Crafting Successful ASC Joint Ventures in 2012: Q&A With Jeff Peo, Donna Greene & Brandon Frazier of ASCOA
Q: What are you seeing this year in terms of hospital/ASC joint ventures? The last few years have seen an increase in these partnerships — do you see the trend continuing in 2012 and 2013?
Donna Greene: I think we're seeing personally seeing an increase. I've been in this business 25 years; this is my 25th official year, and I've definitely seen an increase in hospital joint ventures and believe the trend will continue through 2012 and 2013. Fifteen years ago, it was all about controlling interest — hospitals always wanted a controlling interest, and that would always be a 51 percent deal. Nowadays they're more willing to do a joint venture with a corporate partner and physicians and more likely to do a minority interest deals. They're trying to do everything they can to maintain that book of business for their hospitals. That's my take.
Brandon Frazier: I would agree with what Donna said. We're seeing an increase in the number of JVs, driven by both hospitals as well as ASCs.
Hospitals are looking for a low-cost, high-quality alternative to the acute-care setting. In many cases, we hear hospitals use the term "decant": They're trying to decant low case mix index cases that are money losers and take up valuable OR time, and then backfill that space with higher CMI (more profitable) cases. Savvy hospital executives use the ASC as a tool to attract new surgeons and inpatient cases to their hospital, while gaining profits through the ASC on cases that were money losers or marginally profitable before.
ASCs are looking for hospital partners because they're feeling vulnerable in the face of declining reimbursement rates and what's going to happen in the future with commercial payors. There's a lot of nervousness among ASCs in that respect, and a hospital partner helps provide some security in the minds of physician owners.
Q: Some experts say hospitals are increasingly looking to own ASCs outright rather than pursue joint ventures. Is that the case in your experience?
BF: I’m definitely seeing it more than in the past, but I still wouldn’t say that it is common. The conditions have to be right for it to make sense. Owning an ASC outright is a strategy that's typically implemented by a hospital utilizing a physician employment model. If the hospital can direct cases to the ASC, having 100 percent ownership in the surgery center allows them to benefit from Medicare HOPD rates and they can typically assign existing contracts to the ASC from the hospital. I am also seeing 100 percent ownership in markets where there is a significant (70 percent or more) Medicare population. Again, the hospital is trying to benefit from HOPD reimbursement rates in a situation where a JV center may not be financially viable.
Jeff Peo: I think most surgery centers look at that model and think, "What does 100 percent hospital ownership give the individual physicians?" There's not a lot that a 100 percent ownership does for physicians unless they're getting directorships. The people looking for partners in their surgery center don't want 100 percent partners unless they're looking to move somewhere else. The hospitals usually want the physicians to remain financially vested so they bring cases to the surgery center and participate in its management. I haven't seen a lot of 100 percent ownership by progressive hospitals.
Q: A joint venture isn't a one-size-fits-all answer for every ASC. How can ASC leaders know if they're in a good position to pursue a JV or not?
DG: I think when an ASC is looking at a joint venture with a hospital, they should look closely at whether they can get a bump in net revenue per case. Can they get a blend between freestanding ASC and HOPD rates? If they can, when you get a bump like that, you can expect a 25-30 percent increase, and it makes sense to do a joint venture.
The other thing is whether the hospital can direct care through their employed physician pool. Things like that become very important when you're looking to improve the business of your center. The other thing that would make sense is if the ASC is in a CON state. If you've got a joint venture partner and you're in a CON state and you're developing a new surgery center, the key concern is whether another facility will oppose the CON. With a hospital partner, you have the benefit of someone who's working side-by-side with you and isn't going to oppose the CON.
BF: For an existing surgery center considering partnership with a hospital, it kind of breaks down into two types of ASCs: ASCs that are struggling and looking for a lifeline, and profitable ASCs looking for a hospital partner for potentially different reasons.
An ASC that's not breaking even should be looking for a hospital partner that can help bring cases as well as get a bump in reimbursement that will hopefully take the ASC out of negative territory. However, prior to approaching the hospital, the ASC should get their house in order by ensuring that the physician partners are bringing every eligible case to the center. The hospital will want to see that the physicians are committed to the ASC. The option that works the best for many struggling centers is to bring in a management company at the same time as a hospital partner. This gives the ASC access to greater payer leverage through the hospital as well as the expertise of a management company who can remove unwanted partners, compress schedules, and help the center reduce costs operationally. Improving top line revenue while reducing expenses is typically the shot in the arm that is needed to make the center profitable.
An ASC that's profitable may have different motivations. They may be looking for some type of liquidity event, in which case the hospital may not be the best option since they typically pay lower EBITDA multiples than other companies. They should expand their search to other national development companies as well. The partnership should not be short-sighted, though. They should certainly take the initial purchase price into consideration, but primarily focus on finding a partner that can help grow the center and keep it sustainable in the future.
Q: What are hospitals looking for in the surgery centers they partner with? Do you see hospitals pursuing 'turnaround' opportunities in the same way as some ASC management companies?
JP: I don't think that hospitals are looking for turnaround opportunities because they don't know how to run surgery centers. They know how to run hospitals. They're usually buying centers that are running well if they know what they're doing. Some hospitals, if they're buying into a struggling center, are looking to shut the center down and bring those cases back in house.
Q: What problems do you see commonly plaguing joint ventures? How would you recommend ASC and hospital leaders tackle or solve them?
DG: I think hospitals tend to move at a slower pace than the outpatient world, and I can say that because I've worked in the inpatient and outpatient setting. They're unaccustomed to the pace at which outpatient negotiations move, and I think that can be very, very problematic. My recommendation would be to put together a timeline of events and share that with all parties so everybody's working on the same timeframe.
Hospitals have a difficult time understanding the business of the surgery center. It's not their area of expertise; it's one cost center they have within the hospital system. There's a level of education that has to occur with the hospital partner about how things should move, how contracts should be negotiated, what the satisfactory turnover time per case is and how the center should be run.
BF: I agree completely with what Donna said. The other thing we've seen that's pretty frequent is that hospitals tend to overbuild surgery centers. They frequently turn them into mini hospitals. We can build a four OR surgery center at about 10,000 square feet, and I've seen hospitals build a four OR surgery center in 25,000 square feet. The facilities are beautiful, with gorgeous art and blown glass, but when it comes down to it, the economics don't work. You've got this huge fixed cost of rent that can't be overcome, and you've got a space that's massive and less efficient in terms of moving patients around. It's important that a surgery center be sized properly.
Another one I've seen just recently is distrust. One of the reasons a joint venture can fail is that many surgeons have longstanding relationships with the hospital. Sometimes that's good, but a lot of times there's baggage that comes along with that. The doctors may not trust the hospital, so having a third party management company is a nice bridge between the hospital and the surgeons so that the focus can be on making the ASC profitable and efficient, not focusing on what’s best for one particular stakeholder. A properly established ASC should align incentives among all of its partners.
JP: One thing I've seen happen is that the hospital tries to put their own overhead into the ASC financials, so they end up billing the surgery center for things that are "hospital overhead." This makes for a bad partnership situation. It's important for people to make sure they're looking and understanding ahead of time what the expenditures are going to be. Make sure there is a trust level there: If there's no trust, it's not going to help to make the hospital part of the surgery center.
Q: What kind of ownership structures and percentages are you seeing? What do you recommend for an ASC considering a JV?
JP: There's the 100 percent model that Brandon discussed, as well as the 51 percent model Donna discussed. In some cases, the hospital and management company form a third entity that has majority ownership of the center, which is split between the hospital and the management company. It can be all over the board — I've seen hospitals with 10 percent ownership. It really depends on what the doctors are willing to sell.
Our model is that we buy 51 percent as a holding company, and that holding company is owned 51 percent by the hospital and 49 percent by the management company. That's what we've seen work well, it's been effective in negotiating payor contracts. A lot of other companies in the industry do that too.
Q: Could you describe the set-up of some of the most successful JVs you've seen? What makes the difference between a decent JV and a great one?
JP: The most successful joint ventures occur when you have progressive hospital CEOs that don't care whether employed physicians join the center or not. They realize they're building a healthcare community that treats patients where it's most appropriate, whether that's the hospital operating room or the surgery center. They encourage everybody that they can to come and join the staff and actively recruit people to come and join the surgery center as well.
That kind of feeling resonates throughout the project, and the doctors bring all their inpatient cases to the hospital and take all their outpatient cases to the surgery center. It takes trust, communication and an ability by the hospital to stay out of the surgery center management and let us manage it for them. The most successful models I've seen have been able to negotiate better contract rates with the hospital partnership. The top end is up significantly because of those rates, and we're able to manage the ASC effectively so that the bottom line is better too.
BF: It comes down to the motivation of the hospital and the reasons they're interested in a joint venture. In the past we've seen a lot of hospitals, especially in non-CON states, interested in joint ventures as a defensive measure. They're worried that surgeons will leave the hospital and start a surgery center on their own if they don't build a joint venture. These hospitals aren't motivated to see the center succeed, and they in fact probably want it to fail so that the cases will come back to the hospital.
The partnership with the ASC should fit into the hospital's long-term strategic plan, whether that focuses on reaching out further with branding, building partnerships with surgeons they don't have relationships with currently or getting cases out of the hospital to avoid extensive hospital expansion. The ASC joint venture should fit in nicely with what they're already trying to accomplish, so everyone's incentives are aligned.
Q: If an ASC is in a community with several competing hospitals, how can they go about deciding who to partner with?
DG: I think it depends on whether it's a CON state or not. If it is, you want to partner with the hospital that will help you obtain that certificate of need. We're all familiar with markets like these, and we can use Mississippi as a general rule of thumb. There are five competing hospitals in Jackson, Miss., all with different systems, and Mississippi is a CON state. A surgery center there would want to align with a hospital that could truly help the ASC get that CON.
In a non-CON state, you want to seek out the hospital that's the best at payor contracting. Do they have an employed physician strategy, and can they push additional business to your center? The surgery center should review each of these aspects individually.
JP: Donna hit that right on the head for if you're developing a de novo center. If you're an existing center and you want to choose between several hospitals, you want to ask: Who lines up best with us? Who's going to allow us to do what we've been doing, and who's going to help us if we're not successful? What are our weaknesses as a surgery center, and which hospital can best help us overcome those weaknesses? You need to interview those hospital systems. You need to go to individual hospital CEOs and interview them to see what they can bring to the table.
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