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Size Matters: How Capella Healthcare Executes its Development Strategies

Tennessee is a hotbed of for-profit hospital companies, and Franklin, Tenn.-based Capella Healthcare has been trying to make its own imprint in the arena for more than seven years now.

Capella first launched in May 2005 when its founders partnered with GTCR, a Chicago-based private equity firm. GTCR bankrolled $200 million to get Capella started, and since then, Capella has grown to seven different states.

Capella's first hospitals actually came from the two largest for-profit hospital companies in Tennessee — and the country. Capella acquired four hospitals from Nashville-based Hospital Corporation of America and nine hospitals from Franklin-based Community Health Systems. Since then, Capella executives have continued to expand the company, but in a very meticulous manner.

Here, two executives who are part of Capella's transaction team — Andy Slusser, senior vice president of acquisitions and development, and Doug Johnson, vice president of acquisitions and development — share their thoughts on what makes Capella's acquisition strategies unique and what goes into making difficult transaction-based decisions.

Question: With 15 hospital campuses in seven different states, what makes your acquisition strategy unique among for-profit hospital operators? What are some of the main tenets to your organization's strategy that have made you successful?

Andy Slusser, senior vice president of acquisitions and development at Capella Healthcare.Andy Slusser: It boils down to a couple things. One is size. We are the right size to support hospitals in their community in that we have the financial capacity and stability for long-term success in hospitals. But we're also the right size to give the time, attention and resources to each hospital in our organization. Each hospital is critical, important and is not going to get lost in a system with maybe 50 to 80 hospitals. We think our size is an advantage, and we think it is beneficial to hospitals.

We also think our operating philosophy distinguishes us. We put a great deal of operating responsibility at the hospital level. [The individual hospital] and we jointly agree and discuss what the future strategy should be, but it's really up to the hospital to execute that strategy. And it's up to us at the corporation level to provide the capital and resources. But this is not top-down. We need to actively engage the community, medical staff and senior leadership to define what the strategy needs to be. Our decisions are made on what we're going to do to drive quality care at our organization and make sure that the care level is of the highest quality standard it can be — that's the way we're going to be reimbursed in the future.

Doug Johnson: What also makes us unique, and plays well with county commissioners, board members of hospitals, etc. — if you look at the senior management team of Capella, these are all [former] hospital operators. These are people who came up through the ranks, and their background isn't as a hospital attorney or a handful of guys who know how to make it work financially. These are people that know how to make a hospital successful.

AS: That's exactly right. Our CEO, CFO, myself — we've also all been hospital CEOs or CFOs, so we know what it's like to operate in a hospital. It's not a theoretical understanding.

Q: Capella reinvests 100 percent of net cash flow back into its family of hospitals to strengthen and expand services and facilities. Can you explain this strategy a little bit more in detail?

AS: We are a for-profit entity and a privately-held company. As we're out talking to hospitals, particularly non-profit hospitals, we find that some have jaded views we make all this money and take it back to investors. That's not the case. Every dollar we make goes back into our hospitals. The value to our investors comes from the net value of hospitals as our organization grows. We don't pay dividends to shareholders. Every dollar we generate goes back to our individual hospitals to grow.

Q: Earlier this year, the organization decided to close Hartselle (Ala.) Medical Center. What factored into that decision? What are some of the hardest decisions within a company's development strategy?

AS: The future of healthcare is most certainly about partnerships and being smarter about how care is delivered in each region. With that responsibility come decisions that are sometimes difficult.

Doug Johnson, vice president of acquisitions and development at Capella Healthcare.In the case of Hartselle Medical Center, there were three hospitals in that county, Morgan County, two that we owned. The community was over-bedded by approximately 300 beds, and all three hospitals struggled to be successful. We had worked for several years to form a joint venture with county-owned Decatur (Ala.) General Hospital to form a system and ultimately build a large replacement hospital for all three hospitals. Unfortunately, they wanted to remain independent.

After several years of pursuing that strategy and trying some different operating models for our two hospitals in Morgan County, we reluctantly agreed for Huntsville (Ala.) Hospital to acquire our Parkway Medical Center in Decatur and the real estate of Hartselle. It was a difficult decision, but we know it was the right one. They are in the process now of doing what we wanted to do: Consolidating all three hospitals and strengthening the overall healthcare for that market.

Alabama is a very challenging reimbursement market. It has some of the lowest Medicare and Medicaid reimbursements in the country. We did everything we could to give it the greatest chance of success and to streamline operations. We are very proud of Hartselle Medical Center and its employees. The hospital had some of the highest quality scores, but it ultimately was the right decision for the future of healthcare for that community to combine those hospitals.

DJ: We have been on both sides of consolidation initiatives. With healthcare reform and reimbursement changes, we are seeing lots of consolidation.

But for example, in Muskogee, Okla., it made sense for our two hospitals [Muskogee Regional Medical Center and Muskogee Community Hospital] to come together, and we were the consolidator.

Q: What are some of the most innovative things Capella is doing right now? Maybe you could explain more about the joint venture partnership with Saint Thomas Health in Nashville, Tenn.?

AS: From a development standpoint of working with hospitals, we have three structures: outright acquisition, long-term prepaid lease and joint venture. A joint venture is where we have shared ownership and shared governance. We have five joint ventures with medical staffs, and as you mentioned, we also have a joint venture with Saint Thomas for the operation of our four hospitals in the Cumberland region of Tennessee. This brings the best practices of both organizations — we're good at operating nonurban hospitals, and Saint Thomas is clearly a leader in tertiary care in the provider arena. In this affiliation, we have the ability to bring their clinical programs, the best programs, to small hospitals in Tennessee, and that really strengthens the operations of those hospitals. We think this is a great opportunity for these hospitals and the community.

Q: Do you have any guidance for other hospitals out there that may be struggling in the current environment of healthcare reform and massive consolidation?

AS: Healthcare is a difficult environment. There is a great deal of uncertainty. Hospitals should not feel like they are alone or unique in that feeling. It will be a challenging environment, especially for independent hospitals. Our company is positioned well to take on those healthcare changes that are coming.

DJ: The ones that are successful are the ones that have boards that look out ahead and try to anticipate what's on the horizon — and openly discuss it. We'll introduce ourselves to people who sometimes have their head in the sand. Then four years later, the hospital is in the ditch, and there's nothing you can do. Hospitals that have forward-thinking boards who are putting together strategies are the most fortunate ones.

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