Lesson 12 Discussion

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You are the leader of a community health system in a medium-sized town. You have been approached about consolidating with a regional healthcare powerhouse. This type of relationship could secure your health system for years to come.

What type of benefits would you be looking for in a consultation with a large regional healthcare organization?

Health System Consolidation_Navigating the New Wave of Mergers and Acquisitions Sg2 Intelligence Health System Consolidation Navigating the New Wave of Mergers and Acquisitions Sg2 Staff and Contributors Project Director Elyse Forkosh Cutler Project Associate Dorothy Scott Editorial Review Stephen Jenkins Linda O Prager Bill Woodson Production Team Suzanne Claussen Julie Bastian Contributors Ascension Health Care Network Molly O’Neill SVP, Chief Business Development Officer Carolinas HealthCare System Russell C Guerin EVP, Business Development and Planning HCA Chip Blaufuss AVP Strategic Resource Group PeaceHealth Peter Adler SVP for Strategy, Innovation and Development St Joseph Health Annette Walker EVP, Strategic Services St Peter’s Health Partners James K Reed, MD President & CEO Sutter Health Peter Anderson SVP, Strategy and Business Development Trinity Health Daniel Hale EVP, Trinity Institute for Health and Community Benefits Vanguard Health Systems Rob Jay VP, Development Trip Pilgrim Former Chief Development Officer and SVP Yale New Haven Health System Gayle L Capozzalo EVP, Strategy and System Development Copyright © 2013 Sg2 This analysis was prepared by the staff and consultants of SG-2®, LLC (“Sg2”) and is proprietary and confidential information to be used solely by clients of Sg2’s systems. The projections, trends, forecasts and conclusions provided herein were assembled using the best judgment of Sg2, its staff and consultants, but should not be construed as definitive projections for purposes of financial feasibility or other economic decision making. Events, conditions or factors, unanticipated at the time of the development of this analysis, may occur which could have a material impact on the conclusions contained within. No assurances are offered, either implicitly or explicitly, that the projections, trends or forecasts will occur. Sg2’s analyses, recommendations and forecasts are based on a thorough and comprehensive review of literature, client interviews and discussions with industry participants. Sg2, its principals and editorial staff do not hold any direct investments in commercial enterprises that may be noted in Sg2 publications and reports. Medical device manufacturers, pharmaceutical firms and other commercial vendors (some of whom are clients) are often noted in Sg2 publications to illustrate emerging trends or key clinical developments. Sg2 does not recommend or endorse any specific products or services noted. Sg2’s objectivity and analytical rigor are fundamental to the value of our research and insights. Clients should apply findings to their own market and business circumstances to determine the applicability of the information contained herein. With respect to clinical matters and patient treatment practices, clients should consult with their medical staff professionals prior to adopting or applying any such plans or procedures. Sg2 disclaims any liability for the accuracy, completeness or usefulness of any information, apparatus, product or process discussed herein and shall not be liable for damages of any kind, including, without limitation, any special, indirect, incidental or consequential damages arising from omissions or errors in its conclusions, findings, observations or recommendations. Health System Consolidation Confidential and Proprietary © 2013 Sg2 | Sg2.com 1 Health System Consolidation: Navigating the New Wave of Mergers and Acquisitions Executive Summary Making a Strategic Partnership Decision ■ Put strategy first. ■ Evaluate the market. ■ Identify gaps and determine if partnership can advance the strategy. ■ Quantify the organization’s indispensability. ■ Weigh options based on the Sg2 Indispensability Assessment. ■ Carefully manage communications. ■ Choose the optimal transaction structure. Considerations for Sellers vs Buyers ■ For sellers it all comes back to strategy. ■ Sellers must identify the best partner. ■ For buyers an analytical approach to selecting partners is essential. ■ Buyers must put relationships to work. Health systems around the country are entering into new relationships at a frenetic pace. From small community hospitals to large systems, the mania for mergers and acquisitions (M&A) has become so widespread that some executives are predicting the demise of the independent hospital. Soon, the thinking goes, all hospitals and health systems will be swallowed up, leaving only a handful of national “mega- systems.” This leaves many leaders wondering if they also must get into a deal before it’s too late. At the same time, many organizations do not recognize the value a partnership can bring until the wolves are at the door. At that stage, a hospital’s ability to negotiate an ownership deal that will ensure its ability to thrive in the future can be seriously compromised. Not every independent hospital or health system needs to be part of a traditional merger or acquisition to be successful in the future. But whether or not to partner is one of the most critical judgments health care systems will make. And once a system has decided to consider a deal, determining the right timing, the right partner and the right transaction structure can literally mean the difference between a smooth integration that leads to success and a very bumpy ride. How can organizations best make these critical decisions? Despite the sense of urgency in the marketplace, partnership determinations should not be made in haste—by either buyers or sellers. Rather, these deliberations should be: ■ Grounded in strategy—focused from start to finish on advancing the organization’s vision and strategic objectives ■ Planned, not panicked—methodical and proactive, not simply a reaction to today’s headlines or what the organization’s largest competitor is doing ■ Quantitative, not emotional—based on a specific evaluation of the system’s strengths and challenges, rather than either undue enthusiasm or denial and paralysis ■ Business driven—reflecting a partner’s ability to meet a strategic need, rather than rigid assumptions Health System Consolidation: Navigating the New Wave of Mergers and Acquisitions is designed to help executives steer their organizations through the turbulent currents of rapid market consolidation. Confidential and Proprietary © 2013 Sg2 | Sg2.com2 Industry Consolidation Again Accelerates Sources: Irving Levin Associates, 2013; Barr P and Kutscher B. Mod Healthc. 2013;43:S1–S7. Almost every week for the last year, a new health system merger was being announced. Some of these transactions were large, such as the Catholic Health East–Trinity Health merger; many others were more local, such as the affiliation of St Joseph Health and Hoag Memorial Hospital Presbyterian in Southern California. The number of transactions climbed 18% in 2012, while the number of facilities involved in these transactions was up by well over 60%. Number of Hospital Merger and Acquisition Transactions, US Market, 1994–2012 1994 1997 2000 2003 2006 2009 2012 200 175 150 125 100 75 50 25 0 JJ East, Urban Markets Hottest While deals are being struck all over the country, the large majority of transactions are occurring in the eastern half of the country, where many local markets remain fragmented. Local market fragmentation is particularly pervasive in major metropolitan areas, where transactions have also been common. Perhaps no market has been more active than the Chicago metro area, with nearly a dozen transactions in the last three years. Confidential and Proprietary © 2013 Sg2 | Sg2.com 3 Different Environmental Forces Drive Today’s Deals Sources: Medicare Payment Advisory Commission. A Data Book: Health Care Spending and the Medicare Program. 2012; American Hospital Association (AHA). Trendwatch Chartbook 2011; Impact of Change® v13.0; NIS; Sg2 Analysis, 2013; Moody’s Investors Service. Moody’s: 2012 not- for-profit healthcare sets new record in downgraded debt. February 12, 2013; AHA. How Hospital Mergers and Acquisitions Benefit Communities. June 2013. The last wave of M&A, in the late 1990s and early 2000s, was largely in reaction to the rapid consolidation among health insurers over the same period. At that time, the focus of consolidation was primarily on gaining payer leverage. The for-profit hospital sector was also emerging. Now, however, the factors pressuring hospitals to consolidate are different. JJ The Declining Middle Class (of Hospitals) National statistics on hospital margins reveal one reason for the current round of consolidation— a skewed income distribution, with many hospitals enjoying comfortable margins, a smaller number with poor margins, and a very small group in the middle. The resulting mix of haves and have-nots fuels M&A activity, with both haves and have-nots looking for partners, but for opposite reasons. Hospital Margins, US Market, 2005–2009 Number of Hospitals Note: Non-Medicare margin includes commercial, Medicaid and self-pay. At the same time, Sg2’s Impact of Change® forecast projects that inpatient volumes will decline by 6% over the next 10 years. With revenues stagnant to declining at many hospitals and the inpatient growth engine faltering, the increased scale resulting from consolidation holds the promise of cost containment. The track record on cost savings from consolidation of hospitals is mixed. But in the current cost- conscious era, this savings potential must be realized. JJ Need for Capital Perhaps the most often cited reason for a merger today is capital access. Since 2008, Moody’s has had a negative outlook for the hospital industry overall, indicating a challenging credit market, particularly for small hospitals with limited market diversification. In 2012, Moody’s downgraded a record $20 billion in health care debt, an increase of more than 200% from the year before. Adding to capital needs, the average age of plant for US hospitals has been on the rise for nearly two decades, and now exceeds 10 years. Many organizations are also facing large capital outlays for electronic medical record (EMR) systems and the acquisition of physician practices. JJ Shift From Fee-for-Service to Accountable Care and Population Health As more health systems integrate ACO models, competencies in risk-based contracting and population health management are essential. Hospitals are making classic “buy” vs “build” decisions, recognizing that building value-based care competencies can take years. Systems with these capabilities can immediately add value to organizations that have yet to begin the journey from volume to value. Health System Consolidation 742 1,712 438 Non-Medicare Margin ≤1% Non-Medicare Margin >1% to 5% Non-Medicare Margin >5% 0 400 800 1,200 1,600 2,000 Confidential and Proprietary © 2013 Sg2 | Sg2.com4 Macroeconomic forces sweeping over the health care industry have led to scores of mergers and acquisitions, but these deals tend to fall into six categories. (Some deals may fit into more than one category.) JJ The House Is On Fire Perhaps the most common, yet often preventable, type of transaction occurs when an organization is financially distressed and reaches the brink. The result is a “fire sale”: little to no residual value for the organization and few potential partners. If the hospital’s leaders had been more proactive earlier, the organization might have