Health care costs continue to rise. Payment models for delivering health care services are evolving rapidly. Basic business relationships throughout the system are shifting as participants move from activity-based to value- and risk-based reimbursement — a trend accelerated by the Patient Protection and Affordable Care Act. Changes in Medicare reimbursements are occurring even as hospitals prepare for the growing number of consumers who gain access to health insurance due to the provisions of the ACA.

These forces are driving significant change in health care mergers and acquisitions, including a wave of consolidation among nonprofit hospitals. In 2011 and 2012, nearly 60 percent of M&A transactions in the hospital-health system sector involved nonprofit organizations. A decade ago, the proportion of total transactions involving two nonprofit organizations was just 22 percent. Today's deals are often smaller in size, as organizations seek to fill in strategic capabilities or needed competencies. 

For many nonprofits, a merger, acquisition or financial partnership can be a smart approach, particularly on a regional or local basis. Increased size brings economies of scale in purchasing and other support services as well as the ability to spread the costs and risks associated with new payment mechanisms, technology and reduced reimbursement. Often, larger organizations also are able to attract and retain highly talented people with the expertise to address the challenges ahead.

At the same time, nonprofit hospitals are showing a willingness to consider different kinds of alliances and partnerships that offer the benefits of an acquisition without a complete change of control. Perhaps most important, health care leaders are focusing on integration, rationalization of services and economies of scale.

Transition from "Troubled Sales" Transactions

Another important shift is that, while financial pressures remain a significant motivation in many situations, fewer hospitals are being sold or acquired due to financial distress. Rather than entering deals under duress, hospital leaders are strategically positioning their organizations.

A Hammond Hanlon Camp study of M&A activity demonstrates that nonprofit hospitals are turning more and more to proactive transactions and creative deals to increase their size, diversify and improve their market position. This trend is evident in both nonprofit and investor-owned hospitals.
Nonprofit health care organizations have shown an increased willingness to come together in creative ways, beyond a traditional M&A transaction. They are exploring joint ventures, shared service agreements and other contractual relationships to maintain independence while benefiting from the resources of a larger organization. Additionally, nonprofits have shown growing interest in partnering with private equity firms or investor-owned companies.

The renewed focus on creative partnerships also may be driven by the lower capital requirements inherent in these transactions, or merely by the recognition that value can be created by collaborating, short of a sale or merger. The shared services relationship between Novant Health and Memorial Health, as well as the collaboration between Piedmont Healthcare and WellStar Health System, are examples of these creative structures and relationships. 

Three types of alternative financial structures have emerged as favorites among nonprofit hospitals: nonownership collaborations, shared services relationships and joint venture agreements.

Nonownership collaboration. Smaller, local and nonprofit hospitals take pride in the way they cater to the needs of their specific communities. A nonownership collaboration with a larger hospital system enables nonprofits to continue local control of operations while benefiting from the diverse expertise and financial strength of a larger hospital system. These arrangements often focus on clinical strategies and can be a win-win if both parties have shared values and complementary missions.

Shared services relationship. Nonprofits also can tap into the management capabilities of a larger health system with a shared services relationship. This arrangement differs from a nonownership structure in that the larger system can provide its management services for a fee. The smaller hospital benefits from access to supply chain and clinical engineering expertise, as well as discounts with medical suppliers.

Joint venture agreement. In a joint venture model, two hospitals share ownership in a new entity, often a combination of a large hospital and small hospital. Both hospitals retain equal representation in the governance of the new entity, although the larger hospital often takes a greater stake in ownership and each party may reserve certain governance rights.

While the outlook for M&A among nonprofit hospitals and health systems remains strong, organizations increasingly are considering more creative transactions. Nonownership collaborations, shared services relationships and joint venture agreements are three examples of how nonprofit health system leaders can think beyond traditional M&A to maintain financial stability and ensure their future as local health care providers.

William B. Hanlon III is a principal in the San Diego office of Hammond Hanlon Camp LLC, a strategic advisory and investment banking firm focused on the health care sector.