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Mergers, Acquisitions and Partnerships Lessons From the 1990s.

During the 1990s, hospitals stampeded to affiliate with one another based on the assumption that capitation would soon be the dominant form of payment to providers. Field experience and liter- ature review indicates there were at least as many failures as successes, with failures falling into three categories: hospirals that invested a lot of time, money and energy but never closed the deal; hospitals that closed the deal but subsequently came apart; and hospitals that closed the deal but still haven't achieved expected benefits.

Mergers and acquisitions peaked in 1998 with 287 hospitals participating

in 139 deals, according to the American Hospital Association's (AHA) 2009 TrendWatchC\^2.nhook. (See chart on page 58.) Except for a blip in 2004 (and HCA's restructur- ing of 176 hospitals in 2006), trans- actions trended steadily downward until 2007 when it jumped to 149 hospitals participating in 58 deals. Based on conversations among The Governance Institute's advisors and other experts, most expect the upward trend to continue. But, before rushing into negotiations, prudent leaders should reflect on the lessons of strategy, structure and process used in the 1990s.

To help focus the discussion in this article, the following definitions are provided.

Hospital: a nonprofit, 501{c)(3) freestanding hospital or system-based hospital.

Acquisition: a transaction in which one hospital gains control of most or all o{ rhe assets of a second hospital.

Merger: a transaction In which two hospitals combine most or all of rheir assets to create a third entity, resulting in a change of control for both hospitals.

Partnership: a transacrion in which two or more hospitals agree to cooperate for mutual benefit; not resulting in a change of control.

Affiliations: a term that encompasses mergers, acquisirions and partnerships.

Lessons of Strategy A common business axiom is that structure follows strategy. Yet many affiliation discussions begin as if the opposite were true, with lawyers out- lining complex explanations regard- ing antitrust law, displaying diagrams of corporate structures and develop- ing requests for proposals.

Hospitals affiliate to better serve their communities and to either strengthen their position for the future or fix a problem they can't resolve independently. When 1 pro- vide advice in an affiliation discus- sion, I ask the board and CEO to determine one to three compelling motivations for why the transaction should take place. Pinpointing com- pelling motivation requires the disci- pline to sort through rhetoric and the fortitude to confront practicality. Improving market share and upgrad- ing facilities are not compelling motivations. The root causes in this case are more likely: Organizations need help recruiting physicians (to increase market share) and need access to capital (to replace anti- quated facilities).

In AHA's 2003 Larson Lecture, Samuel O. Thier, MD, said the merger of Massachusetts General Hospital and Brigham and Women's

5 6 Healthcare E.\ecutive JULY/AUG 2009

Hospital to create the dominant Partners Healthcare System in Boston "...was neither a marriage based on love nor a shotgun wed- ding." He went on to describe com- pelling motivations related to contracting and cost reduction.

Although recently terminated, it wasn't hard to find the compelling motivation for Johnson Memorial Hospital, Stafford Springs, Conn., in its negotiations with Eastern Connecticut Health Network (ECHN), Manchester, Conn., which was going to assume $45 million in Johnson's debt and potentially invest $20 million ior capital improve- niients, according to a March 7, 2009, article in tbe Hartford Courant.

Motivations for Mergers and Acquisitions In practice, tbe basis for a merger or acquisition typically comes down to tour potentially compelling motiva- tions: access to capital, physician recruitment, payor contracting and reduction in operating costs.

In the case of acquisitions, another motivation sometimes arises when hospital A acquires hospital B to pre- vent a potential loss of referrals. But be careiul—physicians make referrals, not hospitals. Strengthening physician relationships at bospital B might be more effective and less expensive.

Motivations for Partnerships Strong community hospitals may have a compelling motivation to enhance particular service lines but aren't interested in being merged or acquired to achieve it. Instead, they seek a partnership with a well- regarded tertiary hospital to provide

brand equity, clinical protocols and

availability of specialist physicians.

Lessons of Structure Whether it's negotiating from a position of strength or weakness, wben a hospital is clear about its compelling motivation, the struc- ture almost defines itself. For this article, structure refers co the framework through which organi- zations affiliate: mergers, partner- ships or acquisitions. In general, when determining structure, choices should be made regarding capital—who is supplying it and how the assets will be combined.

In almost all cases, if one organization is providing capital—which can be an

infusion of cash or assumption of debt—to another, an acquisition is taking place. In most instances, the capital recipient will relinquish sub- stantial control of the hospital. When Addison Gilbert Hospital "merged" with Beverly Hospital to create Northeast Health System in Boston, governance of the new entity was dominated by Beverly, the stronger of the two hospitals. Again, the proposed transaction between ECHN and Johnson Memorial was frequently referred to as a merger. But when ECHN abruptly terminated discus- sions, the headline read, "ECHN Cancels Purchase of Johnson Memorial Hospital," and referred to it as an acquisition. Many hospital merg- ers are actually acquisitions.

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But mergers do take place, most often when two organizations of similar strength combine all their assets to create one stronger survivor. Arden Hill Hospital and Horton Medical Center in Goshen and Middletown, N.Y., respectively, now known as Orange Regional Medical Center, merged eight years ago with the compelling motivation to pool capital and create a new, state-of-the-art hos- pital. As the first new freestand- ing hospital in New York in more than 20 years, it will open in approximately 18 months.

Emerson Hospital in Concord, Mass., is a good partnership exam- ple. A 180-bed community hospital, Emerson faces world-class competi- tion in every service line. To better compete, Emerson supplements its own clinical strengths in partner- ships with Massachusetts General, Brigham and Women's Hospital, Tufts Medical Center and Lahey Clinic, which bring strong brand awareness, protocols and physicians to Concord,

Lessons of Process Strategic clarity, achieved through specifying goals and narrowing

options, makes the process of select- ing a partner and successfully nego- tiating a deal much easier. For the transaction to go smoothly, the peo- ple involved and the sequence of events are important.

Hospital affiliations are not, at their core, financial transactions driven by maximization of financial gain for shareholders and execu- tives. Many tenets of corporate America merger and acquisition transactions don't apply. While negotiation is important, hospital affiliations are typically more collé- gial than adversarial.

Announced Hospital Mergers and Acquisitions, 1998-2007

300 I—

250 —

200 —

Number of Deals

Number of Hospitals

249

1998 1999 2000 2001 2002 2003 2004 2005 2006' 2007

Source: Irving Levin Associates Inc., The Health Care Acquisition Report. Thirteenth Edition, 2008, '" In 2006, the privatization of HCA Inc. affected 176 acute-care hospitals. The acquisition was the largest healthcare transaction ever announced.

5 8 Healthcare Executive JULY/AUG 2009

Step one in the process is to deter- mine with whom to affiliate. The object isn't to sell the hospital to the highest bidder; it is to select the best potential partner based on strategy, structure and values.

Step two is to structure a confiden- tial process, where the principles {strategy and structure) are discussed during a 30- to 90-day period in two to four meetings, each approxi- mately three hours in length. This may seem overly prescriptive, but experience underscores the impor- tance of moving quickly and keep- ing the dialogue at a high level. These discussions should involve three to five senior leaders from each organization and appropriate legal

counsel. Most often, one law firm serves as antitrust counsel to the transaction, while each hospital retains its own attorneys for contract review and due diligence. If these negotiations are successful, they should be documented in a memo- randum of understanding.

Step three is a combination of busi- ness planning and legal due dili- gence. Assuming both have positive results, a definitive agreement docu- ment can be developed and the transaction completed. This should take 90 to 180 days.

There is always a question of who should be informed of what and when during these discussions. But

the less that is known outside the boardroom until a milestone has been reached, the better. The trans- action should not be negotiated in the media, within the community at large, in the medical staff lounge or on the floors of the hospital. Communication outside the board- room, however, is important. When a milestone is reached and docu- mented, it is usually a good time to inform employees, physicians and the public. A

Donald W. Seymour is president of Don Seymour & Associates Inc., Winchester, Mass., and governance advisor for The Governance Institute. He can be reached at [email protected].

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