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4 Transaction Models for Community Hospitals

The hospital industry is in the middle of an uptick in mergers and acquisitions, as thousands of organizations seek to adapt to the shifting U.S. healthcare system, according to Jordan Shields, vice president of Juniper Advisory, an investment bank that works exclusively with hospitals and health systems.

Earlier in the 2000s, Mr. Shields recalls many of the hospitals seeking to join forces with others were "distressed" financially and sought consolidation as a way to stay afloat. However, increasingly, that's no longer the case, he said during a webinar.

"The majority of our clients right now are very strong, single 'A' rated hospitals with strong cash positions and strong balance sheets," he said. "We're seeing a lot of hospitals that are strong that are pursuing transactions because they're looking forward at the emergence of healthcare reform. It's a lot more fun for us to work with strong hospitals that are making decisions because they want to really improve care for their communities versus making a decision because they're worried about the lights going out."

Transactions between hospitals and health systems can take on varying structures, depending on the companies involved and their objectives. During the webinar, Mr. Shields, Holly Carnell, JD, an associate at McGuireWoods, and McGuireWoods Partner Bart Walker, JD, discussed various ways healthcare organizations can structure a deal, including the following four models.

1. Membership substitution/stock transfer. This structure is the most common for hospital deals and generally involves a nonprofit buyer and seller, Ms. Carnell said. These are often noncash deals under which the larger hospital takes on the liabilities of the smaller hospital, and one of the parties becomes the corporate member of the other. One of the benefits of this type of transaction is increased access to clinical resources.

"The larger hospital is taking all of the liabilities at the smaller hospital," Ms. Carnell said. "The larger hospital may also take over the bond obligations."

One example of this type of transaction is the deal announced last year between Meriter Health Services in Madison, Wis., and Des Moines, Iowa-based UnityPoint Health. Meriter pursued a membership substitution with UnityPoint and ended up retaining a significant amount of local authority, Ms. Carnell said.

2. Asset purchase. This type of transaction generally involves a for-profit buyer and nonprofit seller and in such case is  referred to as a "conversion transaction," Mr. Walker said. It limits the buyer's legal obligations related to historic operations and typically includes a purchase price and debt being retired or defeased.

"You're converting from a nonprofit to a for-profit, although at the end of the day it's not really a true ‘conversion’ in the sense that the legal entity itself is not converting to a new form. Rather, it is moving assets from a tax-exempt entity to a taxable one," he said. "By transferring the assets, you can pick and choose a lot of times which liabilities go over with those assets. That's a benefit that a lot of buyers see."

Medicare-related liabilities, however, can be "stickier" and not so easily shed, Mr. Walker said. Other types of obligations and liabilities can also transfer. For instance, pension liabilities can become a big issue.

An example of this sort of transaction is the deal between Marquette (Mich.) General Hospital and Brentwood, Tenn.-based Duke LifePoint Healthcare, which closed in September 2012. The hospital's merger with Duke LifePoint involved $350 million from the health system in capital investments and for physician recruiting, according to Mr. Walker.

3. Joint venture. This is a much more rare transaction structure than the others, according to Ms. Carnell. Typically, a smaller hospital and a larger hospital will both hold ownership in a new entity. Although the larger hospital will ultimately take a bigger ownership stake, both hospitals involved will have equal board representation within the new entity.

She said the smaller hospital may be able to retain more of its identity in a joint venture than in other types of transactions. Joint ventures are "unwindable," a step away from a full affiliation, she said. This transaction model can involve two nonprofits or a for-profit and nonprofit.

The joint venture agreement Nashville, Tenn.-based Vanguard Health Systems and Greater Waterbury (Conn.) Health Network ratified this past May is one example of this sort of agreement. Under the deal, Vanguard created a limited liability company called VHS Waterbury Health System to own and operate Waterbury Hospital and the whole system as a for-profit entity. Vanguard owns 80 percent of the joint venture, while GWHN owns 20 percent.

Mr. Shields said only financially strong hospitals should pursue this kind of deal.

"The seller needs to be strong," he said. "They're only selling 80 percent of their equity, typically, so they're getting 80 percent of the purchase price that is then needed to pay down all of their liabilities. So 80 percent of the purchase price needs to be able to retire the liabilities. It's an example of something that well-situated, strong hospitals can pursue, but if they wait too long, it's no longer an option." 

4. Management services agreement. According to Mr. Walker, hospitals and health systems can also choose to pursue "alternative" transaction models short of a full sale, one of which is a management agreement. Under a management agreement, a health system typically provides management services to a hospital for a fee.

The hospital can benefit from better contracting services, integration of billing and IT and access to the system's resources while maintaining local governance and legal independence. If the organizations want to end this type of agreement, it's also much easier to terminate than it would be to undo a merger. These relationships are typically long-term, 10- to 25-year deals.

One example of a management services agreement is the planned affiliation between Nash Health Care Systems in Rocky Mount, N.C., and Chapel Hill, N.C.-based UNC Health Care. The proposed agreement doesn't involve any sale or exchange of assets, and Nash will retain ownership while accessing managerial and operational resources from UNC.

Management agreements have some disadvantages. They are usually less successful in realizing scale efficiencies than mergers are, according to Mr. Shields. Although the hospital retains local ownership in a legal sense, control shifts in a practical sense, and these arrangements have the potential to turn into gradual giveaways where the hospital is assumed by the system for little to no economic or non-economic consideration.

More Articles on Hospital Transactions:
The St. Luke's Antitrust Case: 10 Things to Know
Unity Health System, Rochester General to Form New Health System
California AG Approves 2 Hospital Transactions 

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