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Calling it Off: Why Some Hospital Mergers Fail and Others Don't

Each week, more hospitals announce plans to merge, combine or express interest in some type of partnership arrangement. While many of these deals are executed successfully, another outcome is also possible — that of the transaction unraveling.

In the past year, nearly 25 percent of announced letters of intent failed, according to some estimates. A letter of intent is a non-binding agreement in which parties establish the principal business terms and, in most cases, announce transaction plans to the public. [Editor's note: For the sake of clarity, this article pertains to transactions that are not completed after parties signed an LOI.]

A merger might fall through for a handful of reasons. A lag in timing may slowly kill it. Parties might learn something negative about one another later in the discovery process — a finding that was not initially recognizable on paper but becomes jarringly apparent weeks after the letter of intent. The hospital may have rushed in its marriage to one partner without seeking other bids. Hospital employees, physicians or community members may think the transaction was orchestrated in a questionable or closed-door manner, which creates an enormous amount of backlash.

Any one of these issues, and many more, can derail a merger. Here, experts discuss the reasons hospital transactions can go awry, best practices to avoid problems, and possible serious negative repercussions hospitals and leaders face if a deal does fall through.

Time kills deals
Bart Walker, JD, uses three simple words to sum up a significant concept when it comes to hospital transactions: "Time kills deals." Mr. Walker, an attorney with the healthcare practice of McGuireWoods in Charlotte, N.C., says a slow-moving deal can potentially unravel itself. "The longer anything lingers, the greater a chance that something will go wrong," he says.

This is usually an issue created by the seller, but the burden is shifted to the buyer when something unfavorable is discovered. "Sometimes big issues come up that weren't on anybody's radar," says Mr. Walker. This can be a financial issue, such as something related to taxes, or litigation. Parties usually attempt to salvage the relationship, which may or may not be successful. "There are transactions that die and come back to life multiple times before they're finally executed," says Mr. Walker. "Others die and never come back."

The effects of a lagging transaction can trickle down to the seller's hospital employees, as uncertainty may feed their concerns about layoffs or undesirable working conditions. It could also drive patients away from the hospital, since patients might think the hospital is in transaction limbo and go elsewhere for care. Combined, these repercussions can lower the hospital's value.

Bo Hinton, managing director with Coker Capital Advisors based in Atlanta and Charlotte, N.C., has firsthand experience with a transaction that fell through. In a period of four months, the seller's earnings declined due a myriad of reasons, including economic conditions, issues with medical staff, and stakeholders' concerns around the merger itself. In the end, a valuation gap resulted in a deal unable to close.

"The seller can remember that, only a few months ago, their earnings were relatively high. But the buyer is uncomfortable, and has no reason to believe that this isn't the new normal for that hospital," says Mr. Hinton. He says variations in earnings — from early discussions when the initial price is determined compared to the price when deals are about to close — are a large factor in failing transactions.

No transparency, no transaction
A transaction structured without accountability and straightforward communication faces only a small chance of smooth success. It varies among marketplaces, but the voices of physicians and community members can be extremely powerful when it comes to support for mergers and acquisitions. Whether intentional or not, it's unlikely that the public will support a deal they consider underhanded.

"In smaller or mid-size areas, the hospital may be the largest employer in the community. It might be owned by the county. So, as a result, there can be much more emotion tied up in that transaction process and the significance it has to the local community," says Mr. Hinton.

While transparency is ideal, ignorance of fiduciary duty, conflicts of interest or rushed timing can all lead to questionable transparency. This can lead to extensive problems if not the entire collapse of a deal. Recently, Warren Hospital in Phillipsburg, N.J., received a large amount of backlash from physicians who claimed they were left in the dark when the hospital decided to merge with St. Luke's Hospital and Health System in Bethlehem, Pa. More than 50 physicians publicly criticized the hospital's board via newspaper ad after it formed an exclusive agreement to sell to St. Luke's while rejecting an offer from Community Health Systems the same day it was received.

Besides being bad practice, questionable transparency can also be illegal. All states have their respective open records and open meetings laws. Florida, for instance, has a Sunshine Law that protects the public from closed-door decision-making by a board on any state agency, or authorities of county or municipal bodies. Southeast Volusia Hospital District violated this law in 2010 when it sold Bert Fish Medical Center in New Smyrna Beach, Fla., to Adventist Health after holding 21 private meetings. In February, a judge ordered the sale (which had already been completed) to be undone as a result of the misconduct.

Faulty transaction design
A deal is more likely to go awry when hospital boards or executives enter discussions with a partner without a well-defined idea of what the transaction should entail. What sounds appealing to both parties over informal meetings may not seem as attractive when written in a definitive agreement's contract language, and the deal could fall through due to gaps in expectations. The economic gaps are often measured in the tens of millions of dollars.  

Jordan Shields, a vice president at Juniper Advisory in Chicago, says there are two types of LOIs: soft and detailed. Soft LOIs are developed and signed before the deal's terms are defined, which are "asking for trouble," according to Mr. Shields. Instead, hospitals should develop detailed LOIs, which lay out the specific terms of the transaction.

Recently, more LOIs have been released to the public, announcing mutual interest in affiliation. These are often followed by "research" into each organization and its financial issues, such as capital expenditure needs, and structural details of the transaction are revealed in the definitive agreement. This sequence is out of order, according to Rex Burgdorfer, a vice president with Juniper Advisory.

Discovery and research should occur before signing an LOI. This will determine whether or not the parties are serious and on what terms, and should be completed well before a public announcement. The LOI should outline clear, mutually-agreed upon principles of the deal. The period between an LOI and a definitive agreement should confirm the information each party shared in that discovery process. Finally, definitive agreements should then document the understanding parties outlined at the LOI stage.

Bilateral discussions destroy value
"One-on-one conversations are never going to yield the best outcome from the seller's perspective," says Mr. Burgdorfer. "There needs to be competition." Hospitals should go to market and collect multiple proposals so they have a range of options. "The worst thing a hospital can do is act on that [first] bid without full information of what else is out there," says Mr. Burgdorfer.

"Oftentimes, you'll see failures when the board has an offer and they assume the potential partner is best without fully vetting other opportunities. They sign an LOI, it goes public, and another suitor comes forward with a better offer," says Mr. Shields. This becomes more than an issue of a hospital receiving a low-dollar bid, as it can also involve board seats, maintenance of service lines or capital commitments.

"It might be a new specialty program or a commitment to bring in new physicians," says Mr. Shields. "I've never seen a situation where all of those things are maximized in a bilateral conversation. The board gets one shot at this and should not do it in a vacuum." The original partner might prevail at the end of a competitive process, but after pressure from other participants, its offer is likely to be more comprehensive and advantageous for the seller.

Repercussions of a failed merger
There are bound to be repercussions when a deal fails to close. Greg Zoch, managing director with executive recruiting and search firm Kaye/Bassman, says both parties may suffer damaged reputations due to public misperceptions after a failed merger.

"If the deal was made public, and then not completed, it begs the question as to why," he says. Post-transaction communication can be difficult, and both parties should coordinate how they will frame the news in a way that doesn't harm either organization or insinuate fault or bad faith.

"Essentially, you're talking about a break up. These two organizations were going to get married and now the wedding is off," says Mr. Zoch. "People are going to fill in the blanks." Savvy public relations professionals are crucial to communicate a message effectively and address public and employee concerns.

A failed merger might affect a hospital's standing with physicians, its ability to recruit them, or its good-will in the community.  It is also a financially costly process, as organizations spend a large amount of money on the diligence process. Break-up fees, to be paid by the party calling off the deal, can be built into agreements.

Hospital CEOs can also face a tarnished period in their career if they are leading a hospital through a deal that never closes. Some CEOs might even be forced to step down, depending on how closely they were tied to the transactions' unraveling or if it was somehow a result of CEO oversight or negligence. This causal link, though often not publicly exposed, certainly remains a risk to hospital executives.

Related Articles on Hospital Mergers and Acquisitions:

Varying Degrees of Consolidation: Why Creativity Matters in Hospital Transactions
Healthcare M&A Spending Up, Volume Down
6 Observations on Investment, Mergers and Acquisitions in Healthcare

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