Mergers & Acquisitions: Ingredients for a Successful Union

HealthLeaders magazine , November 14, 2011

HAMMOND: It really is essential to assess the compatibility of the partners, but there is no simple formula or checklist to follow. Where I've seen problems is when organizations do not realize that their prior heritages are being merged to create something that is different from what each had before the business combination. The old aphorism is true: Culture trumps business strategy every time.

HEALTHLEADERS: Naturally, not every deal works out and sometimes there are problems that come up. What's needed for an exit strategy in these agreements?

GALLAGHER: One of our first joint ventures was with a niche women's hospital with a for-profit enterprise. We weren't as smart back then, so when we structured the deal we didn't have an exit strategy. The management group had some struggles with the major physician component of the organization. They were at odds with each other, and in the end, because of that, it wasn't successful culturally or financially. Our lesson learned was if we are a minority partner in a deal, we need a "put" so that when things don't work out we can raise a hand and say, "We want out of this partnership at fair market value." But those are very challenging to negotiate.
Since then our board, as part of our joint venture deliberations, has said that this type of exit strategy is one of the critical covenants. It was a hard lesson to learn, and we lost a bit of money because we couldn't get out of the deal when we wanted to.

MOEN: Typically a "put" is coupled with a "call," in which either party can buy the other partner out. For us, though, we always look at these deals long term—like a marriage without a divorce option. We are in this for the long haul. Still, before you get to that stage where you need a divorce type of exit, you need to have some kind of mediation or a dispute-resolution mechanism.

GALLAGHER: Another area to be sure to have defined in the agreement is what happens when a change of corporate control occurs in one of the partner companies. So, if Company A is the majority partner and the manager of the enterprise and wants to sell their ownership interest in that particular hospital, we would want a right to tag along with the sale. If they sell their whole company, we want a right to "put" our interest at that time. We also ask for a "call" right, and it says we want to call your ownership interest in this hospital if a change of corporate control is about to happen and the management team isn't going to be the same management team we worked with. We ask for a call right with all our agreements; sometimes we get it and other times we don't.

MOEN: All our arrangements have a statement that if we disagree on a significant issue, we can go to a multistep dispute resolution procedure that includes mediation. We pride ourselves that we've never gone through mediation, though. And that gets back to the culture issue and understanding the people you're working with. We're in this for the long term, and if you've got to have somebody else come in to rule on an issue, that's not very good for a long-term relationship. Still, mediation is in the agreement as a safety net, and so you don't immediately have to go to a divorce decree.

HAMMOND: Yes, you just shouldn't push that nuclear button every time.

HEALTHLEADERS: There has been an enormous number of healthcare mergers, acquisitions, partnerships, and joint ventures in the past couple of years. Does this represent the demise of the independent hospital and the independent physician?

GARRETT: I can tell you that in New Jersey, that's how I see it. I feel in the next four to five years there's probably going to be three or four major systems that remain, and the independent freestanding hospitals—perhaps with the exception of a couple of boutique hospitals—will not exist due to market pressures. We're seeing it in the physician marketplace too. Physicians are either looking to be employed by health systems or they are getting together with other practices to form mega-groups; the number of independent practitioners is decreasing on an accelerated basis.

GALLAGHER: The trend of consolidation started for me a dozen years ago. For instance, in Austin there were probably five different hospital group systems, and then in the mid- to late '90s a consolidation took place. Now basically there are two hospital systems, and ours has 45% of the market share. What we're seeing now is that some of the larger community standalone hospitals are realizing that they can't survive in the new era of healthcare reform. They are looking for partners like LHP and others with the capital to help them achieve a greater regional presence than just a single community hospital.

MOEN: Healthcare reform is pushing a consolidation in the industry. If you have 80 hospitals but they are in 80 different markets, you don't get a lot of clout on a regional basis. But as healthcare reform drives the consolidation and regional networks develop, incentives can be aligned with the physicians and the organization can cover the geography in such a way that the payers will pay fairly. For instance, in Dallas there are probably 90 acute care hospitals in the service area, but the majority of them are part of one of three provider networks. Not surprisingly, those are also the three networks that are doing the best financially and providing a high level of care.

HAMMOND: I don't think it's terrible that the hospitals are consolidating or the physicians are joining together and modernizing their business models. Although I am sure that some of the most caring and qualified doctors may be sole practitioners, it is sort of a quaint notion to think it's efficient to have individual doctors practicing medicine as sole practitioners. An individual doctor can't possibly have all the resources or the intellectual capital that a group, or a group aligned with a hospital, can provide. Obviously consolidation may be disruptive at times, but usually it produces a better product for a lower price and with more value.

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