Strategic Partnerships

This article first appeared in the April 2017 issue of HealthLeaders magazine.

The steady march of merger, acquisition, and partnership (MAP) activity shows few signs of abatement, and the long list of factors contributing to healthcare industry consolidation—healthcare reform, the move to value-based care, and provider needs for greater scale and geographic coverage, to name just a few—continue to reshape the industry landscape.

However, unlike with last year's HealthLeaders MAP survey, we can no longer say that there are no mitigating factors with the potential to slow MAP activity. With a new administration in Washington promising to make significant changes to the healthcare industry, notably to repeal and replace the Patient Protection and Affordable Care Act, substantial change appears to be in the wind, and has the potential to bring a pause in MAP activity as providers await greater clarity from the administration.

According to the 2017 HealthLeaders Mergers, Acquisitions, and Partnerships Survey, for example, more than half (54%) of respondents say there are no changes to their organization's MAP plans because of the incoming Trump administration. Another 19% say they are putting some things on hold until they know more, and 9% are revising and updating some plans. No respondents (0%) say that their organization is making extensive changes to its plans.

"I don't think there's enough clarity out of the administration on the healthcare front to be able to pivot yet, and it's been such a short period of time that I'm not surprised to see people waiting to know more before reacting," says Kevin Griffin, MBA, senior vice president of financial planning and analysis at Novant Health, a nonprofit integrated healthcare network with 2,655-licensed beds, 14 medical centers, and approximately 1,500 physicians in more than 500 locations, based in Winston-Salem, North Carolina, and the lead advisor for this Intelligence Report.

Case for continued MAP growth
While 19% of respondents in our survey say they are putting some things on hold until they know more about the Trump administration's plans, several other survey data points reflect little if any diminishment in MAP appetite.

For example, 87% of respondents say that their organization's MAP plans for the next 12–18 months involve either exploring potential deals or completing deals underway, or both. The breakdown: 40% of respondents say that their organization will be both exploring potential deals and completing deals underway, 34% say they will be exploring potential deals, and 13% say they will be completing deals underway. Only 13% of respondents say they have no MAP plans, which is down 12 percentage points from 25% in last year's survey. These results indicate a continued positive trend for MAP activity.

Further, 61% of respondents expect their organizations' MAP activity to increase within the next three years, and 32% expect this to remain the same. Only 6% expect MAP activity to decrease, indicating that the overall trend will likely continue for some time. These results are nearly identical to last year's survey results, which were increase (63%), remain the same (33%), and decrease (3%).

A close examination of the data reveals that a greater share of physician organizations (67%) than health systems (61%) and hospitals (56%) expect MAP activity to increase, and a greater share of hospitals (41%) than health systems (30%) and physician organizations (27%) expect this activity to remain the same.

In addition, based on net patient revenue, a greater share of large organizations (72%) than small (55%) and medium organizations (54%) expect MAP activity to increase, and a greater share of medium (42%) and small organizations (37%) than large organizations (19%) expect this activity to remain the same.

Interestingly, there are some regional differences in expectations for MAP activity. For example, a greater share of respondents who say they expect MAP activity to increase are from the West (82%) than from the South (57%), Midwest (53%), and Northeast (53%), and a greater share of respondents who say they expect this activity to remain the same are from the Midwest (47%) than from the Northeast (37%), South (35%), and West (12%). Note that a greater share of respondents who say they expect this activity to decrease are from the Northeast (10%) and South (9%) than from the West (6%) and Midwest (0%).

Increases in MAP dollar value
Another indicator of MAP activity is the cumulative total dollar value of the mergers and acquisitions respondents say their organizations will be exploring over the next three years . While this year's results are relatively comparable to last year's survey, there appears to be a slight shift toward lower cumulative total dollar value. The shift becomes apparent when you aggregate some of the results, with the less than $50 million range being eight percentage points higher (61% versus 53%) than last year, and the $50 million and more range being eight percentage points lower (39% versus 47%).

However, while cumulative total dollar spend may be declining slightly, the survey results also indicate that the majority of respondents (55%) expect that the size of the merger and acquisition deals their organizations will pursue within the next three years will increase. Approximately one-third (34%) expect the dollar value to remain even, and only 12% expect the dollar value to decrease.

Looking into the data further, a greater share of physician organizations (68%) than hospitals (48%) and health systems (48%) expect the dollar value of the mergers and acquisitions their organization will be pursuing to increase, and a greater share of hospitals (44%) than health systems (35%) and physician organizations (25%) expect the dollar value to remain even. In addition, a greater share of health systems (17%) than hospitals (8%) and physician organizations (7%) expect the dollar value to decrease.

Based on net patient revenue, a greater share of small organizations (61%) than large (48%) and medium organizations (46%) expect the dollar value of the mergers and acquisitions their organization will be pursuing to increase, and a greater share of medium (46%) and small (34%) organizations than large organizations (22%) expect this to remain even. In addition, a greater share of large organizations (30%) than medium (8%) and small organizations (5%) expect the dollar value to decrease.

MAP organizational preferences
Survey responses indicate that the top three entities involved in respondents' most recent MAP activity are health systems (27%), physician practices (27%), and hospitals (20%), which represents 74% of the total MAP activity.

Interestingly, responses indicate that providers favor MAP activity with a provider from the same or a similar setting. For example, a greater share of health systems (35%) than hospitals (26%) and physician organizations (10%) say that their most recent MAP activity is with another health system, and a greater share of physician organizations (48%) than health systems (25%) and hospitals (16%) mention activity with physician practices. Further, a greater share of hospitals (37%) than health systems (17%) and physician organizations (7%) cite activity with another hospital, and a greater share of physician organizations (21%) than health systems (5%) and hospitals (3%) mention activity with another physician organization. These responses appear to indicate that providers have a preference for increasing scale along similar lines of business, and that increasing infrastructure diversity throughout the care continuum is currently a secondary strategy.

Looking forward to the next year, more than half of respondents (59%) say that their organization has a high interest in pursuing a physician practice through a MAP. The response for this type of entity is followed by a second tier of tightly clustered responses, including physician organization (30%), health system (27%), and hospital (26%). The strong response for physician practices is likely because primary care physicians are a key component of the continuum of care, and will play an increasingly important role in population health management and clinical integration efforts in the years to come.

Griffin suggests that, besides population health management and clinical integration efforts, there is another factor behind the high levels of physician organization interest in pursuing physician practices and other physician organizations.

"My hypothesis is that physician practices that wanted to be affiliated with health systems have largely happened by 2015 or 2016 in major markets, and I think the physician groups that are left are ones that generally don't want to be part of health systems. They value their independence, but my guess is they may not have the scale to compete against other physician groups or against the employed physician groups in the health systems. So these independent groups are starting to band together to build scale against the health systems in order to be able to compete with them.

"I think the low-hanging fruit for the healthcare systems has probably been harvested by now, and so the folks that are left and potentially able to do deals are probably fiercely independent. I would guess these are largely specialty groups as opposed to the primary care folks."

Objectives of MAP activity
Respondents indicate that the range of objectives driving their organizations' MAP planning or activity is exceptionally broad in nature. For example, nearly three-quarters of respondents (74%) report that the primary objective of their organizations' overall MAP planning or activity is both financial/operational and clinical/care delivery equally. Sixteen percent say that the primary objective is financial/operational and only 8% say that it is clinical/care delivery.

"Obviously, they're both critically important," says Griffin. "But I'm not surprised to see financial/operational a little bit more important right now, because it's always staring you in the face every day. Everyone is aware of the transition to value-based care and population health, but they're not living in that world every day yet, at least to the same extent that they're dealing with the fee-for-service, financial/operational, blocking-and-tackling world."

Looking at financial objectives specifically, respondents say that increasing market share within their geography (67%) is the top financial objective of their organizations' overall MAP planning or activity. However, there is a large group of responses in the second tier, suggesting that no single objective is responsible for driving MAP activity. This second group includes expanding geographic coverage (58%), improving financial stability (58%), improving position for payer negotiations (54%), and expanding position in care continuum (53%).

It probably comes as no surprise that a greater share of health systems (75%) than hospitals (62%) and physician organizations (59%) say that increasing market share within their geography is the top financial objective of their organizations' overall MAP planning or activity. Note that, while this is the top activity for health systems and hospitals, improving financial stability (74%) is the top activity for physician organizations.

Further, a greater share of health systems (70%) than physician organizations (53%) and hospitals (49%) mention expanding geographic coverage as being among the financial objectives of their organizations' overall MAP planning or activity. While this is the second-ranked activity for health systems, the second-ranked activity for physician organizations (68%) and hospitals (58%) is improving their position for payer negotiations.

According to respondents, the top three care delivery objectives of their organizations' overall MAP activity are improving position for population health management (69%), improving clinical integration (66%), and improving position for care delivery efficiencies (64%).

Griffin says that Novant Health is currently fine-tuning its strategy to focus on tactics other than just market share acquisition and building scale. "We're moving to things such as expanding geographic coverage. This would probably be our No. 1 goal in getting into other markets—while we do want to take market share in our markets, M&A is not necessarily going to drive that. But getting into expanded geographic coverage for diversification purposes, for population health purposes, that's going to be really important for us."

Notably, a greater share of health systems (75%) than physician organizations (68%) and hospitals (64%) mention improving their position for population health management as among the care delivery objectives of their organizations' overall MAP activity. Further, based on net patient revenue, a greater share of medium organizations (76%) than large (71%) and small organizations (64%) mention improving their position for population health management. Last, a greater share of nonprofit organizations (75%) than for-profit organizations (57%) cite this as well.

MAP activity type
Respondents were asked to describe the nature of their most recent MAP activity. The top responses are an acquisition of one organization by another (37%), a contractual relationship, but not M&A (33%), and a merger of two organizations into one (10%). Only 14% of respondents say that their organization has had no activity. Note that non-M&A partnerships are expected to grow over the next few years because it is typically less expensive than traditional M&A and doesn't require an exchange of assets or a change of local governance.

"I do think health systems and hospitals understand that they need to do something but don't want to give up control and financial flexibility at this time," says Griffin. "For example, we have a shared services division that provides management services and other services for about eight or nine hospitals around the Southeast, and I think those folks know they need some help but aren't yet ready to raise their hand and lose local control. And I think many health systems and hospitals have started going down that road a little bit by creating soft relationships maybe to position themselves for what they may need to do but aren't ready to pull the trigger on yet."

Interestingly, M&A activity based on the acquisition of one organization by another is correlated with organizational size. For example, based on net patient revenue, a greater share of large organizations (50%) than small (36%) and medium organizations (31%) mention this kind of activity. Organizational size is also correlated with a merger of two organizations into one, with a greater share of large organizations (18%) than small (7%) and medium organizations (7%) citing this activity. This is likely because larger organizations have the necessary financial resources to support such transactions.

Among respondents who mention a contractual relationship, but not M&A, the top responses for contractual relationship types are affiliation, collaboration, or alliance (47%); joint operating agreement (21%); and professional service agreement (17%). Other joint venture (8%) and joint venture with change of ownership (6%) complete the list of responses.

Note that affiliation, collaboration, or alliance likely receives a high response because this type of agreement is simpler, more flexible, and requires less commitment than a joint operating agreement or joint venture with change of ownership.

Why MAP deals fall apart
When providers enter into MAP negotiations, there are no guarantees that a formal agreement will be concluded. In fact, there are a number of ways that a potential deal can be derailed.

For example, approximately one-quarter (23%) of respondents say that concern about assumption of liabilities is the top financial reason that a MAP involving their organization was abandoned before or during the due diligence phase Note that the full extent of a target organization's financial liabilities may not be apparent until the due diligence phase is completed, which may explain why this important aspect plays a major role as a deal-breaker.

Rounding out the top financial responses for abandoning a deal were concern about price (20%) and regulatory issues (18%). It is worth mentioning that 18% of respondents report that their organization did not abandon the negotiations.

Respondents say that the top operational reasons that a MAP involving their organization was abandoned before or during the due diligence phase was concern about governance (30%), incompatible cultures (27%), mistrust between parties (23%), and concern about the operational transition plan (21%). Only 9% of respondents say that their organization did not abandon negotiations.

Digging into the data reveals that a greater share of physician organizations (58%) than health systems (25%) and hospitals (17%) mention shared governance, and a greater share of hospitals (37%) than physician organizations (29%) and health systems (22%) cite incompatible cultures. Further, a greater share of physician organizations (38%) than hospitals (17%) and health systems (16%) mention concern about the operational transition plan.

Importance of an aligned culture
While there are many financial and operational challenges to overcome during any MAP negotiation, perhaps the most important aspect during the due diligence phase is determining whether alignment exists between the cultures of the respective organizations. Without alignment, a MAP will be destined for failure.

Griffin outlines some of the key considerations. "One, is the management team compatible and do they think about delivering care, which, in our case, we call 'delivering the remarkable patient experience.' Do they believe in that every day? And second, is everyone aligned in what we're trying to do? That, at the end of the day, we're a not-for-profit mission-driven organization just like they are."