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Required Capital Ratio Part 3: Why the Arizona Hospital Market Won't See Much Merger Activity

To read Part 1 about required capital ratio, what it is and how it is affecting the Chicago hospital market, click here.

To read Part 2 about RCR in the Boston-area market, click here.


The hospital consolidation market is kind of like a symphony. It has its high points and low points, crescendos and decrescendos. The Arizona hospital and health system market could be considered like a stringed interlude — it may not have the most musical action, but it is a powerful mainstay of any performance.

Adam Lynch, vice president of Principle Valuation, has a "required capital ratio" theory of the hospital consolidation market and how they are tied to balance sheets — the stronger a hospital's balance sheet and the less it will cost for a hospital to maintain its current operations, the more likely that hospital can stay independent or "strategically" partner with others. Conversely, the weaker a hospital's balance sheet and the more it will cost for a hospital to update buildings and equipment, the greater the likelihood that hospital will merge with another hospital or health system.

When conducting market analyses, Mr. Lynch looks at the balance sheets and tax-exempt bonds of hospitals in a designated market. Recently, he analyzed hospitals within Arizona and created two subgroups: the Phoenix market and the rest of the Arizona market. Previously, he discovered there was a frenzy of hospital merger activity in Chicago and Boston because many hospitals in those metro areas do not have the balance sheet capacity to keep their facilities updated. Au contraire in Arizona, he says.

"I was surprised by the strength of both the Phoenix and, overall, Arizona [hospital] markets based on what we've seen in Boston and Chicago," Mr. Lynch says.

Out of the seven hospitals and health systems in the Phoenix market, six have RCRs that fall in Tier 1 or Tier 2. Tier 1 hospitals are the strongest hospitals with RCRs of more than 125 percent, and this means they are motivated buyers or have the ability to stay independent (parity is around 100 percent). Tier 2 hospitals have RCRs ranging from 70 percent to 125 percent and have sufficient balance sheet capacity to replace their buildings and equipment. Those six Phoenix-area hospitals and health systems were Phoenix Children's Hospital (RCR of 221 percent), John C. Lincoln Health Network (RCR of 134 percent), Banner Health (RCR of 114 percent), Sun Health (RCR of 96 percent), Dignity Health (RCR of 77 percent) and Mayo Health System (RCR of 71 percent).

Major Phoenix-based hospitals have strong balance sheets.

Out of the eight primary hospitals and health systems outside of Phoenix, six have RCRs that fall in Tier 1 or Tier 2. The strongest hospitals outside the Phoenix region are Kingman Regional Medical Center (RCR of 235 percent), Northern Arizona Healthcare in Flagstaff (RCR of 137 percent), Yuma Regional Medical Center (RCR of 125 percent) and Yavapai Regional Medical Center in Prescott (RCR of 102 percent).

Arizona hospitals outside of Phoenix also have strong balance sheets.

"There are not a lot of diversified providers, but there are strong providers," Mr. Lynch says. "That means there are less future capital needs and therefore less market activity."

Some of the financially healthiest healthcare providers in Arizona are medical centers and other standalone hospitals. The health systems in the state are mostly hovering around parity, and although hospitals strive for the strongest balance sheets possible, Mr. Lynch says the Arizona hospital systems are right where they want to be. "Some of the multistate health systems are lower than parity, but that's for a reason," Mr. Lynch says. "They want to be strategic buyers, and they don't need additional flexibility in their balance sheets. This is because they're using that flexibility in these different marketplaces."

Even though Mr. Lynch expects consolidation to be limited among non-profit hospitals and health systems in Arizona over the next five years, there are still some areas of potential amalgamation down the road. Mr. Lynch says there are 12 small non-profit community hospitals and critical access hospitals that did not have tax-exempt bonds and may still need a capital partner to keep their facilities up-to-date, which could give the Arizona healthcare merger and acquisition market a small pulse.

More Articles on Hospital Finance and Acquisitions:

5 Elements Private Equity Firms Consider for Potential Healthcare Transactions

What Does it Take to Be a Hospital CFO Today? 6 Thoughts From Lowell General Hospital CFO Susan Green

Moody's: Outlook for Non-Profit Healthcare Stays Negative for 2012

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