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5 Issues Forcing Standalone Hospitals to Consider the M&A Market

In July, Saint Vincent Health System, a two-hospital network based in Erie, Pa., officially became a subsidiary of Pittsburgh-based health insurer Highmark. After several months of negotiations and regulatory approval, Saint Vincent went from an independent hospital network to a member of Allegheny Health Network, the system created by Highmark.

Compared with multistate health systems and large academic medical centers, independent, standalone hospitals face some of the greatest pressures today, and it's pushing many, like Saint Vincent, to consider entering the merger and acquisition market.

Eb LeMaster is a director with Ponder & Co., a healthcare financial advisory firm. Previously, he was vice president of development for Ardent Health Services, a for-profit, 13-hospital system based in Nashville, Tenn. Mr. LeMaster and Ponder's M&A group served as the exclusive financial adviser in the Saint Vincent-Highmark transaction. Here, Mr. LeMaster explains five main issues, of many, that have independent hospital leaders thinking about whether they should go to the market.

1. Reimbursement and supplemental funding. This week, Moody's Investors Service said the government's low Medicare rate increase to hospitals for 2014 — only 0.7 percent — is a big credit negative for nonprofit hospitals. The reimbursement pressures have extended to commercial payers as well, and Mr. LeMaster says this pressure on pricing is among the top issues pushing independent providers to find a partner.

"Five years ago, the focus for hospitals was access to capital. That was driving consolidation," Mr. LeMaster says. "Now, I would really put healthcare reform pressures on reimbursement on par with, or even ahead of, access to capital as the number one merger driver."

In addition, supplemental funds like Medicaid disproportionate share hospital payments are expected to be cut by $18.1 billion from 2014 to 2020 — a move that could decimate safety-net hospitals in states that don't expand Medicaid. A recent report from the HHS Office of Inspector General also put critical access hospitals in the spotlight. The OIG said the government should reassess requirements for CAHs, which would effectively end above-average Medicare reimbursement for 849 hospitals. Hospital advocates have said that plan would "kill rural healthcare."

2. Getting beyond the low-hanging fruit in cost reduction. Reducing costs is an annual goal for every hospital, and over the past several years, hospitals have implemented many effective strategies. Cutting supply costs through group purchasing organizations, standardizing physician preference items and consolidating business office functions are some of the ways executives have kept their costs in check.

However, hospitals can only cut so much of that low-hanging fruit, Mr. LeMaster says. Independent organizations especially are faced with rising labor costs, especially with salaries and benefits, which have led to numerous layoffs and pension freezes across the industry.  

"The challenge: Does the [organization] and board have the stomach for making more radical changes, and will they be enough?" Mr. LeMaster says. "Even for the highest credit systems, they will be analyzing sacred cows like pensions, salaries and [other] benefits. If I'm going to bend the cost curve, I've got to be able to look at these areas that previously were untouchable."

3. Shifting to value-based care from volume-based care. CMS is incenting and penalizing hospitals that don't meet certain quality outcomes through value-based purchasing, and commercial payers are also moving toward value-based contracting. Standalone hospital executives know these programs and pay-for-performance will be the new norm, but Mr. LeMaster says it's challenging to balance pursuing these new programs while continuing to live in what is still a predominantly fee-for-service system.  

"The interesting thing to me about the shift between those two models is that it's not an easy one," Mr. LeMaster says. "How do you continue to succeed with feet in each boat?"

4. Clinical integration. Virtually every hospital and health system is analyzing or implementing strategies to integrate its medical staff further. Typical integration efforts include employing physicians, enhancing alignment with independent community physicians and developing the information technology systems to make it all happen. This is a complex and expensive endeavor, Mr. LeMaster says, and some independent hospitals do not have the luxury of leveraging these costs and efforts across a system of hospitals.    

"Every client we have is focused on clinical integration at some level," he says. "Whatever healthcare reform ultimately looks like, better alignment with physicians and more coordinated care is essential."

5. Fierce competition. If independent hospitals are not able to work with lower reimbursements, reduced supplemental payments from CMS, rising expenses and the transition to value-based care, they suddenly become prime targets for a buyer — potentially a competitor — if they still have positive demographics, Mr. LeMaster says.

However, standalone hospitals may want to keep their independence. Staying independent is possible for certain hospitals with the right market position and a strong balance sheet, but they will have to work harder to avoid the pursuits of other systems.

"We tell management to develop a list of five to 10 indicators, both financial and nonfinancial," Mr. LeMaster says. "It helps keep the board and management in a thoughtful process even if they are not ready to do anything or never do anything."

Some of the indicators to follow include operating margin, days cash on hand, physician alignment and physician employment, he says.

More Articles on Hospital Mergers and Acquisitions:
Consolidation Nation: Where Will the Hospital Industry Stand After the Tenet-Vanguard Merger?
Moody's: Hospitals Will See "Eroding Profits" in Move to New Payment Models
Hometown Healthcare Isn't Dead: Why (Most) Smart Community Hospitals Can Still Thrive

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