Record numbers, better credit in 2017 M&A dealmaking

It’s no longer just struggling independents or desperate health systems at death’s door looking to merge. More and more, even well-positioned systems see the benefits. Consulting firm Kaufman Hall & Associates, in compiling its annual report on hospital and health system deals for 2017, found that more of the systems being purchased, or the smaller ones in the deals, had credit scores of A- or above. Kaufman Hall counted 14 of those last year, up from nine in 2016.

Back in 2012, it was just one.

Anu Singh, a Kaufman Hall managing director, calls that “a really good sign.” It’s no longer just weakened organizations making deals to survive. Even strong, well-capitalized ones look to partnerships for a strategic boost.

“Organizations that very credibly could remain independent and have that option, are proactively saying, ‘We think partnerships can be a better route for our organization; we think we can do more for our community through a partnership than remaining independent,’ ” Singh said. “That statistic, to me, really stands out.”

All told, Kaufman Hall counted 115 mergers and acquisitions among hospitals and health systems last year, the highest since the firm start counting in 2000, and topping off four straight years in which there were more than 100 deals. Kaufman Hall counted 102 deals in 2016, 112 in 2015 and 102 in 2014. In the early 2000s, the firm would only see 40 to 50 deals per year.

Kaufman Hall also examined the revenue of the smaller organization in each of those deals and found that number doubled between 2016 and 2017: from $31.3 billion to $63.2 billion—despite there having been a similar number of deals.

The fact that well-performing, larger systems are being bought shows the shifting rationale for why deals take place, said Tim Greaney, a professor at the University of California Hastings College of the Law. They’re using “mini systems” to expand their reach.

“To the extent they’re picking up hospitals that have al-

ready achieved sufficient scale and sophistication to be pretty profitable and healthy, it sort of does speak to the idea that there is a push to systematization for its own right, to have real benefits accrued just to being a major system,” Greaney said.

Case in point: The rumored union between Ascension and Providence St. Joseph Health. Though officials have yet to publicly address the reports, the merger would create the country’s largest hospital provider, with 191 hospitals in 27 states and annual revenue of $44.8 billion.

The smaller of the two, Providence St. Joseph Health, is hardly an underdog. The Renton, Wash.-based system has 50 hospitals and is the country’s second-largest Catholic hospital chain behind Ascension.

Aside from watching for word on a possible deal between Ascension and Providence St. Joseph, industry experts expect the dealmaking to continue at a similar pace this year, especially as cash-strapped investor-owned chains like Community Health Systems and Tenet Healthcare Corp. slowly sell off hospitals.

Hospital leaders tend to look for a stable economy and regulatory environment in addition to ample private equity funding waiting to be deployed before they sign off on deals. Dale Stafford, the leader of Bain & Co.’s mergers and acquisitions practice and a senior partner in the firm’s healthcare practice, said he thinks 2018 will deliver on all those fronts.

“I think we’re in a really good position to have a robust deal year in 2018,” he said.

Strategy reigned in 2017

The overarching theme of 2017’s deals was strategy, Singh said. Whether it was gaining geographic diversity or trying to capitalize on the complementary traits of the partnering organizations, last year’s deals were driven by health system executives’ desires to keep up with transformation in the healthcare industry.

An example of the former is Advocate Health Care’s decision to acquire Aurora Health Care, Wisconsin’s largest healthcare provider. If approved, the deal will expand Downers Grove, Ill.-based Advocate’s presence beyond northern Illinois into eastern Wisconsin almost as far north as Green Bay.

“To me, that is a pretty strong validation of the fact that, as outfits grow, they will think about wider basis of geography, they will think about geographic diversity,” Singh said.

The new deal came after a judge rejected Advocate’s proposed merger with NorthShore University Health System, a move that the Federal Trade Commission argued would have resulted in a 60% market share in Chicago’s North Shore suburbs.

That spread the message that it’s becoming riskier to undertake horizontal mergers, Greaney said. In Advocate’s case, jumping over the border into Wisconsin put it at lower risk of being challenged. There’s less case law for challenging vertical mergers, and President Donald Trump has indicated his administration won’t be as aggressive from a regulatory standpoint.

Carolinas HealthCare System’s pending joint venture with UNC Health Care delivers both geographic diversity

and complementary strengths. The former is the state’s largest hospital system, with 47 hospitals, while the latter is an academic health system with research arms and a National Cancer Institute-designated comprehensive cancer center. Carolinas CEO Gene Woods has said the two don’t have much geographic overlap.

The two systems’ CEOs say their partnership will improve access for patients in rural and underserved parts of North Carolina. About 70% of the state’s population would be within 20 miles of a facility operated by the combined organizations.

The Carolinas-UNC deal was also about gaining leverage with local insurers in those communities, Bain’s Stafford said.

Singh said 2017’s deals also showed that systems are increasingly relying on partnerships with counterparts that already hold stakes in certain markets rather than competing for limited volumes within those markets. In that way, they’ve learned to collaborate, align interests and even provide community benefit, he said.

“I think that’s what we’re seeing more often than not with those larger transactions,” he said, “and that’s a pretty big departure.”

Regrets, they’ve had a few

For his part, Michael Dorn, U.S. Bank’s senior vice president and head of its not-for-profit healthcare division, thinks 2017’s deals still had some of the more common goals in mind: boosting soft revenue and operating margins. Scale is still an important way to gain leverage with payers and create efficiencies that lower costs.

That said, Dorn cautioned bigger isn’t always better. “There’s a real danger that once the snowball starts to run down the hill, everyone looks to partner up,” he said. “Those strategic mergers that occur just to get bigger, those are the ones you generally have to watch out for, the ones where perhaps there might be some buyer’s remorse.”

More important than simply being bigger is being the No. 1 player in a specific market, said Bob Joyce, U.S. Bank’s senior vice president and head of its healthcare and food industry divisions. He’s noticed that not-for-profit systems tend to be better at this than for-profits, which historically have been more focused on gaining national presence.

At the J.P. Morgan Healthcare Conference in San Francisco this month, Wayne Smith, CEO of for-profit Community Health Systems, admitted to investors that he regretted his system’s 2014 purchase of Health Management Associates. CHS struggled to integrate the more than 70 struggling hospitals it acquired through the deal.

“HMA may have been big, but did they have the regional dominance in the market they were in? Were they the No. 1 player?” Joyce said.

Last year also showed the constraints horizontal mergers face. Judges blocked proposed mega-mergers between Aetna and Humana and Anthem and Cigna.

“It was quite a remarkable effort: The Justice Department had to scurry up every lawyer in the building, practically, to try two cases at the same time,” Greaney said.

Aetna has since announced its intent to merge with pharmacy chain and immediate-care operator CVS Health in a new format that will encourage patients to get care in retail clinics rather than hospitals.

Failed mergers such as Aetna’s and Humana’s put CEOs on alert and forced them to think about whether the Justice Department and Federal Trade Commission will approve their deals before they enter negotiations, Stafford said.

“To have a deal break down is costly for everybody,” he said.

Scale is still important considering the enormous pressure hospitals are under to drive down costs, said Lyndean Brick, CEO of healthcare consulting firm Advis Group. The way Brick sees it, cost reduction can only happen through experimentation with novel ways of delivering care. But experimentation is risky, and organizations must be large enough to absorb a potential financial hit, she said.

“A single mom-and-pop nursing home can’t do an experiment,” Brick said. “Their margins are razor thin.”

A 50-facility skilled-nursing or post-acute chain, by contrast, could run three or four experiments at the same time to see what works.

“The only way we’re going to sustain healthcare in this country is that level of experimentation,” Brick said.