Greater deal volume could come from a resolution of ongoing federal healthcare policy battles, according to one analyst.

April 19—Broad uncertainty regarding healthcare policy under the Trump administration has had little impact on hospital mergers and acquisitions, which are being driven by market trends.

Various entities that track hospital M&A found that the volume of deals either slightly increased or slightly decreased in the first quarter of the year. That was despite a high-profile effort by the Trump administration to repeal and replace part of the Affordable Care Act (ACA), which could have major financial implications for hospitals.

“My expectation is we’re going to continue to see M&A activity regardless of what happens with reform,” said Anu Singh, managing director at Kaufman, Hall & Associates. “It may change the composition of those transactions, it may change the type of those transactions, but this activity is going to continue just because benefits of scale are almost more important than what’s written in the text of the current or other proposed reform models.”

The steady pace was illustrated in a Kaufman Hall analysis that identified 27 first-quarter hospital and health system partnership transactions, two more than in the first quarter of 2016.

Ponder & Co. found similar continuity, listing 24 announced deals. That was an increase from 19 deals in the prior quarter but a decrease from 27 in the first quarter of 2016.

Despite the ongoing discussions in Congress over possibly overhauling the ACA, said Eb LeMaster, a managing director at Ponder, M&A discussions remain “as strong as ever,” with some differences between for-profit hospitals and not-for-profit hospitals.

At not-for-profit hospitals, healthcare reform is “clearly top of mind, but at this point it isn’t driving their decision to do a transaction,” LeMaster said in an interview. However, the smaller number of for-profit organizations are more sensitive to the possibility that major federal healthcare policy changes could disrupt their business models.

“For-profits are managing quarterly earnings, they have public investors or big private-equity investors who are more sensitive to the trends,” LeMaster said.

The recent trend of little announced activity by the largest for-profit hospital companies continued in the first quarter. The four largest announced deals all involved not-for-profit organizations, according to Kaufman Hall, with the largest being the merger of Beth Israel Deaconess Medical Center and Lahey Health in Massachusetts.

Dan Farrell, a healthcare deals partner at PwC, agreed that major changes to the ACA are more likely to change which entities buy or sell hospitals rather than the number of such transactions.

“It will change risk tolerances and strategies,” Farrell said in an interview.

Such impacts will stem from how payment changes affect valuations throughout the healthcare sector, including among freestanding emergency departments, urgent care facilities, and post-acute facilities.

PwC has found little impact on deal volume thus far, identifying 19 deals in Q1—down from 23 in the previous quarter and 27 in Q1 2016., a platform of Irving Levin Associates, found the same numbers.

Any reform effort that sharply reduces insurance coverage likely would push struggling hospitals into bankruptcy, said Lisa Phillips, editor with Many of the most financially vulnerable hospitals are in rural areas. More than 75 rural hospitals have closed since 2010 and 673 additional facilities are vulnerable to closure, according to the National Rural Health Association.

“One struggling hospital taking over another struggling hospital isn’t exactly a recipe for success,” Phillips said in an interview.

A Predicted Trend

The continued strong M&A activity mirrored a 2017 outlook issued by Moody’s Investors Services in January, before the legislative effort to repeal part of the ACA.

Moody’s noted in that report that many hospitals are facing expensive IT installations, growing challenges in physician recruitment, and an increased need for efficiencies in a “constrained” payment environment.

“These factors drive the need for scale,” Moody’s reported. “Even with the consolidation over the past couple of years, the not-for-profit hospital sector remains highly fragmented, which serves as another sign that affiliations will proceed at the current speed in 2017.”

The typical transaction continues to involve stand-alone community hospitals, according to market analysts.

“For several years now, we’ve seen margin pressure on the cost side, and demands for economies of scale and risk-based contracting,” Farrell said. “That drives stand-alone facilities to seek ‘white knights’ in the form of joining larger health systems.”

Larger systems continue to look for smaller hospitals to expand their market share for population health, find economies of scale to improve cost structure, or improve their negotiating leverage with payers.

Other large systems were expected to continue spinning off unprofitable individual hospitals to reduce debt burden.

2017 Outlook

The first-quarter numbers put 2017 on track for a “strong” year of 90 to 100 transactions, which would fall short of the peak of about 125 transactions a couple of years ago, LeMaster said.

“Similar to last year, which was robust but not to the levels of two to three years ago,” LeMaster said.

Phillips noted that M&A totals have declined since 2013 because of the increasing prevalence of deals that do not result in a change of ownership, such as partnerships or clinical collaborations. M&A watchers don’t track the number of such deals because many are not publicly reported.

Farrell agreed that in 2017 hospital deals will continue to shift toward “softer structures.”

“Those are expected to be particularly useful when health systems are considering vertical integration strategies that are often either riskier or just represent unfamiliar territory,” Farrell said.

Despite the decline from peak volumes, LeMaster said hospital executives exploring M&A need to be as active as ever in figuring out their options because many discussions continue below the surface.

“Don’t be fooled, there’s a lot of activity behind the scenes,” LeMaster said.

Also expected to continue in 2017 is the greater scrutiny of hospital deals by the Federal Trade Commission (FTC). For instance, the deal between Advocate Health Care and NorthShore University HealthSystem in the Chicago market was called off in March after the FTC obtained an injunction, and the University of Oklahoma Hospitals Authority and Trust’s planned partnership with SSM Health to buy out HCA’s stake in the Oklahoma University Medical Center was ended under regulatory scrutiny.

Singh said his firm is advising health systems to avoid acquisitions of hospitals in adjacent or overlapping geographic areas.

“Systems are being a little bit more particular about figuring out how they can expand and grow without having some of those regulatory concerns,” Singh said in an interview.

It also is possible that healthcare policy changes could spur more M&A.

“Ultimately, further clarity on healthcare reform and reimbursement in general is going to drive more activity,” LeMaster said.

But the impact on particular providers will vary.

“One stroke of the pen in Washington could change valuations and strategies drastically, so for anybody—either a buyer or a seller—keeping an eye on Washington is critical,” PwC’s Farrell said.

Rich Daly is a senior writer/editor in HFMA’s Washington, D.C., office. Follow Rich on Twitter: @rdalyhealthcare

Publication Date: Wednesday, April 19, 2017