Health System Transactions & Joint Ventures Current Trends in the Market and Deal Structures

Transcription

1 Health System Transactions & Joint Ventures Current Trends in the Market and Deal Structures James M. Pinna Hunton & Williams LLP Partner Colin M. McDermott, CFA, CPA/ABV VMG Health Director

2 The Buzz Continuing trend of larger and more complex transactions in the hospital space Page৷2

3 Overview Hospital Industry Trends Hospital Transaction Market Trends Deal Structures and Strategies Regulatory Hurdles Page৷3

4 Hospital Industry Trends Fragmented industry dominated by not-for-profits System Category Identified Systems Hospitals (Rounded) While the total number of hospitals in the country has remained relatively steady, many analysts believe standalone operators will need a larger, stronger partner Approximately 20% of all hospitals are for-profit Approximately 25% of nongovernment hospitals are independent Approximately 36% of all hospitals are either independent or associated with a health system with less than four hospitals Major Systems (10 + Hospitals) For-Profit Identified System Category Systems Not-for-Profit 52 1,200 Major Total Major Systems Systems (10 + Hospitals) (10 + Hospitals) Regional For-Profit Health Systems (5-9 Hospitals) , Local Not-for-Profit Health Systems (2-4 Hospitals) , Total Government Major Hospitals Systems (10 (state, + Hospitals) county and city) ,800 1,100 Regional Academic Health Systems(5-9 Hospitals) Local Single Health Hospital Systems Health (2-4 Systems Hospitals) (non-government) 1, , Government TOTAL (Rounded) Hospitals (state, county and city) 2, ,100 5,300 Academic Health Systems Single ~5,000 Hospital Hospitals Health in Systems USA (non-government) ~2,100 (40%) 1,350 Stand-Alone 1,350 TOTAL (Rounded) 2,600 5,300 2,894 (58%) Not-for-profit Hospitals (Rounded) 1,040 (49%) Not-for-profit 1,068 (21%) For-profit 280 (13%) For-profit 1,037 (21%) Government 800 (38%) Government Source: American Hospital Directory, American Hospital Association, VMG Research Page৷4

5 Hospital Industry Trends Medicaid Expansion by State WA VT NH ME Expansion delineated by political lines 29 of 50 states and District of Columbia have expanded According to Kaiser Family Foundation State Health Facts, another six states could expand Medicaid in OR CA AK NV ID UT AZ HI MT WY CO NM ND SD NE KS OK TX MN WI IA IL MO AR MS LA NY MI PA OH IN WV VA KY NC TN SC AL GA FL DE MA RI CT NJ MD DC Expanding Under Discussion Not Expanding Source: Kaiser Family Foundation State Health Facts. As of March 6, 2015 Page৷5

6 Hospital Industry Trends Benefits of Medicaid Expansion Medicaid expansion has led to a decrease in uninsured admissions Overall admissions have increased in states that have opted for Medicaid expansion Hospitals are seeing an important expansion divide in terms of reduction in the percentage of self-pay admissions and ER visits in those states that are expanding Medicaid versus those states that have not expanded. - Wayne T. Smith, CEO, CHS It is clear that hospital operators are beginning to see the benefit of higher levels of insured volume. Page৷6

7 Hospital Industry Trends Negative Outlook: Not-for-Profit Health Care Sector In December 2014, S&P & Moody s affirmed a negative outlook for U.S. not-for-profit health care providers in 2015 due to a multitude of factors: Weak revenue environment overall Reimbursement models shifting away from traditional fee-for-service Rising costs associated with labor and capital investments Not-for-profit health care system downgrades exceed upgrades in 2014 Page৷7

8 Age in Years Hospital Industry Trends Escalating Capital Needs Hospitals have reigned in capital spending since 2008, foregoing refreshing fixed assets and equipment, instead building capital reserves in anticipation of healthcare reform Margins are tightening and cash flow available for capital expenditures is now minimal when aging facilities and equipment now require attention IT upgrade costs (estimated to consume up to 1/3 of all capital expenditures) Average Age of Plant of U.S. Hospitals, S&P Moodys Existing capital reserves and ability to generate earnings to reinvest crucial to success of aging hospitals Page৷8

9 Hospital Industry Trends Emerging changes in reimbursement models Current Environment The Next Five Years Fee for Service HMO / Risk Based Models High Deductible Plans Quality Incentives and Shared Savings??? Risk Sharing Bundled Payments Narrow Networks Value-based Purchasing??? Hospitals are operating under two very different reimbursement models, which is contributing to margin erosion. Traditional fee-for-service, in which higher patient volume leads to higher revenue, has different incentives and staffing models from emerging reimbursement models that emphasize preventative care and the avoidance of hospital stays. The ACA and purchasers of healthcare are encouraging shifts in reimbursement models in an effort to reduce healthcare spending. Source: Moody s Investor Service; 2015 Outlook US Not-for-Profit Healthcare; December 2, 2014 Page৷9

10 Hospital Industry Trends Economies of scale Moody s Score Card Organization Size Matters Greater business diversification Increased access to capital Stronger ability to withstand performance variations Ability to adapt and quickly implement new models of care delivery Increased operational and strategic flexibility Benefit of the doubt $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 $4.100 Moody's Median Revenue per Credit Rating (Billions) $2.200 $1.100 $0.750 $0.634 $0.343 $0.271 $0.250 Moody s U.S. Not-For-Profit Healthcare Scorecard % Weights Factor 1: Market Position (45%) Total Revenue ($000 s) 25 Revenue Growth Rate (%) (3 yr CAGR) 10 Medicare and Medicaid payer mix (% of Gross Revenues) Medicare 5 Medicaid 5 Factor 2: Operating Performance (30%) Operating Cash Flow Margin(%) 10 Debt to Cash Flow (x) 10 MADS Coverage (x) 10 Factor 3: Balance Sheet & Capital Plan (25%) Days Cash on Hand (x) 10 Cash to Debt (%) 10 Month Liquidity to Demand Debt (5) 5 Page৷10

11 Hospital Industry Trends Economies of scale - Revenue Source: Moody s Investors Service; 2015 Outlook US Not-for-Profit Healthcare; December 2, 2014 Page৷11

12 Hospital Industry Trends Economies of scale Expense Management Source: Moody s Investors Service; 2015 Outlook US Not-for-Profit Healthcare; December 2, 2014 Page৷12

13 Hospital Industry Trends Economies of scale Broader Scale / Platform Better managed care leverage Physician recruitment initiatives Supply chain optimization Better access to credit Smaller Scale / Platform Lower revenue environment Increased expenses Limited access to capital Lack of coordinated care Other cost savings Ability to coordinate care across continuum Page৷13

14 Hospital Industry Trends Volume Trends Same-Facility Admissions Same-Facility Adjusted Admissions Downward Revenue Pressure Volume Trends o Inpatient admissions flat to down o Migration to outpatient settings o Medicaid Expansion / Exchanges - lower levels of uninsured o o Rise of high deductible plans Stronger volume in 2014 due largely to Medicaid Exp. +0.1% FY 2012 FY 2013 FY 2014 FY 2012 FY 2013 (without HMA) FY 2012 FY 2013 (without VHS) FY 2013 (with HMA) FY 2013 (with VHS) Not reported FY 2014 FY % FY 2012 FY 2013 FY 2014 FY 2012 FY 2013 (without HMA) FY 2012 FY 2013 (without VHS) FY 2013 (with HMA) FY 2013 (with VHS) FYE 2013 FYE 2014 FY 2014 FY 2014 FYE 2013 FYE 2014 Not reported Page৷14

15 Hospital Industry Trends Margin Trends EBITDA Margins Improving EBITDA Margins 19.8% 19.2% 20.1% The need for increased operational efficiency is heightened, and can be found as size and economies of scale grow The effects of reform along with an improving economy have led to margin improvements for public hospital companies in 2014 Expense management in the quarter was very good as we were able to leverage strong volumes and higher intensity of services. [William B. Rutherford, CFO, HCA Holdings, Inc., Q Earnings Call] FY 2012 FY 2013 FY % 14.9% 14.5% FY 2012 FY 2013 FY % 12.1% 11.7% FY 2012 FY 2013 FY % 9.6% FYE 2013 FYE % 7.5% FYE 2013 FYE 2014 Page৷15

16 Hospital Industry Trends Key Takeaways Despite some positive trends in the hospital sector, the overall outlook remains negative in the near-term. POSITIVE TRENDS Significant expansion of health insurance coverage under ACA Robust investment markets Benefits from M&A activity Improving economy NEGATIVE TRENDS Highly fragmented Harder to find cost savings Access to Capital IT Cost Low demand, especially in inpatient setting Emerging changes in reimbursement models Page৷16

17 Hospital Transaction Market Trends Hospital transaction market overview Disciplined approach to merger & acquisition activity Observed valuation trends Observations on strategies driving hospital transactions Page৷17

18 Hospital Transaction Market Trends Trends Industry Outlook is Driving Hospital Transaction Market There are headwinds facing the hospital industry that are driving consolidation Positioning of health systems to deal with changing reimbursement models and population health management Recognizing need for economies of scale to ensure ability to access capital and manage costs for continuum of care Despite some positive industry trends Hospitals continue to explore M&A to address negative outlook Page৷18

19 Hospital Transaction Market Trends Hospital transaction market overview Pre-2009 deal volumes typically averaged per year, but following recession and PPACA deal volumes have risen to ~100 per year Deal volumes have continued at these higher levels, but buyers have also been more selective pushing deal values up Number of Deals Sources: Irving Levin & Associates Page৷19

20 Hospital Transaction Market Trends Acquisition Pipeline Commentary The acquisition environment for LifePoint continues to be very active. Our acquisition opportunities for community-based hospitals around the country really are driven by the complexity of the business and the need for those hospitals community-based hospitals operating often times alone in a market to access the resources of a larger organization like our. So that s really what I think we continue to see a very strong active pipeline of potential opportunities. William F. Carpenter, CEO, Lifepoint Hospitals Inc. [Q Earnings Call] we actually have probably a dozen of our markets where we have various discussions and it s really all about putting our assets into a system, if you will, whether it s owned or joint venture, where we re in a #1 or #2 position. I think we re well positioned for the future. Keith B. Pitts, Vice Chairman, Tenet Healthcare Corporation [Q Earnings Call] Page৷20

21 Hospital Transaction Market Trends Disciplined approach to M&A Increased scrutiny and selectivity towards deals/targets Health systems can t afford to do a bad deal which could result in rating agency downgrade or financial consequence Increased willingness (and in many cases the ability) to walk away unless target and the deal structure is the right strategic fit we re interested in the opportunity to grow through acquisitions that are appropriate or that have the right market dynamics and recourse for the right pricing discipline. R. Milton Johnson, CEO, HCA Holdings, Inc. [Q Earnings Call] we re truly trying to buy stuff that makes good sense for us and our markets. W. Larry Cash, CFO, CHS [Q Earnings Call] Tenet is being invited into many discussions, giving us the ability to be selective in deciding which transactions will create the most value over the long term. Trevor Fetter, CEO, Tenet Healthcare Corporation [Q Earnings Call] Page৷21

22 Hospital Transaction Market Trends Observed valuation trends Page৷22

23 Total Invested Capital / Revenue Multiples Hospital Transaction Market Trends Observed valuation trends 2.00 x 1.80 x 1.60 x Closed Public Company Transactions (Last 3 Years) n = x 1.60 x 1.40 x 1.20 x 1.00 x 0.80 x 1.00 x 0.88 x 1.20 x 0.92 x 0.98 x 0.84 x 0.81 x 1.00 x 0.86 x 1.27 x 1.20 x 0.60 x 0.40 x 0.20 x 0.00 x 0.48 x 0.17 x 0.45 x 0.30 x 0.49 x 0.40 x 0.55 x 0.25 x 0.39 x 0.29 x 0.72 x 0.32 x Source: Irving Levin Page৷23

24 Hospital Transaction Market Trends Observations on strategies driving hospital transactions Smaller hospitals/health systems seeking affiliation with larger systems For-profit acquisitions of community hospitals (e.g. LifePoint acquisition of Fauquier Hospital) Non-profit acquisition of community hospital (VCU acquiring Community Memorial Hospital) Development of larger hospital networks or super-systems Baylor Scott & White merger to form largest nonprofit system in Texas CHE merger with Trinity Health to form 2 nd largest nonprofit system in the country CHI acquisition of St. Lukes Health System in Houston Building out other service lines to encompass broader continuum of care Tenet acquisition of United Surgical Partners to build ambulatory network HCA acquisition of CareNow to build urgent care network Select acquisition of Concentra to expand into urgent care Dignity acquisition of US HealthWorks to build occupational health network Page৷24

25 Hospital Transaction Market Trends Observations on strategies driving hospital transactions Reallocation of resources to focus on larger networks in specific markets Tenet divestiture of hospitals in Atlanta and North Carolina to focus on markets where it has a more significant presence CHE Trinity divestiture of St. Michael s hospital in New Jersey Joint ventures to share capital and management resources to grow geographic platform or specific service lines Tenet announced joint ventures with Baptist Health in Central Alabama and Baylor Scott & White in North Texas Post Acute Select JVs with Baylor, SSM, Emory; HealthSouth JV with Vanderbilt Imaging Envison JV with THR, SimonMed JV with Dignity, Baylor/Touchstone JV Vertical Integration of providers and payors In 2011, approximately 20% of health systems had their own insurance plans but more systems are showing interest in expanding into payor side Tufts and Vanguard founded Minuteman Health Inova Health joint venture with Aetna Payor are also looking to expand into provider side Highmark acquisition of West Penn Allegheny Health System Page৷25

26 Deal Structures and Strategies Sale / Acquisition Member substitution Merger / Consolidation Joint Venture Other Structures Page৷26

27 Deal Structures and Strategies High Level of Control & Integration Low Key Themes Deal strategies often drive deal structure Certain deal structures are more tailored for nonprofit entities Immediate benefits of a relationship are often less important than longerterm strategic goals New delivery and payment models Focus on synergies Access to capital markets Competitive positioning Page৷27

28 Deal Structures and Strategies Sale / Acquisition Purchase of one hospital / health system by another Change of control and high degree of integration Typical deal structure used by for-profit health systems Strategic Drivers Smaller hospitals / health systems desire integration with larger systems Large systems building out platform in strategic markets Economies of scale & expanded market share Transaction Examples Commentary Expands CHS presence in Florida, Mississippi and Oklahoma Deal is expected to create $150mm-180mm in synergies over 2.5 years Strengthens Tenet s existing market and adds markets in Arizona, Illinois, Michigan, Connecticut, Massachusetts, and Arizona Expected synergies: $ mm per year Page৷28

29 Deal Structures and Strategies Member Substitution Acquiring party becomes sole corporate member of the acquired hospital / health system Typically used by nonprofits - often noncash deals where nonprofit acquirer takes on liabilities of the acquired target and makes specified capital commitments Change of control, but varying degrees of integration Strategic Drivers Smaller hospitals / health systems desire integration with larger systems Large systems building out platform in strategic markets Economies of scale & expanded market share Transaction Examples Commentary UnityPoint acquires Meriter Health and expands into Wisconsin through acquisition UnityPoint also acquired an ownership stake in Meriter s HMO Physician Plus Insurance OhioHealth acquired MedCentral Health System a 2 hospital, 351 bed system in Ohio OhioHealth pledged to commit over $50 million in capital improvements to MedCentral as part of the acquisition. Improvements include a 5-story MOB & Surgical Department replacement project Page৷29

30 Deal Structures and Strategies Merger / Consolidation Combination of two health systems through merger or creation of new parent holding company Shared control and leadership, with full integration of systems occurring over time Strategic Drivers Development of larger hospital networks or super-systems Economies of scale & expanded market share and geographic presence Examples Merger Commentary Created largest nonprofit system in Texas Focused on combining best practices to provide platform for improving population health management 42 hospitals and 3,000 physicians Includes Scott & White Health Plan Created the 2 nd largest not-for-profit health system in the U.S. 82 hospitals in 21 states with combined revenue of $13.3 billion 4,100 physicians Page৷30

31 Deal Structures and Strategies Joint Venture New entity created between two (or more) health systems Acquisition or contribution of certain facilities into JV by one or both parties Shared ownership & governance - JV facilities integrated under payor networks of controlling owner but may participate in branding and clinical networks of minority owner Strategic Drivers Enhanced access to capital and management resources to expand geographic platform May be used to build out platforms in specific service lines Joint Venture Examples Commentary LHP / Hackensack UMC JVs have allowed a capital constrained health system to expand in a competitive market: JV acquires Hackensack UMC Mountainside and Hackensack UMC at Pascack Valley John Muir Health invested $100 million to acquire 49% interest in Tenet s San Ramon Regional Medical Center The JV will seek ASC and ancillary investment opportunities Page৷31

32 Deal Structures and Strategies Other Structures Hospital Leases Generally long-term leases (30+ years) with upfront payment and ongoing capital commitments Often used in for-profit acquisitions of county-owned hospitals Similar to sale/acquisition but with greater controls retained by selling entity Joint Operating Agreement Two systems create new parent company with joint governance and control rights over operating entities for each system, but operating entities continue to be owned directly by each system Similar to merger/consolidation, but with greater ability for health systems to unwind and take back governance and control of operating entities Minority Interest Joint Venture Health system acquires minority interest in hospital owned by another health system Minority owner cannot integrate hospital under payor networks, but may include them in branding and clinical networks May be intermediate step in acquisition of controlling interest (e.g. UVA JV with Culpeper Hospital) Management / Affiliations Loosest form of deal/partnership Service lines, departments, or system wide Best practice sharing Page৷32

33 Regulatory Hurdles Federal Trade Commission Review State Attorney General Review Tax Exempt Issues Fraud and Abuse Considerations Page৷33

34 Regulatory Hurdles Increased Scrutiny from FTC Antitrust concerns based on perceived costs due to reduced competition and unwillingness to accept arguments about better coordination of care and quality Recent successful challenges to hospital mergers/acquisitions based on concentration of providers in specific markets ProMedica & St. Luke s Hospital (Ohio) Phoebe Putney Health System & Palmyra Park Hospital (Georgia) Recent announcement of FTC second request on review of merger between Advocate Health Care and NorthShore University HealthSystem May indicate closer scrutiny of deals between hospitals in adjoining markets Most hospital/health system mergers and acquisitions require Hart-Scott-Rodino (HSR) filing with FTC However, there is unique exception to HSR filing requirement when nonprofit systems create new nonprofit holding company Announcement of proposed merger between Wellmont Health System and Mountain States Health System noted required review by State Attorney Generals, but omitted any reference to FTC review Creation of new nonprofit parent entity may be exempt from HSR filing, but overlapping markets in NE Tennessee and SW Virginia may prompt FTC review Recently passed Virginia bill HB 2316 creates Southwest Virginia Health Authority to review and approve mergers/affiliations between hospitals in SW Virginia and seeks to create antitrust immunity for transactions approved by such authority Page৷34

35 Regulatory Hurdles Increased Scrutiny from State Attorney General Offices Some states have specific statutes/regulations providing for review of transactions AG Office may still have general authority to review transactions involving charities Antitrust Divisions of AG Offices may also review for potential antitrust issues in coordination with FTC review AG Offices often focused on charity care, deal values and concerns around potential rising costs due to combinations May seek to impose specific conditions on approval of transactions including charity care obligations and other specific restrictions on operations Some deals are being abandoned as a result of state agencies reviews/conditions Massachusetts AG opposed Partners HealthCare System acquisition of South Shore Hospital due to concerns about increased costs for citizens Tenet abandoned proposed acquisition of 5 hospital in Connecticut through its joint venture with Yale New Haven based on daunting 47-item list of conditions imposed by Connecticut Office of Health Care Access Prime Healthcare dropped bid to acquire 6 hospitals from Daughters of Charity in California based on extensive conditions placed on sale by California AG Page৷35

36 Regulatory Hurdles Other Regulatory Considerations Tax-Exempt Issues Unique issues for tax-exempt organizations participating in hospital transactions, particularly in joint ventures with for-profit entities Sales or contributions of assets and other contractual arrangements must be at fair market value to ensure no private inurement issues Activities of joint venture attributed to tax-exempt partner Income will be treated as taxable unrelated business income unless activities are substantially related to charitable purposes If JV is substantial part of activities, it could also impact overall tax-exempt status Governance control is key for tax-exempt partner to ensure that activities will be solely in furtherance of charitable purposes Fraud and Abuse Issues Need to consider whether parties to transaction will continue to be in position to influence referrals to the other party, particularly in joint ventures, and potential implications under Anti-Kickback Statute Diligence process may sometimes uncover significant Stark Law or other fraud and abuse issues that may require self-disclosure and repayment Repayment obligations can impact deal value or cause parties to abandon deal Page৷36

37 Closing Thoughts Closing Thoughts Industry trends will continue to drive significant health system consolidations, but it will happen slower than everyone expects Independent hospitals may be determined to stay independent Nonprofit systems may have limited capacity to make acquisitions Certain active buyers in the process of integrating previous targets Buyers will continue to be more selective in strategic acquisitions Increased regulatory scrutiny Page৷37

38 Questions? James M. Pinna Hunton & Williams LLP Partner Colin McDermott, CFA, CPA/ABV VMG Health Director Page৷38