues, and improving quality, it's easy to see why hospital mergers and acquisitions are becoming the new normal.

Yes, there are legitimate concerns that hospital consolidation will raise the cost of care delivery, and there are concerns about a loss of local control, but consider the alternatives. Those concerns have to be weighed against the likelihood that without affiliations with larger systems many of these hospitals that provide needed services to vulnerable populations would otherwise close, no matter how financially strong they are now.

Arguing over care costs and local controls are moot points when community hospitals close.