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Capturing Transaction Synergies: 3 Critical Steps for a Financially Successful Deal

The healthcare industry is unique in its transactions. Although many industries have cashless mergers, only the healthcare industry can merge two non-profit organizations, whereby no compensation in cash or stock is paid to another party, says Bill Baker, partner and head of transaction services for healthcare at KPMG. This may not occur that often, but it is possible. Given the current state of the healthcare industry and regulatory pressures, mergers of non-profit hospitals and health systems are an increasingly common transaction in the sector.

However, despite this unique possibility, healthcare mergers and acquisitions can still result in financially unsuccessful outcomes, even when no cash is exchanged. A recent data analysis highlights this point. When consultants at Booz & Co., a management and strategy consulting firm, analyzed data from 220 hospital transactions from 1998 to 2008, they found only 41 percent of all the acquired hospitals outperformed in their market. Eighteen percent of the acquired hospitals went from positive margins pre-deal to negative margins post-deal.

According to Mr. Baker, in a payment scenario, transactions may fail because an acquiring organization paid too much. "The target made sense, it fit their strategy, but they just paid too much. From a hindsight perspective that's a failed transaction," says Mr. Baker. In addition, cashless mergers may be unsuccessful if an acquired hospital is struggling financially and the acquiring organization is not conscientious in its diligence; factors could materialize post-deal, slowing financial growth. "The day you begin to own a hospital, you have to put cash into it, and it could drag you down. There are a lot of potential negatives that could arise post-close, even in a cashless merger," says Mr. Baker.

To develop a deal with positive financial margins, both parties need to approach the deal guided by strategy and with eyes open. The following three steps could help a hospital avoid a situation where it overlooked a factor with a negative effect post-close.

1. Set a strategy and stick with it. "To help ensure success in a transaction, the first thing to do is set clear goals as an organization, ideally before a deal is on the horizon," says Mr. Baker. "Once goals are defined, they can become a frame of reference for potential deals. For instance, how is [this deal] helping us to execute our strategy? A lot of time executives will look at a merger as separate from their strategy, but this is the first step toward failure."

According to Diana Hueter, senior knowledge leader with Greater Yield, a change management consulting company, and prior CEO of St. Vincent Health System in Little Rock, Ark., executives need to know how the transaction will help them reach their hospital's strategic vision.

"When I was CEO [of St. Vincent Health System] we were acquiring a 300-bed hospital and affiliated physician practices. In the course of doing that, I never lost sight of why we were going about it. The acquisitions filled a need in our strategic vision," says Ms. Hueter. "If CEOs ensure that they are merging or acquiring for the right reasons, the deal will produce more value. The goal will shed a light on where they are going and what they have to do to get there successfully."

2. Conduct robust due diligence to identify synergies. If a transaction fits your strategy, then robust due diligence must be performed in order to understand the synergies of a transaction —the true picture of what two hospitals working together would produce.

Synergies are tangible justifications for making an acquisition, such as whether a large pool of employees will enable the organizations to negotiate for more cost-efficient health benefits plans, eliminate duplicative roles to save on payroll expense or negotiate better pricing in services. Due diligence can reveal both negative and positive synergies; however, the costs of both are often underestimated.

"It comes down to what makes the most sense from a synergy standpoint for two organizations to merge together. Sometimes people look at the negative synergies of the transaction, and it mitigates the financial benefits of going through with the transaction," says Mr. Baker. "Maybe your hospital has worse payor contracts or you have a more expensive operating structure. One would hope that once you merged with another hospital, those negative synergies would be handled to become more positive," says Mr. Baker.

Usually if there are too many negative synergies, hospitals or health systems will dissolve the deal. The biggest transaction failures are actually those where executives do not incorporate the cost of capturing positive synergies. "A lot of effort can go into moving someone into your accounting platform or moving someone off a legacy IT system and onto your IT system. There could be a lot of people expense, software expense, terminating contracts, etc.," says Mr. Baker.

When hospitals assess the potential deal, looking diligently at synergies and the related costs, there will be more financial success. "Usually it comes down to whether the positive synergies outweigh the negative synergies," says Mr. Baker. "It is not so much the historical financial performance that determines the value of a hospital. It is what that company would be worth if owned by you."

3. Design an integration strategy. Once due diligence is completed, hospitals need to plan an integration strategy, which helps to capture the positive synergies identified in the due diligence phase early on in the integration process. According to Mr. Baker, this is a key driver for financial success. "[KPMG's] history with transactions tells us that [a hospital is] much better served by quickly working on the integration. Many times we work with our client to immediately begin integration planning once they are comfortable that a transaction will occur. This will help you start executing integration the day after closing," says Mr. Baker.

The ultimate goal with M&A is to accomplish strategic objectives as well as reach a financially stronger position post-transaction. According to Ms. Hueter, multiple integration details have to be addressed to reach that goal, such as culture, medical staff, support needs, board structure roles and responsibilities and change management.

Looking at a transaction holistically will position a hospital to come out of a deal in the best way possible. If a hospital's deal clearly lines up against its overall strategy, it finds a target to meet that strategy, pays the right price, conducts due diligence to understand the partner's business and potential synergies and has a detailed integration plan, it positions itself in the best way possible. Then, the path to financial success post-close is open and free for the taking.

More Articles on Hospital Transaction Strategies:

To Be or Not To Be Independent: 5 Considerations for Community Hospitals
3 Workforce Management Issues to Address During Transaction Discussions
5 Tips for Clinical Consolidation in Hospital Transactions

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