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Hospital M&A can quickly boost scale, but deals often include unexpected costs

Scale is often the primary motivation behind merger and acquisition (M&A) activities. Among many hospitals, M&A has been growing steadily over the past decade as health systems work to build scale and enter new markets. But unexpected costs and challenges often surface after such transactions conclude.

That was one of the key takeaways from a recent convening session with financial executives involved in hospital deals. In late June, the Deloitte Center for Health Solutions and the Healthcare Financial Management Association (HFMA) invited chief financial officers (CFOs) from 15 hospitals and health systems to talk about their M&A experiences. (We plan to launch a full report based on our M&A research later this year, so please stay tuned.) Many of these attendees represented health systems that had acquired hospitals, while others worked for hospitals that had been acquired. Much of the conversation focused on the often unexpected costs and challenges tied to M&A.

Here’s a look at some of the expenses and challenges hospital CFOs say they faced after a deal was finalized:

  • Technology integration: An acquiring health system might have made significant investments in information technology and IT security, while the acquired facility could be less sophisticated or on a different system. Bringing the new entity up to speed, or shifting it to a new platform can be one of the most expensive elements during the integration process. One attendee cited a recent acquisition where IT spending for an acquired hospital doubled from pre-deal budgeted balances to post-deal actual expenses. This increase was primarily due to temporary IT transition costs that declined in subsequent years. They were not planned by the acquirer and resulted in lower than anticipated financial results for the health system.
  • Clinical staff investments: Acquired hospitals tend to temporarily increase staff after an acquisition, rather than eliminate duplicative positions as one might expect. An acquired hospital, for example, might have to boost its staff to meet the acquiring health system’s patient safety and care-quality standards. One attendee said he hired 30 new nurses because the acquired hospital’s staffing levels were too low. A health system might also need to recruit new physicians or replace departing ones, as a hospital that appears to be having financial problems might have had a difficult time recruiting prior to the acquisition. In addition, the acquiring health system might need to make financial investments to build or restore confidence in the community, and to convince medical staff that the merged entity is stronger. These clinical care investments could pose financial, operational, and quality of care challenges.
  • Employee benefit packages: It can be difficult to eliminate or reduce employee benefits after an acquisition. Some acquiring health systems transition all employees to whichever entity has the richest benefits. Others might average the cost of the benefits between the two entities. In the interim, the health system might need to run duplicate benefits programs, which can cause another layer of expenses.
  • Staff reductions: While staffing cuts might be necessary after an acquisition, pre-deal agreements required to close the deal could keep some employees in place for six months or longer after the deal is finalized. Once that period ends, compensation packages for departing employees could mean additional costs. Several attendees noted that these labor issues made it challenging to realize synergies in first year after acquisition.
  • Fixed assets and investments: A common theme among participants was that investments in property, plant, and equipment are often needed when affiliating with a community-based hospital. A small community hospital, for example, might have inadequate investments in facilities, IT, and infrastructure – particularly if the hospital has had financial challenges and been more focused on saving than investing. That could mean new investments are needed just to bring the acquired facility up to date.

Hospital M&A will likely continue

M&A is a trend that we expect will likely continue given the relative fragmentation of this industry compared to others. Having scale can help health systems diversify risk, improve their access to capital markets, increase volume and referrals, and gain economies of scale.

The pre-deal effort required to close a transaction can be significant, but can really affect the success of the deal. Health systems could benefit from doing financial and operational due diligence, settle valuation and deal terms, decide structure and governance – not to mention prepare for potential regulator reviews. Each of these areas can be challenging, cumbersome, and time consuming in their own way. Moreover, post-deal activities are often equally challenging. It is often during this period that whatever financial and clinical benefits were assumed in spreadsheets and PowerPoints need to come to fruition. This is also a time when unexpected costs and challenges can surface, which can affect early financial results. During the first year or two, for example, both sides might need to pay off legal and other fees, and harmonize departments and employees.

Once the dust settles from congressional efforts to repeal and replace the Affordable Care Act, we are likely to see a new wave of M&A activity among hospitals. Organizations that do go through the acquisition process – both the acquiring organization and the entity being acquired – should likely prepare for expenses that can emerge after a deal closes. Financials might not improve immediately for some, and hospital leaders should try to have realistic expectations when setting both their short- and long-term financial goals.

Author bio

Bryan Martin is the Partner, Deloitte Health Care M&A, Deloitte & Touche LLP. He is a partner in Deloitte’s health care M&A services group and leads Deloitte’s national provider M&A Transaction Services practice. Bryan has spent the past 15+ years in public accounting focusing on the health care and life science sectors. In both public and private sectors, Bryan consults with boards of directors and senior executives on M&A strategy and execution. His experience includes advising both private equity and corporate clients on many aspects of acquisitions including: due diligence, accounting structuring, financial reporting, valuation considerations, financing documents, and the preparation of pro forma financial statements. He also assists clients with many aspects of dispositions such as: sell-side & vendor due diligence, the preparation of data room materials, deal structuring, and the preparation of carve-out financial statements.
Ion Skillrud is a member of the Deloitte Consulting LLP Life Sciences and Health Care Practice where he focuses on serving health care provider clients. Ion’s engagement experience includes merger planning, post-merger integration, functional carve out, and a variety of sustainable margin initiatives. Ion resides in Saint Paul, MN with his wife and three children.