The next deal wave

Some thoughts on where the financial muscle is flexing in health care M&A

Mergers and acquisitions — with a wide range of Nashville residents playing key roles — have long been a staple of the for-profit health sector. And with the rollout of health care reform, a sense of “We have to do something” has emerged in several parts of the market. But that something isn’t what it used to be and that’s throwing up some interesting scenarios.

Yes, consolidation will continue to be primarily horizontal, with sectors such as hospitals, surgery centers and urgent care operators being rolled up into larger and more efficient groups. There are plenty of buyers all over the country but Middle Tennessee-based players figure prominently across the board.

For instance:

• Community Health Systems has in the past year wrapped up deals both big — paying $7.6 billion for Health Management Associates’ 71 hospitals — and small, such as its purchase of Sharon Regional Health System in western Pennsylvania in early 2014. Executives in May said they are planning to pull off one or two more acquisitions this year even as they work to absorb HMA’s operations.

• Acadia Healthcare executives say they still see massive opportunities to build the company, which finished 2013 with revenues of $735 million. Chairman and CEO Joey Jacobs is aiming to get to $2 billion by 2017. In the 366 days spanning Dec. 31, 2012 to Jan. 1 of this year, Acadia wrapped up nine transactions, paying $436 million for 1,370 beds that grew the company by a third.

• AmSurg’s numbers aren’t as eye-popping — the company ran 242 centers at the end of 2013 versus 188 on Dec. 31, 2009 — but the idea is the same. Even though it is the largest player in the ambulatory surgery market, its network accounts for just 5 percent of the roughly 5,400 Medicare-certified ASCs. Narrowing down the market to the company’s preferred gastroenterology, ophthalmology, orthopedic, ENT and urology specialties still leaves AmSurg with a market share of about 12 percent — and a long runway to pursue its measured acquisition strategy.

Those themes will remain largely intact, particularly if operators continue to hit their cost-cutting marks as they generally have. But a second big theme has really taken hold in recent years: In short, it says that the network drives everything and leads to the following thoughts.

Dots on the map aren’t important anymore. It doesn’t feel like that long ago that hospital operators and other consolidators — many of them then and now based in Middle Tennessee — were focused primarily on building scale and the efficiencies that comes with that and not quite so concerned with geographic questions. But a number of big operators, including locals Ardent Health Services and the former Vanguard Health Services, found success by building dense, market-leading networks in a smaller number of markets.

Trey Crabb, managing director in the health care practice of investment bank Ziegler, says “M&A is much more market-specific now,” with most providers squarely focused on filling gaps in their networks or adding facilities nearby. CHS’ activity in western Pennsylvania, for instance, has augmented its big network in northeast Ohio.

Strategic buyers have an advantage. Private-equity firms and other financial backers long competed with pure-play companies, often bidding up prices. Now, the greater attention being paid to network effects is giving strategic bidders a leg up.

“Given the new reimbursement environment moving toward episodes of care, just having additional facilities is not going to win the day,” says Bass Berry & Sims Member Angela Humphreys.

Also playing into that dynamic, Humphreys says, is a sharper regulatory environment. Government agencies have stepped up their scrutiny of proposed deals in a number of ways, which calls for a greater degree of due diligence and a marginal advantage for operators over investment firms.

JVs are often the way to go — for now. Health care payments are migrating toward one payment for one episode of care, even if that care was provided by numerous entities. And while some health systems will buy their way toward a full network, other hospital leaders are realizing that their teams often are not the best at running diagnostic, rehabilitation or imaging businesses even though they need such sub-acute offerings in their networks. The result: Partnerships and affiliations that leave specialties to the specialists but provide for continuity in the delivery of services and the payment for them.

Similarly, the boom in urgent care centers — there are now almost 10,000 locations around the country, with 80 percent of them owned by physicians — has led to a series of tie-ups that have hospital owners scrambling to guard their access to patients without committing a lot of capital to all-out acquisitions.

“The hospitals have realized they don’t need to own 100 percent of these businesses,” says Bill Berrell, director of health care banking at ServisFirst Bank. “They can get a partner who knows that business and still get the patient in the house.”

Today’s relative uncertainty plays into that thinking, too. Why commit to a full-on acquisition if we still don’t really know all the ways in which reform will affect the industry? It remains to be seen how players will react once the dust settles some.

If you’re waiting for lots of insurers to buy lots of providers, be patient. Vertical integration was the Next Big Thing a few years ago. The scenario was to unfold like this: Insurers looking to limit their payouts would bring ever more doctors and hospitals under their umbrellas to closely measure care and add efficiencies. But with few exceptions, that hasn’t happened. Crabb says he isn’t seeing insurers bidding on hospitals he’s marketing, especially in the eastern half of the country.

Think about other ancillary service providers. Many large hospital operators long ago gathered enough scale to develop their own information technology systems. Some, including industry leader HCA Holdings, have marketed those services to others. Other tech-based tasks such as revenue cycle management and prequalification services have spawned many mid-sized ventures that could over time become buyout targets for providers looking to round out their systems.

Similarly, says Crabb, the drive for efficiency could lead to consolidation among nonclinical service companies such as those that handle foodservice or supply linens and other materials. The goal of an all-inclusive network will drive that train, too.

Home health is like community banking. Spend five minutes with two hometown bankers and they’ll tell you three times how the post-crisis regulatory climate has brutalized their bottom lines — and how it’s pushing them toward consolidation. Berrell says the very diffused home health care sector faces a similar dilemma: As providers get tied in more closely to other parts of the system, government agencies are imposing more standards and rules. A big focus area is the use of information technology to track the delivery and quality of care, which comes with a big tab and a need for scale.

Berrell says these trends and others are nowhere near settled. A lot of questions remain to be answered but he says there’s “no question reform is driving behavior” — and that’s generally a good thing when it involves smart operators.

“If you’re making a move to improve care and drive down costs, it’s going to be the right strategy,” Berrell says. “You might be off a bit on the timing here and there, but we’re confident you’ll be well positioned.”

And in line for a slice of the billions that will fund the next big consolidation phase in health care.