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Smaller Hospitals Look to M&A for Survival

Analysis  |  By Gregory A. Freeman  
   August 15, 2018

Mergers and acquisitions continue at a strong pace as hospitals find it increasingly difficult to survive on their own.

The changing face of healthcare is making it difficult for hospitals to make it on their own, with many actively looking for partners who can make them part of a larger organization.

St. Joseph's Health in New Jersey is one of the latest to go looking for a partner, motivated by previous mergers in the state that made it more difficult for smaller or stand-alone hospitals to compete without increased leverage with insurers and greater economies of scale.

St. Joseph's announced recently that it is actively seeking a suitor that will allow it to remain true to its Catholic heritage and mission.

A majority of hospitals are in a partnership and many others are seeking one in order to survive. Of the over 5,500 hospitals in the United States, nearly 60% are part of a health system, according to the American Hospital Association.

That percentage will continue growing, says Fatema Zanzi, JD, partner with the law firm of Drinker Biddle in Chicago.

"Smaller, independent hospitals, and even one- or two-hospital health systems are finding that they can't sustain themselves without being part of a larger health system," Zanzi says.

"There is going to be a point soon where there won't be that many hospitals that are independent, but there still are a good number of independent hospitals in certain markets. Those markets may follow before long," Zanzi says.

The need for capital improvements, especially in technology, is a big driver, she says, and independent hospitals have a more difficult time obtaining that capital with lower bond ratings.

"From a patient care perspective, hospitals are finding that they need to be part of a larger system to provide the kind of holistic care that is expected now, with outpatient care, urgent care, mental health all, everything a patient needs," she says.

Zanzi points out that in addition to the benefits of scale and access to capital, joining a health system or partnering with another facility brings access to talent.

"You want the top talent at your organization to attract more patients, and partnering with someone else broadens your access to the talent pool," she says. "That's true of physicians, but it's true on the executive side too. You get access to the best people."

Looking for the Right Partner

Most hospitals go into merger opportunities with the determination to stick to one's values and do the right thing for the community, says John Maher, EVP and COO at Quorum Health Resources, a hospital management firm.

That can make the search more difficult than if the hospital focused mostly on financial success, but it is the right path when those values are core to the hospital.

"Any time an organization like St. Joseph’s in New Jersey is looking for a partner, it is crucial for the partnership to be mutually beneficial for the system and the hospital. When determining the optimal vehicle to enable an organization’s future success, the form must follow function," Maher says.

"A closer relationship with another organization may be needed to achieve the organization’s long-term goals. However, the mission, vision, and values should drive the structure, rather than allowing the constraints of a structure dictate the outcome," he says.

St. Joseph’s approach to vetting partners based on culture makes a lot of sense, says Stephen Thome, principal in the Health Care Advisory services practice with Grant Thornton.

"So many mergers fail because cultures don’t align, which prevents getting meaningful work done to align strategy, integrate operations, and compete externally instead of internally," Thome says. "Focusing on cultural alignment early will lead to long-term success."

More Access to Capital

St. Joseph's is a good example of access to capital can drive partnerships, Thome says.

"For instance, St. Joe’s achieved a 7.3% operating margin, which is very robust for a healthcare provider, but Moody’s gave St. Joe’s its lowest investment grade rating," Thome says. "Scale matters to lenders, to payers, and any other organizations in the ecosystem who negotiate prices and rates."

Maher notes these other key drivers:

  • Changes to payment models: The evolution of payment methodologies has dramatically increased the need for the alignment of care across the continuum.
  • Gaining scale: To expand across a broader continuum of care and reduce costs, gaining scale is paramount for hospitals. A partner can mitigate the cost of remaining independent, which in turn, helps the organization reduce unit cost and gain scale. Particularly, independent and rural hospitals struggle to access scale; thus, making it difficult to obtain affordable capital and recruit physicians.
  • Inpatient volumes: At the same time, inpatient volumes have been declining. According to Analysis of American Hospital Association Annual Survey Data for community hospitals from the U.S. Census Bureau, between 2004 and 2014, inpatient admissions at community hospitals fell by 5.7% (from 35.1 million to 33.1 million), while the number of total inpatient days declined by 8.7% (from 197.6 to 180.5 million).

200 Deals in 2nd Quarter

There were more than 200 mergers and acquisitions in the second quarter of 2018, according to a recent report on M&A activity by PwC.

Total deal value declined by double-digits versus Q1 2018 and Q2 2017, but PwC notes that both past periods had seen exceptional megadeal activity. In Q2 2018, 255 deals were announced, which represents a decline of 7.3% over the prior quarter but an increase of 9.4% over the prior year.

Zanzi expects the trend to remain steady for mergers, as more hospitals find it difficult to remain independent.

"There are some hospitals and small health systems that are fiercely independent and protective of what they've done, and they feel like they still have the margins to continue that service to the community," Zanzi says. "That's admirable if they can sustain it, but I think it's going to get more difficult as the margins get smaller and smaller."

Gregory A. Freeman is a contributing writer for HealthLeaders.

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