Mergers and acquisitions within the healthcare sector show no signs of slowing down. Although healthcare M&A rates fell slightly in 2014 compared to 2013, industry experts remain optimistic about the M&A outlook for 2015.
But beware. Deals can go bad for numerous reasons, such as when the parties emphasize the wrong goals, fail to conduct proper anti-trust reviews or simply because the cultures of each organization are so different.
Indeed, if history is an indicator, most of these partnerships will fail, according to James Orlikoff, president of Orlikoff & Associates Inc., a Chicago-based healthcare consultancy.
There are two major mistakes providers tend to make during the M&A process, according to Paul Keckley, Ph.D., (pictured right), managing director at the Navigant Center for Healthcare Research and Policy Analysis.
The first is "not as accurate, deliberate and judicious assessment of the operating risk of the organizations when they come together, that typically involves people, roles, functions… it involves technologies [and] the degree to which there's compatibility," Keckley told FierceHealthFinance in an exclusive interview.
The second, he said, "involves post-deal integration. The value created from combinations is typically when the sum of the parts equals something more. What usually happens is the post-merger integration fails to live up to the expectations or even the rationale on which the deal was sold to the respective boards. The classic example is you thought there was going to be a lot of synergies… and a lot of the time, the synergies are not realized."
In this special report, FierceHealthFinance takes a look at why some healthcare deals don't work so hospital leaders can avoid repeating these mistakes.
St. Luke's and Saltzer Medical Group of Idaho
Sometimes, a cultural mismatch has nothing to do with why M&As go wrong. Take for example the recent high-profile case of St. Luke's Health System of Boise, Idaho and the Saltzer Medical Group, the state's largest independent physician group.
In late 2012, the nonprofit hospital system, arranged to buy the Nampa-based physician's practice, in an attempt to improve healthcare delivery in the area by integrating care across all settings. But in 2013 the Federal Trade Commission joined Boise's Saint Alphonsus Health System, Treasure Valley Hospital and the state attorney general to file a complaint that claimed the deal violated antitrust laws, eliminated competition for primary care in the Nampa area and would raise healthcare costs.
Last January, U.S. District Judge B. Lynn Winmill ruled in favor of the plaintiffs, acknowledging that the acquisition would improve local healthcare delivery but writing that "there are other ways to achieve the same effect that do not run afoul of the anti-trust laws and do not run such a risk of increased costs."
St. Luke's appealed the ruling, but in February, Judge Andrew Hurwitz upheld the decision, stating the purchase violated the Clayton Act, which bars M&A that would create monopolies, and that claims it would improve care delivery were immaterial.
"That is a laudable goal, but the Clayton Act does not excuse mergers that lessen competition or create monopolies simply because the merged entity can improve its operations," he wrote.
The health system petitioned the Ninth Circuit for a rehearing before a full panel of judges, but the request was denied last week. St. Luke's must now either unwind the acquisition or appeal the decision to the Supreme Court.
The ruling should serve as an example to other systems considering integration, David A. Ettinger of Honigman Miller Schwartz and Cohn LLP, which represented St. Alphonsus in the suit, told FierceHealthcare in January. Healthcare organizations must consider the anti-trust implications of an acquisition that results in high market shares, he said, and "they must also realize that when they purchase a primary care group, patients are loyal to their physicians and expect to see their primary care physicians in a convenient location."
Furthermore, Keckley told FierceHealthFinance, regulatory risk is always a major hurdle to clear during the M&A process as it leads to situations like St. Luke's experienced. "The "yin-yang going on in Idaho right now … all of that is regulatory, and that becomes pretty challenging when you ask for a private letter or you ask for an opinion and you find out that an opinion can change," he said.
There can be post-merger complications as well, Keckley said, but "typically that stuff stays pretty quiet… you don't hear as much about that, because no one wants to admit 'I promised you I could save 2 percent in my operating costs and then a year later it's only a percent."
Prime Healthcare and Daughters of Charity Health System in California
Meanwhile, the more recent case of Prime Healthcare is an example of how regulatory issues can erode a M&A without actively blocking it, as in the case of St. Luke's and Saltzer.
When the Southern California-based for-profit chain announced a bid for six struggling hospitals operated by the Catholic Daughters of Charity system, it was bound to be controversial from the start; California Attorney General Kamala Harris had already blocked two other bids by the chain to acquire other properties, arguing its business practices would not benefit the community. Prime and its founder, Prem Reddy, M.D., have developed a reputation for cutting costs at the expense of necessary services, not to mention an ongoing investigation over claims of Medicare overbilling.
In February, Harris approved the $843 million deal, but announced more than 300 conditions; among them, Prime would have to maintain the six facilities for at least the next 10 years, providing the same levels of charity care and specialty services, along with continuing to guarantee employee benefits and pensions. These conditions prompted Prime to back out of the deal, calling the conditions, which they estimated would cost more than $3 billion over the 10-year period, "unprecedented."
Daughters of Charity President and CEO Robert Issai disagreed that the conditions were burdensome enough to justify calling off the entire deal. "Simply put, we disagree with their assertion the conditions were onerous," he told the San Francisco Chronicle in March.
The hospitals' financial straits are common in the industry, and have been a driver of M&A activity independent of the Affordable Care Act, Keckley told FierceHealthFinance. Integration involving two hospitals or hospital systems, rather than a hospital and a physician practice, is "something that's been really the result of shrinking operations margins more than it has been the Affordable Care Act," he said. "Since Medicare is the primary payer for the inpatient business for most hospitals, hospitals have been merging as a result of declining operating margins more than as a result of the ACA."
Since Prime's withdrawal, several other providers have expressed interest in some or all of the nearly-bankrupt Daughters of Charity facilities, such as Hospital Corporation of America, as well as New York private equity firm Blue Wolf Capital, which lost out on the facilities during the initial bidding process. Harris emphasized that the conditions that cratered the acquisition would not be the same for all other potential buyers.
"Each case is unique to its facts," she said. "The offer we made to Prime was unique and tailored to Prime."
Tenet Healthcare and Eastern Connecticut Health System
Prime's decision to abandon the deal is not unprecedented. In late 2014, Tenet Healthcare, a major Dallas-based for-profit hospital chain, backed out of its proposed acquisition of five financially struggling Connecticut hospitals, citing strict staffing and pricing guidelines the state's Office of Health Care Access imposed for one of the facilities, Waterbury Hospital.
These requirements "led us to conclude that the approach to regulatory oversight in Connecticut would not enable Tenet to operate the hospitals successfully for the benefit of all stakeholders," Tenet said in a statement.
The aborted deal left Eastern Connecticut Health System, which owns the five hospitals, scrambling for an alternate buyer, sending proposals to four potential in-state buyers in the next 48 hours. "I would say in two to three years there would be a threat to our long-term survival if we don't partner with someone," said CEO Peter Karl. Eastern Connecticut owns nearly 20 percent of the Constitution State's 29 acute care facilities.
Another of the facilities up for acquisition, Bristol Hospital, hopes to maintain its status as an independent provider while developing its partnership with Yale New Haven Health System, the Hartford Business Journal reports. The failure of the Tenet deal has left Bristol increasingly reliant on foundation fundraising and the Yale partnership.
Yale New Haven is currently developing an accountable care organization called Total Health, and Bristol CEO Kurt A. Barwis hopes the hospital's participation will improve both quality of care and revenue, according to the article. Under the terms of their partnership, Yale and Bristol will collaborate on supply purchasing and certain clinical service lines such as urology and cancer care.
Proceed with caution
Some healthcare experts, meanwhile, caution that the consolidation trend itself may be a cautionary tale, according to the Wall Street Journal.
The incentives for consolidation in a post-ACA world may create a landscape of healthcare monopolies that are "too big to fail," hence stringent oversight of the M&A process, such as Harris' stipulations for the abandoned Prime deal.
"When you're the only game in town, you call the shots," wrote Marty Makary, M.D., a surgeon at Johns Hopkins Hospital and a professor of health policy at the Johns Hopkins Bloomberg School of Public Health, in the Journal.
"We can encourage the good work of hospitals to create networks of coordinated care, while at the same time insist that hospitals compete on price and quality outcomes."