Slipkovich's comments about acquisitions are echoed throughout the hospital industry, which is treating the current credit crunch as a yellow light as opposed to red. “A lot of for-profits that were on the sidelines are prospecting again, and choice acquisitions are on the market,” says Richard Wright, vice president of development for publicly traded Universal Health Services in King of Prussia, Pa.

The number of hospital mergers and acquisitions declined from 15 in the fourth quarter of 2007 to 10 in the first quarter of 2008, according to Levin Associates in Norwalk, Conn. However, the first-quarter tally is one more than in the corresponding quarter of 2007. To Sanford Steever, editor of Irving Levin's newsletter on healthcare mergers and acquisitions, the numbers demonstrate that the credit crunch, as well as the general economic doldrums, isn't hitting the hospital industry as hard as others.

“Healthcare isn't anti-cyclical, but it's pretty darn close to it,” says Steever. “There will be fewer deals, but there's still a fair amount of money out there for acquisitions.”

Further tightening of credit — which could happen if interest rates continue to rise — would change the picture. But this screw-down ultimately may strengthen the ability of hospital chains to expand, because if anybody suffers the most from tight credit, it's the stand-alone hospitals and small hospital systems that can't get enough capital to compete in today's brutal healthcare marketplace.

Digesting, divesting, and delevering

For some hospital chains, buying new facilities has taken second place to getting their current house in order.

Consider publicly traded Community Health Systems (CHS) in Brentwood, Tenn., which out-acquired everyone last year when it bought Triad Hospitals and its 50 facilities for $6.8 billion. Now, CHS is forgoing acquisitions for the most part so it can digest Triad, according to its first-quarter earnings report, although company CEO Wayne Smith told stock analysts in a conference call that “if someone is willing to offer us a great price for a particular facility, we would certainly consider that.” Case in point: CHS will complete the purchase of a struggling two-hospital system in Spokane, Wash., later this year.

Likewise, publicly traded Health Management Associates (HMA) in Naples, Fla., is in stabilization mode after earnings dropped 34 percent in 2007, and long-term debt nearly tripled. Its announced game plan is to invest available cash in its existing facilities and pay down debt. To raise cash, it sold a 27-percent stake in seven hospitals in March to non-profit Novant Health in Winston-Salem, N.C. But HMA anticipates returning to the hospital hunt. “We do expect to be growing again with selective acquisitions after 2008,” company CEO Burke Whitman told analysts.

Like HCA, Tenet is highly leveraged, but unlike HCA, it loses money year after year. While Tenet could obtain credit for acquisitions, “The market wouldn't like it,” says Robert Hawkins, an analyst who specializes in healthcare providers at brokerage and investment banking firm Stifel, Nicolaus and Co. in St. Louis, Mo. “Tenet needs to refine its core business and deliver,” he suggests.

Where are the white knights?

What tempts hospital chains to go shopping is the availability of facilities that, due to economic stress, need a buyer to survive.

On top of that, hospitals contend with flat reimbursements from insurers, the growing number of uninsured, and bad debt. Not surprisingly, the average total margin for roughly 450 hospitals studied by Thomson Reuters in New York declined from 8 percent in the second quarter of 2007 to below 3 percent in the first quarter of 2008.

Facing tighter credit and battered margins, many hospitals can't make needed investments in information technology, new equipment, and overall refurbishments, says Rick Gundling, vice president of education and thought leadership at the Healthcare Financial Management Association in Westchester, Ill. “There's a growing gap between the haves and the have-nots, and the have-nots lack the wherewithal to make changes,” says Gundling. So have-nots are turning to the haves for capital.

While hospital chains have always snatched up failing hospitals at fire sale prices, industry observers say the next wave of acquisitions could involve relatively solid facilities that see the handwriting on the wall. “Some might be saying, ‘We'll be in bad shape in five years, so we better sell now,’” says Steever.

Wright, from UHS, which made its last acquisition in January 2007, agrees. “I think there are a few of those out there — non-profits that peaked and want to get out while the going is still good.”

Figuring it out

Slipkovich recalls how lenders in the spring of 2007 offered to finance hospital acquisitions up to seven to eight times EBITDA — earnings before interest, taxes, depreciation, and amortization — of the target institution. By all accounts, the credit crunch has knocked down this ratio in many transactions to five to six times EBITDA. This range seems prudent to Slipkovich, who says he turned down highly leveraged deals in the past to play it safe. “If things get rough, you want to have some leeway,” he says. “Do the deal that's sustainable.”

Likewise, chains can no longer count on “covenant-lite” financing, loans that don't come with as many stipulations on issues like liquidity and debt. “The rating agencies have downgraded some of that debt,” says Slipkovich.

Which kind of hospital chain has a competitive edge when it comes to raising money for acquisitions? Gundling says publicly traded companies have a slight leg up on private for-profits and non-profits since only they can issue public stock.

However, that approach carries risk, notes Steever. “A public offering could dilute the stock's value for existing shareholders,” he says.

Everybody's ability to finance acquisitions will weaken if interest rates continue to trend up. “Capital will cost more, and buyers would be under pressure to lower their prices,” says Hawkins. “Sellers may balk.”

But will they balk? Higher interests rates hurt stand-alone hospitals more than anybody else, says Slipkovich. Unable to raise money for new equipment or a new tower, the argument goes, “they'll call companies like Capella Healthcare.”

And if a hospital chain is convinced that the deal makes sense, it will defy upward ticks in the interest rate.

“We'd certainly factor that in,” says Wright at UHS. “However, we've been a selective acquirer in good times and bad, and if the right opportunity surfaces, we'll figure out how to do it.”