Podcast - Hospital M&A Trends & Strategic Considerations for 2024

Morgan Ribeiro: Welcome to Counsel That Cares. This is Morgan Ribeiro, the host of the podcast and a director in Holland & Knight's healthcare practice. On today's episode, I am joined by two individuals who spend their days working with hospitals and health systems across the country. First, I'll introduce Rex Burgdorfer, a partner at Juniper Advisory, which is an investment bank that partners with hospitals and health systems as they evaluate their future and execute on their strategic plans. And also joining me is Colin Luke, a partner in Holland & Knight's healthcare regulatory and enforcement group. So welcome to the show, Rex and Colin.

Colin Luke: Glad to be here.

Rex Burgdorfer: Thanks for having me.

Morgan Ribeiro: So on today's episode, clearly based on that introduction, we will be talking about hospital and health systems, but in particular looking at transactions and what's driving that activity across the country with hospitals and health systems, partnering together, looking at acquisitions, looking at a sale. Really want to talk about today the types of deals we expect to see over the coming year and much more related to that topic. So to get us started, you know, as we look back at 2023, we saw an uptick in hospital transactions, and industry insiders are expecting more transactions in 2024. In 2023, there were 65 announced hospital mergers and acquisitions, which was up from 53 hospital M&A transactions the year before. So, Rex, I'd love to start with you just to better understand what's driving this activity. What drove the activity in 2023, and why do we expect to see more of this in 2024?

Rex Burgdorfer: So maybe just a little historical context on the structure of the industry. There are about 4,000 hospitals in the United States still controlled by over 1,500 hospital companies. So by most measures, for industries that are regulated, capital-intensive and complicated, it's still pretty fragmented. And the numbers you cited on transaction volume, you know, 450 or so per year to make a dent into 1,500, the pace of change is still relatively slow. The median number of transactions that have occurred on an annual basis going back 30 years is more like 85. So I think we're returning to kind of pre-COVID level of activity, motivated more and more by the belief that operating in standalone independent hospitals in today's environment is really challenging, and most around the country are undertaking some sort of process to evaluate whether a strategic partnership would advantage their community.

Morgan Ribeiro: Awesome. Yeah. And I think that that's helpful content to really kind of look back at a historical perspective and where we are today. Anything else you would add, Colin? As you're looking at your client engagements and what's driving some of the activity that you're seeing.

Colin Luke: These are challenging times for hospitals and health systems generally. Rex alluded to some of the major issues facing standalone hospitals.  They are also experiencing increasingly serious data breaches and ransomware attacks.  As a result, health systems are having to make material investments in security technology and upgrades. These investments involve huge sums for many independent systems. Couple those costs with the post-pandemic labor shortages, increased labor expenses and the difficulty in attracting and retaining physician and you have a perfect storm.  Hospitals are operating in a new era where many physicians are selling to private equity or retiring. However, hospitals are absolutely essential for rural communities in particular and for the health and welfare of communities and their citizens, and they've got to survive. Hospitals have to evaluate what is it that they can do to make themselves more viable for the future and to provide state-of-the-art healthcare with limited resources in difficult times. And, of course, looking at how they can affiliate though innovative structures and still retain the their service to their communities is absolutely essential for the future of hospitals and health systems.

Rex Burgdorfer: That's a big change in the market, and I compliment attorneys for their creativity in this. You know, an, an independent hospital used to have kind of two binary options at its disposal. It could dig in its heels and try to get more efficient and effective on its own, or it could roll over and become subsumed by the big system down the road. There's been a host of innovation in between those extremes that, some of which I suspect we'll talk about today, and that creativity, I think, has caused large or more proactive participants in change in control transactions. The average size of a hospital seller 15 years ago was about $100 million in revenue. Today it's more than $800 million in revenue. So people are more forward-looking and creative in terms of the types of companies they're seeking to form.

Morgan Ribeiro: Yeah, I think that that's perfect. And, you know, both of you have mentioned this, you know, you mentioned it, expenses and, you know, retirements and sort of that succession planning and kind of a future about executive nurses positions, all that transition that's going on in the labor force. Any other trends that you're seeing as it relates to drivers for health systems that are seeking a partner?

Colin Luke: I think concerns about Artificial Intelligence (AI) and how that's going to evolve is a big driver behind affiliations. Also the increasing subsidies that Hospitals are required to pay for their anesthesia providers, for pathology providers, radiology providers and just making sure you have those areas of coverage is another major driver. Hospitals are having to say, we are either going to have to spend the money on technology or to pay the subsidy for these hospital-based physicians, and they're thinking if they can affiliate or come up with a strategy where they're part of a viable group of hospitals that offers some innovative models of care, perhaps with some physician groups.  With new approaches such as population management, maybe they can come up with a strategy that works for the future. Hospitals are sensing we're on the cusp of rapid change, and they've got to be prepared for the future as things develop. Many payers are also providers these days.  well as the chief payer on the commercial side for hospitals. We're seeing direct employer relationships necessitated by that. And that really takes a lot of expertise to keep up with those changes. And you've got to be able to offer value-based care and outcome-based risk payments in order to satisfy those employer groups. And that's hard to do as an independent system. So having economies of scale and greater expertise really helps for the future. And that it is essential for American communities that their hospitals have those abilities to compete and be viable.

Morgan Ribeiro: I think Colin mentioned something there just about, you know, the payers, made me think of this, but just the landscape as we're looking at this, you know, 10 years ago versus now and what types of health systems are participating in M&A transactions and why. But even more specifically, what types of systems are acquisitive right now. So maybe Rex, you can touch on that for a moment and just sort of what you're seeing as you're advising hospitals that are looking at kind of what their next steps are?

Rex Burgdorfer: Colin used the word "expertise" in his last statement, and I would almost expand that to "management bandwidth" because operating hospitals has become much more consumer-driven and as consumers now have data on the cost of the care that they're paying for and the outcome that they're paying for. More and more research is correlating quality of outcomes with size and scale, and to do the things that are necessary, like, you know, secure Leapfrog ratings, position yourself for what's coming out of Washington, D.C., more management bandwidth is being required than many small systems have in terms of participants. More and more of our client base of hospitals seeking a partner are those sponsored by local governments, cities, counties, districts. So sellers are, in an outsized way, sponsored by local governments who are concluding that managing a hospital is really difficult to begin with, especially difficult in the sunshine and all the competitive disadvantages associated with that. So there's kind of a new group of sellers, and there's a new group of buyers, too, many of the academic medical centers that had historically been content being a research-only quaternary injury center in an urban market are now of the belief that they need to form more coordinated, geographically dispersed systems. And so they are making acquisitions in a really meaningful way. So new group of sellers are local governments, new group of buyers are academics, and with two new participants like that, that's playing out in an interesting way in today's M&A market.

Morgan Ribeiro: Well. And I think, you know, as a follow up to that, as we look at the for-profits and them being less acquisitive, I mean, why is that, and what does their deal pipeline look like today as opposed to 10 years ago?

Colin Luke: I think many of them have wanted to focus more on outpatient care, ambulatory care in lieu of the capital-intensive acute care health system model. They're also thinking there's probably going to be some opportunities in the future to buy things at a lower multiple or more attractive price — and interest rates clearly have an impact on their acquisition modes — but I think they're doing more innovative acquisitions, not just the traditional hospital or health system acquisition. And so it means that, I think there are fewer bidders, in a typical transaction — and certainly Rex can speak to a few or potential buyers out there — in an auction process or developing a suitor or the sale transaction, However, you're seeing more nonprofit systems become acquisitive and creating regional or statewide networks as well. And I think Rex makes an excellent point that academic health systems are really trying to have large networks with the tertiary care at the center, and they're compelled in many cases to do the transaction because they may be the buyer or the partner of last resort, and it goes to the mission and the support that they get from the legislature, if they're a public institution, or just the outreach that they're trying to do as a private university. But it's changed. And it, it may change again, but I'd say, the emphasis right now is away from hospital and health system acquisitions, but for profit-companies and looking at how do we expand our primary care network. These institutions are asking themselves, How do we become more physician-centric and more flexible? How can we implement population management opportunities that maybe we couldn't do if we're just operating a health system?

Rex Burgdorfer: And we see that in the numbers. If there are 86 transactions that occur per year 10 years ago, about 40 percent of those were acquisitions won by for-profit companies. Today that number is down to less than 9 percent. So to your point, Colin, the percentage of transactions nationally where for-profits are the acquirer has dropped significantly. Why is that? I think that there are real headwinds in the acute care space for for-profit companies. You know, not being able to participate in 340B, the cost of capital difference between taxable and tax-exempt debt is significant, not paying sales and property taxes is significant, and when you add all those things together, for-profit companies are wise and positioning themselves to do less capital-intensive, post-acute, urgent care things, outside kind of the four walls of the hospital.

Colin Luke: I think there are also some regulatory reasons why it's more difficult for for-profit health systems or investor-owned health systems to acquire, not for-profits or governmental facilities, and that's at both the federal and state level right now. It is much more difficult than it used to be historically.

Rex Burgdorfer: And you're seeing that play out in the number of new for-profit hospital companies formed. There's been a real dearth of those sponsored by private equity companies in the last decade. There have been, you know, very, very few, and so the number of buyers has declined in a sense with new in-market strategic kind of picking up the slack.

Morgan Ribeiro: Can you all elaborate on the regulatory issues that you've mentioned here and sort of the trend there? I think both at the state and federal level, we are certainly seeing a lot more scrutiny around, you know, particularly in market. But I would say that that's kind of across the board that we're seeing just more scrutiny.

Colin Luke: I would say that the biggest area would be antitrust, FTC, DOJ, and that's had a real chilling effect on transactions, because if health systems believe they're going to be subjected to a very lengthy regulatory review process and perhaps litigation, they're having to say, is it worth it? They want to avoid the expense of the negative exposure. The FTC and DOJ have taken a much dimmer view of in-market amalgamations or even vertical integrations in different markets. They've spoken out against those. They really don't want to see the consolidations, and I think it's been clear with even some recent pronouncements, they don't like private equity in the healthcare system particularly and are taking steps to really reduce that. Also, as you alluded to, the states, particularly some on the West Coast and in New England, have added new procedures adopted that make it much more difficult to do healthcare facility acquisitions. And there's an extensive review process. Many states have had a public hearing requirement, Hospital Acquisition Act criteria, if there's been a conversion to a for-profit system for not-for-profit, and many states’ attorneys general have gotten involved, at least in making sure they are protections or that they get certain contractual commitments as part of the acquisition. But those are costly for a potential acquirer. Those have a lot of negative repercussions on the deal, and I think it's making the deal volume go down quite a bit, because if you can avoid those things altogether, you're going to have a much more successful and quicker transaction. And there's an ebb and flow in regulation, and I think we're at the apex, hopefully, of governmental regulation of hospital acquisitions.

Rex Burgdorfer: Yeah. So the two agencies I think you're describing that would kind of classically have purview, column number one or the state attorney general. And you're right, most of their scrutiny in the past was applied to conversion transactions where the tax status of the seller was changing. They're going from a nonprofit to a for-profit and the AG would review the transaction to make sure the terms, the condition, the value, the investment, the protections for employees and the like were fair. Interestingly, because the for-profit sector has declined in activity, we're seeing states' AGs, especially in heavily regulated places like you're describing, you know, California, Oregon, New Jersey, Minnesota, those same questions are being posed when two nonprofit companies are coming together too now. So there's increased scrutiny from an involvement of AGs in transactions where they used to really not play a role. And, on the FTC front, maybe one of the reasons that academic medical centers are becoming selected as the buyer of choice more often is their sovereign immunity from scrutiny on antitrust grounds.

Colin Luke: I certainly think that's the case now. It's not a blanket exemption, but if the legislature has granted them the sovereign immunity, if they have the state action immunity, they can do transactions where some of their for-profit competitors or even not-for-profit competitors could not. So it's a leg up and that will save a lot of headache if you can take advantage of one of those exemptions to consummate a transaction.

Morgan Ribeiro: So I think, you know, one of the things as we look at this regulatory landscape, we can expect to see maybe more transactions where it involves, you know, players from different regions or different markets. And I know that's a trend that we've certainly seen over the last year or so, are there any noteworthy deals? You know, they're fairly unique about the kind of a multi-region transactions like an Advocate Atrium or a Kaiser Geisinger. And what, you know, as our listeners are thinking about is what's interesting to you all about these arrangements. And can we expect to see more of them in the near future?

Rex Burgdorfer: I think if you looked at the past configuration of for-profit hospital companies versus nonprofits, it's insightful. The for-profit companies used to have, you know, one hospital in Florida, one in Texas and one in California, and that was market diversification so that they were not over reliant on any one regulatory scheme or economy but they often lacked real scale and density within each of those markets. Contrast that with the nonprofit systems, excluding faith-based companies, almost all were only in one state. Most kind of industry prognosticators think you're going to need attributes of both of those types of organizations to be successful in the future, national know-how and scale for the reasons we've cited, combined with regional density, especially on some of the vertical things Colin was talking about, direct-to-employer contracting, clout relative to payers who in most states have huge pricing power. And so I think the transactions you're describing, Morgan, where systems especially the nonprofits like Advocate or Atrium are growing across state lines, is important. And the distinction and importance between those state lines is blurring.

Colin Luke: I would agree with everything that Rex said. We've even seen some divestitures in areas where the seller is not a significant player as far as market share that they want. A lot of the potential national operators want to be a leading provider in a market or a region and don't just want a postage stamp collection. They like the regional diversity, but they like to be in an area where they can get economies of scale, where there are in-network referrals, where there's concentration of particular specialties. Systems want to develop some payor relationships or direct employer contracting that cover a region. Healthcare historically has been local. That's changed, and it's maybe become regional, but there's still vast differentiations and payer reimbursement and the extent of managed care or capitation or population health. It varies greatly from geographic region to geographic region, and so how you market your services and manage your businesses is vastly different. I think, with enough scale, you can overcome some of those regional differences. I don't think anyone wants to be the small facility that is an afterthought in the market. Unless you have a strategy to change that, so that you are providing something special and something that patients' desire in the market because patients, as Rex alluded to, will become educated consumers are going online, they're willing to travel for healthcare, certainly to the large town an hour away, and you got to do things to encourage them to come to your particular facility and to have some brand identity in the market. And that's hard to do if you're an outlier.

Morgan Ribeiro: Well, I think along those lines, Colin, it's a good segue into my next question. Do you think about brand identity? I think academic medical centers, you know, tend to have that kind of brand identity in the larger regional marketplace, and we've noticed an increasing role of the academic medical centers and, you know, mergers and acquisitions and looking at, you know, ways to partner with community hospitals. Rex, maybe you can pick us up on that one.

Rex Burgdorfer: Sure. Well, combining, Colin's last point to, you know, a sizable share of the transactions last year were for-profit companies exiting certain markets where they didn't have scale in many cases to academics. So CHS, CA, Prime Steward Tenant, all made divestitures of markets they felt that they didn't have a meaningful enough position in. And many of those were acquired by academic medical centers, which really were absent from the M&A market 15 years ago, they were content being extremely high-quality, you know, downtown ivory tower research-oriented institutions and are now of the belief that they need to cover more lives so as to be able to weather bundled payments and accountable care. They need to have step down levels of care, of vertical integration. You know, their ICUs in the city are full and it's the highest cost setting, and statistics more and more are showing that outcomes for patients are better when they're treated, you know, in a medically safe way close to home. So can we own and operate community hospitals to keep patients out of the urban centers is a strategy that a lot of academics are pursuing.

Colin Luke: And Morgan, you mentioned brand identity, and I think we've seen across the country. If you travel, you can see some variation of world-class care right here at home on a billboard that talks about a service line and names an academic medical center. The idea with the connection of that academic center in a rural hospital or suburban hospital is that you're getting a level of care that's above what was offered without the affiliation. And the affiliation may be a little more than a licensing agreement. It may be a full-blown acquisition. It could be a service line joint venture. We're seeing all those innovative approaches. But in the eyes of the public, you have elevated care because you've got the teaching hospital, the academic hospital affiliated.  Academic medicine has made a lot of innovations  possible.  With an academic affiliation, you can have the world renowned specialist on standby and connect those rural hospitals via technology. They're not going to do that without some sort of affiliation, and it helps with the whole brand identity. But most academic health systems are looking for strategies to expand their footprint, as Rex was talking about. And if they've got attractive costs of capital and leadership that really wants to embrace the idea of expanding the system.  Often academic health systems have been pretty successful in affiliations because many boards are comfortable affiliating with an academic medical system. It's really reassuring to the board to say we have affiliated with the teaching hospital in this part of the state or the state, and it's a safe choice usually for the board. And it depends a lot on the institution and in the form of the affiliation, but we're seeing models from very little governance involvement to full-blown subsidiary model essentially with academic health systems.

Rex Burgdorfer: I think the evidence, too, of the, the caliber of the brand has become more tangible. And it no longer is it just a billboard that you pass on the highway that says, "We're U.S. News and World Report top 20" and it's kind of intangible. When patients go to an academic medical center and they participate in Epic’s MyChart and their visit is well organized and well documented — and the follow up material that they review they receive electronically through Epic’s MyChart is outstanding — they then return to their community hospital setting, and community hospital boards are saying, well, now we need Epic’s MyChart too, because it's the gold standard and patients love it. And it's been proven to be, you know, the best and most comprehensive method of organizing electronic health records, and a lot of community hospital boards just simply don't have the financial resources or the management bandwidth to pursue a tool like that. And so as patients start to experience, not just hear about, differences in how systems operate, a lot of times through IT, that's playing a big role.

Colin Luke: I'd also say physician recruitment, particularly of new graduates, is playing a role that many hospitals are struggling attracting sufficient number of physicians, specialist in particular, and I feel like if they have access through an affiliation to an academic health system that has residency program, they're more likely to get future physicians and to have coverage arrangements. And may not necessarily be the case because physicians are going to make an independent physician decision, but it gives them a leg up if they're affiliating with a source or any source of new residents and fellows to come in and help provide that coverage.

Rex Burgdorfer: Yeah, we were working with a state-sponsored academic medical center in a rural state. And I heard one of the leaders put it really well. He said many of our new graduates and others coming out of our GRE programs want to live in an urban environment and there aren't very many rural/urban environments in this state and therefore we need to have an expanded statewide presence. And the role of the academic medical center in that state has grown from just one side to really believing that they are the safety net provider of last resort for everyone in the whole state. And so how can they do that? Through acquisitions or working more closely with community hospitals is really what they're seeking to answer.

Colin Luke: Legislatures have been more willing to give appropriations to the academic health system, the public academic health system, than individual hospitals, and most cities and counties are limited in rural areas on what they can do to support the hospitals. So it's an indirect way of helping to support healthcare if you've got this connection with the academic medical center system.

Morgan Ribeiro: Yeah. I mean, it's interesting you talk about the role kind of and how that plays out in the rural market. I'm in Nashville. Colin, you're in Alabama. I certainly see a lot with UAB there with Vanderbilt, you know, and what they're doing here, which is more of an urban and then kind of suburban and surrounding communities around Nashville. And just I mean in the last decade, what they've done here and kind of create different access points and getting really creative and how they go about doing that or partnering with another facility on a children's hospital in a suburban market so people don't have to come into downtown Nashville. So, you know, certainly based on this conversation, I expect to see more of that activity here in the near future. You know, I think as we sort of near the end of our conversation, we've talked a lot about trends and kind of the dynamics that are driving this activity and hospital transactions. If you're a board member or an executive at a hospital listening to this conversation, you know, what should they take away from this as they look at their next five-year plan or look to the future of their hospital, how should they be thinking about this conversation and what's actionable for them?

Colin Luke: I think we must encourage board members of health systems to be proactive and to look at options and never just be content with status quo. If the pandemic taught us anything, it taught us how important acute care health systems are to the communities because they were the epicenter of COVID care. But looking beyond COVID and preparing for the next generation and the next healthcare event, board members must ask just what are our options, what sort of affiliation would make sense for our institution? How can we maintain the integrity and the quality of our healthcare services? And what are the key decision points? I think you, you never, as a board member, want to back yourself into a corner where you're being dictated to and you have only one option. So it's being proactive, asking leadership, what are we doing strategically to be thinking about the next 10 years and should we ask for a company like Juniper to come in and evaluate our options.  The process doesn't necessarily mean we're going to sell or affiliate, but rather can we learn just what we can do to make ourselves more viable for the future. And thinking about the big picture items that board members should be thinking about. It's not all doom and gloom. Certainly, there are a lot of serious issues, but you can, even in a rural area with limited reimbursement, you can survive and thrive, with plenty of case studies where that's been the situation. But it's taking great boards and really a lot of future-focused decision making and investments to position yourselves for the survival and in the future and to thrive.

Rex Burgdorfer: I think the psychological component of what Colin's describing is, you know, in the sense many of the transactions were in troubled markets that had waited too long, and they were entering into transactions out of financial necessity and distress. And today, because this has become so commonplace for the reasons we've discussed, the stigma associated with proactively thinking about options has largely been lifted. And so I know Colin and I participated in a few board sessions, kind of in an educational type context, where boards are saying we really ought to think through with comparative analysis, you know, what are our peers doing to contend with change? What are the pros and cons of different approaches? And I think boards today are more inclined to tee up that sort of conversation. Often, it's done in a special retreat-type format to initiate the topic, and, you know, Colin, you and I both participated in a number of those. I think as groups are doing that more and more, that spells good things for the number of options that are at their disposal and the flexibility that they'll have in seeking a partner if that's the direction that they want to choose, or at least making sure they don't repeat the mistakes of the past and wait too long until there are not any options remaining.

Colin Luke: That's an excellent point. I think it's, historically, too, it's been we're going to stay independent or we're going to affiliate and we're going to give up local governance. I think there are a lot of options now where you can retain a strong measure of local governance and involvement and still have an affiliation. So it's not all or nothing. Maybe — and maybe that's the best for the particular situation, but you can still serve the community's long-term needs and enter into some version of an affiliation. And just if you're doing it from a position of strength ahead of time, you're not waiting, you're more likely to get those kind of mechanisms that protect the hospital for the long term.

Rex Burgdorfer: Not to get too technical, but with more of the sellers being sponsored by local governments and with more of the transactions being structured as leases, I think what you're saying is definitely true where there's a continued level of involvement from the board, whether it's an elected board or not, in ways that are probably different than the subsidiary advisory, feel-good only boards of the past.

Colin Luke: Definitely-transactions with a lease structure can have more contractual protections for the leasing hospital and its board, so to speak.

Rex Burgdorfer: Right.

Colin Luke: And some of those transactions have resulted in foundations being created that are supporting improved community healthcare offerings and other important healthcare objectives. So it's a tradeoff, and a lot of things are possible.

Rex Burgdorfer: As nonprofit buyers are becoming more commercially savvy and therefore reasonable in their approach to transactions, we’ve worked on a few nonprofit or nonprofit combinations where the buyer contributed, you know, significantly to a foundation, in a couple cases, you know, tens of millions of dollars into community foundations, really not dissimilar in the way in which for-profit to look at an acquisition.

Colin Luke: And we are seeing, like Rex alluded to, this, just some outright conversions where a governmental sponsored entity has converted into a 501(c)(3), and that structure has a lot of opportunities to free the hospital from expensive regulatory constraints often present in a governmental hospital.  The conversion option often creates other opportunities through affiliation. You're sort of out of the politics, and that makes sense. And that's another option that people should be looking at strongly if you are a governmental entity. Whether it makes sense or not depends on your individual set of circumstances.

Rex Burgdorfer: At 30 years ago, there were about 1,300 public hospitals in the United States. Now there are about 900. That doesn't mean 400 went out of business. That means about 400 did what you're describing, Colin, and became part of multi-hospital systems outside of the auspices of the government.

Colin Luke: It's a definite trend.

Morgan Ribeiro: Awesome. Well, thank you both for your time today. Great perspective on trends that we're seeing in the industry and excellent points and tips for those that are navigating these exciting yet challenging times.

Rex Burgdorfer: Thanks Morgan to you and Colin for hosting. Enjoyed it.

Colin Luke: Thanks for participating, Rex. You added a lot.