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Hospital Consolidation Driven by Uncertainty in Washington, Private Equity Interest

Over the past few years, merger and acquisition activity in the healthcare industry has been increasing. Due to healthcare reform and an emphasis on higher coordination of care, the trend of consolidation and integration among hospitals is expected to continue.

Typically, the following drivers have attributed to increasing consolidation in healthcare: lower payment rates, higher costs associated with care as well as technology and facility upgrades, changes to payment and reimbursement structures, physician recruitment issues, access to capital and efficiencies of scale.

Very few healthcare professionals would argue that these elements are not drivers for M&A activity. Paul Keckley, PhD, executive director for Deloitte's Center for Health Solutions, is not discounting these factors as influential. However, he believes that legislative developments in Washington, D.C. and interest from private equity are two additional drivers of current M&A action in healthcare.

1. Lack of clarity in Washington, D.C. The lack of clarity in Washington, D.C., concerning future budgets, taxes and other financial issues has been an influential catalyst for the influx in healthcare M&A deals.

"The lack of clarity coming out of Washington, D.C., is causing health providers to take action around mergers, versus playing a waiting game," says Dr. Keckley. "The uncertainty with the budget for fiscal year 2015 is making folks light on their feet. You do not really know how — coming out of a lame duck situation — the money flow in healthcare will be. It's not so much the Affordable Care Act as it is the question of the Bush tax cuts, the sequester, the payroll tax and upcoming fiscal year budgets," he adds.

As a result of the uncertainty, larger and financially stronger hospitals have been moving forward with transactions. For them, smaller hospitals with less access to capital are an attractive partner for combination. According to Dr. Keckley, the question is not whether a hospital should consider mergers or acquisitions, but what the goal should be. Should the hospital look to expand its market footprint or generate more diverse combinations of scale?

"I think that the institutions taking a wait-and-see approach are going to be sitting at the starting line wishing they had gotten started sooner," says Dr. Keckley. "You'll see an avalanche of deals that are going to be announced soon after we get clarity. At that point, hospitals [will just be] plugging in numbers to complete deals," he adds.

2. Private equity firm participation. According to Dr. Keckley, private equity firms are better equipped to build projection models and scenarios showcasing outcomes from future legislative decisions. In addition, they have access to capital that the healthcare industry needs. For these reasons, they have been progressively more active in healthcare space, contributing to the influx of deals.

"The acute environment is capital intense. Hospital margins are shrinking. They face eroding payor mixes and higher cost structures. This combination means you need a bigger footprint to survive," says Dr. Keckley. "Private equity has always been the first to fund and manage multiple hospital systems. Since hospitals have the appetite for capital, private equity firms have been jumping in," he adds.

While the typical drivers are still at play in the healthcare transaction market, Dr. Keckley points out that legislative inaction and private equity involvement have been two strong influencers. Furthermore, as policy is mapped out in Washington, D.C., it will have an effect on healthcare consolidation in general and the moves that private equity firms take.

More Articles on Hospital Transactions & Valuation Issues:

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The Income Approach: Valuing Real Estate Versus Valuing a Business

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