Gloves Come Off Over Hospital Mergers & Acquisitions

Is a battle brewing over hospital system mergers and acquisitions post COVID-19?

The acquirers, according to a May 15, 2020 Law360 analysis, will be the big, healthy, financially sound hospital systems that scooped up the bulk of federal hospital bailouts from the CARES Act. The acquired will be the smaller hospital systems that are the collateral damage from a pandemic that left them with little financial margins of error, a fraction of federal aid, and a growing sense of desperation.

25% of Rural Hospitals May Fail

The financial shock of delayed elective surgeries hit some hospitals, especially geographically remote hospitals already operating under thin margins, so hard that their survival may be in doubt without the aid of a big angel partner in the form of mergers and acquisitions (M&A). The big will get bigger.

In April, consulting firm Guidehouse LLP reported, “a quarter of U.S. rural hospitals are at a high risk of closing unless their financial situations improve.”

The price of survival for these small players will be serving the needs of their acquirer who will likely insist on efficiencies and reorganizing the logistics of where and when orthopedic procedures, among others, are delivered. Surgeons and patients will travel further and longer for services.

“There will be this regional rationalization of services based upon the expense of the service and the sophistication of the service,” Rivkin Radler LLP partner Bob Iseman told Law360.

Multiple lawyers also told Law360 that the pandemic may well encourage vertical integration in which hospitals with robust resources snap up different types of providers to offer primary care and other outpatient services.

The consolidation of health systems is not new, of course. Private payers and Centers for Medicare and Medicaid Services (CMS) have been directing patients to lower-cost, non-hospital settings and tying payments to quality of care for years. Hospitals responded by snapping up clinics, physician practices, and financially stressed hospitals to capture patient revenue and “The Bundle.”

But any anticipated reshuffling of the hospital deckchairs will be evaluated with a skeptical eye by anti-trust enforcers, politicians, and the broader business community which still foots the bill for healthcare costs of their employees.

Financial Carnage

First the financial damage.

The American Hospital Association told Congress that hospitals would lose about $200 billion from March through June, made up of $161 billion in lost revenue from the cancellation of nonemergency treatments and $37 billion in net expenses for coronavirus care. A report from accounting and consulting firm Crowe LLP estimated that hospitals nationally have recently been losing $1.44 billion per day because of declining patient volume.

Too Little, Too Late

Congress immediately kicked in $175 billion with the signing of The CARES Act on March 27, 2020, to be spread out across the entire health care industry, not just hospitals.

But the hospitals’ lawyers and lobbyists said it was not enough. Tim McCrystal, health practice co-chair at Ropes & Gray LLP, told Law360 that “the payments…for many hospital systems do not come close to covering the costs and lost revenue that those systems have incurred in connection with COVID-19.”

Congress is considering another $3 trillion relief bill, which would add another $100 billion for hospitals, but early bipartisan support has quickly vanished. Republicans have withheld support. “Right now, we’re kind of on a precipice,” Iseman told Law360. “We don’t know how much more money the government is going to be willing to print to bail out the health care industry.”

Looking for a Financial Angel

If more bailouts aren’t on the way, stressed hospitals will run out of cash and start looking for partners. David Dahlquist, health group co-chair at Winston & Strawn LLP, said he expects “a greater push for consolidation” in the aftermath of COVID-19’s earnings earthquake. “That is an element that we’re seeing in a lot of phone calls.”

“We think that there’s going to be a lot of tendency for standalone hospitals to think that they can no longer be standalone,” said Jim Boswell, health team leader at King & Spalding LLP.

Will Certain Hospital Mergers be Outlawed?

But, like epidemiologists responding to the initial virus, anti-trust regulators, politicians, and purchasers of health care services are ringing alarm bells.

A California Senate committee has already forwarded legislation to outlaw certain mergers. U.S. Senate Democratic senators wrote to Treasury Secretary Steven Mnuchin and Federal Reserve Chairman Jerome Powell urging them to “restrict large corporations that receive bailout funds from engaging in potentially harmful mergers and acquisitions.”

The Federal Trade Commission’s (FTC) Mergers IV division, which investigates health care provider transactions, is keeping their thinking private for now on pandemic-inspired M&As.

Some lawyers who spoke to Law360 pinned any hope of FTC M&A sympathy on a legal theory called the “failing firm” defense. This argument says it’s better to allow a questionable merger than to let one of the entities die. Others argue that over-enforcement of mergers by the FTC in the past created a situation where there are now too many unsound hospitals.

There have been no FTC decisions since COVID-19 regarding hospital mergers, but the commission blocked a merger between two Pennsylvania hospitals in February, on the grounds that consolidation would mean the systems would have fewer incentives to keep costs down.

Not only are regulators skeptical of allowing more hospital consolidation, some industry giants have expressed fears.

The Big Get Bigger

On May 22, Reuters reported that the Pacific Business Group on Health, whose members include Boeing, Salesforce, Tesla, and Walmart, said in a letter addressed to congressional leaders that it feared that further consolidation in the health care industry could lead to higher costs.

The group noted that physician practices’ revenues plummeted due to bans on elective surgeries. They said even before the pandemic, big hospital systems were taking over smaller doctor groups and hospitals to increase market share.

There is now a fear these larger players are even stronger to buy struggling practices coming out of the crisis, raising health care prices for employers. The group asked for a year-long M&A ban for any health care provider receiving any of the $170 billion government relief approved for the industry.

Following the Money Trail

The case for mergers wasn’t helped with a May 25 New York Times analysis that showed federal bailouts are going to hospitals that had already built up deep financial reserves. By comparison, the analysis showed that smaller, poorer hospitals are receiving tiny amounts of federal aid by comparison.

The Times reported that 20 large chains received more than $5 billion in federal grants while sitting on more than $100 billion in cash.

Seattle-based Providence Health System was cited as sitting on nearly $12 billion and generating more than $1 billion in profits. Providence received at least $509 million in government bailouts. A Providence spokeswoman reportedly said the grants helped make up for losses from the coronavirus.

HCA Healthcare and Tenet Healthcare together received more than $1.5 billion in federal funds.

The Cleveland Clinic got $199 million. Last year $7 billion in cash helped generate $1.2 billion in investment profits. The Clinic reportedly paid investment advisers $28 million to manage the funds.

St. Louis-based Ascension Health, which operates 150 hospitals nationwide, has received at least $211 million. The company, with $15.5 billion in cash, operates a venture capital fund and an investment advisory firm that helps other companies manage their money.

The Haves…

The Times report said that after the CARES Act was passed, hospital industry lobbyists met with senior Health and Human Services (HHS) officials, including Secretary Azar, to advise the agency how to distribute the money. One formula based payments on how much a hospital collected from Medicare the previous year. Another was based on the hospital’s previous year’s revenue. HHS did not consider each hospital’s existing financial resources.

But time was of the essence as reported cases of the virus spread around the country raising fears that hospitals and their intensive care units would be overwhelmed with patients. Fortunately, that did not happen.

A spokeswoman for HHS told the Times “This simple formula used the data we had on hand at that time to get relief funds to the largest number of health care facilities and providers as quickly as possible. While other approaches were considered, these would have taken much longer to implement.”

The Times cited a recent Kaiser Family Foundation study that showed that hospitals that served a greater proportion of privately insured patients got twice as much relief as those focused on low-income patients with Medicaid or no coverage at all.

…And the Have-Nots. What Can They Do?

“If you accumulated $18 billion and you are a not-for-profit hospital system, what’s it for if other than a reserve for an emergency?” said Dr. Robert Berenson, a physician and a health policy analyst for the Urban Institute, a Washington research group.

Even before the pandemic, roughly 400 hospitals in rural America were at risk of closing, said Alan Morgan, the chief executive of the National Rural Hospital Association. On average, the country’s 2,000 rural hospitals had enough cash to keep their doors open for 30 days.

At St. Claire HealthCare, the largest rural hospital system in eastern Kentucky, the number of surgeries dropped 88% during the pandemic. The system furloughed employees and canceled some vendor contracts. The $3 million the hospital received from the federal government in April will cover two weeks of payroll, said Donald Lloyd, the health system’s chief executive.

In 2018, Providence paid its chief executive, Dr. Rod Hochman, more than $10 million. That would be enough, noted the Times, to finance about a month of operations at the St. Claire hospitals in Kentucky.

The push for greater consolidation is inevitable. The legal hurdles will be significant. Eventually, economics will pick winners and losers. Stay tuned.