Hospital M&A in the Age of Coronavirus
(Levin Associates online)
Hospitals have always been a prime target in the healthcare services market. Suddenly the novel coronavirus pandemic has thrust them squarely into the national conversation. While the attention is warranted, it hasn’t been completely positive regarding a shortage of intensive care beds and personal protective equipment for healthcare workers.
We hosted a webinar on the effect the coronavirus will have on hospital M&A market later this year. Chris Schoeplein, Vice President at Ponder & Company, was a panelist who gave us his thoughts.
HealthCareMandA.com: Looking back to what feels like another era, pre-coronavirus, how would you characterize the hospital M&A market in 2019? Were the same drivers in place from 2018?
Chris Schoeplein: In 2019, announced hospital transactions totaled 85, down 27% from 116 in 2018. With this decrease in transaction activity, 2019 tied for the second lowest volume over the last 10-year span.
There were four primary drivers, from our point of view. First, there was a reduction in for-profit divestitures. In 2018, over 40% of hospital transactions were for-profit divestitures compared with 20% in 2019.
Second, we saw a decline in mega-mergers and reduced activity among healthy independent health systems. This is partially driven by the focus needed to integrate and assess the mega-mergers we have observed in previous years.
Third, a significant number of mergers were called off post-LOI. For example, South Dakota’s Sanford Health and UnityPoint in Iowa called off their merger in November 2019. Two Wisconsin-based systems, Marshfield Clinic Health System and Gunderson Health System, called off their merger in December, and Baylor Scott & White Health in Dallas pulled the plug on a merger with Memorial Hermann in Houston in February 2019.
Finally, consolidation led to a continued decline in independent hospitals. In 2009, almost 45% of community hospitals in the U.S. were considered independent. As of 2017, 33% were independent.
HCM&A: Now, how would you characterize the hospital market in March 2020, with the coronavirus ramping up across the United States, bed and protective equipment shortages, etc.?
CS: We anticipate a significant decline in announced transaction volume over the next three to six months, given the organizational focus needed to address the coronavirus pandemic. However, we believe as hospitals emerge from this period and move forward into 2021, there will be pent-up activity potentially amplified by the financial pressures related to the virus impact.
In 2020, hospitals and health systems will face the triple challenge: lower margins, a decrease in days cash on hand, and greater liabilities.
Distressed smaller rural hospitals face additional closures due to this additional strain to the system without additional funding from the federal government or other partner organizations.
HCM&A: Hospitals that were running negative margins are already threatening to close. Do you see a significant reduction in the number of independent hospitals across the U.S. as a result of this pandemic?
CS: In this challenging time, we believe many of the small to mid-sized hospitals will have considerable strain placed on their organizations. This will be a culmination of operational challenges through margin pressures as well as strain on balance sheets from decreases in investment portfolios and growing pension obligation liabilities due to a lower interest rate environment.
HCM&A: How are valuations being determined today? Is it operating margins? Net patient revenue?
CS: Publicly traded hospital companies’ equity valuations have dropped by 40% year-to-date 2020. It will be interesting to see how that affects hospitals’ M&A valuations.
We continue to see individual transactions valued by two primary metrics, a multiple of revenue and/or a multiple of EBITDA. Although the majority of not-for-profit to not-for-profit transactions are non-cash mergers, the acquirer assumes the assets and liabilities of the target and will make long-term commitments in the form of a capital commitment.
It is likely too early to predict the exact impact the current pandemic will have on valuations.
HCM&A: How do you price in a value-based care model in this pandemic? Or do you?
CS: A health system’s success in value-based care is centered on the delivery of high-quality care at an affordable price. Paramount to success on this front is an organization’s ability to predict the healthcare needs of the population they serve. Given the uncertainty of the novel coronavirus pandemic, it makes this task extremely challenging.
Special reimbursement exceptions are being made in the COVID-19 environment, and the focus for now is not on value-based models or their pricing. But the focus of value-based models will return when the environment stabilizes.
In the future, we believe that smaller organizations looking to partner will put renewed emphasis on their partner’s ability and resources to operate and build technology platforms. For example, we have witnessed a fury of activity over the last month of organizations accelerating the rollout of their telehealth platforms to address patient needs amid this pandemic. These investments will likely bleed into other technologies such as artificial intelligence with health chatbots. Given the substantial costs associated with these technologies, it will be challenging for smaller health systems to address on their own.
HCM&A: How do you think deal structure could change, post-COVID-19?
CS: Membership substitutions will continue to be the top structure utilized in change of control transactions, especially as non-upfront payments are preferred by acquirers in thise challenging environment. Alternative structures such as joint ventures and minority equity investment transactions will continue to be a focus although there could be some swing toward change of control structures due to the financial and operational changes of this period.
HCM&A: Will financing these deals change in any way?
CS: There has already been a trend to fixed-rate debt over the last five years given the low rate environment. Our expectation is that organizations will continue to utilize fixed-rate debt to fund transaction need, given its low risk.
HCM&A: How do you see hospital M&A playing out through 2020 and into 2021?
CS: Often there is a natural pause following a heighted period of acquisitions as health systems digest the new mergers and integration takes place, just as we experienced in the decreased activity of 2019 following the frenzy of activity in 2018. As we move forward into 2021, in the wake of the natural pause in 2019 and the pent-up activity from COVID-19 priorities in 2020, we expect to see an increase in hospital M&A.
We think we will see some of the larger mergers that have taken place over the last several years look to right size and divest assets that do not fit. That is what CHI and Dignity, now called CommonSpirit, have done, as well as the now-merged Advocate Aurora Health, RCCH HealthCare Partners and LifePoint Health in November 2018, and Bon Secours Mercy Health, which merged in September 2018.