Why Private Equity Is No Strategy for Struggling Hospitals

Strategic Planning, Affiliation/M&A

If you’re part of a hospital or health system facing a difficult financial future, affiliation is a specter that lurks constantly in the background. Healthcare M&A is simply a fact of life for an industry with spiraling costs and shrinking margins. Private equity sometimes looks like a lifeline.

Until fairly recently, the affiliation question was largely one of degree. A full merger was always possible, but many other options offered varying degrees of autonomy, including clinical affiliation, regional collaboratives, joint ventures, and management service contracts. Regardless of the specific affiliation model, the choice of suitors was usually limited to another hospital or health system.

Lately, however, private equity has begun shaking up the world of healthcare M&A, and the numbers are staggering. Since 2006, these investor groups have poured nearly $1 trillion into U.S. healthcare, according to the American Investment Council, an industry trade group. Most of that money is focused on areas such as life sciences or medical devices, but billions of dollars are going into healthcare delivery, as well.

Within the delivery ecosystem, many PE investments are focused on the for-profit players such as physician practices and ambulatory surgery centers. That probably makes sense, given the underlying architecture: It’s simply easier to boost (and extract) profits at organizations that were designed from the start to generate profits.

By contrast, most hospitals and health systems were founded as nonprofits, so any margin that they generate on operations should be reinvested in their mission. Despite that obstacle, PE firms have been snapping up hospital assets, and MedPAC estimates that 4 percent of hospitals are now owned by private equity.

Those investments don’t always turn out well. To cite just one example, PE-backed Noble Health recently locked the doors on two community hospitals in rural Missouri, barely 18 months after courting local leaders with “a sales pitch heavy on charm.”

At Ascendient, we have worked with many clients on merger and acquisition strategy, but I can honestly say we’ve never recommended a deal with private equity and probably never will. The reason is simple: Nonprofit hospitals have a mission at their very core, and our strategic advisory services help them achieve that mission in the most effective and sustainable way.

Private equity, in our experience, is never a strategic decision that hospital leaders make because they see the chance to provide better healthcare in their communities. Rather, accepting an offer from private equity is a strictly financial decision for hospitals that have run out of options. 

The Strategic Case for Avoiding Private Equity

The best strategy seeks to leverage whatever strengths an organization might have. Yes, healthcare providers operate in a difficult environment, but they also have significant assets that make them attractive to potential suitors – including decades-long investment in facilities, equipment, specialists, and community goodwill, to name just a few.

When leaders recognize and maximize their organizational strengths, then the affiliation process can be seen simply as a way to manage weaknesses or external threats. In other words, healthcare M&A is a management tool just like any other, and the process can be driven by data rather than desperation.

To keep the process data driven, we created a dashboard comprising about 10 simple numbers, each with a benchmark that flashes green, yellow, or red to signal a hospital’s relative strength in the marketplace. As long as most benchmarks are in the green or yellow range, independence is probably the best option. But when too many of the signals turn red, then it’s time to pursue the affiliation process in earnest.

The key word here is process. A well-managed healthcare organization will have plenty of warning that affiliation is in the offing, and leadership can negotiate the terms based on strategic goals such as:

• Minimum guaranteed service levels and specialties
• Primary care availability
• Best use of existing facilities
• Local autonomy in decision-making

Again, this kind of negotiating power is only possible when a provider organization has been proactive in managing strengths and monitoring the environment. In that situation, multiple suitors will typically express interest, and leadership can hold out for an agreement that best meets the healthcare needs of the local community.

Private equity deals simply don’t leave that kind of room for negotiation, because profit margins trump all other concerns. In or opinion, these are strictly financial deals as opposed to strategic ones, and takeover targets have little or no say in what happens after the ink is dry.

To put it another way, private equity is – or should be – a partner of last resort. For providers in imminent danger of closing their doors and halting all service, private equity might be better than nothing.

But only just.