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Do Reported M&A Terms for Hospital Deals Tell the Whole Story?

A simple formula exists for hospitals and health systems that undergo an affiliation, merger, sale or some other type of transaction.

Evaluate all options, choose a path, conduct due diligence and communicate the results. That last part, communicating the results, is not as cut-and-dried as one may think, though.

News releases from hospitals and health systems often provide the public with basic information: What type of transaction is occurring? Which parties are involved? What are the overarching goals? When will a deal be finalized?

However, the financial nitty-gritty of transactions often remains behind the curtain of the legal documents.

Here, VMG Health Founder and Senior Partner Greg Koonsman explains the basic elements of a hospital transaction and what considerations must be made when communicating the details of a deal. (Editor's note: Interview has been edited for length and clarity.)

Question: What are some of the foundational terms and elements of an affiliation, merger, or other transaction between hospitals and health systems?

Greg Koonsman: The underlying basis for the economic terms of a hospital transaction begins with the fundamental pricing of the hospital business enterprise. The fundamental value is developed by buyers and sellers based upon valuation methodologies, such as the discounted cash flow analysis and the market approach to value (market multiples). In our experience in valuing hundreds of hospitals and health systems, there are a series of additional considerations in developing the terms associated with the transaction.

Those additional elements include consideration for excess property, such as medical office building, land and other real estate assets. Additional add-backs to the fundamental value include the consideration of excess cash and marketable securities and equity ownership in businesses that are not consolidated on the income statement of the hospital.

Liabilities assumed are also important to consider (deduction from fundamental enterprise value), such as long-term debt, unfunded pension liabilities and any other long-term liabilities.

Q: What information can/do organizations release to the public? What can be gleaned from the information that often is provided?

GK: There is not a lot of motivation for the buyers to disclose transaction terms to the public unless required by authorities like the attorney general of the state in which the transaction occurs. At minimum, we find that publicly disclosed hospital transaction consideration can be very misleading. Without a complete disclosure of the terms of the transaction, the consideration can be easily misunderstood. There's an assumption of excess assets (cash, securities, real estate, working capital) and liabilities (debt, unfunded pension liabilities and any other long-term liabilities).

The key financial terms of a transaction can only clearly be understood by reading the details of the purchase documents related to the transaction. We often see "hidden consideration" in transactions, such as capital spending commitments made by the buyer that are over and above the replacement capital cost of a facility. In many cases, we see the buyer committing to a significant amount of capital expenditures related to deferred capital spending, building replacement and projects that are over and above maintaining operations at the hospital.

Q: With all those elements in mind, are reported M&A terms in hospital and health system deals accurate? Do they tell the whole financial story?

GK: Terms reported in most publicly available data or transaction reporting is incomplete. There is a great deal of additional research that must be done to develop transaction pricing multiples. In many cases, people tend to use incomplete information to develop pricing multiples of net revenue and EBITDA.

Our experience in doing transaction-related valuation in hundreds of hospital deals had led us to conclude that there are very few instances in which data reported to the public are complete enough to develop pricing metrics.

Q: What are the primary reasons hospitals and health systems can't divulge all terms of a transaction? Especially for nonprofit organizations, isn't there a call for more transparency?

GK: There is no benefit for the buyer and seller to disclose detailed transaction terms. The only requirement for disclosure for private not-for-profit hospitals would come from governmental authorities such as the AG. Public entities, such as county hospital, would require public disclosure because they are community assets. Complete transparency of hospital transaction data is not very practical and certainly not typical. Therefore, the use of incomplete information must be considered by the users of that information.  

Q: What are some best practices for hospitals and health systems undergoing or considering transactions? How should they disseminate information of their deals responsibly?

GK: Our experience, in having valuated more than 200 hospitals and health systems in the last three years, is that there is a tremendous amount of information within the purchase agreements for those transactions. The assumption or exclusion of certain excess assets, liabilities, commitments of capital by buyer matter greatly to the economics of a transaction.

The opportunity to develop rules of thumb in this market is very difficult, and hospitals should be careful about using incomplete or misleading transaction data. Additionally, we find that the facts, circumstances and market fundamentals that can greatly impact hospital transaction economics are typically very different market to market and individual hospital to hospital.

It is important to understand key drivers to hospital value and utilize the information to capture the true economic value of any transaction being considered by both buyers and sellers. Application of rules and thumb and general valuation multiples can result in misleading and inaccurate conclusions about value.

More Articles on Hospital Transactions:
Bankruptcy Court Approves Sale of Saint Francis Hospital to Westchester
Wellmont Signs Kaufman Hall as Transaction Adviser
Orlando Health Searches for Partner

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