Community hospitals that have fought to stay independent may be ripe takeover targets later this year as health systems assess coronavirus-related trauma, several sector advisors said.

Hospital M&A has been robust in recent years, driven less by financial stress than by strategic initiatives to achieve geographic scale, according to Carsten Beith, co-head of health systems M&A at Cain Brothers. Dealmaking in the space dipped slightly in 2019, as compared with previous years – according to data from healthcare-focused boutique investment bank Ponder & Co, there were 85 announced hospital transactions last year, against 116 in 2018 and 118 in 2017. Mergermarket data show 248 transactions among healthcare providers as a whole for last year, compared with 321 in 2018 and 294 in 2017.

The novel coronavirus has set hospitals of all sizes into a tailspin as providers work overtime to service an influx of patients, the experts said. And independent community hospitals, which may have been under-resourced to begin with, are now at critical mass, said Hector Torres, a healthcare managing director at Focal Point Partners.

Community hospitals without best-in-class specialists and physicians are underprepared to take on an entirely new type of patient, Torres said.

“And these small hospitals have to spend resources on intake, only to refer a patient to a larger health system because they don’t have an otolaryngologist to deal with a coronavirus patient,” Torres added. “So the economic value of treating that patient has left your system and you basically gave that value to your competitor.”

Fingers on the trigger

While the length of the epidemic remains a black box – and many deals, healthcare or otherwise, are on hold as businesses work to plug leaks in their revenue – some health systems and hospitals may not be able to wait out the crisis before pursuing a transaction, some advisors said.

Torres said his firm has seen an uptick in inbound inquiries in recent weeks from hospitals seeking relief in the form of refinancing or a sale.

Additionally, some independent hospitals that were previously pursuing joint venture-type partnerships with would-be acquirers, as opposed to an outright sale, are now returning to the deal table, according to King & Spalding Partner Torrey McClary. McClary advises health systems and academic research organizations on various types of transactions, including acquisitions and joint ventures.

“I have a client who was interested in acquiring a hospital, but that hospital was instead proposing service-line JVs and other ways of collaborating and accessing the brand and resources of my client as a hospital,” McClarey said. “That hospital is now coming back and saying, ‘Actually, let’s talk about an acquisition.’”

Cain Brothers’ Beith noted that some consolidators are either moving forward with transactions that started prior to the crisis, or are “evaluating the market and saying, this is an opportunity to achieve strategic affiliations in an environment that’s highly uncertain.”

That said, many health systems are deploying any available manpower towards handling the immediate crisis, rather than diligencing deals, all advisors said.

“Is a [hospital] board going to vote on its future via a Zoom call or a WebEx?” said Eb LeMaster, a managing director at Ponder & Co. “To literally get the people together to make the decisions, we’re finding that’s on hold. I’m not saying every process is on hold, but major decision-making is very challenging.”

Fiscal-year reckoning

However, by June of this year – when the fiscal year ends for many health systems – most hospitals will be staring down slashed balance sheets, LeMaster said. Elective procedures, which are normally cash-cows for most hospitals, are being delayed indefinitely, while the capital markets have been knocked into disarray due to the pandemic. By the time most hospitals and health systems report annual earnings, portfolios will be down meaningfully, LeMaster said.

“Coming out of the backside, there’s going to be some pain from all this,” LeMaster said. And otherwise healthy systems may be lacking when it comes to emerging care delivery capabilities like telemedicine, which has seen significant demand during this epidemic, he added.

“Telehealth and other emerging delivery modes – those aren’t cheap,” LeMaster said.

For-profit hospital operators were hit hard at the beginning of the month amid the capital market downturn. On 9 March, Community Health Systems’ [NYSE:CHY] share price had sunk 20.7% by market close, while Tenet Healthcare [NYSE:THC] dropped 15.3% and HCA Healthcare [NYSE:HCA] dropped 8.3%, Modern Healthcare reported.

As of 27 March, HCA is trading at USD 86.80 per share, down significantly from its 2020 high of USD 151.04. As of 27 March, Community Health is trading at USD 3.31 per share, nearly half its YTD high of USD 7.18, while Tenet is trading at 17.29 per share, compared with its 2020 high of USD 38.35.

LeMaster noted that all three have made divestitures in recent years in non-core markets. While the companies have “done a significant job eliminating those (non-core assets), there’s a next tier where they’ve held on,” he said. These assets could be divestiture candidates moving forward as the operators assess their balance sheets in the aftershock of coronavirus, LeMaster said.

Despite the shakeup in the capital markets, Beith said he expects for-profit operators to continue their strategies much as they have been.

“Community and Tenet are still really focused on repositioning portfolios and reducing leverage,” said Beith. “HCA is a disciplined consolidator. I don’t see HCA retrenching from an M&A standpoint – this will be an opportunity for them to make acquisitions.”

McClary agreed, noting it is too soon to speculate on whether for-profit operators will position themselves defensively.

“It’s hard to say what the public companies are going to do,” said McClary. “The situation we’re in would give them increased ability and ammunition to fend off unwanted or undesired acquirers.”

Underscoring the situation is expected government funding. On 26 March, the Senate passed an approximately USD 2trn coronavirus response bill designed to accelerate relief across the US economy. About USD 100bn of that funding is intended to “reimburse… eligible health care providers for health care related expenses or lost revenues that are attributable to coronavirus,” according to the bill’s language. The legislation does not specify how that funding will be disbursed.

“A lot of moving pieces will impact what happens,” said McClary. “But we can certainly see, as of today, a lot of factors that could drive increased M&A activity (in the space).”