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Hospital M&A activity update: Robust deal flow continues in 2017

At the outset of 2017, we predicted that the outlook for healthcare M&A activity would remain strong in the upcoming year.

With well over half the year behind us, it is clear that deal flow in this sector continues to be as robust as ever. PWC reported that the broader US health services industry executed over 200 deals in Q2 2017 for the eleventh quarter in a row, with the Hospitals subsector experiencing positive volume growth on both a quarterly and yearly basis. According to a recent report by Kaufman, Hall & Associates, LLC, hospital and health system-specific M&A deals increased 15% in Q2 2017 (with 58 announced transactions) over Q2 2016 (with 52 announced transactions). In addition, six “megadeal” hospital deals with organizations exceeding $1 billion in revenues were announced in the first half of 2017 compared to only four megadeals in all of 2016.

While hospitals and health systems cite a wide variety of reasons for entering the M&A market, a few key themes driving recent consolidations and acquisitions have emerged. These forces include strategic plays to right-size a portfolio to manage debt or to grow in a particular market or region, leveraging scale to lower costs, and doing deals to access better facilities, capital and management and other resources. While some hospitals, such as Marin General Hospital in the Bay Area, have publicly stated their preference for partnering with potential competitors rather than consolidating, it appears that many other hospitals and health systems are realizing important benefits by engaging in M&A transactions.

Dispositions of health care assets to reduce the debt load of publicly traded hospital operating companies have driven several high-profile transactions that were publicly announced or planned this year. Franklin, TN-based Community Health Systems (CHS) outlined its strategy to sell 30 hospitals in order to generate $1.5 billion in proceeds and reduce its debt load, currently at about $15 billion. As of CHS’ 10-Q filing for Q2 2017, 20 of these dispositions had been completed. Similarly, Dallas, TX-based Tenet Healthcare has announced plans to divest 17 hospitals or facilities (8 in the US and 9 in the UK), which is expected to yield between $900 million and $1 billion in proceeds to help eliminate approximately $680 million of debt.

Strategic plays to achieve growth in a particular market or geographic region are also driving deal activity in this sector. St. Louis, MO-based SSM Health (SSM), a Catholic health system, recently signed a letter of intent to purchase the sponsorship interests of Agnesian HealthCare and Monroe Clinic facilities, both in Wisconsin, as part of SSM’s strategy to pursue mission-driven organizations in the Midwest and add to its Midwestern hubs in St. Louis, MO, Madison, WI and Oklahoma City, OK. In July, Lahey Health and Beth Israel Deaconess Medical Center signed a definitive agreement that will create the second-largest health system in Massachusetts. In August, Carolinas HealthCare System and UNC Health Care System signed a letter of intent to merge their operations in North Carolina, a deal that is expected to be submitted for review by the Federal Trade Commission. Consolidations of healthcare providers in certain markets may impact competition, so careful evaluation of the antitrust implications of such deals is essential in order to ensure they pass regulatory muster.

In order to weather the uncertainty of the changes in the Affordable Care Act and the healthcare economic sector, standalone hospitals continue joining larger systems to gain economies of scale, increase negotiating leverage with payors and vendors, and grow market share and visibility. Union Hospital in Dover, OH has announced plans to join Cleveland Clinic after a year of cost-cutting measures, citing the “opportunity to add physicians, grow services and become fiscally stronger.” In the Chicago area, Amita Health President and CEO Mark Frey described the recently-announced acquisition of Presence Health by Amita Health as providing an opportunity to “really lower the cost of care by getting efficiencies and redundancies out of both organizations.” In an increasingly competitive landscape that puts pressure on providers to keep costs down while maintaining quality, transactions that enable hospitals to cut down on expenses and fund growth can be critical to their survival.

Joining with another hospital or health system may provide access to new facilities where a hospital can perform additional services or provide existing services more effectively. Such arrangements can allow a provider to avoid the cost of replacing or upgrading existing facilities or building new facilities. UW Health in Madison, WI recently deepened its partnership with UnityPoint Health-Meriter via a joint operating agreement in part to share resources and facilities. In February 2017, prompted by Cleveland, OH-based University Hospitals’ opening of a new level-one trauma center, a Cleveland group consisting of MetroHealth, Cleveland Clinic and Southwest General brought University Hospitals into its regional trauma network to take advantage of the University Hospitals’ new facilities. Availability of additional facilities also offers hospitals opportunities to re-align services and programs among their facilities in order to provide health services in lower cost settings and achieve improved access and coordination of care to patients.

Certain hospitals may project a financial deterioration as a standalone entity, so being embraced by a system with access to matrix management for managing cross-functional, cross-business group employees, centralized system infrastructure or a notable brand is attractive because these systems can provide needed capital and help turn around operations to restore financial health. Larger systems often commit to provide future capital commitments and debt support to the hospitals they acquire, particularly in deals structured as member substitution transactions where upfront cash consideration can be limited or nonexistent. For example, in June 2017, Cole Memorial signed a letter of intent to integrate into University of Pittsburgh Medical Center (UPMC) in exchange for certain commitments from UPMC, including support of Cole’s outstanding debts and ongoing investments in Cole of at least $27.5 million over the next seven years. More recently, Colorado’s UCHealth closed on its purchase of Yampa Valley Medical Center (YVMC) in Steamboat Springs, CO, a move that provides YVMC access to UCHealth’s system infrastructure and capital commitments totaling over $105 million for new services, facilities improvements and other resources and gives UCHealth an expanded service area served by YVMC.

Based on the substantial hospital M&A deal flow in 2017 thus far, it appears that initial uncertainty around amendments to the Affordable Care Act by Congress has not prevented providers from engaging in transactions necessary to execute on strategies aimed at ensuring the survival and long-term success of their health care operations. Indeed, it could be the looming impetuous of further change to the healthcare landscape that itself is driving hospitals to partner with other providers to deliver high quality services and more streamlined, cost-effective and efficient care.

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