Competing with Hospitals: Why Buyers Should Consider Healthcare Acquisitions

The healthcare industry, normally blocked with high barriers to entry, is more accessible than ever to buyers. Many smaller private practices are looking to be acquired or to merge with other firms, due to rising costs from regulatory reform, declining reimbursement margins, harrowing malpractice rates, overhead, and rising employee benefit costs. With such a negative laundry list, many buyers would question the sanity of getting involved in an industry that is undergoing such a transformation. However, for the right buyer, the changes present in this sector offer a compelling opportunity to compete with hospitals. Given the quantity of potential targets, buyers have the opportunity to cherry-pick practices, combine resources to generate economies of scale, and produce highly competitive offerings to traditional hospital-based care.

Hospitals have long recognized the benefit of acquiring smaller healthcare practices. The Medical Group Management Association estimates that over 50% of physicians are now employed by hospital owned practices. Unfortunately, many institutions had difficulty successfully integrating the acquisitions during the healthcare merger craze of the 1990s, due to lack of a long-term strategy and poor management planning (e.g., poorly negotiated employee contracts, paying premiums for practices, etc). The Patient Protection and Affordable Care Act (PPACA) passed in March of 2010 continues to encourage the consolidation of physician networks with hospitals, under the guise of Accountable Care Organizations (ACO), with the goal of creating organizations that can be easily regulated and allow central management of medically provided services. While this has the benefit of eliminating the administrative hassles and financial realities that small practices are looking to escape, it also presents the very real consequence of making it difficult for doctors to practice medicine with the same degree of freedom. Not only will doctors have to work under the red tape of the physician networks owned by the hospitals, but ACOs may also eliminate the bedside feel patients receive in private practices, compared to traditional hospital-based settings (depending on how the institutions are ultimately designed).

The passing of PPACA has been a driving force in the healthcare mergers and acquisitions trend. Although the Act comes with much uncertainty, many strategic buyers and capital management groups are focusing on the positive anticipation of 32 million additional people receiving health insurance and their need for a healthcare provider. According to research by Irvin Levin Associates, Inc., there was a 65% increase in the amount of financing for healthcare M&A between the first quarter of 2010 ($32.9 billion) and the first quarter of 2011 ($54.4 billion). While this includes healthcare technology sectors, such as pharmaceuticals and biotechnology, hospital consolidation is still a multi-billion dollar M&A category; the top ten hospital mergers and acquisitions in 2010 had an estimated value of approximately $3.8 billion. This consolidation offers many benefits, including larger market shares, improved negotiating power with insurance companies and vendors, and cost-side efficiencies.

Non-hospital buyers may be missing a golden opportunity to control a portion of this multi-billion dollar industry and help to shape the future of the healthcare landscape. A 2011 Executive Insights study found that corporate executives and private equity respondents agree that the healthcare industry offers one of the most significant opportunities for growth this year. Both sets of respondents also agree that there is a market shift coming down the pipeline that will soon favor sellers. With the market currently favoring buyers, the time is ripe for interested parties to enter the healthcare sector.

Buyers who understand the intricacies of healthcare practice management will be better able to merge practices and manage a larger, single entity like any other regulated business. This consolidation will refocus the intellectual assets of the business, allowing physicians to practice medicine and shifting the administrative strategy for all consolidated practices to a single source. While the PPACA theoretically applies a similar theory for development of ACOs, private practice administration will likely be more efficient (due to its more manageable size) than larger scale hospital networks. Additionally, the economies of scale of a consolidated healthcare practice will help to achieve greater profits than any private practice would achieve alone. For instance, the PPACA requires that healthcare facilities implement an electronic medical records system. This endeavor generally has a base cost and a cost per doctor, as well as additional expenses, such as information technology (IT) help and maintenance expenditures. On the scale of a single private practice, the implementation of such a system is cost-prohibitive. However, a larger, consolidated practice would have a lower overhead expense as more doctors shared the base cost of implementation and IT fees.

There is an opportunity in healthcare for a buyer to acquire and centralize the costs of physician practices and essentially compete with hospital-based care. While the PPACA is pressing for ACOs, hospitals may find this transition to be riddled with challenges, from burdensome regulation to unhappy physicians and patients. The consolidation of smaller healthcare practices provides an opportunity for a buyer to provide an alternative healthcare source to the millions of additional individuals who will be searching for healthcare services in the coming years.

This article is provided by Axial Inc. and its affiliates for educational and informational purposes only and is not intended to constitute, and should not be construed as, legal or business advice. The opinions presented in this article are those of the contributor, and do not represent the opinions of Axial Inc. and its affiliates. This article is a summary that we believe may be of interest to you for general information. It is not a full analysis of the matters presented and should not be relied upon. Prior to acting upon any information set forth in this article or related to this article, you should consult independent legal counsel.