Becker's Hospital Review

Save the Date: Becker's Hospital Review CEO Strategy Roundtable - Nov. 5, 2014 - Chicago 12 As the pressure mounts to transform care delivery while holding down costs and increasing quality, Mr. Lupica says smaller, local hospitals who've been splashed (perhaps with pension problems or other fiscal issues) may be the lucky ones. They have a chance to do something about it. That something may take the form of joining forces with larger health systems through mergers, affili- ations and other transactions. "I think hospital leaders understand the need to prepare for a wide range of contingencies before the water boils," Mr. Lupica says. "To try another metaphor, you no longer have to wait for the un- dertaker before you try for a merger. That's not much of a plan anyway." At the same time, some larger healthcare organiza- tions are becoming more selective in who they ac- quire, says Carsten Beith, managing director of the healthcare investment banking firm Cain Broth- ers & Co. This especially holds true in the realm of for-profit hospital operators, such as Nashville, Tenn.-based Hospital Corporation of America and Dallas-based Tenet Healthcare Corp. "We've certainly begun to see the for-profits be more disciplined in terms of the acquisitions they're looking for," Mr. Beith says. "For most for- profit acquirers, the potential dilution from a fi- nancially stressed hospital to their credit profile is a strong disincentive for them to acquire." As more hospitals and health systems engage in mergers and acquisitions, Mr. Beith says the hos- pitals left standing alone tend to be financially stressed and not as attractive to buyers from a balance sheet perspective. Still, Mr. Beith, Mr. Lupica and other industry experts agree that, for now, hospitals that do find themselves financially cooked aren't necessarily out of options if they seek to avoid closing by joining a larger health system. Financially stressed hospitals still have options In fact, Mr. Lupica says there are still a consid- erable amount of "troubled sales" transactions taking place. "If there is an apparent decline in troubled sales, I believe it's only relative to the non-troubled mergers," he says. In recent years, hospital and health system consol- idation has accelerated. In 2012, more than $143.3 billion in healthcare mergers and acquisitions took place, one of the highest volumes recorded in a decade, according to a report from strategic advisory and investment banking firm Ham- mond Hanlon Camp. Mr. Lupica says strong hospitals and health sys- tems haven't been hesitating to carry out transac- tions. "A merger used to be seen as a last resort," he says. "We are finding that hospital leaders now look to mergers and affiliations as opportunities to gain strength in the new paradigm of care." Although Mr. Beith says the number of healthcare organizations that fit the profile of troubled hospi- tals that face an "inevitable transaction" has declined as more consolidation occurs, the market is still "fairly robust" for smaller hospitals with big finan- cial problems. He says more aggressive buyers such as Ontario, Calif.-based Prime Healthcare Services are still willing to take on troubled facilities. "We still see a reasonable three- to five-year run- way of significant merger and acquisition activ- ity," Mr. Beith says. "We'll continue to see financial stressed hospitals pursue transactions." Michael Lane, a managing director with Ham- mond Hanlon Camp, predicts troubled hospital sales will actually pick up as merger and acquisi- tion activity in general continues at a rapid pace and more independent hospitals realize they can't survive on their own. Additionally, he says he has observed some of the "big guys" in the hospital industry still see stra- tegic value in acquiring a struggling facility that they can rehabilitate with the right management, expertise and oversight. "There are some strategic opportunities the smart acquirers don't shy away from," as larger health systems look to grow in size and expand their market areas, he says. Jordan Shields — vice president of Juniper Advi- sory, an investment bank that exclusively advises hospitals on mergers and acquisitions — says his firm has seen an uptick in strong hospitals seeking partners, while the number of distressed hospitals looking to carry out transactions has remained about the same. He says it seems to be getting harder for financially shaky hospitals to find buy- ers as acquirers become pickier, but it doesn't ap- pear that troubled sales are on the decline yet. "For a distressed hospital, they have two options: Either find a partner, or restructure their debt, often through bankruptcy," Mr. Shields says. "We haven't seen a huge swell in hospital bankruptcies." Filing before selling: How bankruptcy can play into hospital transaction strategy However, sometimes going bankrupt and finding a partner can go hand in hand. Recently, several hos- pitals have filed for Chapter 11 bankruptcy before announcing an acquisition. For instance, in Febru- ary, Casa Grande (Ariz.) Regional Medical Center filed for Chapter 11 bankruptcy, a move executives said was necessary for the completion of its sale to Phoenix-based Banner Health. Only a few weeks lat- er, Long Beach (N.Y.) Medical Center filed for bank- ruptcy and announced the sale of its assets to South Nassau Communities Hospital in Oceanside, N.Y. Hospitals may choose to employ this strategy of filing for bankruptcy as part of the transaction process when they have few alternatives, accord- ing to Mr. Beith. "The basic financial implica- tion of that is they are significantly upside down in terms of value versus their total outstanding indebtedness," he says. "Cleaning them up, so to speak, through bankruptcy process is an appro- priate way for an acquisition to occur." When hospitals file for bankruptcy immediately before announcing an acquisition, they already have "the solution in their pocket," Mr. Lupica says of bankruptcies known in the trade as "pre- packaged Chapter 11s." "The idea is that the newly combined entity is looking for a fresh start, so they will often go through the reorganization of the weaker entity if they're truly insolvent," he says. Mr. Shields says identifying a partner before fil- ing gives healthcare providers "a little bit of secu- rity" going into bankruptcy, although the strategy does have risk. "They have a clear idea going into bankruptcy court that there will be someone on the other side to operate the hospital and take control of their assets," he says. "But there's risk in that. Once you go into bankruptcy, all bets are off. There's no guarantee that the bankruptcy judge is going to agree with your plans or that the partner will be there on the other side." However, sometimes going to bankruptcy court proves to be the right decision for both health- care organizations. That was true for the sale of Saint Francis Hospital in Poughkeepsie, N.Y., to Westchester Medical Center in Valhalla, N.Y. A bankruptcy judge approved the sale of the 333- bed hospital in February. Saint Francis filed for Chapter 11 bankruptcy in December in response to growing debt during the past few years, partly because of health IT costs and uncollectable bills. Health Quest, a three- hospital system based in LaGrangeville, N.Y., ini- tially offered to buy the hospital, but the 643-bed Westchester emerged as a competing buyer. Saint Francis executives ultimately filed paperwork with the bankruptcy court choosing Westchester. Michael Israel, president and CEO of Westchester, says he and his fellow executives decided to ac- quire Saint Francis, despite its financial problems, because of assets like its culture and employees. "While the hospital didn't have cash, it was cer- tainly not a bankrupt hospital," he says. "We have great admiration for the institution." Additionally, Mr. Israel says he and his leadership team have experience turning around a struggling institution. In 2005, Westchester's balance sheet was $225 million underwater, and the board was getting ready to prepare a closure plan. However, Westches- ter's current leaders were able to save the medical center. "On the revenue side and the expense side, we basically tore it apart and put the institution back together," Mr. Israel says. "We did a lot of physician recruitment, staff recruitment and focused on the medical center being the best it could be." Arthur Nizza, president and CEO of Saint Francis, says the hospital determined filing for bankruptcy was the best course of action to achieve a funda- mental transformation. "We had access through that to debtor-in-possession financing to allow us to have a runway to seek a merger partner and complete a transaction," he says. Mr. Israel says Saint Francis' bankruptcy was ul- timately a positive in bringing the two organiza- tions together. "Without the bankruptcy, this may not have happened for a few years," he says. "For us, it turned out to be an opportunity." n Troubled Transactions: Why There's Still Hope for Financially Struggling Hospitals (continued from cover)

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