🏥 New-Age Health System M&A: Part 1
 PARTNERED WITH  Good morning Hospitalogy fam, One quick housekeeping item - I had a huge bounce rate on my Tuesday send. If you’re part of a healthcare organization, could you please do me a huge favor and whitelist the Hospitalogy e-mails? I would greatly appreciate it! Today we’re diving deeper into the world of health system mergers. Specifically I’m talking about the Advocate-Aurora and Atrium $27 billion deal announced a couple of weeks ago. The essay will be split into 2 parts. Part 1 will provide context for the specific Atrium/Advocate merger, including how mergers have evolved over time and headwinds facing hospitals. Then, next Thursday, Part 2 will cover why we’re keeping an eye on the future of population health management strategies as health system mergers evolve to prioritize risk and additional sources of revenue diversification, and we’ll make a prediction on whether or not the Advocate Aurora-Atrium and Intermountain-SCL mergers are likely to raise or lower prices based on historical precedent and the nature of each system’s operating model. Also, for these next two weeks, I’m excited to be joined by Daran Gaus, who writes The Scroll. He knows everything value-based care (like, REALLY knows the space), so drop him a subscription! Was this email forwarded to you?  SPONSORED BY FRESHPAINT There are so many companies building software & other technical infrastructure for digital health startups. For operators running health tech firms, it’s super challenging to know what products and solutions can best fit your current - and future - growth needs. Freshpaint has pulled together the best of the best when it comes to developing a framework for building an optimized tech stack for your organization. This webinar panel has a ton of expertise (that I can personally attest to!) across some of the top digital health organizations and will help answer pertinent questions facing tech & services operators. On June 1st, 2022 at 2PM PDT, join more than 300 health tech leaders by signing up for the virtual webinar. I’ll be there!  HEALTH SYSTEM M&A Key Takeaways.Historically, large health systems have engaged in horizontal mergers to increase market share, gain leverage from payors for better rates, and expand access to resources. Such resources might include access to more physicians & specialties, shared staffing, new service lines, and cutting costs through combined purchase power. In addition to the above, running hospitals is capital intensive and cost inflation from vendors and staffing are a constant pressure, eating up cash flow and margin. Some hospitals and health systems are forced to merge just to survive. This effect is most notable in the rural and critical access hospital sphere. In the world of 2022, it’s pretty dang tough to run a hospital. Here’s the problem, though. The hospital market is growing more and more concentrated. Hospital consolidation has developed an insane amount of notoriety for increasing prices. As a result, proposed mergers are increasingly failing state antitrust review due to hospital market concentration concerns. Because of this antitrust concern, health systems are transforming their M&A strategy. In 2022, the two largest announced mergers between Intermountain/SCL and now Advocate-Aurora/Atrium have included pointed language around pursuing risk-based population health strategies, a focus on charity care, medical research, enhanced data analytics, and investment in digital health infrastructure. That strikes me as a major shift in the type of mega-merger we’ll be seeing in the future. The days and opportunities associated with consolidating JUST to boost market share and command higher payor rates are evaporating in the hospital market. From here on out, health system mega-mergers will look to open different doors that also benefit from economies of scale - like more venture investments into health tech infrastructure (for both the hospital and consumer) and the ability to get closer to the premium dollar to compete with the traditional insurer. TL;DR - My primary thesis is that health system M&A strategy is shifting from horizontal (market power play) to vertical integration, thinking about upstream and downstream revenue, taking on risk, and becoming more of a fully integrated institution. Advocate/Atrium Merger Context.Let’s jump into the behind the scenes of the Advocate/Atrium merger. Advocate is no newbie to mergers. In 2014, the Illinois-based health system announced a merger with NorthShore Health in Colorado, which was ultimately struck down by the FTC in 2017. Turns out the merger would have resulted in 55% acute care market concentration at the time. Then, in 2016 (while the NorthShore merger was still under review, mind you), Advocate Health merged with Aurora Health to create a 27-hospital footprint in Wisconsin and Illinois, around $11 billion in total revenue and good enough for the 11th largest health system at the time:  Since then, Advocate has been sniffing around the M&A market looking for another suitor. In 2020, Advocate tried to merge with Beaumont Health to create a $17 billion system, but this attempt was ultimately called off after clinical leaders (nurses, physicians) voiced safety concerns. Beaumont is now successfully merged with SSM Health, by the way, after several failed attempts with multiple other health systems. Finally, Advocate found a suitor in 2022 - Atrium Health. Charlotte, North Carolina-based Atrium Health enters the Advocate merger with around $11 billion in revenue. Atrium is fresh off the heels of another completed integration with Wake Forest Baptist Health, an academic-based institution, announced in late 2020. Atrium’s footprint is connected throughout Georgia and the Carolinas:  Atrium Health, formerly known as the Carolinas Health System, has merged with Wake Forest Baptist Health, Navicent Health and Floyd Health in the past three years. The system lives in M&A integrations, apparently. Summary of Key Merger Provisions.Here’s the high-level overview of the AA merger. Advocate Aurora Health is merging with Atrium Health to create a $27 billion health system which will operate under a new name: Advocate Health. The new system's combined revenues puts it on par with that of Ascension & Providence at about $27 BILLION - good enough for the 6th largest health system in the U.S. (including Kaiser) I mean, that is just absolutely massive.  Advocate's new footprint will include:
You might be wondering - “how can there be any sort of synergy here? The two health systems are separated geographically. What’s going on?” Notably, Advocate Health will be structured as a joint operating company (JOC). Instead of just contributing assets in a specific area, the two systems appear to be layering the JOC on top of 100% of their combined footprint. The thinking pervasive throughout most health system mergers is “bigger is better.” Even though rate plays and payor negotiation might not be as strong of a synergy here, there are other ways that a $27 billion institution can unlock value. I mean, there have to be, right? We’ll get into that a bit more in Part 2. Here’s a good overview of the combined org from the press release. Like I mentioned and as you can probably imagine, the footprint is expansive:  Brief History of Health System Mergers and recent Hospital Activity.So, why do health systems merge? In the traditional sense, health systems conducted mergers for scale primarily related to rate plays and favorable expense management - better purchase agreements, contracted rates with vendors, and ability to share staffing & other resources, along with plenty of other synergies identified by a slew of consultants. Some more notable examples of these kinds of mergers include Dignity / CHI to form CommonSpirit and Providence / St. Joseph’s to form Providence Health & Services about 5 years ago. Some of the larger, more notable hospital & health system deals that have been announced within recent memory include the following:
In general, hospital deals are slowing down. We’ll increasingly start to see more creative strategic partnerships between health systems, or larger health system mergers. I’m betting that the larger, regional mergers will be structured similarly to the Intermountain/SCL and Advocate/Atrium deals. Meanwhile, I’m willing to bet that existing, scaled health systems will start to focus in on population health strategies. Why Hospitals Merge.Like I said in the intro, it’s tough out there for hospitals - in lots of cases, really their only option is to consolidate. Here’s a non-exhaustive list of things causing headaches for operators nationwide: Labor Shortages & Inflation. Stemming from the pandemic and a piping hot reopening economy, the Great Resignation, and supply chain constraints, inflation and labor shortages are top of mind for healthcare executives. Like I covered in my Q1 review of publicly traded operators, hospitals saw a ton of travel agency costs, which dampened margin quite a bit - especially for the nonprofit operators. Staffing comprises about half of a hospital’s cost structure, and 33% of nurses are planning to leave their current position. Burnout is at an all-time high in healthcare. Nursing shortages are projected to reach pretty dire levels by 2025. Turnover is costly as hell, so hospitals have been focused on retaining staff through signing bonuses and other initiatives. Once travel nurses return home, a sense of normalcy will return, but they’ll be getting some major base salary escalators. Still, that’s better than travel rates. From a drugs & medical supply perspective, almost all hospitals in the U.S. reported facing procurement issues. Drug & equipment distributors will pass on their inflated costs to providers to maintain their already-low margins. Finally, health systems & hospitals are dealing with general & administrative cost inflation, which will likely be the most variable. Hourly rates from lawyers, consultants, and other professionals will reflect inflation increases. Any travel costs, insurance expenses, utility bills, and more will reflect higher expenses. Reimbursement. CMS is making changes to disproportionate share payments, while providing a pay bump of just 3.2%. Wage index adjustments (for elevated staffing costs) to Medicare payments will lag until CMS incorporates 2021 and 2022 data into the reimbursement formula. Further, boosted reimbursement from ‘Rona and the public health emergency will likely fizzle out sometime in 2022. Finally, Medicare sequestration (a mandatory 2% cut to reimbursement) will happen eventually…maybe. Unless the AHA gets its way! Capital. Finally, interest rates are rising, tightening capital just a bit more. Hospitals refinancing debt will have to do so at higher rates and subsequent higher interest payments. Is there an option besides merging? To combat various operational challenges, health systems are throwing around their weight and increasingly forming coalitions. For instance, health systems formed Civica Rx in 2018 to address drug shortages, Truveta in 2019 but picked up steam in 2021, a health system data platform, and now Evolve Health Alliance, a staffing agency sharing labor resources between participating hospitals to pare down travel nursing agency costs. Even UPMC created its own internal staffing agency.
Antitrust.Speaking of the FTC, THE biggest headwind to hospital M&A, healthcare gets a ton of antitrust scrutiny, especially when Democrats are in office. The Biden Admin made antitrust a high priority during its administrative run and has generally cracked down on mergers in healthcare along with state review. There have been a number of health system mergers canceled or struck down in very recent memory for a number of reasons:
Any hospital acquisition or merger that might result in increased market concentration over a certain threshold is very likely to be blocked in this transaction environment - especially in the Northeast. Daran’s Thoughts: Why is antitrust a concern? A significant and growing body of research shows that provider consolidation leads to higher healthcare prices for insurers, and that this notion holds for both horizontal and vertical consolidation. Hospital mergers diminish market competition and increase health system negotiating leverage with payers (which means they have the bargaining power to force insurers to pay higher prices). To put this into context, a recent RAND study found that employer-sponsored (read: commercial) health plans pay hospitals 244% more than Medicare prices in 2020. Hospitals claim that they must charge commercial insurers more (or cost-shift) to cover the losses from inadequate Medicare payments. Further, they argue their higher prices result from the need to offer unprofitable services and that quality improvements justify the price increases. RAND researchers found no evidence to support the cost-shifting or quality premises. These price hikes do not stay with insurers, however, as they are an intermediary that passes these price increases onto employers (and employees by proxy) and taxpayers (insurance margins tend to hover around 4%). This isn’t a universal effect though. Hospital groups have presented some evidence that mergers can reduce hospital costs and improve outcomes. However, these cases tend to be the exception rather than the rule. Got it, so you are saying that healthcare mergers are bad…right? Not so fast. Mergers are just a tool, M&A activity isn’t inherently a good or bad thing. It is the intent behind the merger and what it achieves that matters. When mergers serve to perpetuate the volume-based, fee-for-service operating model which dominates the healthcare industry, then the increased negotiating leverage is likely to raise prices without accompanying quality improvement. Madden’s Musing: These days, among the general population, hospital M&A is generally frowned upon since it’s notorious for increasing costs. But I’d encourage you to look at M&A from an operator’s perspective as well. Hospitals operate on razor thin margins. Yes, there’s a ton of bloat in these organizations, and hospitals could stand to lean up their expense profiles. But even the best run facilities - HCA - operate on a 20% EBITDA margin. As hospitals continue to face pressures and headwinds outlined above - we’re going to continue to see M&A whether we like it or not, and whether it passes antitrust review or not. Conclusion.Hospitals and health systems are reaching a critical mass in the U.S. where continued horizontal mergers are getting increasingly shut down for market concentration concerns. As antitrust picks up, health systems are getting more creative with their merger strategy, offering more concessions, job growth in their local markets, higher levels of charity care, and investments into the local community. Thanks for reading Part 1! In Part 2, Daran and I will cover the new value-based population health opportunity available to scaled health systems, and why we think it’s a winning strategy - if done the right way!  HOSPITALOGY HITS
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Telemedicine Lead Psychiatrist, Lyra Health: Lyra is transforming mental health care through technology with a human touch to help people feel emotionally healthy at work and at home. We work with industry leaders, such as Morgan Stanley, Uber, Amgen, and other Fortune 500 companies, to improve access to effective, high-quality mental health care for their employees and their families. Senior Director of Customer Success, Health Plans, Virta Health: Virta is looking for a seasoned customer success leader to scale our health plan team while growing our relationships and footprint with our existing clients. You should be a subject matter expert at working with national & regional health plans and third party administrators across fully insured, ASO, and Medicare/Medicaid lines of business. Senior Data Analyst - Product & Clinical Analytics, Omada: Join Omada in helping to develop and derive data-driven insights focused on member engagement, clinical outcomes, and the overall effectiveness of our products and care teams. You’ll perform statistical analysis and develop dashboards with data from across our Diabetes, Hypertension, Musculoskeletal, and Diabetes Prevention programs. In your day-to-day, you will work cross functionally with our analytics, engineering, product, clinical, and commercial teams. Thanks for the read! Let me know what you thought by replying back to this email. See you Tuesday! — Blake   Loving this newsletter? Get in front of 3,400 executives and healthcare decision-makers by clicking below: |
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