Black Jet Theory – Volume 2020-22 – Hospital Survival – Are Mergers and/or Acquisitions the Answer. November 20, 2020 by Marshall Snipes
Earlier this month, Intermountain Healthcare based in Salt Lake City, Utah and Sanford Health based in Sioux Falls, South Dakota announced they have signed a letter of intent to merge the two organizations.[1] To put the potential merger in perspective, these are two very large and well-respected health systems who both own health insurance companies commonly referred to as Health Plans. The combined organization would employ 89,000 people, include 70 hospitals and 435 clinics in 7 states representing $12.5 billion in revenues. Additionally, the combined entity would provide senior care in 366 locations in 24 states and the combined health plans would cover 1.1 million lives.[2]
In the 13 years of being involved in healthcare and healthcare public policy, attending dozens of conferences, hospital system planning retreats and having read hundreds of articles in the healthcare literature, the constant theme has been for a hospital or hospital system to survive, revenues must grow. The fastest way to grow revenues is through merger, acquisition or some other financial arrangement that pools the resources of separate entities. The Intermountain/Sanford merger would seem to be an example of that theme. The number of merger and acquisition (M&A) transactions for 2020 has significantly declined from 2019 in all likelihood because of the pandemic and the economic uncertainty in the economy. That decline makes the Intermountain/Sanford deal all the more significant.
So far this year, healthcare merger and acquisition activity has been down,[3] primarily as a result of COVID-19. The second quarter of 2020 saw M&A activity drop 20% from the first quarter and 34% when compared to the second quarter of 2019, according to Irving Levin Associates. Not only were there fewer mergers and acquisitions in the second quarter of 2020, but the ones that did occur were worth less than those in first quarter of 2020 and the second quarter of 2019, according to S&P Global Market Intelligence[4]. The aggregate transaction value of the M&As in the second quarter of 2020 was $12.26 billion compared to $29.31 billion in the first quarter of 2020 and $137.29 billion in the second quarter of 2019. Despite the second quarter of 2020 being the lowest quarter as far as M&A activity in five years, analysts at Waller and Kaufman Hall predict that the pent-up M&A activity from the pandemic will “very likely” cause a surge of M&A’s[5] moving into 2021. They predict that M&As will be particularly active among small and independent hospitals looking to partner to stay afloat.[6]
Within the health system industry there has been and continues to be transition, albeit slow, to a system of “value” versus the costly fee for service model that exists today. The notion is that to lower cost and improve quality, the provider of the service needs to be at risk for the outcome of the service provided. One of the ways to accomplish this transition is for the revenue of the provider to be at risk through a health plan or insurance company model. In this scenario the health system becomes the risk taker thus replacing the traditional insurance company. This is the model of both Intermountain and Sanford. In fact, the provider owned insurance company model was one of the main reasons Sanford wanted to partner with Intermountain as explained by Kelby Krabbenhoft CEO of Sanford.
“It’s the insurance piece that has challenged Sanford in recent times. We’ve had an insurance company for 25 years and we do a good job with it in this region. But we’re stuck,” Krabbenhoft said. “To grow outside this region with our insurance in a mobile society has become a daunting challenge for Sanford Health. Meeting an organization like Intermountain Health with their reach, with their reputation and their insurance company being four or five times the size of our insurance company, really was the missing ingredient … what makes this one different? It’s that. It really solves a problem for us.” [7]
As M&A activity heats up in 2021 it will be important to know if those activities push the marketplace further towards a system of “value” by including health plan considerations or whether those activities are merely financially driven transactions that don’t necessarily drive the marketplace to value. There will be and always has been transactions that were financially driven for the sake of “size”. As hospital systems become larger, they approach the notion of “too big to fail”. The Black Jet Theory would suggest that too big to fail is too big.
Other standard considerations in any merger or acquisition must also be considered. Many years ago, I was working on a transaction on Wall Street with a person I considered a mentor. I had prepared all of the financial projections and assumptions, which pointed toward a successful transaction. My excitement was dampened when he said, “more transactions fail because of culture than because of cash flow or profits.” The transaction died because the buyers could not be convinced the merger was a cultural fit and, accordingly those projections would not be met. The Black Jet Theory would suggest that transactions that are merely driven by “size” and other financial considerations and do not consider culture, are at further risk of failure.
And finally, as a friend and veteran of these types of transactions reminded me, in all transactions there is a winner and a loser. Believing otherwise is like believing that a round peg can be inserted into a square hole. Although, I suppose that occasionally a round peg will fit when forced. The Black Jet Theory suggests that it makes no sense to take that risk. As M&A transactions heat up in 2021, it is imperative that those transactions further the transition from fee for service to fee for value where the provider is at risk for the outcome of the service provided, that the resulting organization is culturally compatible and an acknowledgement ahead of time of who is likely to be the winner. Otherwise, that round peg just might not fit.
Don’t take my word for it, think for yourself.
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[1] Hackett M. Intermountain Healthcare to merge with Sandford Health in 2021. October 26, 2020 Healthcare Finance. https://www.healthcarefinancenews.com/news/intermountain-healthcare-merge-sanford-health-2021
[2] Ibid.
[3] Lagasse J. Healthcare M&A transactions see large decline from Q1 to Q2. August 11, 2020 Healthcare Finance.
https://www.healthcarefinancenews.com/news/healthcare-ma-transactions-see-large-decline-q1-q2
[4] Hackett M. Mergers and acquisitions worth significantly less in Q2 compared to last year. July 22, 2020 Healthcare Finance.
[5] Hackett M. M&A activity expected to surge as independent health systems look for partners. August 22,2020 Healthcare Finance.https://www.healthcarefinancenews.com/news/ma-activity-expected-surge-independent-health-systems-look-partners
[6] Hackett M. Intermountain Healthcare to merge with Sanford Health in 2021. October 26, 2020 Healthcare Finance.
https://www.healthcarefinancenews.com/news/intermountain-healthcare-merge-sanford-health-2021
[7] Reed T. One of the Big Reasons for Intermountain Healthcare, Sanford Health merger: their insurance plans. October 26, 2020 Healthcare Finance. https://www.fiercehealthcare.com/hospitals/sanford-health-plans-to-merge-intermountain-healthcare