A wave of consolidation is sweeping through the healthcare industry as regulatory change drives organizations to prepare for an uncertain future. Mergers and acquisitions (M&A) activity in healthcare surpassed $143 billion in 2012 and the number of transactions increased by 6 percent to 1,063 deals, the highest volume of transactions reported since 2007. This trend will continue into 2014, as we expect hospital-to-hospital transactions to continue at a robust pace this year. However, the transactions will be more complex and occur at a somewhat slower pace than in 2013.
Complex transactions are likely to become more common as companies across the service sector consider how best to mitigate risk and position themselves as the “preferred option” for accountable care organizations (ACOs) and health insurance exchanges. Across the industry, health service organizations are increasingly looking to grow in size and diversification to achieve economies of scale and provide a broader array of services.
Although the dynamics driving M&A can vary greatly by sector and by market, several significant trends are influencing transactions industrywide. Evolving regulations have accelerated fundamental changes in the business models of healthcare providers, which are reorganizing to accommodate a shift from activity-based to risk-based reimbursement. Organizations are embracing more creative financial structures and relationships, with several unusual relationships emerging in the past year that may indicate a trend of mega-mergers, especially in the hospital and managed care sectors. Vertical integration is common as organizations blur the traditional lines between healthcare service sectors.
Focus increases on strategic acquisitions and creative structures to gain market position. As market consolidation has progressed, there has been a slow and steady movement away from “troubled sales.” Fewer organizations, especially hospitals, are being sold or acquired due to financial distress or the inability to remain financially viable. Instead, acquisitions are increasingly being driven by the desire to strategically position the business rather than just for the sake of growth. This trend means transactions in some segments are smaller, as organizations seek to “fill-in” strategic capabilities or needed competencies.
A willingness of different organizations to come together in creative ways, outside of a full M&A transaction, appears to be picking up steam. Exploration of joint ventures, shared service agreements, and other contractual relationships are increasingly common. This trend may be driven by the lower capital requirements inherent in these transactions or merely by the recognition that value can be created by collaborating, short of a sale or merger. The shared services relationship between Novant Health and Memorial University Medical Center as well as the collaboration between Piedmont and Wellstar are representative of these creative structures and relationships.
Many financially successful organizations are seeking to merge to gain scale and market position in preparation for full implementation of the Affordable Care Act. This strategy is being seen on a regional or market basis, in particular. The conventional wisdom is that increased size brings economies of scale in purchasing and diversification as well as the ability to spread the costs and risks associated with new payment mechanisms, technology and reduced reimbursement.
Vertical integration and the blurring of traditional sector boundaries continues. A blurring of traditional lines between healthcare service sectors has continued, as organizations have diversified upstream or downstream to position themselves as integrated delivery systems or ACOs to accept risk. Many organizations are seeking direct access to physician segments. Hospitals have been aligning with physicians through practice purchases and other creative arrangements, while physicians have appeared more willing to affiliate with other organizations to gain access to information technology and to position themselves for healthcare reform. United Health’s acquisition of Monarch Healthcare in 2011 appeared to signal the start of a bolder trend among payers as well. Additionally, not-for-profits have demonstrated an increasing willingness to partner with private equity firms or for-profit companies.
Higher levels of recent M&A activity in home health, rehabilitation, and long-term care reflect the importance of these sectors with shifting payment models. Access to these capabilities, either through ownership or partnership, will be critical to an organization’s ability to manage the overall health of a population at the lowest cost. However, these industries are highly fragmented, with a few large players but mostly dominated by many smaller private companies. Hospitals are now looking anew at how best to gain these capabilities after shedding many of these businesses in the late 1990s. Transaction activity in the behavioral health sector has also increased, driven by improved insurance coverage and growing demand for services.
The outlook for healthcare M&A remains strong for next year. As industry leaders assess how best to guide their organizations in an evolving environment, expect a more strategic, systematic approach to transactions, with buyers taking more time to identify, evaluate, and pursue deals that will best deploy their limited capital.
William B. Hanlon III is a principal with Hammond Hanlon Camp LLC, a strategic advisory and investment banking firm focused on the healthcare sector.
Publication Date: Wednesday, January 15, 2014