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54 Transaction & Valuation Issues In the past year, numerous hospital and health system deals were announced, including several "mega-mergers" such as Franklin, Tenn.-based Community Health Systems' acquisition of Health Management Associates in Naples, Fla. This year, as many of the PPACA's major provisions take effect, hospitals and health systems will continue to consolidate. Industry experts predict non- ownership collaborations will rise in popularity, while healthcare leaders become more strategic and selective in deciding who they choose to partner with or acquire, among other trends. Looking forward to the rest of 2014, here are 10 healthcare transaction trends and facts to keep in mind. 1. Hospital and health system transaction activity will likely slow slightly in 2014. Although 2013 was a busy year in the healthcare M&A world, hospital transaction activity will probably decelerate slightly this year as providers concentrate on refining their existing operations to cut costs and increase quality. M&A activity already dropped in the fourth quarter of 2013, according to a report from Irving Levin Associates. The hospital sector saw a 35 percent decline in transaction volume, from 34 deals announced in the fourth quar- ter of 2012 to 22 in the fourth quarter of last year. Deal volume also declined 8.3 percent from 24 deals in the third quarter of 2013. Eighty deals were an- nounced during the first 11 months of 2013, compared with 96 made in the first 11 months of 2012. Joseph Cerreta, assistant vice president of Juniper Advisory, says the per- ceived level of activity in the market has also been "somewhat inflated by the fact that hospital and health systems are being more transparent about exploring their strategic options than they were willing to admit publicly in the past." "While transaction volumes have still yet to reach the levels that were seen in the late '90s, more and more organizations are proactively assessing their ability to remain independent, which creates the illusion that more consoli- dation is actually taking place," he says. Still, Carsten Beith, managing director of the healthcare investment banking firm Cain Brothers & Company, says he and his colleagues are seeing higher hospital and health system transaction volumes. "I expect that over the next five years significant consolidation will continue at unprecedented levels," he says. 2. Mega-merger activity characterized 2013 but may not be as prominent in 2014. Last year, several health systems announced their intentions to combine and create large, multihospital networks in "mega- mergers." These deals included the CHS-Health Management merger, a transaction valued at $7.6 billion — $3.9 billion in cash and stock and the assumption of $3.7 billion of Health Management's debt. The merger makes CHS one of the biggest hospital systems in the country, with 206 hospitals in 29 states. Dallas-based Tenet Healthcare Corp.'s acquisition of Nashville, Tenn.-based Vanguard Health Systems — valued at $4.3 billion — was another high- profile deal. Tenet now owns and operates 77 acute-care hospitals, 173 am- bulatory surgery centers and outpatient facilities, five health plans and six accountable care organizations. Last May, Mich.-based Trinity Health and Newtown Square, Pa.-based Cath- olic Health East merged, creating an organization that encompasses 82 hos- pitals across 21 states, assets of more than $19 billion and annual operating revenue of $13.3 billion. Although standalone hospitals will continue to join larger healthcare organi- zations to stay afloat and ensure market relevance, an Irving Levin Associates report issued in October 2013 stated there likely wouldn't be any more mega- mergers in the near future. However, not everyone agrees with that forecast. Mr. Beith of Cain Broth- ers says he knows of a number of organizations engaged in discussions that would lead to mega-mergers and expects to see several more deals of this type during the next few years. Mr. Cerreta says despite the recent large-scale transactions, the hospital in- dustry remains "extremely fragmented." "Even with the several 'mega-mergers' in 2013, the ten largest hospital sys- tems combined still only account for between 15 percent and 20 percent of the total industry revenue," he says. 3. Nonprofit hospitals and health systems in particular will con- tinue to consolidate. Various factors such as the transition to value-based payments, more risk-based contracting and Medicare payment cuts are straining the finances of nonprofit hospitals and health systems in particu- lar. Standard & Poor's Ratings Services, Fitch Ratings and Moody's Investors Service have issued negative forecasts for nonprofits in 2014. As nonprofits seek to stay strong and strategically position themselves in their markets, strategic advisory and investment banking firm Hammond Hanlon Camp has predicted they will continue to seek out mergers, acquisitions and other types of transactions. They have already been responsible for a consid- erable chunk of healthcare M&A activity; of the 94 hospital and health sys- tem transactions in 2012, 60 percent of them took place among nonprofits. However, according to Mr. Beith of Cain Brothers, it's important to keep in mind that 80 percent of hospitals are nonprofits, meaning they are less active proportionately. All five hospital sector deals announced in November 2013 involved non- profit acquirers and targets, reflecting a trend of nonprofit health systems and standalone hospitals joining larger organizations to stay afloat, according to Irving Levin Associates. However, Newpoint's Mr. Lupica is skeptical of trend-spotting in the nonprofit arena. "When dealing with a vital element in the social fabric of their communities, fiduciaries decide to affiliate – or stay independent – for a variety of reasons," he says. "Calling a group of fiduciary decisions a 'trend' comments on history more it really predicts the future." 4. "Troubled sales" transactions are declining as healthcare or- ganizations become more selective. Transactions driven primarily by one organization's financial distress and inability to remain independent seems to be drawing to a close, although those types of deals continue to take place, according to Hammond Hanlon Camp. Instead, hospitals and health systems are approaching transactions with the main goal of proactively posi- tioning themselves in their markets. Mr. Cerreta of Juniper Advisory affirms this observation: "We are seeing more hospitals and health systems acting from a position of strength while searching for a partner. Without a burning platform, these organizations are able to leverage their strength to execute on a broader range of transaction models." Furthermore, Mr. Beith of Cain Brothers says strategically driven transac- tions are "substantially more appealing" to buyers. 5. Hospitals and health systems employ a variety of transaction models. As hospitals and health systems take a more strategic approach to transactions, they can choose to structure deals in a variety of ways depend- ing on their objectives and the internal and external constraints that exist, according to Holly Carnell, JD, an associate at the law firm McGuireWoods, McGuireWoods Partner Bart Walker, JD, and Jordan Shields, vice president of Juniper Advisory, an investment bank that works exclusively with hospitals and health systems. A transaction can take the form of an asset purchase, which generally in- volves a for-profit buyer and nonprofit seller. This model limits the buyer's legal obligations as far as historic operations are concerned and typically in- cludes a purchase price and, when acquired by an investor-owned operator, debt being retired or defeased. "One of the main benefits of the asset purchase model is that you can attempt to partition liabilities as between the buyer and the seller," Mr. Walker says. 10 Key Healthcare Transaction Trends (continued from cover)