Current Trends in Hospital Mergers and Acquisitions

Healthcare reform will result in more consolidation and integration among hospitals, reversing a recent trend in which hospitals tended to stay away from such transactions. Regardless of the ultimate fate of the Affordable Care Act, healthcare reform is becoming a powerful catalyst for consolidation and integration in the hospital industry.

At a Glance:

Healthcare reform will impact hospital consolidation in three key areas:

  • Payment rates will decrease, indirectly encouraging consolidation by forcing hospitals to find new ways to reduce costs and increase negotiating clout with suppliers and payers.
  • The cost of doing business will increase as hospitals spend more on compliance, technology, and physician employment.
  • The ACO model will encourage hospital network formation by rewarding integrated healthcare systems that can reduce costs and improve quality.

Regardless of the ultimate fate of the Affordable Care Act, healthcare reform is becoming a powerful catalyst for consolidation and integration in the hospital industry. We are seeing a significant number of mergers between hospital systems and cases of integration with physicians and other providers.

Consolidation activity has picked up considerably compared with the overall trend for the hospital industry in recent years. In the mid-1990s, the external threat of managed care had prompted many transactions.a According to one source, the industry saw a peak in the growth in healthcare mergers in 1996, with 768 hospital facilities involved in 235 transactions, followed by a decline until 2004, when the growth rate began to gradually rise again (Ettinger, D.A., and Berenbaum, S.P., Health Care Mergers and Acquisitions: The Antitrust Perspective, Bureau of National Affairs, 1996, updated annually). The decline in transactions was dramatic, dropping to between 30 and 50 per year. The transactions that were occurring were largely due to microeconomic issues facing smaller hospitals and some larger systems (usually loss of access to capital and the need to defend against competition).b

According to American Hospital Association data, the overall number of hospitals declined by about 3.5 percent from 5,194 in 1995 to 5,008 in 2011 (Chartbook: Trends Affecting Hospitals and Health Systems, American Hospital Directory). Yet the number of hospitals affiliated with systems has been increasing. In 1999, only 2,524 of the hospitals in the United States were part of systems, whereas by 2009, that number had increased to 2,921.

Today, approximately 80 percent of the roughly 4,500 hospitals are operated by not-for-profit organizations and local governments, while for-profit companies operate about 20 percent of hospitals (Fast Facts on US Hospitals, American Hospital Association, updated Jan. 3, 2012). For an industry representing 5 percent of U.S. gross domestic product, the number of independent hospitals represents a staggering amount of fragmentation.

The few companies involved in transactions, which average only between one and two hospitals per transaction, indicate a highly fragmented industry. Among the top 10 companies in the hospital industry, each one accounts for only about 1 percent of the total market, and the largest accounts for only 4 percent of the market. With 80 percent of hospitals owned by not-for-profit organizations, hospitals have less access to capital than is enjoyed by leading companies in other industrie. Not-for-profits’ source of external capital is the municipal bond market, unlike for-profit companies, which can use equity to finance growth. Some industry analysts also blame fragmentation for a portion of the industry’s inefficiency. Federal healthcare reform, in part, seeks to bring this industry into the modern era.


Several reasons are behind the hospital industry’s relatively slow rate of consolidation in the past 15 years. A pervasive notion exists that hospitals are part of the local economy and that consumers prefer local oversight and a high level of access to healthcare resources. This notion is underscored by hospitals’ desires to remain tax-exempt.

The municipal bond market is, in part, responsible for the hospital industry’s fragmentation, but this is changing. As the investor base of municipal securities shifts from retail to institutional holders, issuers will be held to a higher standard and required to float larger offerings. Moreover, when politics rather than business needs drive decision making, local thinking thrives. Thus far, market forces have not been sufficient to force hospitals to consolidate. With the advent of healthcare reform and the decreasing availability of funding through the bond market, the hospital sector is slowly shifting to resemble most other major industries.


Healthcare reform will have three key effects on hospital consolidation: decreasing revenues, increasing costs, and directly rewarding or encouraging integration.

Decreasing revenues. Healthcare reform seeks to increase preventive care, keeping patients out of the hospital and thereby decreasing inpatient revenues. Healthcare reform also will decrease payment rates (or at least slow their growth), which will indirectly encourage consolidation by forcing hospitals to find new ways to reduce overhead and increase negotiating clout with suppliers and payers. The Affordable Care Act includes a value-based purchasing program, which rewards hospitals that exceed quality measures and penalizes underperformers with payment cuts. Many commercial payers are also pursuing this model. The cuts in payments to below-average performers will cross-subsidize the increased payments to above-average performers, ultimately increasing competition and penalizing those that can’t keep up.

Larger systems or organizations that have greater critical mass will be able to compete more effectively in this environment for several reasons. First, larger systems can spread fixed costs over a broader revenue base and allow higher-performing business units to compensate for those that lag in certain quality measures. Second, they will have easier access to capital and at better rates. Finally, larger systems will be able to more easily develop sophisticated systems that can measure quality-a key ingredient for future success-and share best practices.

Increasing costs. Healthcare reform is likely to increase the cost of doing business for providers (particularly hospitals) because compliance costs will significantly increase. For example, each hospital now must publish a list of its standard charges. In addition, every 501(c)(3) hospital must conduct a community health assessment every three years and follow new debt-collection practices. Technology expenditures will increase as both clinical and operational systems are put in place to better manage patient care. As another step to improve clinical quality and manage population health, hospitals will continue to employ more physicians, even as the outlook for physician payment remains bleak. Moreover, the cost of capital for smaller institutions is increasing and directly correlated to size and credit rating.

Encouraging integration. Healthcare reform will directly reward greater clinical integration through the accountable care organization (ACO) model promoted by the Medicare Shared Savings Program and “medical home,” or capitated payment models. An ACO allows the sharing of cost savings or the sharing of a set of payments for achieving quality measures, which will directly encourage integration. One particular ACO model would comprise a hospital, primary care physician group, and a specialty physician group.c The ACO model requires both shared governance and quality reporting. Hospitals will need a relatively high level of sophistication to develop and manage ACOs. Generally, larger systems and those with more resources are more likely to take advantage of this opportunity.


A new set of buyers and sellers has changed the current merger-and-acquisition (M&A) market during the past 20 years. Historically, not-for-profit systems were not acquisition-minded, but have now shown interest in expansion during the reform era.

Although not-for-profit systems are sophisticated organizations, they are often inexperienced in merger transactions, which have resulted in some awkward approaches. Sellers also are less motivated by financial desperation than they once were. In the past decade, many hospitals with good market share lost access to capital. Faced with urgent needs to modernize facilities, hospital boards accepted the need to enter into business combination transactions. Today, this is often not true. Because smaller hospitals and systems are not being forced to merge due to financial considerations, their boards are finding it difficult to agree on potentially transformative transactions.

One clear trend is the increasing difficulty of completing transactions. The incidence of failed mergers-those in which a letter of intent is signed and publicly disclosed, but the transaction does not close-historically did not exceed 5 percent. Last year, however, 25 to 50 percent of letters of intent failed. Although this high percentage of failed transactions might slow the pace of increasing consolidations, it has done nothing to slow the growing interest in consolidation.


Current deal structures are different from those of past deals, which were characterized by many conversions and outright sales for cash by not-for-profit to for-profit organizations. Today, discussions about combinations between growth-minded sellers and commercially sophisticated (but merger-market unsophisticated) large consolidators are common. Cashless transactions of one form or another (e.g., membership substitutions or mergers) are common.

Recently, hospitals changed their preferred means of acquisition. Larger not-for-profit systems apparently took advantage of the 2008 economic downturn to conduct internal strategic reviews. They now seem ready to be more proactive in acquiring hospitals, even outside their historic markets and across state lines. Today, large not-for-profits are less willing to acquire hospitals by funding a local hospital foundation because they lack control over the local foundations. Both the larger not-for-profits and their targets seem to be more interested in investing in hospitals directly, making capital commitments over a multiyear period and assuming existing debt. Some not-for-profit systems are making strategic acquisitions that make it harder for investor-owned companies to compete, forcing investor-owned buyers to revise their traditional valuation methodologies to account for premiums paid by large not-for-profit strategic buyers that may not be as financially driven as they are.

Investor-owned companies are also exploring creative models to make their offerings more attractive. For example, LifePoint has received significant attention for its relationship with Duke Medicine. These types of partnerships can be attractive in that they offer the operating and scale efficiencies of a for-profit buyer focused on growing healthcare services at the acquired facility, while simultaneously bringing the clinical and quality infrastructure from the not-for-profit partner. These innovative models will continue to gain prominence.

Some major cities with large indigent populations are recognizing that from a social perspective they cannot afford to lose hospitals. This perception is driving a new trend in the industry, which is exemplified by two recent transactions in Massachusetts and Michigan that have been historically hostile to investor-owned buyers. The transactions, which involve the for-profits Vanguard Health Systems in Detroit and Cerberus Capital Management in Boston, illustrate the states’ greater acceptance of for-profit companies when these investor-owned systems prevent closure. These transactions represent solutions for hospital systems that, like many banks, have been deemed too big to fail. In Detroit, for example, the state of Michigan approved the sale of the Detroit Medical Center, an eight-hospital not-for-profit health system to Vanguard. In Boston, Caritas Christi Health Care, the state’s second largest hospital system, agreed to be purchased by Cerberus, after reportedly unsuccessful attempts to sell to another Catholic-based system. An increase in transactions such as these could change the makeup of the industry to include a larger percentage of for-profit companies.


When considering a consolidation or sale, a hospital’s management and board of directors should consider the community and public relations element. Selling a hospital, especially to an out-of-town buyer, is an emotionally charged issue in most communities. There have been several public-relations disasters where communities rightly or wrongly concluded that their hospital was sold without adequate disclosure or community input. It is important to prepare boards and the community for any change in hospital ownership. Mistakes in the communications process, or worse, transaction executions, are often measured in the tens or hundreds of millions of dollars.

The educational process begins with the board of directors. The board needs to understand all the factors driving consolidation in general and the circumstances pertaining to its hospital in particular. Once the board understands the key issues, the hospital should decide how to communicate with community leaders and other stakeholders, including physicians and employees. Because lawyers and investment bankers are not experts in public relations, hospitals should consider hiring a public relations firm.

A hospital should be open and transparent when starting a search process for an affiliation partner. Of course, the identity of the parties and negotiations should be kept strictly confidential. It is important to have one or two well-respected physicians on the negotiating committee to create a sense of involvement with medical staff, provided they will not gossip about negotiations.

Finally, the board should consider briefing local leaders and politicians about their plans, even if only by phone. Politicians do not like surprise announcements of a hospital merger. Briefing key local leaders in advance of any public announcement can lead to a warmer reception of the deal.


The charters of many tax-exempt hospitals require that they serve their local communities. There are many ways to ensure the local community benefits from the sale or merger of its hospital, and to further the charitable mission of the hospital.

First, the transaction can leave a local board in place even if it is subject to reserve powers by the acquiring entity. One particularly effective example is when HCA took control of the remainder of HealthOne and maintained a local board with significant fiduciary responsibility. A deal might also require that a certain percentage of future board members reside in the community.

Commitment to charity care is an important consideration, and most acquiring entities quickly agree to maintain the hospital’s charity care policies or adopt a comparable policy. They also typically agree to retain all employees and medical staff privileges as part of the transaction. This issue is usually important to state attorneys general who may be required to review the transactions. Affiliation agreements often contain commitments to maintain certain core services and to invest capital or add new services within a certain time. However, such commitments can sometimes be changed if the resulting local advisory board of the seller agrees that changes are warranted.

One way to solidify a new organization is to ensure that an entity remains in place that can enforce the agreement against the acquiring entity. Maintaining a local foundation that will not be folded into the new organization can achieve this goal. The local foundation board might be contractually authorized to enforce the agreement. Alternatively, the hospital could designate an individual or organization, such as a community foundation, to ensure that the commitments are fulfilled. If, at some future date, the hospital is sold to a for-profit corporation, the local board could be given the authority to seek an alternative deal with a for-profit or not-for-profit organization of its choosing on similar financial terms if it so desired.

Consideration in these transactions typically comes from the sum of purchase price, assumption of liabilities (e.g., long-term debt, pension liabilities, interest rate swaps), and a legally binding commitment to make capital expenditures. Historically, not-for-profit boards negotiated for one, two, or all three essential elements of consideration. The new set of consolidators (the newly acquisitive, large, regionally prestigious not-for-profits) and the new sellers (strategy-minded, small not-for-profit hospitals) have struggled with transactions where the buyer accrues most of the benefit, with only incidental benefits to the community. In the absence of corporate (SEC) standards and consequences of the TransUnion case, distressingly little attention is given to the notion of “fair market value” in the not-for-profit hospital M&A market.

The heart of the issue is the fiduciary duty of the board to the hospital and the community to further the hospital’s charitable purposes. The key issue is whether the hospital receives fair market value for ceding ownership and control of the organization. Boards should understand the strategic alternatives and assess them simultaneously, not sequentially. Tactically, this approach can be difficult, but it best fulfills the board’s fiduciary obligations.


In a merger or acquisition of a heavily regulated business, such as a hospital, the purchaser can inherit serious regulatory liabilities. Because purchasers typically do not like problems, a potential seller should try to fix problems that would deter buyers. By taking a proactive approach, a seller can alleviate the problems that arise in a deal.

The most significant issue is making sure that the hospital’s survey history and results (e.g., accreditation, Medicare, and environmental surveys) are in order. If the hospital’s record is not completely clean, the hospital should adequately address all issues or deficiencies. The hospital also should have in place a robust compliance plan, in which it regularly monitors physician compensation and financial relationships, to address purchasers’ likely concerns about fraud-and-abuse issues.

Billing and payment issues also should be reviewed. In any transaction where the target is paid by a government program, a billing and coding audit is recommended. Certain problems can be detected by examining payment and coding rules. An audit will eliminate any billing and coding compliance shortcomings.


Federal healthcare reform is spurring consolidation in the hospital industry, bringing the promise of substantial change to an industry that has changed little over the past 20 years and remains highly fragmented compared with other industries. What was recently a cottage industry is rapidly advancing into the modern era. How hospital leaders, boards, and the communities their organizations serve react to this consolidation will determine the shape of the industry in future decades. It will therefore require their great diligence in addressing the many important considerations that consolidation raises.

In the same way, senior finance leaders (both internal and external) will need to be cognizant of these trends to be prepared with a plan of action when presented with a possible affiliation, merger, or consolidation transaction. In many cases, the economics will drive the overall deal’s success or failure. Senior finance professionals should pay particular attention to the true extent of hospital liabilities. These include bond issuances, pension liabilities (which may fluctuate dramatically based on market performance and rates), capital leases, and other debt. Accurate knowledge of the true amount of these liabilities is crucial to being able to evaluate the sufficiency of any potential combination offers. Finance executives will continue to play a lead role in advising their boards on the ultimate decision of whether to proceed with a transaction.

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a. The hospital industry is defined here as all U.S. hospitals, not including Veterans Affairs (VA) hospitals and safety net hospitals.

b. See “Statement of the American Hospital Association Submitted to the Federal Trade Commission,” March 25, 1996.

c. For case studies of four successful approaches to forming ACOs, see From Volume to Value: The Transition to Accountable Care Organizations, American Hospital Association and McManis Consulting, April 2011.