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H2C INDUSTRY INSIGHTS • MERGERS & ACQUISITIONS
 

Reconsidering Options for Independent Hospitals and Health Systems Post COVID-19 

May 28, 2020

Hospitals and health systems are essential pillars in their communities, often serving as one of their community’s largest employers and an important driver of the local economy. For not-for-profit healthcare organizations, maintaining independence and autonomy through local control of this essential community resource is frequently a priority. However, the pressures independent hospitals and health systems have experienced during the COVID-19 outbreak and the future uncertainties the pandemic has created are prompting some healthcare leaders to assess their options in a heightened-risk environment.

 

Prior to the coronavirus pandemic, not-for-profit hospitals and health systems had been performing well. As recently as December 2019, both Moody’s Investors Service and Fitch Ratings changed the outlook for the not-for-profit hospital sector from “negative” to “stable,” with Moody’s predicting 2 to 3 percent growth in operating cash flow and an increase in revenue of 4 to 5 percent in 2020. Fitch and Moody’s expected consolidation in this sector to continue this year, driven in large part by a desire to increase in size and boost revenue.

 

Additionally, extraordinary investment returns in recent years have bolstered the financial positions of numerous hospitals and health systems, and low-cost capital has enabled many providers to invest in growth projects. As a result, the not-for-profit sector entered 2020 in a stronger financial position than it has been in many years, with Fitch stating that organizations’ balance sheet measures were hitting levels "not seen since before the 2008 market crash and have ... mitigated some of the operational pressures seen in the sector in recent years.”

 

But the emergence of COVID-19 in the United States this spring is changing the game for hospitals and health systems. By mid-March, rating agencies had changed the outlook for the not-for-profit hospital sector to “negative.” Even after the outbreak is contained, expected pressures for not-for-profits include:

 

  • Lower cash flow due to unprecedented financial pressures, including delayed elective procedures and higher operating expenses (estimated impact, according to the American Hospital Association: $50.7 billion per month nationally)

  • Reduced value of hospital investment portfolios

  • Debt risks, including the risk of tripping financial covenants in existing debt agreements

  • Risk of a prolonged recession and the impact on unemployment levels, state budgets / Medicaid funding and potential pressure on Medicare funding
     

These challenges—coupled with pressures hospitals and health systems have long confronted, such as the costs of caring for Medicare and Medicaid populations relative to reimbursement, increased cost-sharing by individuals with limited ability to pay for their care, and the rising costs and complexity of the clinical enterprise—demand that the leaders of independent hospitals constantly explore new and innovative ways to maintain financial viability. The immediate reactions to the challenges created by the pandemic, such as deferred capital expenditures, employee furloughs, and salary reductions, are necessary in a crisis environment, but are likely not sustainable and do not lead to long-term viability.

 

Increased Pressure for Independent Hospitals and Systems

 

Even before states put restrictions on elective surgeries during the COVID-19 pandemic, it was not uncommon for independent hospitals and health systems to be challenged financially. In some markets, independents have found it increasingly difficult to deliver high-quality care at a competitive cost, as they lacked the leverage required to significantly reduce operating and supply costs.

 

Over the years, many independent hospitals and health systems have creatively engineered solutions—including service line collaborations, clinically integrated networks, outsourcing, IT investments, and a variety of other strategies—to enhance performance and compete effectively in their market.  Now, however, these strategies may no longer be enough. 

 

As noted in a recent H2C commentary, “5 Factors that Will Make the Next Recession Different for Hospitals,” the looming economic recession will further exacerbate pressures on hospitals,

and previous strategies to manage through a recession may no longer be readily available.  And while government stimulus efforts may provide short-term relief for stressed balance sheets and diminished working capital resulting from forced loss of revenue and COVID-19 derived market turmoil, it is unlikely that government support alone will be sufficient to sustain a healthy organization once the crisis subsides. The financial impact of the COVID-19 pandemic—which will vary by organization depending on the severity of the outbreak and the ways in which hospital volumes are affected—may require healthcare leaders to reassess their current position and potential options.

 

The current health crisis demonstrates the critical importance of access to care in both urban and rural areas. To preserve needed assets, many governing boards are exercising their fiduciary duty through thoughtful and structured analyses of what the future may bring and how their organizations could be affected. Divestitures of non-core assets, clinical affiliations, joint ventures, and partnerships—both formal and informal—are all responses that could be explored. Some institutions may also face the choice between remaining independent or affiliating more directly with a larger healthcare organization.

 

After the Outbreak: Evaluating Next Steps

 

To survive and thrive following the COVID-19 pandemic, operational efficiency is key. Unexpected declines in cash and investments will take time to rebuild, so mitigating other areas of weakness will be crucial to generating the strong returns required to rebuild an organization’s balance sheet. For independents with strong balance sheets, significant changes may not be as urgent; however, all organizations should routinely evaluate the efficacy of their overall business model to ensure their ability to provide care, especially in today’s uncertain environment. 

 

One way that organizations can protect and support their clinical delivery capabilities is to unlock and properly allocate value through a deliberate portfolio review and optimization process. Portfolio optimization is accomplished by first assessing all of the business assets owned and operated by a health system and then prioritizing internal resources for those that deliver the highest quality and strongest financial performance. A clear understanding of the market value as well as the strategic value contributed by each of these business lines to the overall organization is an important part of this process. Portfolio optimization may result in continued ownership and control of “core” assets, including major service lines and administration, while indicating the need to establish partnerships to deliver excellence in “non-core” areas. It may also suggest the exploration of partnerships for “core” services as well to deliver the optimal value for the community. Understanding exactly what it is that must be controlled and what elements of control can be delegated to others is an important part of determining the right balance to strike between core and non-core businesses and the appropriateness of partnerships. H2C works with clients to parse out the elements of control and identify these critical concerns.

 

All of these factors are incorporated in a thorough assessment of the strategic options available to an organization. H2C’S Portfolio Optimization Matrix, presented below, was designed to help leaders understand their options.

 

Portfolio Optimization Matrix
 

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ABOUT HAMMOND HANLON CAMP LLC

Hammond Hanlon Camp LLC (“H2C”) is an independent strategic advisory and investment banking firm committed to providing superior advice as a trusted advisor to healthcare organizations and related companies throughout the United States.  H2C’s professionals have a long track record of success in healthcare mergers & acquisitions, capital markets, real estate, and restructuring transactions, acting as lead advisors on hundreds of transactions representing billions of dollars in value.  Hammond Hanlon Camp LLC offers securities through its wholly-owned subsidiary H2C Securities Inc., member FINRA/SIPC.  For more information, go to h2c.com

 

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Examples of service lines where opportunities may exist to optimize a health system’s portfolio of business assets through newly formed relationships may include: 

 

  • Non-flagship Hospitals

  • Rehabilitation Services

  • Behavioral Services

  • Home Health and Hospice Services

  • Real Estate

  • ASCs

  • Labs and Diagnostics

  • Urgent Care Centers

 

Depending on where the asset falls on the matrix, the strategy may vary. In some instances, small enhancements can make a significant difference; in others, partnering with an expert provider may improve the value of the service for the community. Not all optimization strategies will meet the hospital or health system’s primary needs, but most will accomplish at least one major goal from among the following:

 

  • Improved balance sheet

  • Enhanced service line performance

  • Operational improvement

  • Expanded reach

  • Additional expertise

 

Additional Partnership Opportunities

 

For key stakeholders that wish to consider a broader transaction, partnering with a larger organization can produce a positive outcome for a community. As we have observed, care coordination happens locally, and larger systems are often more readily able to allocate beds, physicians, supplies, and other resources to respond to community needs. Systems have granted more local control than ever; important clinical decisions are frequently made at the local level, with supply and back-office functions handled at the corporate level. Systems offer scale efficiencies that can lower costs and often are better positioned to survive an economic downturn. While the market typically moves in the buyer’s favor during periods of economic uncertainty, independent hospitals and health systems still possess advantages, including:

 

  • Scarcity value — Consolidation has been a consistent trend over the past few years, leaving fewer available opportunities for growth through partnerships and acquisitions.

  • Barriers to entry — State certificate of need laws and other impediments make partnerships and acquisitions the only viable market entry strategies in many markets.

  • Local market knowledge — Virtual health and other technology-enabled healthcare strategies notwithstanding, healthcare continues to be delivered locally. An understanding of the community, its preferences, strengths, and limitations is a valuable resource that is very difficult to duplicate

 

As organizations evaluate these areas of concern, an outsider’s perspective can be helpful. As active participants in the market, H2C helps decisionmakers quickly assess the strategic and financial value of the services and assets that drive the organization’s performance in the short- and long term. We work with healthcare leaders and their boards in performing a portfolio optimization assessment, identifying gaps and potential opportunities. Once complete, we assist an organization’s leadership in charting a strategic direction and crafting a path to success. 

 

For more information, contact us.