Looking at Hospital M&A Activity in the Value-Based Care World

Nov. 11, 2016
According to the latest analysis by the Skokie, Ill.-based advisory company Kaufman, Hall and Associates, hospital and health system mergers and acquisitions in 2016 are on pace to match the large-scale level of M&A activity in 2015.

According to the latest analysis by the Skokie, Ill.-based advisory company Kaufman, Hall and Associates, hospital and health system mergers and acquisitions in 2016 are on pace to match the large-scale level of M&A activity in 2015.

Kaufman Hall identified 77 transactions announced in the first three quarters of 2016, compared with 78 transactions announced in the same period in 2015. Hospital and health system transactions have been on the rise in recent years as organizations have attempted to enhance market presence, achieve economies of scale, and attain capabilities for value-based healthcare.

“It is not surprising that hospital transactions are continuing at this volume,” Kit Kamholz, managing director, Kaufman Hall, said. “Payers and purchasers are intensifying their demands across multiple dimensions of value, and few organizations can rely solely on internal resources to meet those demands.”

According to Kaufman Hall’s analysis, two of the announced transactions involved organizations with more than $1 billion in revenue—a $1.25 billion real estate transaction with a minority investment in Steward Health Care System by Medical Properties Trust, Inc., and NYU Langone Medical Center’s proposed partnership with Winthrop-University Hospital.

Kaufman Hall’s analysis also found that Texas was the most active state with three announced transactions (New York, Wisconsin, Georgia, and New Jersey all had two transactions). Additionally, 10 of the transactions (40 percent) involved for-profit acquirers. In eight of the announced transactions, an academic health system was the acquiring organization; in six of those transactions, the organization to be acquired was a non-academic institution. And, eight additional transactions involved less than fully integrated partnerships: six management services agreements and two real estate transactions.

Recently, Healthcare Informatics Assistant Editor Heather Landi spoke with Kamholz to discuss the broader implications of hospital and health system consolidation. Below are excerpts from that interview.

What are some of the overall trends and factors that continue to drive hospital merger and acquisition activity?

We’ve seen a heightened level of M&A activity between hospitals and health systems over the last five or six years. And in the last two years, we anticipate topping over 100 transactions in each of those years. I think the current run rate has just over 100 transactions in 2016. There are a variety of factors that are leading that. I would break it into four categories of things that are driving the amount of M&A activity. The first I’ll start with is there are organizations that are experiencing some level of distress, whether that be financial distress, or clinical distress, or some other level of distress, and those tend to be smaller facilities and those facilities continue to seek out potential partners as a backstop for their level of distress, so that is one piece of the market. The second pieced of the market is strong community-based hospitals that are seeking a partner for two reasons—one is they are looking at the transition from fee-for-service to value-based healthcare and the requirements to be successful under a value-based environment and realizing that they just do not have the intellectual or financial capacity to ultimately get there and be successful in the marketplace. And, then we combine that the idea that the underlying cost structure of a hospital is becoming an incredibly important element in long-term success under the value-based environment, being the low-cost provider. And certain strong players have felt that they’ve done as much as they could on their own relative to their cost structure and they are looking at potential partnerships as a way to further reduce their cost structure, so those two categories I’d put into play that are relevant for strong organizations.

Kit Kamholz

And then the final category is we have a whole host of large, multi-hospital health systems that are rationalizing their portfolio of hospitals, so Community Health Systems, Quorum, the Catholic providers, where they are deciding which markets they can be successful in in the long-term and which ones they cannot be and divesting the ones that they cannot be. So that’s the final piece that is driving the overall amount of volume in M&A transactions.

Drilling down into the ongoing movement toward value-based care and value-based payment models, how do you see that specifically impacting the merger and acquisition activity?

As we think about the characteristics that are necessary for a healthcare organization to be successful in a value-based environment, we think that there is probably eight or nine things that are going to be critically important—clinical and physician alignment; quality and safety; care management capability; clinical and business intelligence; networked development configuration; financial strength; purchaser relationships; customer service and engagement; leadership and governance.

And those are the factors that organizations are going to have to transition to be successful in within a value-based environment. We see organizations looking at those factors and saying, ‘Okay, we’re a traditional organization today, and across each and every one of those factors, do we have the intellectual capacity and the financial capacity to ultimately transition each one of those factors to be highly functioning in a value based environment?’ And so as organizations look at this, they might currently accelerate in one or two of those, but most often with most community-based hospitals and health systems, they have some gaps in their capabilities, and it’s those gaps that they are trying to solve through partnership. So, let’s say they fall short in clinical and physician alignment, purchaser relationships and financial strength, so in those instances, they might look to an organization as a partner that has a long history of working collaboratively with physicians, one that is a AA-rated financial credit and perhaps one that either has a health plan or has an existing relationship with a third-party health plan. That’s the type of organization that could immediately bring those skills and capabilities to the community hospital and accelerate what otherwise might be a multi-year journey for that community health system to be able to get to those capabilities.

As you mentioned, hospitals and health systems are trying to obtain capabilities for value-based healthcare through these mergers and acquisitions. Do you see health IT, technology and data analytics capabilities as being a part of these capabilities that hospitals are trying to obtain?

Absolutely, if you were to say there’s a top 10 things that community health systems are looking for,  health IT is definitely in the top 10, and probably in the top five. Another trend that we see in the marketplace is the merger of two relatively large and relatively equal-sized organizations, and what we think about size there is that if both organizations are a billion dollars or greater in revenue, those would be these large partnerships in healthcare, and I think, for those organizations in particular, this clinical and business intelligence component, information technology component, the health IT component, is probably even a bigger piece of those deals than perhaps a community-hospital joining a larger health system. These partnerships will allow them to take the complimentary skills that each have developed, and combine them together, and get the best of both worlds. Perhaps one of the organizations is great in quality and safety and care management and the other one is exceptionally strong financially and has exceptional capabilities in physician and clinical alignment, so it allows them to take those complimentary capabilities and those functional areas and leverage that across the broader system, and will also allow them to ultimately lower cost not only for their systems, but for the patients overall.

Looking ahead, do you see this pace of M&A activity accelerating?

I’m sensing that there is a leveling off. The practical reality is that, whether there are 95 transactions in the year or 110, it’s about in that same range, so I think we’ve been in the stable environment for four or five years. I think it’s going to continue to be at those stabilized levels. And, to be fair, having 100 hospital transactions in a stabilized environment is still twice as many transactions that occurred on an annual basis from 2000 to 2010, so while it’s a stabilized environment, it’s a much higher level than we’ve seen historically. I do believe that we are seeing, and will continue to see, a further collision between hospital providers, physician providers and health plans. And to take it one step further, from physicians joining hospitals and health system, health systems also are trying to figure out how can they effectively get closer to their end customers, and examining can they develop insurance operations on their own, should they be partnering with insurers, or should they just be developing and continuing on with contractual relationships with those organizations? So I think there will be a further acceleration of the vertical integration, as opposed to horizontal integration, so the health system, managed care and physician provider-type of transactions.

The industry is completely in flux in terms of who will ultimately be the healthcare company of the future. Historically, for hospitals and health systems, the business model was very clear. They worked collaboratively with physicians, physicians referred patients to the hospital and the hospital look care of patients. It is unclear whether that relationship is going to continue into the future and whether there is going to be some other intermediary that’s going to come in here and really control that flow of patients so hospitals and health systems are trying to move closer and closer to having ultimate control over patient flow and that means getting closer to looking like an insurer. And insurers, to be honest, are trying to figure out what their place is in the world, should they also become physician providers and hospital providers, or can they effectively carve out an insurance niche and be successful in the long term in that niche. It’s very unclear who or what might ultimately come out on top in that fight to be controller of the dollar.

It’s also unclear whether what is currently considered an outsider might step in and take that role–is it somebody like a Google, or a Walmart, or Walgreens that has gotten active in the clinical space. Or is it a company like DaVita Healthcare Partners that is very active on the physician acquisition front. It’s unclear who ultimately is going to be that healthcare company of that future, and so in addition to the managed care physicians and health systems fighting it out, you’ve got third parties that are sticking their head in there and innovative providers trying to play that role as well.

The current disruptions that we’re seeing from third party providers is happening very quickly, it’s not evolving over five or 10 years, but it’s happening over the period of a couple of years. A really good example is Teladoc. I think three years ago, if you went to a large physician group or a large health system that has a strong physician network, and said, ‘You’re going to be handling 20 percent of your patient flow via the Internet in a video conference,’ they probably would have told you you’re crazy. Recently, Kaiser Permanente reported that it estimates by 2017 or 2018 they will have more virtual visits than actual visits, so the pace here is really accelerating.