The BIG squeeze

CHS-HMA merger tight­ens the vise on in­de­pen­dent hos­pi­tals

Modern Healthcare - - COVER STORY - Beth Kutscher

Com­ing on the heels of the re­cent Tenet-Van­guard merger, last week’s pro­posed $3.9 bil­lion tie-up be­tween Com­mu­nity Health Sys­tems and Health Man­age­ment As­so­ciates demon­strates the rise of the hos­pi­tal mega-sys­tem as a re­sponse to de­clin­ing in­pa­tient vol­umes and pay­ment rates. It would cre­ate the largest hos­pi­tal chain in the coun­try by hos­pi­tal count.

The deals, if con­sum­mated, would re­duce the num­ber of large, pub­licly traded hos­pi­tal com­pa­nies from seven to five. They also come as not-for-profit sys­tems—such as Catholic Health East and Trin­ity Health, whose May deal cre­ates a sys­tem with $12.8 bil­lion in op­er­at­ing rev­enue—are sim­i­larly con­sol­i­dat- ing and rolling up in­de­pen­dent hos­pi­tals across the coun­try.

As the big get very big in the in­vestorowned and not-for-profit hos­pi­tal worlds, the stakes are be­ing raised across the coun­try for smaller, in­de­pen­dent, not-for-profit fa­cil­i­ties that in­creas­ingly are be­ing driven to­ward al­liances, for­mal and in­for­mal, to achieve the same pur­chas­ing and hir­ing power and economies of scale.

A re­port last month from Moody’s In­vestors Ser­vice—is­sued in re­sponse to Tenet Health­care Corp.’s ac­qui­si­tion of Van­guard Health Sys­tems— said block­buster tie-ups among for-profit providers put pres­sure on smaller, stand-alone fa­cil­i­ties. For in­stance, a large hos­pi­tal sys­tem is in a bet­ter po­si­tion to re­cruit physi­cians, giv­ing it more lever­age with pay­ers and of­fer­ing a di­ver­sity of ser­vices that draw pa­tients into its net­work. Smaller hos­pi­tals, par­tic­u­larly in ru­ral ar­eas and smaller cities such as those owned by Com­mu­nity and HMA, of­ten have a hard time re­cruit­ing top-notch physi­cian groups.

“We’re see­ing an in­creased aware­ness and even a sense of ur­gency from not-for-profit sys­tems to band to­gether to match the for­prof­its,” said David Cyganowski, man­ag­ing di­rec­tor at con­sult­ing firm Kauf­man Hall. “Th­ese two deals are lead­ing in­di­ca­tors that size and scale mat­ter.”

In an in­ter­view, Com­mu­nity Chair­man, Pres­i­dent and CEO Wayne Smith said the pro­posed deal al­lows his Franklin, Tenn.based sys­tem to de­velop its physi­cian and out­pa­tient-care net­works, adding not only 71 hos­pi­tals, but 472 clin­ics and 1,000 physi­cian of­fices. Build­ing those net­works in­creases the en­try points through which pa­tients ac­cess the sys­tem—a key ben­e­fit at a time of fall­ing pa­tient vol­umes, par­tic­u­larly on the in­pa­tient side.

Com­mu­nity and HMA op­er­ate pri­mar­ily in nonur­ban ar­eas, and both sys­tems have re­ported de­clin­ing ad­mis­sions num­bers in their past two quar­terly earn­ings re­ports.

“The vol­umes are a lit­tle more crit­i­cal in nonur­ban hos­pi­tals than ur­ban hos­pi­tals,” Smith said. Over the short term, the deal would al­low Com­mu­nity to di­ver­sify and find syn­er­gies where it can cut ex­penses. “As 2014 gets here and we start en­rolling peo­ple (in health in­sur­ance ex­changes), then the rev­enue will start to grow,” he pre­dicted.

The deal will give Com­mu­nity at least 10 hos­pi­tals in eight of its 29 states, Smith said, adding that it also al­lows the sys­tem to pur­sue ad­di­tional con­tracts with pay­ers.

Com­mu­nity and Tenet have both high­lighted the op­por­tu­ni­ties to cut costs and achieve op­er­a­tional ef­fi­cien­cies through the merg­ers. The deals also al­low the sys­tems to in­crease their clout in states where they al­ready have strength.

Com­mu­nity’s pro­posed deal with HMA

would bring to­gether 206 hos­pi­tals in 29 states, ac­cord­ing to the com­pa­nies. Com­mu­nity would ac­quire all of HMA’s out­stand­ing shares with a mix of cash and stock. In­clud­ing the as­sump­tion of HMA’s debt, the com­pa­nies val­ued the deal at $7.6 bil­lion.

Tenet last week re­ceived an­titrust ap­proval for its $1.8 bil­lion ac­qui­si­tion of Van­guard, which Tenet says will cre­ate a sys­tem with 77 hos­pi­tals in 30 mar­kets, with a largely ur­ban fo­cus.

One no­table dif­fer­ence be­tween the Tenet and Com­mu­nity deals is the fo­cus on new pay­ment and de­liv­ery mod­els. While Tenet em­pha­sized the value of Van­guard’s ex­per­i­ments with th­ese new mod­els, in­clud­ing ac­count­able care or­ga­ni­za­tions, Smith said Com­mu­nity re­mains skep­ti­cal about ACOs. Nev­er­the­less, he said his com­pany is pre­par­ing for “what­ever comes in the next five years,” in­clud­ing pop­u­la­tion health man­age­ment and the in­creas­ing strate­gic im­por­tance of out­pa­tient care.

There are some con­cerns about over­lap in the mar­kets where Com­mu­nity and HMA both have hos­pi­tals. Even if they don’t reach the level of giv­ing the new merged com­pany mar­ket power that would prompt ac­tion by an­titrust reg­u­la­tors, the added mar­ket power may put pres­sure on stand-alone hos­pi­tals in those states.

Com­mu­nity has a hos­pi­tal pres­ence in each of the 15 states where HMA hos­pi­tals op­er­ate. In at least three states—Alabama, Florida and Ok­la­homa—the sys­tems own hos­pi­tals within 20 miles of each other.

Smith ac­knowl­edged that the sys­tems share some ter­ri­tory and that Com­mu­nity would agree to di­vesti­tures if nec­es­sary. “We’ll have to work our way through that,” he said. “It won’t be any­thing that would de­rail the deal.”

Ge­orge Paul, a health­care an­titrust at­tor­ney at White & Case, agreed. He said he doesn’t ex­pect reg­u­la­tors to find sub­stan­tial over­laps on the “highly lo­cal­ized” level on which reg­u­la­tors are likely to eval­u­ate the deal.

Van Con­way, CEO of Con­way MacKen­zie, a re­struc­tur­ing and fi­nan­cial ad­vi­sory firm, said the costs of op­er­at­ing a free-stand­ing, full-ser­vice hos­pi­tal are un­sus­tain­able in the long-term, es­pe­cially as re­im­burse­ments are cut and pa­tients travel to larger fa­cil­i­ties for higher-acu­ity con­di­tions. He said they are fac­ing pow­er­ful pres­sures to sell or face clo­sure. “The big guys want to buy them for the re­fer­ral busi­ness,” he said.

Martin Gaynor, a pro­fes­sor of economics and health pol­icy at Carnegie Mel­lon Univer­sity, cau­tioned that there is strong ev­i­dence that hos­pi­tal con­sol­i­da­tion raises prices, par­tic­u­larly when the num­ber of com­peti­tors is re­duced in a given mar­ket. In one study in the Bay Area of Cal­i­for­nia, that price in­crease was as much as 20% to 40%.

Yet even when the num­ber of com­peti­tors doesn’t change, there’s ev­i­dence that hav­ing a mul­ti­state sys­tem in a mar­ket puts the stand­alone at a com­pet­i­tive dis­ad­van­tage, and may even raise prices.

Large chains have the ad­van­tage of be­ing able to lever­age their scale in ne­go­ti­a­tions with pay­ers, said Wil­liam Vogt, as­so­ciate pro­fes­sor of economics at the Univer­sity of Ge­or­gia’s Terry Col­lege of Busi­ness. “You’re a less valu­able con­tract­ing part­ner if you only bring one hos­pi­tal to the ta­ble,” he said.

Suzanne Del­banco, ex­ec­u­tive di­rec­tor of Cat­a­lyst for Pay­ment Re­form, sim­i­larly noted that mul­ti­state chains of­ten try to es­tab­lish a sin­gle rate across the sys­tem that may be “way higher than (lo­cal) com­pet­i­tive pay­ment rates.”

“They try to put into place an all-or-noth­ing ap­proach,” she said.

How­ever, Gaynor said the for-profit con­sol­i­da­tion is rip­pling over to the not-for-profit space. “Firms feel in essence that they’re en­gaged in a game of mu­si­cal chairs,” he said. “No one wants to be left stand­ing when the mu­sic stops.”

Yet many stand-alone hos­pi­tals re­main “fiercely in­de­pen­dent” and are find­ing other ways to com­pete with mega-sys­tems, Cyganowski said. They are do­ing so through looser al­liances such as Stra­tus Health­care, which brought to­gether 23 hos­pi­tals in Ge­or­gia, and the BJC Col­lab­o­ra­tive, a four-hos­pi­tal part­ner­ship in Mis­souri and Illi­nois. No­vant Health, a 12-hos­pi­tal sys­tem in Win­stonSalem, N.C., has made a busi­ness out of nonown­er­ship deals through its shared sav­ings di­vi­sion.

Still, those al­liances are barred from ne­go­ti­at­ing jointly with pay­ers with­out a le­gal change in own­er­ship.

Con­necti­cut, once a state with three large health sys­tems and a mul­ti­tude of in­de­pen­dent hos­pi­tals, has seen for-profit sys­tems buy up stand-alone fa­cil­i­ties, with Van­guard lead­ing the way.

Vin­cent Capece, pres­i­dent and CEO of Mid­dle­sex Hos­pi­tal in Mid­dle­town, Conn., has watched the for-profit in­ter­est heat up in the state. He ac­knowl­edged that large sys­tems can take ad­van­tage of economies of scale and raise money more cheaply from the bond mar­ket. How­ever, he said merg­ers can also cre­ate “dis-economies of

scale”— more lay­ers of man­age­ment, more time to make de­ci­sions and is­sues with meld­ing cul­tures.

“The big­gest strate­gic threat is re­duced govern­ment re­im­burse­ment, which we all rely on,” he said. “One of the fun­da­men­tal fac­tors that will drive per­for­mance is get­ting your op­er­at­ing costs in line with your rev­enue stream.”

The 211-bed Mid­dle­sex Hos­pi­tal un­der­took an eval­u­a­tion sev­eral years ago and de­cided against link­ing up with a larger part­ner, and it’s stick­ing with that de­ci­sion for now.

“I don’t know how much longer that will be vi­able,” Capece said. “I per­son­ally be­lieve that health­care is still a lo­cal busi­ness. I still be­lieve there are still mar­kets where in­di­vid­ual hos­pi­tals will sur­vive.”

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