One reason the repeal-and-replace push is having less impact is that many hospital M&A deals are occurring in non-expansion states.

July 25—Hospitals mergers and acquisitions ticked up during the latest quarter, even as Congress considered healthcare reform legislation that could sharply impact future payments from Medicaid.

Ponder, which found that hospital change-of-control transactions increased 30 percent from the first quarter of 2017 to total 34 in the most recent quarter, was among several tracking firms that found an acceleration in hospital M&A deals. The increase from the first quarter to the second was 15 percent according to an analysis by A Kaufman Hall & Associates report found 31 “partnership transactions” among hospitals and health systems in the second quarter, which was a 15 percent increase over the 27 that occurred in the second quarter of 2016.

Driving the latest surge is divestiture activity by large for-profit health systems, such as Community Health Systems.

“It’s just blazing,” said Eb LeMaster, a managing director at Ponder & Co., referring to for-profit health system moves.

Thad Kresho, partner at PricewaterhouseCoopers, said he expects deals to continue at about the same rate between for-profit systems and not-for-profit health systems in the same regions for “several more quarters.”

“It’s more of the same there,” Kresho said in an interview. “That activity is going to continue.”

The uptick followed the generally steady volume of deals that were reported in the first quarter of 2017. Additionally, so-called alternative transactions, such as strategic alignments or affiliations, in the not-for-profit hospital sector may not be garnering as much attention these days but are still happening, Kresho noted.

Not-for-profit health systems also are engaged in “significant pruning of portfolios,” LeMaster said in an interview.

Of the transactions announced in the second quarter of 2017, eight involved for-profit acquirers, 22 involved not-for-profit acquirers, and one was a for-profit/not-for-profit combination, according to Kaufman Hall.

Margin Pressure

Another factor in last quarter’s uptick in hospital deals was increasing margin pressure, LeMaster said.

Expense growth at not-for-profit and public hospitals in 2016 surpassed revenue growth, according to a May analysis of preliminary sector financial medians by Moody’s Investors Service. The analysis showed almost a complete reversal of 2016 expense and revenue growth compared to 2015, with growth in annual operating expenses rising from 6.2 percent in 2015 to 7.5 percent last year, while annual operating revenue growth dipped from 7.4 percent to 6.6 percent, according to the anal­­ysis (login required).

“It’s a shift in payer mix, it’s some of the government programs kicking in with some challenges on the hospital side in terms of reimbursement, and more of a more shift in managed Medicaid,” LeMaster said.

Reduced margins have impacted valuations, according to Kresho.

“The smaller players that are struggling don’t have the same capabilities as the larger players,” Kresho said. “They don’t have the payer leverage or the purchasing leverage in general and [face] other things like that that hurt their margins.”

The shrinking margins have increased the need for a strengthened due-diligence process, including the need to be “a lot more granular, in terms of understanding why those facilities aren’t doing as well and what’s causing that,” Kresho said.

On a practical level, that means due diligence work that took potential buyers three to four weeks to perform several years ago can now take a couple of months.

Reform Impact

A nonfactor in deal volume is the accelerating push by congressional Republicans to repeal and replace parts of the Affordable Care Act (ACA). On July 25, the Senate passed a motion to begin debate on a replacement bill this week.

“I don’t think that’s changing the transaction levels,” Kresho said. “And I don’t see people in ruins saying, ‘We’re not doing the deal because of what’s being discussed.’”

Instead, health systems and other entities buying hospitals are looking at some of the potential financial impacts, such as whether Medicaid is a large part of the payer mix at a target hospital. The American Hospital Association most recently objected to the legislation in a July 25 letter to senators, noting that the nonpartisan Congressional Budget Office concluded the latest such bill would reduce the size of future Medicaid spending increases by $842 billion over the coming decade.

“If Medicaid funding changes dramatically, how does that impact a particular hospital, a particular business?” Kresho said. “They’ll absolutely evaluate that, but that’s not stopping them from doing the deal.”

LeMaster said potential Medicaid revenue losses or increases in uncompensated care have not yet become factors in deals that his organization is tracking.

“People are still too unsure of what is going to happen,” LeMaster said.

Another reason the repeal-and replace push is having less impact is that “a lot of the [M&A] activity continues to be in non-expansion states,” LeMaster said.

Nineteen states opted not to accept the Medicaid eligibility expansion authorized by the ACA.

“And even in a lot of the other states, I still think most of our clients understand they have got to significantly bend the cost/quality curve,” LeMaster said. “What they think is going to happen long-term is unchanged: There’s still going to be pressure on margins and they’re going to have to take up quality” improvement efforts.

The ACA’s future is also seen as a side issue to a strategy driving many deals: regionalization, or an effort to strengthen a system’s presence in a geographic area to bolster its negotiating position with local health plans. 

 “You have all these counter-pressures where I know I need to grow and I need to protect my region, so that continues,” LeMaster said.

Future Surge?

Mid-tier and large-tier hospitals (those with revenues of more than $750 million) have generally avoided M&A offers in recent years. But LeMaster is watching whether that class of hospitals likewise moves to sell if margins tighten further.

“That group has been staunchly independent—not across-the-board, but mostly. If the headwinds get too much stronger, they have to think about their own options,” LeMaster said, referring to payer pressure and the shift to value-based payment.

That would be a big departure from the current M&A landscape, where the average deal involves a $200 million community hospital.

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

Publication Date: Tuesday, July 25, 2017