Industry Insights

Hospital Merger, Acquisition & Affiliation Objectives

At a high level, the fundamentals driving hospital consolidation are basic to many industries and include:

• The need to spread fixed technology and administration costs over a larger revenue base
• The need to strengthen market penetration
• Access to capital
• Attempts to add key service lines

However, in addition to these drivers, government actions have created significant uncertainty in the health care industry, forcing hospitals to be compensated more on value and less on volume. These factors are driving hospitals toward an unprecedented volume of mergers, acquisitions and affiliations. Some of these transactions involve whole hospital mergers, while many others involve hospital systems acquiring physician practices or other service lines to strengthen market position.

Overall, hospitals are in a long-term period of financial strain and operational upheaval. To manage these challenges and thrive in the long term, integration and scale are often viewed as critical success factors.

Facing these fundamental challenges, many organizations are pursuing strategic mergers and acquisitions. As an example, North Shore-LIJ Health Systems identified a weakness in its market penetration in the Manhattan market. It targeted Lenox Hill Hospital in Manhattan as a good strategic fit and proposed a merger in 2010. The transaction gave North Shore-LIJ Health Systems a foothold in the coveted Manhattan market while providing Lenox Hill with needed capital and scale.

To deliver a broader continuum of services without a merger or acquisition, health systems increasingly are seeking affiliations or joint ventures. Affiliation arrangements can bring together similar organizations to gain scale in specific areas or share differing strengths. Done correctly, affiliations of all types can create win-win scenarios for both parties.

For example, General Hospital in Elkhart, Indiana, and Memorial Hospital in South Bend, Indiana, are affiliating to gain scale. Under the announced agreement, the systems would affiliate under a joint board of directors with the reported goals of purchasing a shared electronic health records system and making joint bulk medical equipment purchases.

Meanwhile, the affiliation of Bayhealth, Inc. and the University of Pennsylvania Medical Center is an example of organizations affiliating to share differing strengths. Bayhealth was looking to form a clinical partnership with a much larger health system around cancer, cardiology and other highly complicated service lines. The University of Pennsylvania Medical Center agreed to the affiliation and now provides surgeon recruiting assistance, education opportunities and consulting in return for patient referrals from Bayhealth.

While growth strategies may differ, hospitals will continue to seek the scale necessary to survive and thrive in the new value-based reimbursement environment. Mergers, acquisitions and affiliations will continue to be important considerations for hospitals as they determine a long-term strategy to serve their patients, communities and employees.

Hospital Consolidation Attracts Private Equity Groups

Private Equity Groups (PEGs) are taking advantage of operational and financial uncertainty in the health care industry to make significant investments in hospitals and health systems. Over the long term, PEGs expect government support of the health care system to stabilize and create further opportunities for industry consolidation and investment monetization.

Within the past year, Cerberus Capital Management has purchased six hospitals formally owned by the Archdiocese of Boston for $895 million, and Cerberus’ Steward Health Care System has acquired four additional Massachusetts hospitals while making multiple offers on other troubled health systems from Florida to Rhode Island. Blackstone, Oak Hill Capital Partners, The Heritage Group, Madison Dearborn Capital Partners, Cornerstone Equity Investors, GTCR and Leonard Green & Partners have been among the most active and high-profile PEGs in the health care industry.

Publicly Traded Hospital Systems – Historical Performance

The following is a summary of the historical stock performance for five of the largest publicly traded U.S. hospital systems. The graph aggregates these public companies into an index based on market capitalizations and compares them to the S&P 500. Since a low point in 2008, these hospitals have shown a dramatic increase during the last few years. Despite this increase, the S&P has consistently outperformed this index.

Publicly Traded Hospital System Index Versus S&P 500 Performance

Source:  Capital IQ

Historical Transaction Activity & Recent Transactions

Within the health care services industry, hospitals accounted for 17 percent of overall transaction activity in 2010 and $17.7 billion in transaction value. The level of hospital mergers and acquisitions activity has continued to increase in 2011. For the six-month period ending June 30, 2011, hospital transaction activity accounted for 20.9 percent of total health care services transaction activity. In light of recent health care reform legislation, most experts expect this trend to continue.

The following is a summary of transaction activity within the health care services industry over the past five years, including results through June 2011.

Source:  Irving Levin Associates

Source:  Irving Levin Associates

Recent Select Hospital Transactions

The following is a summary of select hospital transitions in the second quarter of 2011, according to Irving Levin Associates.

Source:  Irving Levin Associates

For more on the health care mergers and acquisitions market, contact your BKD Corporate Finance advisor or email Steve Blumreich at sblumreich@bkd.com.