M&A update: A quiet quarter for hospital deal-making reflects the ongoing consequences of the pandemic

• Merger-and-acquisition activity among hospitals and health systems remained well under pre-pandemic levels in Q1 2022.
• A change from recent quarters was the drop-off in high-revenue transactions.
• Regulatory pressures could be inhibiting M&A volume.
• For-profit hospital owners seemed to be looking to exit non-core markets.

After a stretch featuring a number of high-impact transactions amid a downturn in volume, hospital merger-and-acquisition activity was quiet in both quantity and deal size during the first quarter of 2022.

Prominent tracking firms all reported diminished volumes. Kaufman Hall reported 12 transactions, the smallest first-quarter tally since it began tracking deals in 2016. The low volume is consistent with pandemic-era trends: There were 13 deals in Q1 2021, compared with between 25 and 30 in the first quarter of the five previous years.

Ponder & Co. reported 14 transactions, the third-lowest number during the pandemic after Q3 2020 (13) and Q3 2021 (12). Those are the three lowest-volume quarters seen in the firm’s tracking since 2009.

The latest quarter also trailed Ponder’s rolling four-quarter average, highlighting “the dampening of announced transaction volume that has been experienced during the pandemic.”

H2C Securities Inc. reported a mere seven transactions, down from 16 in Q1 2021. The firm’s analysis points to an infusion of cash from federal relief funding and strong investment returns as helping potentially struggling hospitals remain viable rather than be forced to pursue a merger. Other hospitals and health systems may have paused strategic conversations to focus on pandemic-related operations.

KPMG, which issued a report that found a dip in M&A activity across healthcare, said there may be fewer appealing targets in the hospital sector at the moment.

“Providers with high employee attrition that are financed with variable-rate debt may look less attractive in the harsh light of 2022,” the report states. “The basic economics for hospital systems are increasingly challenging, with rising costs and volumes of elective procedures still below the pre-pandemic level.

“Most large for-profit chains are in good financial position, despite declines in profitability, but smaller hospitals in smaller markets could be vulnerable, potentially leading to consolidation, restructuring, closures and bankruptcies.”

Such factors also deterred private-equity deals, according to the report. PE transactions involving hospitals dropped by 61% quarter over quarter, while purchases of physician practices fell by 24%.

Few big-dollar transactions

A deviation from the prior year was the absence in Q1 of so-called mega transactions, defined as deals in which the revenues of the seller or smaller partner exceed $1 billion. Kaufman Hall reported no such transactions, and in four of the 12 deals it reported, a party had average revenues of less than $100 million. Ponder reported a single billion-dollar transaction: the separation of Hoag Health System from Providence.

In contrast, according to Kaufman Hall, 2021 featured “the highest percentage of mega transactions seen in the past six years,” which led to a “historic high” of $619 million in revenue per seller over the course of the year. In Q1 2022, the average fell to $246 million.

In terms of deal size, “We expect that this quarter’s results will prove to be an anomaly as we (hopefully) move beyond the COVID-related distractions that health systems have faced over the past two years,” Kaufman Hall wrote.

Ponder said the lack of big deals suggests that “many small- to mid-sized systems are holding off on major strategic decisions while they continue to assess their options.”

Underlying market dynamics will continue to pose a challenge and could encourage greater transaction activity going forward, H2C noted, citing labor costs and shortages, rising interest costs, the end of government stimulus funding and unstable equity markets. Such an environment could nudge organizations to explore the merits of an M&A deal as they strive for operational excellence.

FTC scrutiny as a factor

While the financial and operational tumult of the pandemic is an obvious factor, Ponder said regulatory concerns also could be tempering activity.

Due to a backlog of applications, the FTC in August announced it would issue letters of non-review to parties pursuing a transaction. The commission clarified that a merger could be deemed illegal “even after the companies have merged and even if the merger was subject to premerger review.”

According to Ponder, “The ambiguity in regulatory approvals and the challenges and expenses of a post-closing injunction are expected to slow the pace of announced transactions in the current regulatory environment.”

Deals that have been scuttled recently, according to Ponder, include:

• The withdrawal of a merger application between Care New England and Lifespan in the wake of federal and state regulatory opposition
• The blocking of a merger between Englewood Hospital and Hackensack Meridian Health in New Jersey by an FTC injunction that was affirmed by a federal appeals court

For-profit owners considering their options

Kaufman Hall noted a shift in ownership from for-profit to not-for-profit health systems. For-profit owners were sellers in seven of the 12 recorded transactions, comprising a record share of 58%. Among buyers, 11 were not-for-profit organizations.

The seven transactions involved 14 hospitals, including two deals in which California-based Prospect Medical Holdings sold a total of seven hospitals in Pennsylvania and Connecticut, exiting both states. The buyers, Christiana Care and Yale New Haven Health, will shift the acquired hospitals to not-for-profit status.

Ponder noted that CHS and LifePoint Health likewise announced divestitures during the quarter. LifePoint will sell two Colorado hospitals to Centura Health.

“Hospitals that did not have a strong market presence or financial position going into the pandemic have been under significant strain as infection surges have continued to disrupt operations,” Kaufman Hall wrote. “This is likely motivating some for-profit operators to exit markets where efforts to turn around financial performance or seek growth have been unsuccessful.”