Strategic Partnerships Mergers and Acquisitions

Healthcare M&A: Are you prepared for the pitfalls?

March 30, 2021 2:23 pm

Embarking on a merger or acquisition involves a considerable degree of risk for a hospital or health system. There are many potential pitfalls, and leaders need to be prepared to address every one of them.

Viewing a proposed merger or acquisition simply as a transaction is an all-too-common error that hospital and health system leaders can make when first pursuing an M&A strategy, said Michael Dandorph, president and CEO, Wellforce, a large regional health system headquartered in Burlington, Massachusetts. “You have to view it as a process,” he said.

Dandorph noted that organizations contemplating a merger may be inclined to make this mistake when they hire and completely rely on consultants to advise them and serve as arm’s length brokers or intermediaries for negotiating potential deals.

Michael Dandorph

“Brokered marriages don’t necessarily achieve the goals that the parties are looking to create,” Dandorph said. “That’s true in marriage, and it’s true in mergers. It’s been said, ‘Culture eats strategy for lunch.’ But what do we mean by culture and how do we even assess it? When you start thinking about culture, you have got to truly get to know one another, and you can’t do that solely through a broker. Both board and management [have to invest] time with one another to really understand how each other operates to make the most informed decision — and its more than just dollars and cents. And when it comes to hospitals, the medical staff — or in the case of academic centers, the faculty practice physicians — are key stakeholders in understanding whether there is alignment and a shared vision of what you’re collectively trying to achieve, especially if it involves clinical integration.”

Losing sight of the overall process required for two organizations that are thinking of coming together is a major pitfall that can prevent a merger from moving forward successfully, Dandorph suggested.

Culture and vision: 2 prime ingredients

So where does the process begin? Assessing cultural fit, and whether there’s a shared vision, is an important starting point, because that will be instrumental in determining whether a merger can move forward at all.

“You need to make sure the cultures of the organizations are aligned in what they are trying to achieve,” said Kevin Brown, president and CEO of Piedmont Healthcare in Atlanta. “When we’re talking with potential partners that are thinking about joining the system, I look, and I listen: Are they talking about quality and safety? Are they talking about coordinating the care? Are they talking about serving the healthcare needs of the community? And if they are, and we get a pretty good sense that we share the same cultural focus, then we feel we can successfully partner together. But if the first thing they mention is that they need us as a banker because they’ve gotten into economic trouble, or they want to do some large capital project that they can’t fund or they really want to stay independent but need somebody to help them with their balance sheet, we just walk away from those opportunities, because it’s not a cultural fit or a strategic fit for either party and the chance of long-term success is low.”

Kevin Brown

Brown reinforced that Piedmont Healthcare’s vision is expressed through its focus on caring for the community and improving the quality of care. “We have a goal of getting to zero harm, and we are making great progress toward it.” Brown said. “Our partners have got to have the same focus. So when you’re talking to them, you both are getting excited about what you can collectively do to improve quality, and that consumes the majority of the conversation. If quality and safety are your focus, everything else will follow. There is no question that higher quality produces lower cost.”

Vision, relationships and the meaning of success

The lack of a clear vision for a merger also was one of three potential pitfalls identified by Alan Kaplan, MD, president and CEO of UW Health in Madison, Wisconsin.

“Clearly, there has got to be a compelling vision for why you are doing this — what’s driving it,” Kaplan said. “Without that compelling vision, it’s hard to get through the tough questions that need to be taken care of pretty much early on or the whole thing falls apart.”

Alan Kaplan, MD

Those tough things start with governance and senior leadership, Kaplan said. “And by senior leadership, I really mean the CEO. I’ll take it right down to personalities: I’ve seen CEOs kill mergers because [they] didn’t get along with the other CEO, or it was a control thing — Who’s going to be in control? But with a compelling vision that’s strong and truthful and executable, and with valid goals, you can get the governance and the CEO issues settled. And everything falls in place from there.”

Kaplan says the second pitfall comes when relationships push vision to the back burner. “Sometimes the CEOs and the boards get along so well, they actually do it without good goals,” he said. “Personalities jibe so well and everyone is so excited about coming together that the deal becomes the driver. Then people don’t want the deal to fall apart because they are so in love with each other and with the deal. So they don’t really crisply settle governance issues, or they avoid discussing important post-integration issues like, ‘Are we going to consolidate our legal teams?’ and ‘Are we going to have one revenue cycle office or not?’ They say, ‘Well, we’ll take care of that later.’ And they end up not addressing the tough conversations up front, which is critical.”

The third pitfall Kaplan mentioned is the inability to look at a failed merger as anything other than a failure.

“There are times when backing out of a merger is a success,” Kaplan said. “It speaks highly of the board and of management, because even though we had this great vision, and our boards got along, when we really went through it with diligence, we were able to see it wasn’t going to work. We may have discovered some liabilities for one organization or the other, or we may have found one wasn’t really ready to share control. So at some point, you have to cut your losses, back off and consider that as success, and celebrate that.”

Good things can still come from a failed merger, Kaplan said. “Sometimes it just helps you to the next merger, or you may find yourself coming back around to the same organization with a different approach.”

Setting reasonable expectations, while being open to learning

Dandorph agrees that one of the biggest hitches is not addressing the critical issues upfront.

“The time invested on the front end saves an enormous amount of time on the back end, so you wind up spending less time overall,” he said. “But if you shortcut the front end, because you think it’s important to speed the transaction along, it  makes the long run much more challenging.”

The front-end conversations also need to address expectations. “Sometimes the expectations are unrealistic,” Dandorph said. “People think, ‘We’re going get economies of scale, but nobody has to change anything.’ Well, that doesn’t work. The reality is that to get the benefit of economies of scale, there needs to be change. Sometimes, for example, you have three leaders where you need only one. I’m a big believer that you put the difficult issues on the table during the discussions, because it allows you to solve problems together.”

Dandorph also stressed keeping an open mind when discussing best practices that will be adopted after the merger.

“You have to enter the process by being ready to listen to and learn from the other organization,” he said. “Sometimes it’s not the biggest organization that has the best way to do it. There needs to be an openness to where the best practices actually exist that you want to expand across the organization. There are some organizations that have completely eradicated hospital-acquired infections or come close to it. And sometimes, it’s the smaller organization that could teach the larger organization. So both organizations have to come to the table with receptivity to learn from each other.”

Why relationships are important

Although there was consensus that personal relationships are not more important than vision or strategy, leaders also did not discount the value of relationships in a successful merger.

“Relationships matter, right?” said Dandorph. “Obviously, it can’t be purely about relationships: If it’s only two friends and there’s no business rationale behind it, that usually doesn’t work. But I also think relationships are incredibly important because, as with anything, you can have the best plans in the world and set the right expectations, and then the world happens and it doesn’t quite play out the way that you thought it would. Then, all of a sudden you have to come together and solve problems. And if there aren’t strong, trusting relationships, you may not have the strong problem-
resolution skills, and that can be a big impediment to integration. If true integration were easy, everybody would have done it, and nobody would have any problems.”

Having a clear rationale for growth

Viewing growth as strategy unto itself was another common pitfall cited by leaders.

“I think some people are growing just for growth’s sake,” Brown said. “We have some organizations that are from out of state picking up assets randomly in Georgia that, from our perspective, don’t really seem to fit together strategically.”

Again, it comes back to having a clear organizational purpose and a vision for the communities to be served and, as partnership opportunities arise, to having the discipline to stay true to and focused on to these principles.

“You need to make sure you have a longer-term plan for every step that you take in acquiring or merging or partnering,” Brown said. “I call it a puzzle. We have got a puzzle for the state of Georgia, and we’re putting the pieces together. And I can see it on a map how the puzzle pieces will come together over time, because especially in the non-profit world, you don’t get to choose when you are going to have an opportunity to expand. But when those opportunities come along and the right organization is ready for a partner, we’re ready to pick up the piece and put it into the puzzle for the collective benefit of the communities served.”

Brown differentiates this deliberate, planned approach from having a grow-for-growth’s-sake mindset. “It seems like some organizations just bid on everything and that is their growth strategy. Some get caught up in the economic bidding and getting to multiples and commitments for some of these transactions that don’t seem sustainable. I think it will hurt them in the long term, even though they might have some success growing in the short term.”

Addressing potential concerns and objections

Ensuring all stakeholders, and physicians in particular, are on board with a merger or acquisition is imperative to avoid potential objections that could derail the initiative.

Kaplan stressed that persuading physicians to come on board starts with sharing the vision and the rationale underlying it with clarity. He noted the physicians typically want specifics rather than broad vision statements.

“As administrators, we say, ‘Our vision is to become more efficient.’ Then the doctors will say, ‘How? What does that mean? You’re going to close my program?’ When we say we want to be able to consolidate or reallocate resources, they come back with, ‘So you can close my program? What does that mean?’ And if we tell them we want to be more effective in our population health initiatives, they say, ‘If you weren’t effective individually, how are we somehow going to become better symbiotically? What does population health even mean? What are you doing to my practice?’”

It’s all about the different perspectives. Kaplan says: “At the leadership level, I think about big pictures of efficiencies and consolidations and bottom lines and bond strengths and all those things. But as a physician, it’s all very personal to me: ‘It’s my comp. It’s my call schedule. It’s my practice. It’s my patients.’ So it has to be brought down to a personal level so that they understand how it affects their lives.”

Kaplan suggests physicians will become allies if they receive the communication, the reassurance and the answers they need. “And giving them data is helpful, because if you throw out a management word, like efficiency, they’re going to say, ‘OK, what does that mean? Tell how me how that happens, and what’s the data?’”

Kaplan also stresses that this conversation has to be mindful of sensitivities around the merger discussions. “You can’t just broadcast it,” he said. “I’m in confidential discussions, and I may have signed a nondisclosure agreement. But what you can do is make sure that you have a respected physician leader at the senior level in early negotiations. They will advise leadership on how to work through the physicians, but they also will be your advocates and the ones to help you build that consensus, that coalition. Also, make sure you have a plan for socializing physicians to the concept that’s consistent with the confidentiality agreement and for bringing them as early as possible into the process to gain them as allies, not adversaries.”

Brown suggested it also is important to address potential concerns of the prospective partner in a merger. “When someone is thinking about joining the system, we have them talk to the most recent two or three that have joined the system to ask them, with and without us in the room, ‘Tell us the real story about how this has worked, the good and the bad.’ You need to be transparent and say what you are going to do and do what you say. Some organizations seem to say one thing and the reality turns out to be something different. This obviously causes undue stress on the new partnership. You don’t want to get a year into the transaction, and have people saying, ‘That’s not what we signed up for.’”

Going in with your eyes open

Healthcare organizations need to recognize that a merger takes time, even after the arrangement is finalized. Kaplan summed it up this way: “Completing a merger is a celebration. But you have to keep in mind actually realizing the benefits of that merger can take years. I’ve been in situations where the mergers have been five, six, seven years post-merger, and we’re still working that integration to achieve the full benefits.”

A merger also hardly ever is a slam dunk. “I always like to describe M&A processes as going through a series of gates,” Dandorph said. “You’re testing one another, you’re testing the business case, you’re testing the cultural case. It takes time, and at some point, you may not be able to get through a gate and have to decide that, as attractive as the opportunity may have seemed, it just doesn’t make cultural sense.

“If there’s a real cultural disconnect, and we go ahead with it anyway, then we may have made a bad decision. But I want to be clear: There’s no way to get through 100% of the ambiguity — you can’t plan for everything. At some point, you have to make a decision, and it’s almost never going to be all black and white. What I espouse is to make sure you build your process to collect as much information as you can to make the most informed decision possible.” 

The healthcare M&A process is a step-by-step journey

Keith Moore 

Keith Moore, CEO of McManis Consulting in Denver, suggested that the first consideration for health system leaders when embarking on a merger or acquisition (M&A) is whether the proposed new arrangement is both strategically and financially accretive.

Moore said that leaders need to be able to answer ‘yes’ to three basic questions in assessing whether a transaction meets that requirement:

  • Will we be better able to deliver care that reflects the Triple Aim?
  • Will we be more attractive to those who pay us for services?
  • Will we have a better margin because, for example, our unit costs will be lower?

Most M&A initiatives prove to be financially accretive, Moore said. “I remember the CEO of one health system told me that simply by spreading the cost of IT across the larger system, his organization was able to recover the costs of the whole integration.” 

M&A requires a phased process

One key to a successful merger, Moore suggested, is to take the proposed participants through a careful, step-by-step process. “For the first phase, it’s a good idea to keep discussions private as long as possible, so that there is no embarrassment if it ultimately turns out not be a good match — perhaps as many as 60% of transactions that are conceptualized are never consummated.”

The second phase, Moore said, is to bring physicians and other key players into the discussions.  Here the important questions include:

  • Can we agree on vision and key goals?
  • Do we see organizational culture and decision-making processes the same way?
  • Who will make up the leadership team?
  • How will we structure governance?
  • Where will assets reside? 
  • What will be the financial flows?

“Often, the hardest issues come up during this second phase,” Moore said. “Due diligence often occurs on a parallel basis. There’s a need to consider further value-based care, electronic medical records and other IT-related tools, all of which are almost essential as healthcare evolves.”

Moore offered the example of having an electronic health record that expands over an entire market area. “Let’s suppose you want to vaccinate people, and let’s suppose you have Epic. It’s easy: You send everybody a portal message and tell them when their time is to come in, and then they do come in, and it gets done very efficiently. That’s just one glimpse of the future of healthcare.”

The last phase usually involves going public. “This often requires making the case to those outside the system — to community leaders, state attorneys general, the broader physician community and those who will receive the care.”

The case for pursuing M&A

Often, the case that needs to be made is, “Why is getting bigger worth it?” Moore offered a compelling answer: “The investments required for next-generation IT and patient-centered care are quite high. Meanwhile, the potential economies of getting scale are quite high. It’s natural to consider putting the two together in the same financial model.” 

It also is incumbent on healthcare leaders today to look for opportunities to grow, Moore added. “Over the last few years, CEOs have come to realize that it’s almost irresponsible not to consider M&A. Of course, there are antitrust concerns, but there are also significant benefits from having these organizations be able to become larger, so it may be time for us rethink the public interest around mergers.”

Healthcare M&A is picking up in 2021

The COVID-19 pandemic had a dampening effect on M&A activity involving hospitals and health systems in 2020, but that effect was not as significant as many industry observers might have expected, according to a recent report by Kaufman, Hall & Associates.a  

“Although the impacts of the COVID-19 pandemic resulted in a lower number of announced transactions (79 in 2020 compared to 92 in 2019), the number of announced transactions remained within the historical range of the past 10 years,” the report noted.

Kaufman Hall’s report also noted that “it appears that COVID-19 has actually confirmed the strategic rationale underlying many transactions that were already underway and may be acting as a catalyst for innovative strategic partnerships and tactical transactions.”

The report concluded, “The pandemic has accelerated the need for strategic initiatives that address the opportunities of industry transformation and that reward well-thought-out alignment opportunities.”

Industry transformation resumes with 2021 M&A activity

Anu Singh, a managing director with Kaufman Hall, reinforced these points by emphasizing the ongoing strategic rationale for mergers and acquisitions.

Anu Singh 

“We expected to see some impact on the number of transactions as organizations and management teams dealt with more urgent operational issues around COVID,” Singh said. “But we were on a path to industry transformation well before the pandemic started, and we are going to recommence that very soon.”

This likelihood reflects the strong strategic rationale for pursuing partnership opportunities, Singh said. “We’re seeing a consistent level of activity with what I would call the distressed and underperforming hospitals that has been pretty consistent over many years now — even decades,” he said. “But what we’re seeing right now is an increase in the number, the scale and the size of organizations that have a solid, independent market leadership path already in place but are saying, ‘Boy, here’s even more that we can do with our system.’”

Singh also noted that the synergies have changed around M&A activity. Twenty years ago, it was about scale and economic efficiency, he said.

“But the new scale today is about what intellectual capabilities and attributes you bring to a market. That’s what’s driving today’s transactions,” he said. “Are we seeing an uptick? Well, of course we are, because more strategic-minded organizations are initiating discussions with partners at a greater pace than we would have seen 10 or 15 years ago.”

Exploring M&A opportunities is a fiduciary duty

Singh concluded, “I think the most important aspect to even investigating or executing on a strategic partnership or transaction is to remind oneself and teams that this is essentially an expression of your fiduciary duty as board members, or as fiduciaries, as executive leaders and as management of what is, in most cases, a community asset. So at its core, the first thing that has to be addressed when we pursue such an opportunity is to think about what we are trying to accomplish. How do we articulate it for our community? How do we make it compelling for our stakeholders? How do we ensure that the collective benefits associated with the risks of taking that action are better than remaining independent?”

 

 

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