Are Partnerships and Local Control an All or Nothing Game?
Hospital partnership transactions are often an emotional roller coaster, particularly for local leaders who may lack health care mergers and acquisitions experience. Nevertheless, at Sg2, our clients continue to say their interest in partnering remains high. In fact, a recent Healthcare Financial Management Association survey of senior executives found that more than 80% had recently either entered into an acquisition/affiliation, or were actively considering or open to the idea.
Despite the strong interest, our clients report the biggest impediment to partnering is almost always the reticence to give up local control. Yet it’s not an all or nothing choice. Health system boards and leaders can pursue various partnership options that allow for some measure of local control.
In the past several months, we’ve seen an uptick in the number of transactions with “nontraditional” deal structures, such as whole hospital joint ventures. These types of arrangements can be a great option for organizations that want to retain significant influence. The transactions announced recently have not received the media attention that full-asset mergers do, but are important models for those considering partnership to understand.
Pursuing Transactions From Strong Position
Late last year, Portage Health in the Upper Peninsula of Michigan entered a “seller joint venture” to share ownership and operation of its system with LifePoint Hospitals. Portage was in an enviable financial position at the time, with a 4.9% operating margin and more than 200 days cash on hand. However, Portage’s board and leadership believed that a partner would enable the organization to successfully weather declining reimbursement, increasing capital costs and an impending physician shortage. LifePoint purchased 80% of the system’s assets and Portage retained an ownership stake of 20%. LifePoint also committed to a $60 million capital improvement plan for Portage and established a $40 million charitable foundation. Perhaps most interesting is that despite LifePoint’s 80% stake, it shares governance equally with Portage. Both organizations have four board seats each.
Local Partners Can Magnify Challenges
Although Portage entered its joint venture transaction from a position of strength, that is not universally the case in these transactions. Just last month, CharterCARE Health Partners in Rhode Island transitioned to a joint venture structure with Prospect Medical Holdings, an eight-hospital for-profit chain based in California. Prospect purchased an 85% stake in CharterCARE for $45 million and made a $50 million long-term capital commitment. Like the Portage/LifePoint deal, board seats will be divided 50/50
Yet the CharterCARE story is somewhat of a cautionary tale. The organization was created in 2009 by cross-town rivals in Providence, RI, that came together to stem their respective losses. At that time, the two predecessor organizations were collectively losing in excess of $8 million annually. By 2011, CharterCARE continued to experience losses, along with a significant pension liability. The organization then looked to complete another transaction. Today, although Prospect is making a capital commitment, $50 million across two aging facilities won’t go far, and Prospect is not assuming any pension liability. The organizational instability associated with an ever-evolving ownership structure means that CharterCARE has a challenging road ahead, even with a more stable partner.
Sharing Rewards and Risks
Another interesting joint venture recently occurred in Houston, TX. When Catholic Health Initiatives (CHI) bought St Luke’s Health System in 2013, the resulting $1 billion foundation that was created caught everyone’s attention. The subsequent transaction did not make headlines, yet is equally newsworthy. In early 2014, the Baylor College of Medicine (BCM) and CHI St Luke’s Health formed a nonprofit joint venture that now owns the St Luke’s flagship hospital and a new 250-bed community hospital being built just one mile from the Texas Medical Center. “This is a relationship unique in academic medicine,” said Paul Klotman, MD, BCM president and chief executive officer. “We will be in this together, with joint governance, sharing the rewards and the risks. It provides Baylor the independence we have sought in charting our future.”
Key Partnership Considerations
So what do these nontraditional partnership structures we’re seeing mean to you?
- You have options. The partnership “marketplace” is not a one-size-fits-all equation. You can improve your organization’s market or financial position and still retain some (but likely not all) local control.
- Timing is everything. Organizations with strong financial performance can strike better deals. “We encourage leaders to pursue transactions from a position of strength. If the finances of the hospital or system have already deteriorated significantly, the choices can become more limited,” said Dave Gordon, principal of Juniper Advisory.
- Local control is not always the most important factor. CharterCARE is now headlong into its second transaction in five years. The desire to maintain the majority of local control often leads boards to dismiss certain options out of hand, and the communities we serve can be hurt in the long run.
In the end, the most important question a health system CEO or board member can ask is, “Do we need a partner to achieve our organizational goals and vision?” It is not a simple question and the answers are not simple either. Ultimately, if it is a question you can’t answer with confidence, give Sg2 a call. We stand ready to help you wade through the issues.
Sources: Healthcare Financial Management Association (HFMA). Acquisition and Affiliation Strategies: HFMA National Institute (ANI) Preview Copy. 2014; Portage Health. Portage Health and LifePoint Hospitals form joint venture [press release]. December 2, 2013; Rhode Island Office of Health Care Advocate. Hospital Conversion Application. www.health.ri.gov/applications/submitted/merger/ProspectCharterCare/Application.pdf. Accessed July 2014; BCM. FAQ on Baylor, CHI non-profit joint venture [press release]. January 7, 2014; BCM. Bold new alliance among Houston’s leading health care providers to transform care delivery in the region [press release]. January 7, 2014.