The Drive to Merge, Acquire, or Partner

The individual reasons are varied, as are the models, but healthcare leaders continue to look beyond their own organizations to survive and thrive.

This article first appeared in the April 2016 issue of HealthLeaders magazine.

While healthcare reform and the transition to delivering value-based care are pushing merger, acquisition, and partnership (MAP) activity to ever-higher levels, these are not the only factors responsible for driving this growing phenomenon. In fact, increasing momentum for MAP activity is noteworthy both for the range of influences playing a role in its acceleration, as well as the absence of mitigating factors slowing its proliferation.

According to the 2016 HealthLeaders Media Mergers, Acquisitions, and Partnerships Survey, for example, the top financial objective for MAP activity is to increase market share within our geography (70%). However, there is ample support for a range of objectives and the remainder of the top five—improve financial stability (60%), improve operational cost efficiencies (58%), improve position for payer negotiations (57%), and expand geographic coverage (57%)—all have response levels above 50%, indicating that no single objective is responsible for driving MAP activity.

Likewise, the top five care delivery objectives follow a similar pattern: to improve position for population health management (70%) receives the highest response, followed by improve position for care delivery efficiencies (63%), improve clinical integration (61%), gain care delivery cost efficiencies through scale (54%), and expand into new care delivery areas (51%). Note, however, that a reform-related care delivery objective occupies the top spot, so its influence cannot be understated.

"I would say that in every conversation that I have about this, somebody asks me how much did the Affordable Care Act have to do with driving the decisions that this particular group of people made, that this is all in response to healthcare reform and the implications that that poses for people. My observation is that it's possible to make an argument or connect a lot of things back to that, but in our case and in others that I'm hearing, it's not necessarily any one of the elements, but it's all of them together," says Greg Devine, former senior vice president of provider strategies at ThedaCare, an Appleton, Wisconsin–based nonprofit health system, and current president and CEO at AboutHealth, a Wisconsin-based clinically integrated network.

MAP activity levels
Without question, survey respondents are bullish on the prospects for higher levels of MAP activity. Seventy-five percent of respondents say they will either be exploring potential deals or completing deals that are underway in the next 12–18 months, and only one in four respondents (25%) say they have no MAP plans. Further, nearly two-thirds of respondents (63%) say that their organization's MAP activity will increase within the next three years, and only 3% say it will decrease. Thirty-three percent say it will stay the same.

Another barometer of MAP activity is the total dollar value of the mergers and acquisitions that respondents say their organizations will be exploring over the next three years. While this year's survey results are comparable to last year's, there is a small shift to a higher total dollar spend on mergers and acquisitions. The $50 million–$99.9 million range is up three points to 17%, and $100 million–$499.9 million is up five points to 21% compared with last year (for a combined eight-point increase), while the lower $10 million–$49.9 million range is down nine points to 23%.

Interestingly, respondents indicate that it is not only total MAP spend that is increasing, but also the size of the deals being pursued. Nearly half of respondents (49%) say that they expect the dollar value of the mergers and acquisitions their organization will be pursuing within the next three years will increase, and only 5% say the value will go down. Sixteen percent say it will remain even.

Factors driving MAP activity
As mentioned earlier, the reasons behind the high rate of MAP activity range from traditional considerations such as the need for increased market share, improved scale, and increased financial stability, which are more tactical in nature, to more strategic and far-reaching factors such as anticipating the impact of the Affordable Care Act and the transition to value-based care.

For example, survey respondents who have considered or are considering a merger, acquisition, or partnership with another organization were asked about the main reasons for doing so. Two-thirds (66%) say that supporting sustainability of their long-term mission is the main reason for considering a MAP with another organization, an indication that providers are mostly thinking strategically when engaged in this activity. Note that expanding market share (55%) and improving scale (49%) rounded out the top three responses, suggesting that tactical considerations also play an important role in provider strategy.

Respondents were also asked about the considerations they thought were most important to their organization when considering a merger, acquisition, or partnership. Mission/cultural compatibility of organization (73%) is the top consideration, while strength of new organization's network (56%) was the No. 2 response, which reflects the importance of expanding clinical reach to improve volume, scale, or expansion of care continuum capabilities.

One thing to remember is that not all providers are alike—each organization has its own unique set of circumstances that may ultimately lead them down the path to seeking a merger, acquisition, or partnership. Advisors to this Intelligence Report suggest that attributing increased MAP levels to the Affordable Care Act and value-based care alone provides an incomplete picture of the forces at work.

"The Affordable Care Act is certainly driving some of it," says Paul Tait, chief strategic planning officer for University Hospitals, a Cleveland-based nonprofit health system. "But there's usually a financial reason, which is the catalyst, and there's a couple different elements to that. One is that there's a lot more capital availability for acquisitions these days—and with lower interest rates—so if you're a larger, well-established health system, then you probably can borrow money at a reasonable rate.

"On the other side of it, I think with a lot of the hospitals that are linking up, it's because they need access to capital or they need new investment. And in some cases, they're just running out of money. There's an awful lot of financial margin pressure on hospitals, and I think that's just going to get worse because of the payment changes that have already started and will accelerate. So as you see more of a move to value-based payment, some organizations aren't going to be able to deal with that very well and they're going to end up with even more pressure on their margins."

Tait points out that increasing scale is a key driver of increased MAP activity because of the range of its many benefits. "You obviously get greater purchasing scale with vendors; you end up getting larger volume discounts and better rebates and all those things. You can leverage all of your business functions across a broader system and more revenue, so they become more efficient. You can leverage corporate functions, and it also improves your leverage with health plans when you're negotiating managed care contracts.

"If you have more scale, you can also afford to recruit more doctors. And you become more attractive for physicians that are looking to be employed because, if you're a larger health system, you're probably going to offer them more opportunities to grow their practice and you're more stable as an employer. And then, if you think about population health, you're spreading risk over more lives."

Devine agrees that many organizations are pursuing mergers and acquisitions to achieve increased scale, and that scale is an important element of population health strategy.

"There's a belief that there's a certain scale that's necessary to be competitive and to be able to afford investments in either process design or technology, or the ability to buy goods and services. And that target of what's the necessary scale is sort of a phantom number. It appears that people are making it bigger all the time. But I think it's the notion of scaling population health to the extent that that becomes linked to managing risk in a population, and this becomes relevant because you have to have a certain scale to that population. I think most people would argue to be able to manage that risk effectively, price it, and manage it, you need scale."

Dave Krajewski, chief financial officer of LifeBridge Health, a Baltimore-based nonprofit health system, explains the drivers behind MAP activity this way. "There are two reasons that come to mind. One is the need to expand and do more than just what we typically did as a hospital system. As we're being held accountable for the total cost of care for patients, and we are entering into risk-based arrangements, we need to have a degree of influence over what happens in the physician office, what happens at the nursing home, and what happens at an urgent care center or an ambulatory surgery center because that care increasingly ends up being, in aggregate, a larger chunk of the healthcare pie than what happens at hospitals.

"On the nonhospital side, what you're seeing is hospitals and other provider organizations acquiring parts of the rest of the continuum of care so they can more readily control and influence the total cost of care. That's why you're seeing a pickup in hospitals acquiring physician practices, or hospitals doing joint ventures with urgent care centers or nursing homes," he says.

"On the hospital side, you're looking at an era where utilization, at least in the state of Maryland, is going to be going down per capita and not up for hospitalizations. And I think what you're seeing is hospitals trying to beef up a little bit, knowing that their scale is going to diminish over the next 10 years or so," Krajewski says.

Organizational types
According to survey respondents, the top three entities involved in their most recent merger, acquisition, and/or partnership are health systems (29%), hospitals (25%), and physician practices (20%).

Interestingly, responses for retail clinic/urgent care clinic (3%) place well down the list. This is somewhat surprising given the current focus by many providers on growing their ambulatory/outpatient networks, but growth in that area is expected.

Looking to the future, respondents were also asked to identify the organizations that they had a high interest in pursuing through a merger, acquisition, or partnership within the next year. The top five responses are: physician practices (61%), health systems (41%), hospitals (39%), physician organizations (34%), and retail clinics/urgent care clinics (26%).

Results for this question are illuminating. While physician practices are the entities mentioned third most frequently as the most recent MAP target, the level of response for physician practices jumps 41 points for the coming year, making it the top response for MAP activity within the next year. The response for physician practices is also up 11 points over last year's survey result for activity expected in the coming year. The strong interest in physician practices is likely because primary care physicians are a key component of the continuum of care, and play an increasingly important role in population health management and clinical integration.

Also noteworthy is the level of response for retail clinics/urgent care clinics in the coming year. The response is up 23 points to 26% compared with most recent activity, and demonstrates the high level of interest providers have in expanding their outpatient/ambulatory care networks.

According to Devine, the high level of MAP activity involving physician practices indicates the key role that primary care physicians play in the continuum of care, making them attractive acquisition targets. As a result, providers in some areas of the country are facing tight supplies of physicians.

"I would say particularly in Wisconsin—I don't even know if there's 1% of the primary care physicians in Wisconsin anymore that are not part of some large, integrated system. So particularly at that primary care level—I think the models change with the specialty practices—I think it's not for the sake of ownership or control that's driving this. It really is being driven by the need to align the various elements of the continuum of care around delivering better outcomes and waste elimination," he says.

"And it's really important that whoever you define as your team generally shares those commitments to those outcomes and those standards. If you can't do that in a contractual relationship, oftentimes you're compelled to look at alternatives. The issue appears to be growing—at least in the markets that I'm aware of—and the challenges are greater especially in rural communities. If you step back and look at the country, there's an awful lot of rural communities that are probably pressed to fill those needs," Devine says.

Tait agrees, and explains the financial ramifications of the problem. "We're seeing some providers that are just having a terrible problem with their physician networks. We've seen a number of community hospitals that have been unsuccessful replenishing their medical staff as people leave or as people retire. In some cases, they may have lost physicians to competitors in their local market, and if they try to employ some doctors, they don't have the scale to do it well. It's very common for us to see a single community hospital that might be trying to employ anywhere from 15 to 30 doctors, and they're losing over $200,000 per doctor."

Krajewski explains that for LifeBridge Health, physician practice acquisitions started out as a strategy for growing scale for contract negotiation purposes. Eventually, however, its focus evolved into building a network to support population health initiatives.

"Originally, we started looking at physician practices probably five or more years ago. It was more about leverage in the marketplace, making sure that down the road, we wouldn't be cut out of contracts. Our belief was that we weren't the largest hospital system in the state, but if we had a very large base of primary care doctors and specialists, that we would become indispensable from a contracting standpoint. So originally it started with that thought process in mind, but then as the Affordable Care Act hit, it became a population health play as well."

Merge, acquire, or partner?
Respondents were asked to describe the nature of their most recent MAP activity. The top response is acquisition of one organization by another (38%), followed closely by a contractual relationship, but not M&A (33%). A merger of two organizations into one (9%) received the lowest response. In a follow-up question to those who had selected a non-M&A contractual relationship, respondents were asked to describe that model, and affiliation, collaboration, or alliance (46%) and professional service agreement (31%) received the top two responses. This is likely because these contractual relationships are simpler, more flexible, and require less commitment than joint operating agreements (14%) and joint ventures with change of ownership (6%).

Tait says that, while he expects MAP activity in general to remain steady over the next few years, he thinks the rate of non-M&A partnership activity will probably increase because it is typically less expensive than a merger or acquisition, and it doesn't require an exchange of assets or a change of local governance.

"You're seeing a lot more innovation in terms of the way people structure relationships and affiliations and partnerships. It isn't always just straight merger or acquisition," he says.

"First, I think the reason some of these non-ownership models come together is less capital is required or no capital is required, depending on what you're doing and the scope of the agreement. Second, there's still the sense of maintaining local control. So you can get into an affiliation or a partnering agreement, and you may still retain your local governance and your local control," Tait says. "And probably a third broad reason is, people structure these partnerships for a more narrow purpose, meaning they're not trying to integrate everything. They may be trying to collaborate or integrate in a particular area or a particular service line."

When good deals go bad
When providers enter into MAP discussions, there are no guarantees that a formal agreement will eventually come to pass. There are a variety of hurdles that have the potential to derail the initiative.

Concern about the assumption of liabilities (29%) is the top financial reason for a deal not proceeding before or during the due diligence phase, and it was the top reason in last year's survey (28%). The extent of a target organization's financial liabilities may not be apparent until the due diligence phase is completed, which may explain why this can be a deal-breaker. Concern about risk/revenue sharing (23%), concern about price (22%), and regulatory issues (20%) round out the top four responses. Regulatory issues had the greatest increase in response compared with last year's survey—up 8 points. Advisors mention the complexity of deals that cross state lines as a potential source of regulatory trouble.

Incompatible cultures (35%) and concern about governance (33%) are the top operational reasons for a deal not proceeding, and these were the top two responses in last year's survey. The response for mistrust between parties (24%) places it in the top three.

Krajewski says that organizational culture is one of the core elements that it considers when looking to partner or acquire. "For us, it really becomes assessing whether the organization you're looking at, the hospital you're looking at, has a similar culture, a similar direction, and a similar set of goals. Whether everything's lining up together, and then convincing the other organization that, 'Hey, you know, we're on the same path; we might as well join forces, add some scale, and help out with the economics. And maybe complement each other's strengths and weaknesses related to clinical care and the continuum.'

"We use the term aligned autonomy a lot around here," Krajewski says. "As an example, we'll go into an acquisition with a physician practice with the idea that they're going to still continue having a large degree of autonomy, but before we do the acquisition, we make sure that that autonomy is aligned with the direction we have at LifeBridge."