Levin Associates attended AHLA’s Health Care Transactions Conference on April 17-19, 2023, and the insights shared below are from panel discussions our writer observed in person.

Healthcare investments among private equity firms have attracted a lot of attention in recent years but they’re far from the only players looking to consolidate the market. Traditional not-for-profit health systems are pursuing mergers and acquisitions too, with an emphasis on cross-market deals.

Health systems are facing financial threats.

Traditional health systems are looking to develop stronger economies of scale because right now, there is a revenue problem. Hospitals are facing serious financial constraints, as laid out in the presentation by Ben Wilson, a Partner at Ropes & Gray LLP, Thomas Donohoe, SVP and General Counsel for Centura Health, and Larry Kraemer, EVP and General Counsel for Northwell Health.

Wilson explained that higher costs due to increased labor expenses and rising interest rates, coupled with “soft volume,” have contributed to “razor-thin margins” for health systems.

The panel noted that in 2022, the median operating margin for hospitals was 0.9%, down from 3.8% in 2019. More than half of hospitals (53%) were projected to have negative operating margins in 2022, up from 34% of hospitals in 2019.

For comparison, the panelists cited median operating margins for other healthcare entities based on company earnings reports from the fourth quarter of 2022:

  • Pharmaceutical companies like Pfizer and Merck: 25%+
  • Medical device companies like Abbott and Stryker: 10%-20%
  • Medical supply distributors like Cardinal Health and Amerisourcebergen: 5%-9%
  • Insurance companies like Cigna and United Healthcare: At least 3% and higher

“2022 was a real nail-biter from a financial perspective,” Wilson recalled. “We had hospitals and health systems defaulting on their bond covenants and I was quite surprised at how many didn’t default in some ways.”

“When my four daughters were young, they used to love to watch a show about a character who had a no good, very bad, horrible day,” Kraemer shared, “and 2022 was a no good, very bad, horrible year for hospital operations.”

A cross-market merger is one solution for growth.

Greater operating margins can help sustain a not-for-profit hospital’s goal of providing quality healthcare. One way to achieve those margins, Kraemer remarked, is “to grow. We need to get into other areas of the healthcare industry where we can support the mission of the inpatient hospital.”

However, Wilson mentioned a caveat, “You can’t grow too large or you’ll be seen as a monopoly or oligopoly in your market.” He continued, “At the same time, hospitals are finding it difficult to grow within their market because the game of musical chairs has played out and there are no more seats left. Or they need to expand into new geographies.”

Many health systems are embracing this idea of expanding into new geographies by partnering with other providers located in different states or regions.

“We’re definitely seeing a lot more cross-market relationships and mergers,” Jim Cotelingam, the chief strategy officer for the Cleveland Clinic, noted during the opening panel. He referenced examples such as:

Cotelingam added that he expects to see more cross-market deals because “in-market opportunities for many health systems are very limited. But I also wonder at what point will there be more regulatory scrutiny over the cross-market deals.”

Health systems and investors can expect increased oversight.

Managing antitrust concerns and handling increased oversight from federal and state regulators was another recurring theme of the AHLA conference.

“I think a lot of these cross-market mergers are a reaction to the FTC being less permissive and turning down some deals,” theorized Matthew Weiss, a Managing Director at EY Parthenon. As an example, he referred to the FTC’s decision to block a merger between RWJBarnabas Health and Saint Peter’s Healthcare System, which are both located in New Brunswick, New Jersey.

“On the states’ side you have a lot of attorneys general who have become much more interested from the antitrust perspective,” Donohoe said. He explained that in his experience in Colorado, the AG’s office has been involved in healthcare merger discussions. “So you have both the federal and the state level scrutiny on those types of transactions.”

Consolidation among health systems will impact private equity strategy.

Increased consolidation in the healthcare marketplace will eventually force organizations, especially private equity firms, to change their strategy, predicted Eric Major, a Managing Director at Provident Healthcare Partners.

“Private equity firms have been predominantly focused on single specialty roll-ups,” Major explained. “But look at an area like gastroenterology, for example. This has been consolidated now for the last seven or eight years by private equity.”

Levin Associates’ proprietary data platform, which tracks healthcare mergers and acquisitions in real-time, shows a significant rise in the number of physician group deals in recent years: 246 in 2019, 188 in 2020, 613 in 2022, and more than 250 in the first five months of 2023.

Major said as the number of independent practices shrinks, either because they’ve been acquired by private equity or merged with traditional health systems, he expects to see multi-specialty groups form.

“I could see a group like a GI Alliance merging with a urology group where a lot of the ancillaries are fairly similar in terms of the pathology that they’re doing,” Major continued. “We see those types of trends happening over the next five to ten years. I think a lot of that is in response to the health systems and what they’ve been doing and consolidating in the market.”

Another strategy shift involves private equity and traditional health systems choosing to team up rather than compete against each other. As Donohoe remarked, “Health systems have a wealth of experience, data, and other things they can offer. So the hope is that they’ll find ways to do that so they can be financially sustainable going forward.”

To read more insights about health systems partnering with non-traditional entities, read our accompanying article here: A Growing Trend: Health Systems Collaborating with Private Equity

Erin Laviola is a writer for Levin Associates.

Levin Associates provides comprehensive coverage of the deals, companies, and trends shaping the healthcare industry. Clients access proprietary M&A transaction data and daily news/analysis through the LevinPro platform. Schedule a demo today to see what LevinPro can do for your team.