Healthcare M&A Predictions, Take Two: Under Biden & Post-COVID-19

Last July just as the world was about to reopen and fallout from months of lost revenue was about to descend, we polled our extensive network to see what the future held for hospital mergers and acquisitions.

Who would be buying? Who would be selling? How would a previously active M&A landscape change in light of the pandemic? And might the looming election shift power from one side of the aisle to the other, leading to significant regulatory or legislative changes?

You can see what our experts said then.

So, what do they say now?

Glad you asked. Because we did too.

We checked back with several of our prognosticators, along with a few other players in the legal, financial, strategic planning and management consulting sectors, asking them four questions:

  • Are deals going to be harder to do now?
  • When thinking about getting a deal done, what is one consideration particularly important for moving things forward from the perspective of the buyer and the sellers?
  • When will we see the pace of hospital deals pick up?
  • Regarding that last one…Why?

As before, we’ve condensed the answers into a few themes, but the full verbatim can be found below the summary.

Asked if the rate of transactions will begin to climb, a slight plurality predicted the pace and volume of transactions will remain at current levels throughout 2021. The rest said they expect to see the pace of transactions ramp up in Q2 or Q3.

  • Current Pace

  • Q2

  • Q3

Why did our experts pick the timeline they did?

The consensus was that operational hurdles created by the pandemic have subsided or will soon subside, and that atypical events like the distribution of Cares Act relief funds didn’t change “underlying economic pressures.” Moreover, they noted that the endgame to the pandemic seems to be taking shape, as does a path to economic recovery.

As a return to some “normalcy” occurs, it will become apparent who has emerged stronger, who is weaker and which organizations that were struggling and looking for a partner before the pandemic brought life screeching to a halt – might resume a courtship.

These factors and trends were common across the responses we received, with the differences generally being whether people thought they had resolved enough to have already pushed the pace of transactions to a plateau (“the pace we see today is the pace we’ll see this year) or if they’re still getting worked out (Q2/3).

When we asked about top considerations for buyers and sellers, our experts mentioned:

Buyers balancing resources: recovery vs acquisition
Sellers being flexible and setting realistic expectations
Need for care in the deal process to get through regulatory scrutiny
Buyers helping sellers address the state of their workforce
Need for alignment on strategy and purpose behind a deal (not just scale)

When it came to whether or not deals will be harder to do today, the consensus was “yes.” We heard a few common reasons why:

Federal Scrutiny

(Likely) HHS Secretary Xavier Becerra’s name and reputation came up repeatedly.

State/Local Scrutiny

Non-local control and the effect of consolidation on health equity and community good may be a concern.

Value Proposition

New economic realities and getting to underlying valuations may make deals harder.

Purpose

“Scale for the sake of scale” won’t work. Deals need to be strategic and close existing gaps in services/operations.

Transformation

There is a need to pursue deals that will advance technology and value-based care.

COVID-19’s Wake

Sorting out the underlying fundamentals from the noise of relief funds adds layers of complexity.

Whatever predictions do come true, the tone of the comments reveals something quietly significant and hopeful: There will be a renewed focus on non-COVID-19-related work. Providers are turning their attention to what comes next, signaling the pandemic’s last miles and the opening push for the new administration.

Take a look at the full comments below.

Joe Cerreta

Partner

Barry Sagraves

Partner

Are deals going to be harder to do?

Transactions will be harder to complete, though for reasons beyond changing attitudes of federal regulators. While the new administration is likely to neutral to negative toward consolidation, the FTC will continue its historic opposition rather than ratchet it up. Most of the increased difficulty is completing transactions will be the result of a fundamental change in the economics of the hospital industry, with COVID-19 accelerating trends toward value based care and a risk based reimbursement model as well as increasing consumer preferences for outpatient settings and digital interaction. Systems looking to add members will face more uncertainty and risk in transactions. There will be more organizations seeking to join a system than systems seeking new members. Finally, state and local government may be more hostile to consolidation as concerns about health equity and the good of the community add to worries about non-local control.

What are key considerations for buyers and sellers?

Buyers

Buyers will have to effectively balance resources between trying to complete transactions while recovering from the pandemic and meeting the many changes in the industry. Promising appropriate consideration to successfully be selected as the partner of choice and then delivering the promised benefits will be key for overall system success.

Sellers

Those seeking to join a system will need to have realistic expectations. While many partner-seekers will be distressed, those with stronger financial and competitive positions may find fewer and/or less-aggressive suitors. It will be more important than ever that those considering joining a system utilize a flexible, appropriate approach to the market and not unintentionally chase away a high-quality partner with overly cumbersome RFPs, lengthy negotiations or excessive demands.

When will deals pick up?

Q3

Partnership activity (though not necessarily announced transactions) will pick up in the third quarter.  Visibility on vaccines and the course of the pandemic should be more clear, as well as the state of the economy. Buyers should be feeling more certainty and will need to address the underlying needs for growth and scale after a pandemic-induced hiatus.

Ascendient

Dawn Carter

Founder & Senior Partner

Are deals going to be harder to do?

I definitely believe that there will be heightened scrutiny from the Biden administration and the FTC. In addition, buyers will continue to be more discerning in deals they pursue, for their own strategic reasons, as well as to avoid lengthy, expensive efforts that are eventually blocked by the FTC.

What are key considerations for buyers and sellers?

Buyers

Clearly articulating the strategic purpose of the deal and understanding the value the target brings to the organization.

Sellers

Making sure the organization is as financially strong as possible before embarking on a process, as most buyers have very little interest in financially vulnerable organizations.

When will deals pick up?

The pace today is the pace we’ll see.

Things slowed a bit in 2020, particularly as health systems were trying to get their operational “sea legs” for COVID-19.  Despite the ongoing pandemic, those operational hurdles have been dealt with for the most part and there is a lot more normalcy around M&A transactions. The challenges to the pace will continue to be a) a lot of “low-hanging fruit” deals have been done, so those remaining are more difficult for a reason and/or are much larger deals, which then gets to #1 above; b) overall conservative, low-risk position of most buyers.

Bass, Berry & Sims PLC

Angela Humphreys

Chair, Healthcare Practice Group and Co-Chair, Healthcare Private Equity Team

Are deals going to be harder to do?

There certainly will be more considerations at play, including calibrating for a return to pre-COVID volumes, addressing government funding such as Provider Relief Funds, Medicare Advance Payments and PPP loans, and the potential for increased antitrust scrutiny under the Biden administration.  That said, with a bit of pent up demand, 2021 is poised for high deal flow, particularly for companies that have a view towards value based care and the implementation of technology solutions.

What are key considerations for buyers and sellers?

Buyers

Comfort around the long-term sustainability of the business post-COVID.

Sellers

Certainty of valuation.

When will deals pick up?

Q3

Smaller hospitals have been struggling in the wake of COVID-19 due, in part, to a downturn in elective procedures and thin financial reserves.  As a result, they will need to pursue strategic alliances and partnerships to survive. Separately, query whether this will be a year of the mega merger that brings together large competitors to capitalize on synergies from streamlined management and payor and vendor contracting strategies.

R. Christopher Regan

Founding Partner, Managing Director

Robert York

Director, Value-Based Care Practice Leader

Are deals going to be harder to do?

Increasing regulatory scrutiny and industry impact due to COVID has refocused healthcare executives to increase overall partnership evaluation and diligence efforts. We don’t see deals happening just to make a deal. It is critical to ensure that future partnerships are sustainable and will deliver on the organization’s long-term strategic goals and objectives as well as satisfy any regulatory concerns.  The partnership process from evaluation to close consumes tremendous organizational bandwidth and so it is critical to make sure there is a clear and sustainable business case for a particular partnership upfront before investing significant time and effort.

What are key considerations for buyers and sellers?

Buyers

Healthcare leadership is re-evaluating overall organizational portfolios given the lessons learned from this past year and identifying capabilities and relationships they need to build out operationally, clinically and financially to stabilize and strengthen the organizational position into 2021.  No matter where you sit in the healthcare eco-system it is time to re-evaluate your organization’ position and needs based on the changed external and internal situation and go-forward outlook.

Sellers

Hospitals and health system partnerships have been focused on building up scale and reach for the sake of scale and reach. But, building scale for scale’s sake is no longer a sufficient case for partnership by itself and healthcare leadership is placing a greater focus on partnerships that can diverse revenue/risk profile and materially advance capabilities and close gaps in the current portfolio including physician, ambulatory and other non-hospital based businesses, virtual/ technology enabled care delivery and management and payor and health plan products.

When will deals pick up?

The pace today is the pace we’ll see.

Hospital deals started to pick back up in Q4 2020 and we see that continuing.  Broader healthcare M&A activity outside of hospitals including both virtual/ digital health plays and physician and ambulatory really remained strong and is continuing to do so.  We expect this resurgence of partnership activity to continue through 2021 as healthcare leadership attention shifts from crisis management to mid- to long-term strategy and sustainability; however, the range of options will look different from years past and continue to extend well beyond traditional hospital to hospital deals.

Juniper Advisory

Rex Burgdorfer

Managing Director

Are deals going to be harder to do?

Health care combinations won’t necessarily be harder to do, but partnership processes will likely need to be more robust to meet heightened regulatory scrutiny. The leadership of Vice President Harris and HHS Secretary nominee Becerra may influence policy at the FTC and DOJ. It is also worth noting that State Attorneys General are also playing a more active role in reviewing hospital transactions. 

COVID has, and will continue to, drive transformation in health care. The experience of a global pandemic has accelerated the rate of change in the industry dramatically. As a result, hospitals and health systems are increasingly looking for new ways to work together to serve their communities and ensure their ongoing vitality. There are a few trends we expect to see more of in 2021: 1) number of transactions between large $1+B health systems across geographic boundaries, 2) partnerships between providers and payors and 3) unique structures that bring two health systems very close together operationally but stop short of change of control. 

What are key considerations for buyers and sellers?

There has been a growing focus on regulatory review in M&A transactions.  As the market for corporate control in the hospital industry matures, data like the American Bar Association “Deal Point Study” are settling in on what constitutes ‘market’ value, terms, and conditions.  The wildcard, however, which always seems to arise in the final negotiations of a definitive agreement, is the risk exchange surrounding various government programs and oversight.

For both buyers and sellers, speed and moving partnership processes forward continues to be a main objective. The benefits of partnership and scale have never been more important than during the pandemic response. The sooner hospitals can affiliate, the sooner their institution and their community will see the positive impact.  However, for buyers of distressed hospitals, we are seeing prolonged periods of due diligence as they evaluate their financial positions and risk. 

When will deals pick up?

Q3

Systems that we work have a pent-up demand for forming regional partnerships.  COVID proved to be a significant disruption to hospital operations and strategic plans. The federal Cares Act relief funding was helpful but has not changed the underlying economic pressures causing management teams to believe that better coordination across the sector is needed to improve the efficiency and quality of care.  Once vaccinations are more widespread, and long-term strategic initiatives dusted-off, I think we’ll see a return to ~100 transaction per year.

Are deals going to be harder to do?

The effect of the Biden Administration on transactions is uncertain, but the guess is that we will see a more active FTC going forward.  But I don’t believe that the regulatory environment and any changes implemented under the Biden Administration will be a material impediment to closing deals.  The challenges are going to be around valuation expectations for both buyers and sellers given the last 12 months of operations for hospitals were so impacted by COVID.   An additional uncertainty that will influence the valuation discuss will be any progress on expanding the coverage of the Medicare program.

What are key considerations for buyers and sellers?

Buyers

Buyers will need to evaluate the state of the workforce at a target facility to understand the potential and the length of time for employees to return to “business as usual.”

Sellers

Sellers will want to assess what a Buyer brings to the table that might help the same workforce fatigue issue.

When will deals pick up?

Q2

My prediction is that we will see the pace of hospital transactions increase in Q2, assuming that the recent positive trend in COVID-19 cases continues and more of the population is vaccinated.  Hospital leaders will be able to see the light at the end of the tunnel and turn back to strategic planning.  Also, there will be a number of hospitals/systems that will need to take strategic steps having been financially weakened over the last year.

Are deals going to be harder to do?

Yes, the historic trend of the mega-merger will be under a microscope by the Biden Administration. The Biden Administration has made it clear that it will intensify its review of healthcare mergers and acquisitions and the expectation is that there will be longer periods for review and greater likelihood of second requests by the FTC. In addition, State Attorneys General have become much more aggressive in their review of potential combinations, resulting in increased involvement in the terms of the agreement, particularly focusing on the covenants of purchasers post-closing, including provision of indigent care, limitations on rate increases and attention to social determinants of health. As a result of these factors, Buyers will have to take into account the increased time delays, expenses, potential divestiture of assets and increased commitments to the community in connection with such transactions. That being said, although it is anticipated that Secretary Becerra may indirectly and discreetly play a role in the policies connected with healthcare merger and acquisition review, we anticipate that Becerra’s strong support of the ACA will be a counterbalancing factor, along with continued relaxation of regulations and issuance of waivers at least for the remainder of COVID-19. In addition, buyers have the burden of scoping and quantifying the potential COVID-19 liabilities and the complications to a transaction as buyers try to understand what stimulus funds were received and the restrictions regarding use of the funds and the potential requirement to repay such funds. Finally, there is just the simple fact that healthcare mergers and acquisitions have become increasingly complex, time consuming and expensive. For all of the aforementioned reasons, it will be imperative for the parties to have a clear and strong strategic basis for the transaction, and go in in with eyes wide open to the challenges.

What are key considerations for buyers and sellers?

Buyers

From the perspective of a buyer, it is important to identify the key strategic goals of the transaction and create clear and consistent communication regarding how the transaction will satisfy those goals both within executive leadership and ultimately to the board. Increasingly, we are seeing that if the board is not tracking closely with the executive leadership team in the process, then there is more opportunity for the deal to not advance forward.

Sellers

As has historically been the case, certainty of close is imperative for sellers. As a result, I think that it is important for sellers to proactively take as many issues as possible off the table by being proactive in terms of diligence, transparency in terms of identification and resolution of issues so that the parties can minimize the closing conditions.

When will deals pick up?

Q2

There is significant capital that has been sitting on the sidelines for the better of part of 2020 that is waiting to be deployed.  Now that we have the (i) certainty of the election results, (ii) declines in COVID-19 cases, (iii) positive vaccine projections and (iv) boards and management teams more able to focus on strategic growth, hospitals and health system deal activity is picking up.  We are seeing an increase in activity in the letter of intent/definitive agreement stage already that should lead to deals closing Q2 of 2021.  In addition, we have seen a significant uptick in the hospitals and health systems focused on strategic service lines and vertical integration.  We also anticipate that the regional consolidations will continue to trend in 2021 as they have for the past few years.

Are deals going to be harder to do?

Deals have been difficult to do for a while and it does not seem that will be getting any easier, whether that is due to state Attorney General enforcement, lower HSR filing thresholds and FTC interest, or more discerning financial, operational, cultural and legal due diligence by parties. Having said that, while timelines may get drawn out and deal terms may get modified to accommodate stakeholders and regulators, deals will still close.

What are key considerations for buyers and sellers?

Buyers

Since many hospital M&A transactions are effectuated through “membership substitutions”, one consideration for buyers in such structures is what post-closing operational covenants buyers are willing to commit to the “seller” (and, in effect, the communities served by the seller’s facilities). In prior years, many buyers were willing to commit to continue to operate the facilities, service lines and programs “as is” for a number of years, as well as committing to spend significant funds on capital commitments, IT integration or other meaningful projects at the seller facilities, and those are increasingly difficult commitments for buyers to make.

Sellers

On the flip side of a buyer’s consideration regarding making significant, long-term post-closing commitments, sellers need to consider, in the absence or reduction of such commitments, what is appropriate transaction consideration to “hand over the keys” and still obtain necessary approvals from their board, stakeholders or regulators. As hospitals move away from a focus on bricks and mortar development, and invest in telehealth, value based-care arrangements and innovative care delivery models, sellers will need to consider whether preservation of existing operations is appropriate.

When will deals pick up?

The pace today is the pace we’ll see.

The pace for 2021 is already very active, and such pace is likely to continue throughout the year, as C-suites and boards of hospitals looking to engage in discussions with potential buyers are now more able to commit the necessary time and attention to strategic initiatives. Buyers are also willing to engage in such discussions and are anxious to execute on opportunities that may not have presented themselves but for COVID-19.  In addition to “traditional” M&A, parties are actively discussing alternative transaction structures, including joint operating agreements, joint ventures, clinical collaboration arrangements, adding to the already energetic pace of transactional activity thus far in 2021.

Ponder & Co

Eb LeMaster

Managing Director

Are deals going to be harder to do?

In the context of regulatory scrutiny, there are several compelling reasons for why deals may become more difficult to consummate. As a long tenured member of the California Assembly, a House Representative and California Attorney General, Xavier Becerra, has a strong track record for aggressive antitrust oversight, including his opposition of the proposed deal between Adventist Health and St. Joseph Health and adding stringent conditions to the Cedars-Sinai Medical Center merger with Huntington Memorial Hospital. Moreover, spurred by the challenges of the pandemic in an already challenging operating environment, we expect the stakes of regulatory intervention to continue to rise as providers seek in-market or adjacent-market acquisitions. Notable deals that received FTC intervention, or are under regulatory review, include Prisma’s acquisition of three LifePoint hospitals in South Carolina and Methodist Le Bonheur’s attempted acquisition of Tenet’s Memphis assets. As providers continue to evaluate their strategic options and expand out from regional hubs or divest non-core assets to in-region competitors, we expect this trend of increasing regulatory scrutiny to continue. Consequently, to help mitigate protracted deal processes due to regulatory intervention and significant legal expense, we are already seeing buyers, more intentional on the front end of due diligence, proactively engage anti-trust counsels and economic advisors, to assess the merits of a deal from a regulatory perspective.

What are key considerations for buyers and sellers?

Assessing the likely breadth and intensity of buyer interest prior to marketing is more important than ever during the pandemic. In some cases, buyers are focusing almost exclusively on pre-pandemic financial/operating trends and results while in other cases, they are factoring in the impact of the pandemic, adjusting run rate cash flow downward and adjusting target results for governmental financial support. New Hanover Regional Medical Center, for example, was able to hold the line on its $1.5 billion pre-pandemic valuation from Novant Health, certainly benefitting from the significant interest from a range of for-profit and not-for-profit partners in the event terms changed. Other sellers with less interest from the market have not been so fortunate as transactions have been repriced or commitments changed. Ultimately, this is as much an art as it is a science, and the outcome is heavily dependent on the breadth and depth of partner interest.

When will deals pick up?

The pace today is the pace we’ll see.

We expect the average quarterly volume in 2021 to be similar to the levels of 2020. On the one hand, Q4 2020 announced volume was strong with 28 announced transactions, the highest single quarterly total since Q1 of 2018. Also, there is a healthy backlog of more than a dozen systems in partnership discussions and under LOIs towards affiliation from the latter part of 2020. However, the pandemic will continue to hold down transaction volumes as healthcare systems and hospitals have been given short-term breathing room through pandemic government support payments and as volumes continue to ramp up ahead of original expectations despite the continued pandemic. Many health systems are using this time to recalibrate financial projections for the remainder of 2021 and continue to study strategic options. Also, the top driver of consolidation–significant negative governmental reimbursement change—is highly unlikely in the near-term in light of the pandemic and related pressures on health systems.

Are deals going to be harder to do?

Historically, Democratic administrations have applied more regulation to transactions. So, we believe we can expect that there will be more scrutiny particularly of larger transactions. Xavier Becerra and Kamala Harris were very engaged in looking at anti-competitive behavior when they were in the Attorney General’s office in California, so it would not surprise me if larger transactions got additional scrutiny from the FTC. For example, this article cites Becerra’s antitrust litigation against Sutter Health.

What are key considerations for buyers and sellers?

Buyers

Buyers need to consider and make sure that the grants and loans provided to facilities in 2020 are not masking systemic financial issues and considering the impact repayment of those amounts may have on the cash flow of the hospitals. Using CHS as an example, the government appears willing to spread repayments out over quite a long period of time.

Sellers

Sellers will need to move quickly. Transactions that take 9-12 months are more costly and increase the likelihood the deal won’t get done. It also weighs on your employees and could lead to attrition. Sometimes you can’t avoid it, getting AG approvals and the like, but if you can, getting a deal closed quickly will save everyone money and make for a happier workforce.

When will deals pick up?

Q2

I think second quarter due to more vaccinations, more return to normalcy, and more pent-up demand. 2020 was a surprising year for M&A activity, but I remain bullish on transactions. I think the pandemic has strengthened some systems and weakened others which is a natural setting for more M&A transactions.

David Shifrin
dshifrin@jarrardinc.com