Acquisition/Affiliation – Scenario 1

Triangle Health, a standalone hospital, senses, “Now is the time to consider our options.” How will Triangle navigate its opportunities?

Assessing the Situation

Triangle is an independent not-for-profit hospital. Historically, it has achieved a 2% operating margin. However, its cost structure is above its desired goal of 95% of Medicare rates.

Leaders at Triangle recognize that the organization needs to reposition to be successful as payment models move from fee-for-service to value-based reimbursement. They believe this transition will require investment in population health management capabilities such as data reporting and analytical capabilities, chronic disease programs and care coordinators. However, they recognize that Triangle is not well positioned financially to invest in infrastructure, as it has inadequate access to cash and an unfavorable operating position.

Triangle operates in a slowly growing marketplace with a typical payer mix. Within its service area, Triangle competes with one stronger and one weaker competitor. Leaders at Triangle are aware that the stronger competitor is making purposeful improvements in population health capabilities. There are also several for-profit hospital systems represented in the community; none of them is considered a significant competitor at present.

Overall, Triangle leaders characterize the market as being in the first stages of moving toward value-based reimbursement. Executives are wrestling with the question of what scale, breadth and depth of services it needs to provide to be successful in a value-based payment environment. There is a strong sense that Triangle’s current patient population base is insufficient; the issues are how much larger it needs to get, and how that is accomplished.

Unlike many marketplaces today, Triangle has the opportunity to add both primary care physicians and specialists as employees of the organization. How many to add, by specialty, is an important strategic consideration for Triangle. Conversely, physicians will assess how well positioned Triangle is to succeed in the emerging reimbursement environment as they consider becoming employees of the organization.

Triangle’s commercial payer market is fairly diverse. Some of the commercial payers have begun to offer gain-sharing, with one payer moving aggressively in this area.

Given these particular organizational and market characteristics, leaders at Triangle Health have prioritized the following needs:

• The capabilities, infrastructure and expertise to manage health at the population level
• Additional physicians integrated and aligned to the goals of the organization
• Ability to invest in the organization beyond current internal financial capability
• An evolution in Triangle Health’s brand and culture as it repositions in the marketplace

Both the executives at Triangle and its board recognize that other organizations have capabilities that could meet Triangle’s needs. There is openness to leveraging other organizations’ assets to help Triangle accomplish its objectives.

Evaluating Options

Given these prioritized needs, Triangle leaders hone in on two options: participating in a collaborative, and being acquired.

Leaders recognize that collaboratives are an emerging, somewhat unproven form of affiliation. Some collaboratives are structured to focus on population health, which aligns with a key goal of Triangle’s. However, collaboratives are a weak source of capital, which is another critical organizational need. Triangle’s competitive environment does not offer strong potential partners for a collaborative. For these reasons, leaders decide that a collaborative is not the optimal model for Triangle.

Triangle’s executives and board believe a better alternative is to negotiate a deal with one of the two large regional systems, or even one of the national for-profit systems, competing in their marketplace. (This thinking represents the “more integrated” end of the spectrum of transaction structures depicted in Figure 1.) They anticipate this deal will result in the acquisition of Triangle by one of these organizations.

Triangle leaders know that the two large regional systems (one of which is Catholic) are more selective than the for-profits in adding hospitals; however, the regional systems have expressed interest in acquisition of Triangle. There are some negative opinions among Triangle Health leadership (both executives and board members) toward the two regional systems in particular, based on strong competitive rivalry. Additionally, some initial resistance is expect by the board to the Catholic and for-profit options.

When Triangle leaders evaluate the known pros and cons of their options for merger/acquisition, the answer about which is the best partner is not that clear. Therefore, Triangle engages an advisory firm to organize and manage a competitive process. This process consists of the following high level steps:

• In response to a letter of interest, both regional systems as well as three for-profit systems respond with interest.
• After data exchanges and site visits, the two regional systems and two of the for-profit systems submit detailed proposals.
• The field is narrowed. Presentations and follow-up questioning occurs.

The detailed proposals reveal several major differences:

• The two regional systems propose sole substitution legal models. In this model, the acquiring entity becomes the sole member of a limited liability corporation that has all assets and liabilities of Triangle Health. 
• One for-profit proposes a full acquisition.
• The other for-profit proposes a 75%/25% joint venture with the existing board remaining in place. Voting rights, board selection and reserve powers become important elements of this proposed agreement.
• The two for-profit systems’ proposals entail purchasing the assets of Triangle Health. The liabilities are satisfied, and the residual establishes a local not-for-profit foundation.

Each respondent submitted a detailed acquisition proposal. For example, one organization proposed:

• A sole substitution model, with the parent organization assuming all assets and liabilities.
• Triangle’s board will assume an advisory (i.e., non-fiduciary) role.
• Overlapping board members. One member of the advisory board will become a member of the parent board, and one member of the parent board will become a member of the advisory board. (The parent board chair will select the overlapping members.)
• All members of Triangle’s management team will remain in place for six months at their current compensation.
• A management transition team will be established.

Triangle leaders considered additional factors, including:

• The four proposals, from a financial perspective, are roughly comparable.
• Regulatory and image issues exist in all four options, but are considered manageable in all cases.
• One for-profit system is in position to deliver impressive system-wide savings (e.g., revenue cycle, supply chain, etc.)
• One large local system is able to deliver impressive information technology, population health management capabilities and physician support, as well as significant system-wide economies.
• Triangle’s board, physicians and management indicate a willingness to overcome previous negative feelings toward the two large regional systems that are based on their long histories of competition.

Having worked through the pros and cons of each proposal, and determining which best aligned with Triangle’s needs, leaders decide to merge with the large not-for-profit system with the edge on IT, physician relations and population health. The potential advantages of this model to address the needs of Triangle Health outweighed the disadvantages of a full merger. Examples of these advantages and disadvantages are shown in Figure 2.

Figure 2.  Potential Advantages and Disadvantages of a Full Change in Control

Potential Advantages of a Change in Control	Disadvantages/Challenges of a Change in Control
Large short-term investments in infrastructure	Loss of control of future direction of the hospital
Greater financial stability	Finality; no going back
Common control can facilitate clinical and financial integration across facilities	Integration and implementation challenges (organizational and cultural barriers to integrating different practices and facilities)
Advantages of size and economies of scale	Legal challenges (anti-trust, governance)
Improved brand/reputation

Source: Doug Hastings, Epstein Becker