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6 Observations on Investment, Mergers and Acquisitions in Healthcare

Christopher Mercier, managing director, and Sean Sullivan, director, lead the healthcare investment banking practice at Duff & Phelps, a global investment banking and financial advisory firm. Mr. Mercier and Mr. Sullivan discuss current trends in healthcare investments, mergers and acquisitions.

1. Merger and acquisition activity has increased significantly over the past year.
According to Mr. Mercier, mergers and acquisitions slowed considerably in 2009 due to the debate over healthcare reform and the difficulty of obtaining credit. "I think there was an incorrect sense that the healthcare sector would be somewhat shielded from the downturn in M&A activity," Mr. Mercier says. Over the past year, however, credit has started flowing again, and the effects of healthcare reform — including regulatory measures, reimbursement cuts and other financial burdens — are clearer.

"The major reform effort caused a lot of uncertainty with regard to the future environment, and it became challenging for business owners to predict cash flows," Mr. Mercier says. "It was difficult for buyers to get comfortable with what the outlook would be, and they were forced to stand on the sidelines." In 2010, the dollar volume of healthcare services transactions spiked dramatically, indicating a much healthier M&A environment, Mr. Mercier says. He expects merger and acquisition activity to continue over the next few years as credit continues to flow, ancillary service providers seek to gain scale, and hospital chains pursue acquisitions of smaller facilities.

2. Hospitals are looking to acquire physician practices; practices may be hesitating. Mr. Mercier and Mr. Sullivan see a strong desire on the part of hospitals to acquire physician practices and align their providers with organizational goals. Practices, on the other hand, may be hesitating. "In terms of a knee-jerk reaction [to healthcare reform], there's certainly a higher level of interest among hospitals," Mr. Sullivan says. While hospitals stand to gain by protecting their referral stream, physicians in a group practice have to adjust to the idea of selling their business and working more closely with the hospital. "I think that at a high level, it's clear there are benefits to both sides, but the physician has to sit across the table from his partners and say, 'we're going to sell this business that we built together,'" Mr. Sullivan says. "That's a process that can be like herding cats because there are a lot of different viewpoints. It often takes a long time for a group of independent physicians to achieve consensus." He says that while hospital acquisition is probably inevitable for many physician practices, it may take a few years for practices to seek out hospitals with the same enthusiasm.

3. Visibility of future reimbursement cuts makes M&A activity more likely.
Healthcare reform put a damper on M&A activity as hospitals, health systems and other providers paused to consider their next move. But as the economy improves and future reimbursement patterns become clearer, Mr. Mercier and Mr. Sullivan expect to see increased M&A activity — already in evidence based on the 20 percent growth in reported deals in 2010. While reimbursement rates are scheduled to drop over the next few years, Mr. Mercier says mergers and acquisitions will likely continue because lenders, private equity groups and strategic acquirers can plan for the future. "As long as they can get their arms around what reimbursement is going to look like over a three- to five-year period, they can adjust for those rate cuts and develop a business case that makes sense," Mr. Mercier says.

4. Outpatient rehab and hospice are growing. Mr. Mercier and Mr. Sullivan expect that outpatient rehab will continue to grow as an industry in the coming years, as a result of cost-containment measures by healthcare payors — which are resulting in higher patient volumes in low-cost settings of care — the aging population, greater focus on wellness and preventative medicine and patient preference.

The aging population also means that hospice services that treat end-of-life patients should experience growth over the next several years, according to Mr. Mercier. "When patients are nearing the end of life, they would certainly rather be at home with their loved ones than spending their final days in an acute-care facility or nursing home," Mr. Mercier says. "You do see macro trends suggesting that hospice growth will continue." While home health reimbursement has run into challenges, Mr. Mercier has had recent conversations with a number of private equity investors looking for platforms in the hospice space. The value of such businesses is compounded by the lack of sizeable hospices available for sale.

5. Technology-enabled cost containment services are expected to experience a surge. While the healthcare reform effort made major strides in providing coverage to millions of uninsured Americans, it lacked clear plans to manage increasing costs, Mr. Mercier says. "There is a recognition that there is going to have to be heavy pressure on reimbursement, and the only way to maintain profitability is to ensure that care is being provided in the most cost-effective way possible," Mr. Mercier says.

The current options for cost containment technology are somewhat limited, but Mr. Mercier expects the market for such technology and related services to increase significantly in the next few years. He adds that the growth should not be limited to software products; while technology is important, providers have to use technology effectively rather than just purchase a piece of software. "It's one thing to put in a new IT system, and it's another thing to make sure it's being used appropriately, in order to maximize its potential," Mr. Mercier says.

6. ASC acquisition activity is increasing.
According to Mr. Sullivan, ASC acquisition activity increased significantly in 2010, although to a lesser extent than other physician practice acquisitions. "There was a long hiatus in terms of hospitals acquiring physician groups," Mr. Sullivan says. "It was a very popular practice in the 90s, but a lot of those deals didn't work out.  Over the past year or two, however, the regulatory and reimbursement environment has evolved in such a way that activity has increased dramatically." He says the ASC market is different; while ASC acquisitions and partnerships have experienced an increase in the past year, the level of activity has been robust for a while.

Read more on healthcare mergers and acquisitions:

-13 Recent Hospital Transactions

-New York's Upstate University Hospital Submits CON to Acquire Community General

-Connecticut's New Haven and Hospital of Saint Raphael Sign Letter of Intent

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